The 1987 Crash -- a Dress Rehearsal?

[Herman Munster]

http://www.fool.com/investing/general/2007/11/05/the-1987-crash-a-dress-rehearsal.aspx?source=iflfollnk0000003

Meet GSAMP Trust 2006-S3

By most measures today, this $494 million securitized pool of second mortgages was a drop in the bucket of the nearly half trillion dollars or so of mortgage-backed securities issued in 2006. GSAMP was sold by Goldman Sachs (NYSE: GS) and originally stood for Goldman Sachs Alternative Mortgage Products.

GSAMP comprised more than 8,000 second-mortgage loans, or loans taken as collateral for your first mortgage. In other words, the equity in the first mortgage was being funded by another mortgage. The average real equity in this pool of loans was 0.71%. The loan resembled more than 99% of the value of the home.

On top of that, 58% were no-documentation loans. To bring this all home: For almost no money down and no proof of income, you could own a $250,000 home. How easy is that? You can see why borrowers were in such a hurry for the loans. You were essentially buying a house with no money at risk. If home prices rose, you were fine. If prices fell and you were unable to make your payment, well, you just walked away having lost virtually nothing out of pocket.

Let the games begin

To sell this batch of mortgages, the issuer (in this case Goldman) pooled them and sliced them into tranches, or various pieces, to satisfy every investor's desire and appetite for risk. The top tranche is assured of first payment and is given the coveted AAA rating. On down the line we go, with each subsequent tranche being paid next, receiving a lower rating, and a higher interest rate. Just like that, a security is backed by mortgages taken out by individuals who have zero incentive to make mortgage payments that would back the securitization pool, and it is rated AAA. Leave it to Wall Street to take a toad and dress it up as a prince.

The next question is: How could the sophisticated buyers of securities such as the GSAMP Trust know how safe and sound they are? There were two ways: either read the several-hundred pages of the prospectus and related documents, or rely on the credit rating agencies -- Moody's (NYSE: MCO) and Standard & Poor's, which is a unit of McGraw-Hill (NYSE: MHP).

Guess which option was used just about every time. Even if investors choose to read through the documents, they still didn't get all the facts, because most issuers don't reveal borrowers' identities. So the rating agencies didn't have all the information either.

While the individual loans in the Goldman pool were toxic, 68% of the issue was rated AAA by both rating agencies. Apparently, issues backed by second mortgages of subprime borrowers were as secure as U.S. Treasury bonds.

[whistle]

1. The 1987 crash was like 1929, what we have now is far worse

...an economic meltdown and financial collapse and bankruptcy. To recover from this we will need an FDR style New Deal for the 21st Century

[SoCalDem]

2. '87 was a pimple..a small rash.. This one's gonna be a big ole ulcerated carbuncle

In 87 , medical care was less expensive by percentage of income, and gasoline was a LOT cheaper..so was food.

and look at how many MORE people have credit cards now..with BIGGER balances and higher interest & penalty rates..

[KharmaTrain]

3. It Wasn't That Bad...

The '87 crash was no where near as bad as '29...you didn't see people with applecarts or eating at soup kitchens after the '87 crash. It was more like the harbinger of the massive profit taking that we now witness when the market falls 100 or 300 points. The market rebounded within a couple days thus the damage wasn't really lasting. '87 was bad, bad primarily for the many fools who bought into the "booming" market during the 80's and got wiped out...the big boys came out just fine. I'm not sure that's the case this time.

No matter what the economy does, we need a new FDR-style New Deal in this country to fix or replace crumbling infrastructure and closely regulate the lending pratices of banks.

[whistle]

4. I was talking about the actual crash in the stock market and the loses

...which wiped out investors in 1929. The apple-carts and soup kitchens and homelessness resulted from the asinine Hover administration policies which followed over the next 38 months and did nothing to curtail the major economic depression which swept over the entire country.

The same thing happened in 1987 to the stock market because of Reaganomics, but the saving grace was Alan Greenspan riding on on his white horse to save the economy from total breakdown when he made financial derivatives and hedge funds an acceptable part of monetary policy and used controlled recessions called belt-tightening, Gulf War I and the BushCo lunacy of tax reductions for the rich and raiding Social Security trust fund to finance the continued deficits and the Iraq/Afghanistan Wars to enrich the very rich and then Greenspan left.

That opened the door to someone like Ben Bernanke to fund the financial markets with hyper-inflationary fiat currency to finish off the job of completely destroying savings, the middle class and all but the top 3% of the wealthiest people in the country.

So who will that FDR-type person be that will be able to rescue the United States and put the country back on a secure positive economic course of infrastructure investment, development and restoration for the next two and a half generations?