Could a subprime market crash happen again ?
The fundamental question we should answer to is : what about regulators... Did they do anything to avoid any excess from the banks and the credit agencies ?
To answer to this question, let's first have a look at the 3 major factors that caused a big crash in the housing market.
1) Financial innovation on the mortgage market.
Before the year 2000, it was very difficult for someone with low funds to have a loan for a house. Houses were accessible only for the "Prime" category which are those who had solid financial guarantees. People who weren't in the "Prime" category where considered as very risky consumers. But the new technologies allowed this to happen : anyone can have a loan for his house even if he is not in the "Prime" category. We call this category the subprime. So how the new technologies allowed this to happen ? Well, new financial techniques like credit scoring allowed drawing statistics and evaluate someone's credit risk. When asking for a loan, algorithms are evaluating the risk that represents a borrower and calculate his score. The higher the score, the safer the borrowing. The main actors who participated in this innovation are Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). These agencies were guaranteed by the Federal State.
Next part is about Collateralization : this is when you lean a mortgage loan with a standard bonds of different risk classes. Collateralization allowed banks to offer loans even to borrowers with a low FICO score (subprime loan). We call these bonds the Asset-Backed securities (ABS). To sum up, Collateralization is just a way to finance mortgage credits.
But financial innovation goes much further. You should had already heard about CDOs (Collaterelized debt obligations) which are in reality a basket of different MBS (Mortgage-backed securities). They contain very risky and less mortgage credits and are mainly designed to satisfy the investor's risk preferences.
So how a CDO's risk is determined ? Every "slices" are different. The most secure of them is the senior slice with a AAA rating. The most risky slice is the "mezzanine" one that is usually not rated.
Another product called "NINA" loan (No Income No Asset) allowed everyone to buy a home. Even a homeless could buy a property !
2) Relations between the different actors in the mortgage market.
CDOs became very speculative products. Real estate brokers were just focusing on their commissions which explains why they granted so much risky loans even when they knew that borrowers were unlikely to assume they borrowing. Market had been flood by CDOs.
It was the same situation with commercial banks and financial institutions who won a lot thanks to the creation and selling of CDO products. In other terms, they were prompted to make loans to everyone.
3) Rating Agencies
Agencies such as Moody's or Standard & Poors won commissions by rating the products. They also advised their clients on how to obtain the highest ratings. We easily understand that agencies had an strong interest to evaluate these products at a higher rating than it should be rated. After the 2008 crisis, the SEC prosecuted these rating firms for conflicts of interest.
What about the actual context ? Does it look like before the 2008 subprime crisis ?
About financial innovation : we could think that CDOs and collateralization in the mortgage sector could have been abandoned but it is totally wrong. Why abandoned a golden business ? It represents so much money for the big firms that they might think it would be stupid to miss this opportunity, even if a new crisis must happen.
CDOs still alive but under a new name : BTOs (bespoke tranche opportunity). It is exactly the same as CDOs as it contains different slices and is designed to satisfy investors' risk appetite. BTOs are just a way to sell CDOs without alarming investors which would be afraid if they knew they were buying a CDO. But they are not stupid (or not totally), for sure they guess what really is a BTO but if the product exist, it means that there is a strong demand...
But what about loans then ? Can a homeless buy a home without any guarantees ? The thing is that NINA loans still exist and you just have to search for it on google and you will find agencies ready to allow you a loan even if you don't have any job and assets.
Interest rates are much lower than before the subprime crash but they will be raised in the next years and it could be very dangerous simply because people will have to pay more interests !
Finally, a subprime crisis seems to be unlikely to happen in the next months but it is possible and I think that it might happen in the next few years.
