The Way it Was

One of our axioms here at the Daily Reckoning, is that information
degrades like magnetism or radiant heat - by the square of the distance
from the source.

We mention it today, because it helps explain the troubles in the subprime
mortgage market. The old fashioned banker used to sit at his oak desk, and
if a man wanted to borrow money, he'd have to sit down in the chair
opposite him and explain himself. The banker would then ask a lot of nosey
and awkward questions. And then, unless the two men knew each other, he'd
want to see some proof - tax forms, pay slips, deeds, etc.

The banker would already have the man's banking records in front of him,
because the man wouldn't dare to ask for a loan unless he'd been a good
customer for at least a few years. And the banker probably would have
driven by to take a look at the house, too, just to make sure it looked
solid.

The whole encounter was laced with suspicion and doubt. Would the borrower
lose his job? Did he have a drinking problem? Were things okay between him
and his wife? How much was the house really worth? In the unlikely event
that the bank had to sell it to get its money back, would there be enough
margin for error? Lend 100% of the purchase price? You'd have to take your
business elsewhere!

But in the great housing boom of 2006-2007, the suspicion and doubts
disappeared, along with the oak desks and nervous interviews. No credit?
No money? No job? No problem...

And then, the whole affair took two giant steps away from the basic
transaction. The loan originator, we suspect, may not have met his
borrower in some cases. But there is no doubt at all that the financier
who put the loan into a mortgage-backed security had never laid eyes on
him at any time.

And the math whiz who invented the collateralized debt obligation into
which the mortgage was eventually stuffed, could care less if there was
even a human being attached at the other end of his geekery. By the time
the mortgage finally came to rest in the hands of an investor he had no
idea what he actually had.