Welcome back to Lisa Black, a real-life forensic scientist and a heck of a thriller writer, with a great example of how real-life events inspire novelists. Read on for Lisa’s explanation and an excerpt from Perish, A Gardner and Renner Novel, new from Kensington Books.
Why did the world’s economy crash in 2008? Well, as a Wall Street exec explains to my detectives in Perish:
“Remember way back when banks used to issue mortgages, knew who they were lending to and had incentive to make good loans? Then came computerized credit scores so consumers could shop around and get better rates. Then Lew Ranieri took these assets that weren’t liquid—mortgages take a long time to pay back and you can’t cash them out quickly—and turned it into something that could be bought and traded in the short term.”
“Securitization,” Maggie said.”
In the 1970’s Lew Ranieri of Salomon Brothers invented mortgage-backed securities. Mortgages are common and steady income, but have some qualities that make them unattractive to investors: they might be paid off early, ending the interest stream; at the same time thirty years is a long time to wait for an investment to trickle back; and since one pays down the principal every month, the amount of interest income decreases over time; and that the buyer might default and abandon the house (default).
“With securitization, mortgages were grouped together to create a pool of collateral and bonds are issued based on that collateral. The bonds are divided into ‘tranches’ based on risk—the top tranch will not suffer if any of the loans default, but the bottom tranch people agreed to a higher risk (and, not coincidentally, a higher return) and could lose their shirts. All quite aboveboard and fair, but there remained a flaw no one saw for nearly thirty years, as the exec explains:
“The two detectives sent her funny looks, but Bowman barely paused. “Exactly. This wasn’t a bad idea—even if housing prices fell in one city, they wouldn’t fall in all cities. Until they did. But instead of spreading the risk, it dispersed the disease.”
Bowman leaned back in the swivel chair, one ankle across one knee, then partially turned so he could look at the detectives, the sky outside, and the managers at their desks with only the slightest shift. “They based everything on the assumption that at the absolute worst defaults would hit six percent. They had historically been one percent. People get very attached to their homes.”
“Ya think?” Riley said.
“So that even if the entire bottom tranch, say twenty percent, defaults, the two top tranches are one hundred percent safe. Except that housing had never seen the leaping increases that occurred in the first ten years of the new century. So historical data might not have been the best indicator, but no one wanted to think about that. People took out home equity loans or bought houses on spec based on the assumption that the value would keep shooting up. Construction workers and waitresses were trying to become real estate moguls. But every market eventually saturates, and defaulting on an investment is not as wrenching as suddenly being out on the street.
“So banks finally realized their mistake and a bunch of mortgage lenders went out of business or got bought by other banks and they all tightened up their lending practices. All our budding real estate moguls couldn’t sell their investments and couldn’t even pay for their own, as values dropped and all these balloon payments came due and those adjustable rates that sounded so good at first jumped up and tripled their monthly bill. The housing market crashed like a pelican diving for a fish, and the economy followed.”
“Interesting,” Jack said. “But why is Joanna Moorehouse dead?”
Lisa Black has spent over twenty years in forensic science, first at the coroner’s office in Cleveland Ohio and now as a certified latent print examiner and CSI at a Florida police dept. Her books have been translated into six languages; one reached the NYT Bestseller’s list and another has been optioned for film and a possible TV series. Visit her website, http://www.lisa-black.com , and follow her on Twitter, @LisaBlackAuthor.