The documents suggest that the primary way Morgan Stanley guided New Century was in contracts that spelled out the kinds of loans the bank was willing to buy in pools of mortgages. A 2006 term sheet said that the bank wanted a $1 billion pool to be at least 85 percent adjustable-rate mortgages, with at least 75 percent of the pool to include a prepayment penalty. And it dictated how many loans the bank wanted from various geographic regions.So, do you get that? Do you see how dastardly Morgan Stanley was? They told a mortgage originator what sorts of mortgages they would like to buy. Dirty bums.
I will tell you that, on principle, whenever I do something like buy a new car, I refuse to tell the salesman anything about what kind of car I need. Why? Because I'm not an animal. I have morals. Whatever sorts of cars the factories are making, I'm sure those will work just fine.
Seriously, though, it amazes me what a low bar there is to imagining what sort of nonsense banks were up to. I suppose the idea here is that, since they were predators, these sorts of impositions are just ways to extract fees from helpless customers. As if this is just a one way street. The fat guy in the tux, with dollar bills stuffed into his chest pocket and a fat cigar in his mouth, maniacally laughing after sending out his new more devilish plans.
But, these are just standard risk management issues. Remember, by the time these private loan pools were numerous, the Fed Funds rate was nearing 5% and the yield curve was flat. At that point in the cycle, ARMs are commonly used. The level of ARMs was not even high (pdf), relative to past levels. The reason, I presume, that they wanted ARMs was because reasonable borrowers would be more apt to use ARMs, and when rates are high or rising, adjustable rates eliminates interest rate risk. This is finance 101 stuff. Same deal with the prepayment penalty. The fact that mortgages can be refinanced makes mortgages much less valuable as interest rates rise, increasing the spread lenders have to charge. As rates rise, if prepayments aren't mitigated somehow, lenders have to charge higher rates (which, here, means that Morgan Stanley would demand a higher rate on the mortgage bonds).
This idea that ARMs were some sort of conspiracy is so dumb, I don't know what's happened to the world. People used to know these things. The housing "bubble" ate our brains. This is made more exasperating by the fact that rates went down after those 2005 and 2006 ARMs were originated. Nobody lost their house because rates went up on their adjustable mortgages. They lost their homes because the mortgage industry was shuttered, their equity vanished, and once the broader dislocation hit, many lost their jobs and couldn't make payments, sell, or get refinanced. Most defaults happened after 2008, by the way, when rates were WAY down.
And, they "dictated how many loans the bank wanted from various geographic regions." Um. OK. Why does this warrant a mention? If you work for a bank that buys mortgage securities and you DON'T dictate how your holdings are geographically diversified, please go into your boss' office and inform them that you are firing yourself. This is basic stuff.
I really don't know how to address this stuff in the book. So many of the details like these have little credibility to me. But, there is the problem that in a nation with millions of mortgages, especially in the middle of a housing supply bust, there is bound to be a set of credible anecdotes about actual fraud, and there are bound to be even a few whole operations that operate at the border, or over the border, of reasonable tactics. But, the problem is this is all bathed in what can only be called bigotry. Anecdotes become generalized to "what Wall Street was doing" and this is combined with trumped up and incoherent accusations that frequently simply don't mean anything. These are basic, well known tools of bigoted thinking. Bigotry in some form has always been a problem in human endeavors, because these tools are effective. And it usually doesn't go away because people notice what they are doing and adjust. It goes away by generations slowly succumbing to lived experience.
For this reason, I almost prefer to not address it at all. This will lead many readers to dismiss my other arguments. But, I think many of those readers will not be on the margin of readers who might consider my thesis, anyway.
Any input is welcome. This may be the most difficult issue I have to tackle, rhetorically. Is it enough to simply tackle the empirical issues (the lack of rate-triggered defaults, the normal behavior of ARM originations, the fact that these cases all focus on banker's actions after 2004 - generally after the peak of ownership and prices). Is all that enough without having to act like a defense attorney in the witch hunt-of-the-day?