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Today, even the local gas station and supermarket use computer technology and applications that are much more advanced in their capability than the computer systems used to launch and recover the first generation of spacecraft (Evans, 2004; Kaku, 1997).
Modern computer applications perform calculations and allow analyses of very high volumes of information that far exceed the capacity of direct monitoring by human operators (Larsen, 2007; Nocera, 2009). That is not necessarily inherently problematic; in fact, it is incredibly beneficial in too many ways to count. Today, international manufacturers and shippers can pinpoint the location of goods thousands of miles away in real time; supply chain managers in one office can monitor stock throughout hundreds of retail and wholesale outlets electronically and automatically adjust output and shipping schedules to match their rates of sale at the local level (Evans, 2004; Larsen, 2007). However, the interdependence of modern life in general and of modern business in particular and computer networks combined with some of the indirect results attributable to the evolution of business practices in the name of the profit motive created the potential for a perfect storm-like disaster in the first decade of the new millennium. The Evolution of Complex Problems in the Financial Services Industries
In the 1970s, financial analysts at the historic Wall Street firm Solomon Brothers devised various commercial transactions and related mechanisms that allowed the trading for profit of outstanding debts held by creditors such as the millions of home mortgages in the U.S. (Nocera, 2009). However, the complex nature of those transactions in any large number prevented a wide scale use of the new financial mechanisms that would eventually become the securitized mortgage debts that precipitated the collapse of the Wall Street companies who pioneered their use as computer technology became sophisticated and powerful enough to permit their negotiation for profit (Bhide, 2009; Nocera, 2009).
In principle, what happened in between approximately 1990 and 2007 was that investment banks began purchasing the millions of mortgage debts of private real estate held by banks and other lending institutions. Through incredibly complex computer applications and financial analyses, they had managed to develop ways of, in effect, "chopping up" millions of mortgage debt obligation and recombining them into tradable securities whose value was guaranteed by all of those underlying mortgages (Lowenstein, 2007; Nocera, 2009).
This fundamental change in financial securities allowed investment banks to transform what were previously non-negotiable financial obligations into negotiable instruments that could be used to secure subsequent investments for profit (Bhide, 2009; Nocera, 2009). As was the case with the evolution of greater and greater complexity of computer systems in modern society, the development of negotiable instruments backed by mortgage securities was not necessarily problematic in and of itself without the additional factor of human ingenuity applied in ethically questionable ways.
A Perfect Storm: Computerization, Complexity, Greed, and Unethical Business
One of the unintended consequences of the evolution of mortgage-backed securities in investment banking was that it eliminated the primary mechanism that had maintained the integrity of the real estate market and the mortgage system. Specifically, banks, lending institutions, and mortgage brokers traditionally extended credit to home buyers very carefully and only after a thorough review of the financial qualifications of those prospective lenders to ensure against their default (Bhide, 2009; Lowenstein, 2007). When homeowners default on their mortgages, the mortgage debt holder loses money because their profit is strictly a function of the interest and financing charges they apply to mortgage loans as the price of extending their credit. For this reason, lenders have always been extremely diligent about "vetting" prospective borrowers (Markels, 2007; Lowenstein, 2007).
The introduction of negotiable (tradable) mortgage-backed securities changed that entire relationship, simply because the original lending institutions typically no longer held onto those mortgage debts for more than a few months, weeks, or even days, before they sold the financial obligations that mortgages represent to investment banks (Bhide, 2009; Lowenstein, 2007; Markels, 2007). As a result, the original lenders no longer had any reason or financial incentive to be careful about who their borrowers were (Nocera, 2009).
Unlike the situation where a defaulting debtor costs the lender money, the process that emerged was that lenders could extend mortgage credit to just about anyone without worrying about whether or not the loan would eventually be paid off over decades as agreed or go just into default within several years of being issued. The fact that mortgage lenders could sell those obligations almost as soon as they were created meant the more mortgages they could sell, the more money they would make, and all without any concern about the qualifications of their lenders (Bhide, 2009; Lowenstein, 2007; Markels, 2007).
Mortgage brokers and real estate brokers have traditionally worked on commissions, earning more when they sell more homes. Once the lending institutions stopped caring about who borrowed money from them, mortgage brokers and real estate brokers throughout the country began selling homes much more aggressively, recruiting purchasers with no-interest loan offers (Lowenstein, 2007). In many cases, brokers and real estate agents actually coached prospective lenders exactly how to lie on their loan applications by inflating their income and their net worth to qualify for mortgage loans on homes far beyond their means to pay off. The so-called "no-doc" loan (for "no documentation") became standard practice throughout the industry (Lowenstein, 2007; Markels, 2007).
In fact, the practice became so widespread in the industry that brokers and bankers routinely referred to those transactions as "liar loans" (Bhide, 2009; Markels, 2007). Even worse, many real estate agents and mortgage brokers purposely misrepresented the terms of mortgage loans to unsophisticated borrowers, such as through the variable-rate mortgage. That mechanism is a mortgage obligation that provides an extremely low "introductory" monthly payment very similar to that traditionally used to entice credit card customers to open new credit accounts or transfer balances from one lender's card to another's (Lowenstein, 2007; Markels, 2007). In countless cases, home buyers were presented with extremely low monthly payments based on the variable mortgage rate concept for very expensive properties. After the first year or two of the life of the loan, the payments increased substantially, and often far beyond what the homeowner could afford (Lowenstein, 2007; Markels, 2007).
At the same time, housing prices were steadily increasing across the country. That was because in the process of securing all of these mortgages without any real concern about the loans they represent being repaid, brokers and borrowers were also overstating the appraised value of those properties (Lowenstein, 2007; Markels, 2007). In many cases, borrowers who could not afford their mortgages in the first place began borrowing additional money against the appraised value of those homes (Lowenstein, 2007; Markels, 2007).
As a result, property values continued to rise artificially, prompting ambitious builders to develop more and more homes, especially in areas with high projected growth such as large areas of California, the Southwest, and the Florida Coast. Furthermore, in many of those areas where housing prices were growing the fastest, a consumer pattern of buying homes and then selling or "flipping" them within the period of the introductory mortgage rate sprouted in which thousands of people purchased homes with no intention of actually living in them. They merely held on to them while their value increased and then resold them a year or two later as substantial profit. Many homes doubled or tripled in their appraised value in only a few years, increasing in price with every "flip" (Lowenstein, 2007; Markels, 2007).
Beginning in late 2006 and early 2007, analysts had begun issuing warnings about the possible consequences of this artificially inflated housing market (Lowenstein, 2007; Markels, 2007). Their concern was precisely that the artificial increase in housing prices and the resulting housing boom and "bubble" was not capable of being sustained indefinitely and that the nationwide increase in property development and home building would inevitably lead to an oversupply of homes.
An oversupply in the market would cause home prices to fall in accordance with the traditional economic rules in relation to supply and demand. Eventually, large numbers of homeowners would find themselves stuck with expensive mortgages for homes whose value had fallen far below the amount of their appraisal upon which the mortgage payment rates had been established at the time of the loans (Bartiromo, 2009; Lowenstein, 2007; Markels, 2007).
Ultimately, that is exactly what happened and after the housing bubble finally burst in 2007 so many homeowners began defaulting on their mortgage obligations that many of the mortgage-backed securities that had been absorbed into the financial markets and traded in the highly complex securities developed with the help of computer-based processes pioneered on Wall Street became worthless. By that time, unfortunately, those instruments had been purchased, traded, and invested many times, frequently also becoming absorbed into large retirement funds of hundreds of businesses, credit unions, and municipal pensions (Bartiromo, 2009;…[continue]
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