Photographer: Jacob Kepler/Bloomberg

The Big Downgrade That Fueled the Subprime Crash

  • Ten years ago today, the AAA subprime mortgage facade crumbled
  • Ratings firms started cutting billions in mortgage bonds

“I’d like to know: Why now?” asked Steve Eisman. It was July 10, 2007, and the hedge fund manager was on a 10 a.m. conference call with analysts at Standard & Poor’s, which had just decided to put $7.3 billion of subprime mortgage bonds on watch for downgrade.

A growing number of investors like Eisman had been betting on a crash as overdue home loans rose. But up to that point, much of the world was still putting its faith in the safe-as-Treasuries ratings that had been awarded to the bonds, which helped bankroll $445 billion of risky mortgages in 2006 alone. From that day onward, even the most cautiously optimistic economist or sanguine Federal Reserve governor should have known that the housing mess and the subprime debacle wasn’t going to be contained.

“The news has been out on subprime now for many, many months; the delinquencies have been a disaster for many, many months,” Eisman said on the call. “I’d like to know why you’re making this move today instead of many months ago.”

Over the next year, S&P analysts (who told Eisman they had to wait until the bonds were adequately “seasoned” before they would downgrade them), would join Moody’s Investors Service and other credit raters in downgrading more than $1 trillion of mortgage-related securities. The price of the index Eisman was betting against -- a trade that later became known as The Big Short in Michael Lewis’s book by the same name -- went into meltdown, and the global financial crisis began to unfold.

A decade (and trillions of dollars in bailouts and stimulus) later, debt markets are booming again. Annual mortgage originations are getting closer to the $2.5 trillion peak reached in 2006. Risky borrowers have piled on hundreds of billions of dollars in auto loans and credit-card debt. Some economists and executives are worrying that those borrowings are reaching the point of being unsustainable. But in the housing market, stringent regulations have kept loans to borrowers with weak credit in check. Subprime originations are a shadow of their pre-crisis levels, data from Equifax show. And the American Dream of homeownership? That’s been hovering at a more than 50-year low.

(This is the first in a series of stories looking back at the events of the global financial crisis 10 years ago, and how markets and the financial system have evolved since then.)

— With assistance by Mira Rojanasakul

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