Making irresponsible sub-prime loans was hugely profitable for companies.
You're right, but think about this: In a free market, doesn't this sound crazy?
"Making irresponsible sub-prime loans was hugely profitable for companies."
We all know the REASON why the "irresponsible sub-prime loans were HUGELY PROFITABLE", but it seems we can't face it: The irresponsible government guarantees.
Actually, no, government guarantees had absolutely nothing to do with the major profit system of the subprime market. It was entirely a private enterprise. There's a huge public misconception about it because it's made out to be incredibly complicated, but really it's not. It's, in effect, a life insurance scam. And I hope you read this, WhyteRain.
First off, you start off with the subprime lenders, guys like Countrywide. Contrary to popular belief, they really aren't players here. They are manufacturers for the real players: investment banks and insurance companies, or best yet investment/insurance companies.
So, let's say you're Countrywide and you manufacture $750 million in terrible sh**tty loans. You know that these loans are highly likely to fail. In a normal, regulated loan system this would be a path to bankruptcy. $750 million in loans and likely only $50 million worth of them will end up paying them back. How does one profit here? Simple, they sell the debt.
In comes our first player, the investment bank. Countrywide has $750 mil in terrible loans and needs to find some way to make a profit and so they go to Goldman Sachs and say, hey, we will sell you this $750 million in loans for $1 billion. Goldman says yes and Countrywide profits $250 mil for making terrible loans. But why Goldman Sachs buy these? In a normal, government regulated loan system, Goldman would end up losing even more money than Countrywide, with $950 million in losses. But this isn't a normal system, because in comes the next player.
The brains behind the operation is the second player, the investment/insurance bank--most famously played by AIG. They know Goldman is running around with $1 billion in toxic assets that they bought from Countrywide and like any good insurance company, they know that all cars will crash, all people will die, and all homes will burn down eventually; and there's money to be made in the meantime. AIG comes to Goldman with proposal:
for a premium of $10 million per month, AIG will give Goldman a $2 billion insurance policy on those assets, if they were to fail. In normal, regulated government system, this offer would be illegal. There literally was a line in our US code that prevented this deal in the books until 1998, Gramm–Leach–Bliley Act allowed insurers and bankers to do business with each other.
The
hugely profitable,
totally irresponsible,
entirely free market, system was now place. AIG would profit $15 million a month (when combined with other similar deals billions a month) until an asset failed. Goldman would sit and wait HOPING for loans to default so that way they could make the $1 billion profit of the insurance payout, which trumped any profits off mortgage interest. At the same time, they would be ORDERING Countrywide to give out more bad loans for them to buy, hoping that they would default faster and they could collect AIG's money.
Everybody sees profit.AIG would hope that they wouldn't default soon, or better yet, like life insurance systems, the annual profit from the premiums would outweigh the payout of a few $2 billion plans here and there. The problem was in the housing bubble, the defaults all happened at one time: 2008. AIG ended up owing Goldman Sachs some $150 billion in the end and Goldman wasn't the only insurer they worked with during this time. That is why Goldman famous posted profits during the financial collapse. They were the company all that bailout money was owed.
So you see, it was the free market that created this profit motive. In fact, the free market is far more efficient in these matters of risky bad business than the government, as violent economic swings are always hugely profitable.
