So just a bit of a review. What happened from 2000 and 2004? So from 2000, and I should really say from 2000 to 2006. Because that really was when the housing bubble happened.
Well, financing got easier. So financing easier or essentially they lowered their standards. And it got progressively easier and easier every year we went. So then, that allowed more people to bid on homes. So it increases the demand artificially in certain ways. Because we saw from that New Times article that people’s income wasn’t increasing and the population wasn’t increasing anywhere near as fast to suck up the supply. So all it did is allow people, who were renting before and who couldn’t save the money for the down payment, now it participates. Now you have more people bidding for the same house. But that led to the obvious question, why did financing get easier and easier?
So let's go back to the good old days. The early 90s, or actually let's go even before that. Let’s go to the classic, what happens to get a housing loan? Traditionally, if I want to get a loan I would go to my bank. And that loan officer at the bank, he’s going to be giving the bank’s money for your house. Right. He gives you money and you're going to pay him interest. And so that loan officer at the bank, he really cares that they're not going to loose money on the transaction. If he’s going to give you a million dollars, he wants to make sure that no matter what happens. If you lose your job. If you get arrested. If you skip town. That he still going to be able to get his million dollars back. And if you go back to our equity and balance sheet presentations, that’s why back in the day, they made sure that you put 20-25% down payment on your house. That you have a good credit rating. That you have a good steady income. Because that banker, that loan officer’s going to be in trouble and he’s bonus is base on how good the loans he gave held up.
So that was the traditional model. What happened that started to happen in the mid 90s in California and then nationwide in about 2001-2002, is you had what we call securitization of the mortgage market. And this, and all fairness, this actually happened a while before with things like Fanny May and Freddie Mac and I’ll do a completely separate video on those. But Fanny May and Freddie Mac essentially had the same standards. They had a standard of a, you call them conforming loans that I think the number you have to have 20% down. You have to have a certain credit score, certain steady income. So Fanny May and Freddie Mac were these entities that might buy the loan from your local banker. But their standards were just as high as the local banker. I think they were actually, they were oversight by congress. They weren’t giving away loans for free. But I’ll do a whole other presentation on Fanny May and Freddie Mac.
But what you had happened in the late 90s and especially in the early part of this decade is that a whole industry outside of the government sponsored entities. The government sponsored entities are Fanny May and Freddie Mac, and this is essentially instead of you going to your local bank for a loan. This is me again. I would go to my local mortgage broker. Countrywide is the most famous of them. I think their CFC, I think that’s their stock décor, they're not bankrupt yet. So I would go to Countrywide and essentially I would get a million dollars from them on home loan. I would get a million dollars from them and I agree to pay interest to Countrywide. But then Countrywide would do this like a million times. So times a million. Right, they’ll give a home to million people, put them all together. And then they’ll sell the loans to like Bear Sterns. So that’s an investment bank. Let's call it Bear Sterns, hope none of these people sue me. I guess they have bigger troubles now than wondering about my YouTube videos.
They sell it to Bear Stern and then Bear Sterns will package a bunch of these mortgages together. Essentially IOUs from people. And they would sell those to investors. Right. So essentially instead of Countrywide being responsible for my loan, my payments now go to these investors. And you could watch, that says investors, I know my penmanship is horrible. But you should watch the video on mortgage bank securities and collateralize debt obligations. If you want to get a better understanding of exactly how the money flows go.
But the bottom line is because of this process, what's happening? Countrywide is just being a transactional. They're just doing the paperwork for my loan, they're temporarily holding the loan, and they're doing a little bit of diligence. And in return for that, that Countrywide mortgage broker will just get a fix fee for doing that transaction. Maybe they’ll get like $5000 for just doing the paperwork for my mortgage. Right. and then Bear Sterns will package a bunch of these mortgages up in, now it’s going to be in the billions. And then repackage them and sell them to investors. And in the process, Bear Sterns get a cut. And Bear Sterns is doing this for millions of mortgages at a time. So maybe Bear Sterns, it’s in the billions of dollars that Bear Sterns gets a cut. So Bear Sterns is essentially gets a fee, like the mortgage broker. Of course it’s a huge fee. And then the investors are going to get my interest payments. Right. And let's say if the interest rate, if I'm paying 7%, and the other million people are paying 7%. The investors are going to get 7% on their money.
And that’s seems like a pretty reasonable proposition. And of course the investors would care that the money that they're essentially giving. Because they're giving money to the investment bankers. They're giving money to Countrywide. And that’s where my million dollars is essentially coming from. The only reason why the investors would give their money is if they have a lot of confidence that these are really, really good loans. Well the investors, they don’t know who I am. They don’t know what my job is. How likely I am to pay the loan. So the investors have to rely on someone to tell them that these are good loans. And that’s where the rating agencies come. And these are Standard and Poor’s and Moody’s and they rate these assets, these mortgage bank securities. And what they say, well, they’ll look at this big package of mortgages. This million mortgages that Bear Sterns has package together. And they’ll look at the historical default rate. And they’ll say, wow, you know these mortgages really haven’t been defaulting and you can think about why they haven’t. Because housing price has been going up.
So these mortgages really haven’t been defaulting. There's a very high chance you're going to be able to get all your money back. So were going to give this what they call, let's say they say triple A rating.
So this investor, who knows, it could be the central bank of China. It could be hedge fund, it could be a whole set of people. It might be the investment bank themselves sometimes. They actually bought this just to make some extra money.
These investors, they don’t know who actually borrowed the money or what kind of credit rating they have or anything. But they just took a leap of faith. They said, well Standard and Poor’s or Moody’s did the work, they're telling me that this is triple A. triple A means the highest level of debt or whatever they told them. Maybe it was single A or, I forgot all of the different qualities of debt. But they just took their word for it. And they got their 7% interest on their money, or whatever it was, 6% money. And that worked out pretty well. And so these guys, they like the fact that they were getting the 7%. They said, this is good asset class. So then they funneled even more money. So then there were even more investors. There are even more investors that wanted to do this. So like, this is great, this is like with very little risk I'm getting a pretty good return of money. That’s better than putting it in the bank. That’s better than buying treasury bills. Right. So the even more money flowed in.
Well, more money wanted to invest on people’s mortgages, but Countrywide would say, well we're already giving mortgages to all of the people who qualified. So in order to actually find more people who want mortgages from us, we’ll just have to lower the standards a little bit. Right. And we can lower the standards because we find even when we do lower the standards no one has defaulting on their mortgages.
In the next video, I’ll maybe give a little bit more color wide. So Countrywide will issue even more mortgages and give them to these investors with the even lower standards. And of course, Countrywide, the mortgage broker’s of Countrywide, they love it. Because every time they do a transaction, they just get some money and then them give them mortgage to the investment banker which packages them up and then sells them to investors. So they get it off of their hands. And they just got the fee. So they just collected big cash. The investment banks love it. Right. They just love doing the transactions because they get more and more money every time they do the transactions. And for the moment, the investor seems pretty happy. Because they keep giving money into this system, so to speak, even though they might be reading the newspaper and seeing that the standards are going down. But they're consistently getting their return. And because the default are very low at this time period, and I’ll explain in the next video why the defaults were very low. They felt that they were getting a good return, maybe 6 or 7% on investments that had very, very low risk.
So in the next video, I’ll explain why the defaults were very low in that time period. See you soon.
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