A recent segment on NPR’s Fresh Air highlighted really well the sequence of events that got us where we are today.  Host Terry Gross interviewed Paul Muolo, executive editor of National Mortgage News and co-author of Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis.

The segment offers a pretty accurate, yet easy-to-understand view of how we got here.  First, it’s important to understand that a single underlying premise – held by mortgage brokers, homebuyers, builders, Wall Street, and investors – is the root cause of all this trouble: the belief that housing prices would keep rising – what Muolo called an “investment in the belief that there was no gravity to housing prices.”

Oops.

But let’s step back a minute to understand the process of originating and packaging loans into these bundles – mortgage-backed securities – which have been called the downfall of the mortgage market:

1) A mortgage broker originates the loan (basically, sells the loan to the homebuyer) – this is the guy who’s on the front lines dealing with borrowers.  The broker is originating the loan on behalf of the wholesaler (the institution that’s actually lending the money).

2) The wholesaler – Countrywide, AmeriQuest, for example – pays the broker a hefty commission (which is higher the higher the interest rate on the loan) and then sells the loan to a Wall Street investment firm.

3) The Wall Street investment firm (Merrill Lynch, Bear Sterns, Lehman Brothers, for example) pays the wholesaler a commission for the loan, then takes that loan – along with thousands of others – and bundles them into a security.  The Wall Street firm then sells that security to an investor and makes a commission on the bond sale.

In that scheme, Muolo said, “it’s all about the yield.”  The higher the interest rate on the loan, the higher yield that the security can pay.  The safest securities are Treasury bonds, which at the height of the boom were paying 4-5% yield.  The mortgage-backed securities paid 7% yield, in exchange for the higher risk.

“That all sounds great unless people can’t pay their loans,” Gross said.

And that’s what happened in the end.

As it turned out, default rates on those subprime loans -- which had been packaged into securities and labeled as relatively low risk to investors – pushed 30% in many cases (market-wide, default rates on subprime loans are at about 21% right now).

Muolo blames Wall Street for creating the mess.  He says that Wall Street firms pushed underwriters to approve loans even if they were too risky, under the rationalization that home prices would keep rising.

It’s true that the market for subprime mortgage-backed securities – which Wall Street created – allowed subprime loans to flourish.  Certainly I don’t want to let Wall Street off the hook (of course, with Bear Sterns in the pot and Lehman Brothers on the brink, I don’t think you could say they’re off the hook).  But everybody played a role.

And the greatest culprit of all?  The belief that housing prices would keep rising 20% a year and never stop.

What do you think?