WEBVTT 00:00.550 --> 00:04.230 I'm going to start by talking a little bit about the history 00:04.230 --> 00:07.500 of mortgage lending. 00:07.500 --> 00:15.170 And then, I want to talk more recently about how we do 00:15.170 --> 00:20.240 commercial real estate finance, and then, residential 00:20.240 --> 00:22.620 real estate finance. 00:22.620 --> 00:28.520 And then, if I have time, I'm going to try to get into 00:28.520 --> 00:29.850 discussing -- 00:29.850 --> 00:53.840 [SIDE CONVERSATION] 00:53.840 --> 00:59.110 PROFESSOR ROBERT SHILLER: So when we talk about real estate 00:59.110 --> 01:04.740 finance, it's really about financial contracts that 01:04.740 --> 01:09.830 involve real estate, and that particularly use real estate 01:09.830 --> 01:11.080 as collateral. 01:13.510 --> 01:18.310 So, it's a very complicated history. 01:18.310 --> 01:20.510 But I'd like to put things in a long-term perspective. 01:24.039 --> 01:31.069 I want to start with the word mortgage. 01:36.260 --> 01:39.630 It actually goes back to Latin. 01:39.630 --> 01:40.880 Mortuus vadium. 01:45.400 --> 01:48.130 And that means in Latin, death pledge. 01:51.030 --> 01:56.930 And then, in the Middle Ages in France, they substituted 01:56.926 --> 02:00.086 the French word for vadium. 02:00.090 --> 02:01.890 And that's [CIRCLES GAGE ON BLACKBOARD]. 02:01.890 --> 02:03.090 I don't know how to pronounce it. 02:03.090 --> 02:05.310 That means pledge in French. 02:05.310 --> 02:09.190 And I don't know why they called them death pledges. 02:09.190 --> 02:11.600 That doesn't seem to involve death to me. 02:11.600 --> 02:14.290 But in the long history of these 02:14.290 --> 02:18.730 institutions, it became important. 02:18.730 --> 02:22.290 The Oxford English Dictionary says the word mortgage entered 02:22.290 --> 02:25.610 the English language in 1283. 02:25.610 --> 02:27.350 So, we've got a long history here. 02:31.020 --> 02:35.130 Actually, I can take it back further than 1283. 02:35.130 --> 02:39.270 I was inspired by the research of Yale historian Valerie 02:39.270 --> 02:46.230 Hansen, who has been reading old documents related to the 02:46.230 --> 02:48.760 silk trade. 02:48.760 --> 02:53.250 And her documents are based on a trove of old documents from 02:53.250 --> 02:58.320 the Tang Dynasty in China, between the 7th and 10th 02:58.320 --> 03:03.440 centuries, which reflect loans that were 03:03.440 --> 03:04.960 made to finance trade. 03:04.960 --> 03:08.690 So, you had people going back and forth from the Middle East 03:08.690 --> 03:13.200 to China with silk, and other items, and they needed 03:13.200 --> 03:15.700 financing for the trade. 03:15.700 --> 03:19.920 So, she reads these old documents in Chinese. 03:19.920 --> 03:23.380 And I was looking over her work a little bit to see 03:23.380 --> 03:26.370 whether they had mortgages. 03:26.370 --> 03:30.620 She says that in China, it didn't seem, at least if I'm 03:30.620 --> 03:33.280 getting her generalities right, they didn't seem to 03:33.279 --> 03:36.259 mortgage property, at least in these documents. 03:36.260 --> 03:41.470 But she says that among these documents are some -- 03:41.470 --> 03:44.390 they weren't all in Chinese, because they were trading 03:44.390 --> 03:47.330 between China and many other countries. 03:47.330 --> 03:53.620 So, she found some in the Sogdian language. 03:53.620 --> 03:55.560 She reads all these languages. 03:55.560 --> 04:00.200 It's an ancient language of what's modern day Iran. 04:00.200 --> 04:03.730 And it's a dead language. 04:03.730 --> 04:06.240 It died out in the ninth century. 04:06.240 --> 04:10.560 But she finds some Sogdian documents 04:10.560 --> 04:12.570 that look like mortgages. 04:12.570 --> 04:16.270 So, some people borrowed money for their silk trade, and they 04:16.270 --> 04:21.070 would mortgage their property, or their slaves. 04:21.070 --> 04:22.810 You could mortgage slaves. 04:22.810 --> 04:24.500 It's an awful thought. 04:24.500 --> 04:28.770 And then the contracts would additionally say that you were 04:28.770 --> 04:31.770 obligated to maintain the property or the slaves. 04:31.770 --> 04:33.200 I guess that meant feed your slaves. 04:33.200 --> 04:34.510 Keep them healthy. 04:37.140 --> 04:45.830 Those were mortgages from over 1,000 years ago. 04:45.830 --> 04:49.780 So, it's a very old institution. 04:52.900 --> 04:59.130 But I think it formed its modern form more recently. 04:59.130 --> 05:06.040 And it became a well-known term for the general public 05:06.040 --> 05:09.240 maybe in the late 18th century. 05:09.240 --> 05:10.450 I was trying to confirm that. 05:10.450 --> 05:16.710 I'm interested in history, just out of a passion for 05:16.710 --> 05:19.490 understanding origins of things. 05:19.490 --> 05:27.330 So, I looked up mortgage on ProQuest to find, what were 05:27.330 --> 05:28.950 they talking about. 05:28.950 --> 05:35.550 And I found an article in the Hartford Courant, dated 1778. 05:35.550 --> 05:37.540 Actually, it wasn't an article, it was an ad that 05:37.540 --> 05:39.740 someone took out. 05:39.740 --> 05:41.780 And I think it's kind of revealing of what the mortgage 05:41.780 --> 05:44.960 market looked like in 1778. 05:44.960 --> 05:47.010 We here in Connecticut, have -- did you know this? -- 05:47.010 --> 05:50.110 the oldest newspaper in America. 05:50.110 --> 05:52.030 That's the Hartford Courant. 05:52.030 --> 05:59.530 So, a man by the name of Elisha Cornwell took out an ad 05:59.530 --> 06:04.830 in the Hartford Courant in 1778. 06:04.830 --> 06:23.220 And he explains in the ad, that he sold his farm, and, 06:23.220 --> 06:26.580 instead of taking the money right up front, he'd mortgaged 06:26.580 --> 06:34.990 the farm, so that he sold it for GBP 800 to another farmer. 06:34.990 --> 06:37.680 And the farmer was promising to pay him. 06:37.680 --> 06:41.110 And if he didn't pay him, he should get back the farm. 06:41.110 --> 06:54.350 The farmer subsequently mortgaged the same 06:54.350 --> 06:57.470 farm for GBP 880. 06:57.470 --> 06:59.830 So he's made GBP 80 profit. 06:59.830 --> 07:02.140 Which would all be fine and good, except he still hadn't 07:02.140 --> 07:04.420 paid back the first mortgage. 07:04.420 --> 07:09.830 And then the guy mortgaged it again for GBP 1,000. 07:09.830 --> 07:14.580 And Mr. Cornwell is protesting: "Hey, you didn't 07:14.580 --> 07:17.210 pay me for the farm in the first place, so you 07:17.210 --> 07:18.090 don't own the farm. 07:18.090 --> 07:21.710 How are you mortgaging it multiple times? " So he said, 07:21.710 --> 07:24.840 "I thought I better put an ad in the newspaper, so that any 07:24.840 --> 07:34.310 subsequent victims of this farmer, would be warned." So, 07:34.310 --> 07:35.470 that's the end of the ad. 07:35.470 --> 07:38.710 He said, "this is my farm because he didn't pay me." 07:38.710 --> 07:40.540 But this shows how undeveloped mortgage 07:40.540 --> 07:43.810 institutions were in 1778. 07:43.810 --> 07:47.690 Because he had to put an ad in the newspaper to explain that. 07:47.690 --> 07:53.330 The problem was that nobody had any systematic way of 07:53.330 --> 07:55.660 representing title. 07:55.659 --> 08:02.359 The farmer, who supposedly bought it from Mr. Cornwell 08:02.360 --> 08:04.650 really didn't, and nobody would know that. 08:04.650 --> 08:06.380 You know, he could fool people. 08:08.980 --> 08:12.320 I think that's partly why you didn't see so many mortgages 08:12.320 --> 08:13.280 in those days. 08:13.280 --> 08:16.690 Because the law wasn't clear. 08:16.690 --> 08:24.640 The institutions were not clear about property. 08:24.640 --> 08:26.970 And so, you couldn't really do a mortgage business, if you 08:26.970 --> 08:30.950 couldn't find out whether the guy mortgaging the farm really 08:30.950 --> 08:32.910 owned it or not. 08:32.910 --> 08:40.770 And so, it wasn't until the late 19th century that 08:40.770 --> 08:49.300 government started to get rights to property 08:49.300 --> 08:52.740 sufficiently advanced that we could develop a big national 08:52.740 --> 08:55.310 or international market in mortgages. 08:55.310 --> 09:07.290 So, an important step is in Germany, in 1872, or Prussia, 09:07.290 --> 09:15.310 the government created a Grundbuch law that created a 09:15.310 --> 09:21.710 system for Prussia that established in a central book, 09:21.710 --> 09:24.190 who owns what exactly. 09:24.190 --> 09:26.430 That was in 1872. 09:26.430 --> 09:34.580 And in 1897, they made it a national German institution. 09:34.580 --> 09:36.510 Still, the United States did not have a 09:36.510 --> 09:37.990 Grundbuch at the time. 09:40.860 --> 09:45.350 It developed throughout the 20th century in different 09:45.350 --> 09:50.610 countries of the world, that property rights would be clear 09:50.610 --> 09:54.550 enough that one could do a mortgage lending business. 09:54.550 --> 09:57.080 So that's, why I think mortgage lending has really 09:57.080 --> 10:02.370 taken off in the 20th century. 10:02.370 --> 10:07.620 Hernando de Soto was a Peruvian economist. He wrote a 10:07.620 --> 10:11.510 book a few years ago called Mystery of Capital. 10:11.510 --> 10:13.790 And it's about the developing world. 10:13.790 --> 10:18.470 He argued in that book that property rights, the problems 10:18.470 --> 10:22.000 that we just heard about from the Hartford Courant are still 10:22.000 --> 10:25.430 very big and alive around the world today. 10:25.430 --> 10:29.690 That you can't easily establish who owns what in 10:29.690 --> 10:32.830 many or most countries of the world. 10:32.830 --> 10:35.810 So, that's a problem. 10:35.810 --> 10:38.070 That's why we don't see mortgage 10:38.070 --> 10:40.790 finance developing there. 10:40.790 --> 10:42.270 You can't make a loan. 10:42.270 --> 10:44.360 You know, if you go to some small town in some less 10:44.360 --> 10:47.370 developed country, you can ask around, "who owns this 10:47.370 --> 10:50.750 property?" And they'll tell you, "that's been in the such 10:50.750 --> 10:55.060 and such family for a long time." But if you want solid 10:55.060 --> 10:59.310 knowledge of that, if you're going to base financial 10:59.310 --> 11:03.690 transactions on it, you can't base it just on hearsay. 11:03.690 --> 11:06.310 Someone else might have a different opinion. 11:06.310 --> 11:10.610 So even today, in many countries of the world, the 11:10.610 --> 11:13.500 laws are not developed well enough. 11:13.500 --> 11:17.860 We don't have property rights established well enough. 11:17.860 --> 11:20.150 And we have laws that might inhibit mortgages. 11:20.150 --> 11:24.970 For example, in many countries, if you give a 11:24.970 --> 11:28.760 mortgage on a property, in other words, if you lend on a 11:28.760 --> 11:34.960 property, and the person doesn't pay, you're supposed 11:34.960 --> 11:37.680 to be able to seize the property, right? 11:37.680 --> 11:40.880 But if the court system doesn't function well, or if 11:40.880 --> 11:47.400 it's kind of left leaning and supporting the rights of the 11:47.400 --> 11:50.410 person living in the home, you might not be able to get it. 11:50.410 --> 11:52.550 Or it might take you 10 years to get the guy 11:52.550 --> 11:55.210 thrown out of the house. 11:55.210 --> 11:57.930 Now, it seems cruel to throw someone out of a house, who 11:57.930 --> 12:01.110 doesn't pay on their mortgage, but you have to think of the 12:01.110 --> 12:01.980 other side of it. 12:01.980 --> 12:04.500 If we don't throw them out of the house, no one's going to 12:04.500 --> 12:05.620 make a mortgage. 12:05.620 --> 12:07.290 You have to be able to get the house. 12:07.290 --> 12:07.550 Right? 12:07.550 --> 12:09.290 That's the idea of the mortage. 12:09.290 --> 12:13.790 The guy doesn't pay, the lender gets the house. 12:13.790 --> 12:18.270 And so, I think there's a general process of 12:18.270 --> 12:22.940 development, improving the definition of property rights, 12:22.940 --> 12:25.730 and improving the ability of lenders to get the property if 12:25.730 --> 12:31.760 it fails, which accounts for the advance of mortgage 12:31.760 --> 12:37.260 lending in the 20th and 21st century. 12:37.260 --> 12:39.670 So, that's my long history of mortgage lending. 12:54.950 --> 12:55.090 But I want to get into some specific institutions. 12:55.085 --> 12:55.245 I said, I would start with commercial real estate and 12:55.250 --> 12:57.520 then I'll move to single-family homes or 12:57.520 --> 13:00.650 residential real estate. 13:00.650 --> 13:03.510 I will to talk now mostly about the United States. 13:03.510 --> 13:09.040 There's just too many countries to think about. 13:09.040 --> 13:11.620 One thing about finance is that it tends to develop a 13:11.620 --> 13:15.380 sort of tradition, and a sort of standard contract. 13:15.380 --> 13:18.620 It's encouraged by laws and regulators. 13:18.620 --> 13:21.670 You have to do the same sort of contract that other people 13:21.670 --> 13:24.330 are doing in your country. 13:24.330 --> 13:28.360 And I think the standardization is kind of a 13:28.360 --> 13:29.110 limitation. 13:29.110 --> 13:33.120 We can't be creative in financing, because the public 13:33.120 --> 13:38.600 and the regulators will not be receptive to new things. 13:38.600 --> 13:42.620 Let me talk about some of the institutions in finance in the 13:42.620 --> 13:43.350 United States. 13:43.350 --> 13:46.610 It's natural to start with commercial real estate. 13:46.610 --> 13:49.900 So, you see a lot of buildings. 13:49.900 --> 13:52.080 My question is, how are they owned? 13:52.080 --> 13:54.070 I don't know whether you think about this. 13:54.070 --> 13:55.460 Who owns these buildings? 13:55.460 --> 14:03.790 In much of the 20th century and still today, they tend to 14:03.790 --> 14:07.220 be owned as partnerships. 14:07.220 --> 14:10.350 Real estate partnerships, which is different from a 14:10.350 --> 14:12.400 corporation. 14:12.400 --> 14:14.270 In a corporation -- 14:14.270 --> 14:15.600 we talked about that yesterday [correction: last class]-- 14:15.600 --> 14:19.130 you might sell shares on the stock exchange if it's public. 14:19.130 --> 14:21.390 And it's defined as a legal person. 14:24.790 --> 14:30.290 And it has limited liability, so that all the shareholders 14:30.290 --> 14:33.710 don't have to worry about being sued as a result. 14:33.710 --> 14:35.980 But a partnership is different. 14:35.980 --> 14:41.740 And most real estate, that's not part of a larger business, 14:41.740 --> 14:46.370 is owned in a partnership, rather than a corporation. 14:46.370 --> 14:50.420 And the reason is that they're taxed more favorably. 14:50.420 --> 14:54.710 Corporations have to pay a corporate profits tax. 14:54.710 --> 14:56.880 They're double-taxed. 14:56.880 --> 15:00.240 You as an individual pay an income tax, and your 15:00.240 --> 15:03.660 corporation pays a corporate income tax, or corporate 15:03.660 --> 15:06.240 profits tax. 15:06.240 --> 15:07.700 So, you're taxed twice. 15:07.700 --> 15:11.260 If you incorporate yourself, or you set up some friends to 15:11.260 --> 15:14.830 do business in a corporation, you get taxed twice. 15:14.830 --> 15:16.750 So, you don't like that, and obviously you 15:16.750 --> 15:18.450 try to avoid that. 15:18.450 --> 15:24.070 The way to avoid it is not to have a corporation, but a 15:24.070 --> 15:25.320 partnership. 15:30.230 --> 15:31.900 The law allows you to form 15:31.900 --> 15:34.220 partnerships to own a building. 15:34.220 --> 15:37.440 So, you're building like 360 State Street. 15:37.440 --> 15:40.300 It's a new building that just went up in New Haven. 15:40.300 --> 15:41.800 You know this building? 15:41.800 --> 15:43.570 The biggest construction. 15:43.570 --> 15:45.650 Does anyone know who owns it? 15:45.650 --> 15:46.790 It's probably a partnership. 15:46.790 --> 15:48.350 I haven't investigated that. 15:53.826 --> 15:58.046 Or it's called a Direct Participation Program. 15:58.050 --> 16:05.320 So, the partnership is an investment that is offered 16:05.320 --> 16:08.230 only to accredited investors. 16:08.230 --> 16:12.020 It's not generally available to the general public. 16:12.020 --> 16:14.850 And what is an accredited investor? 16:14.850 --> 16:17.980 The Securities and Exchange Commission takes it upon 16:17.980 --> 16:25.110 itself to define, who are accredited investors that 16:25.109 --> 16:29.079 don't need the protections of the SEC. 16:29.079 --> 16:33.969 Basically, accredited investors are wealthy people. 16:33.970 --> 16:40.150 And it's defined in the SEC laws who is accredited. 16:40.150 --> 16:46.600 You have to have at least $1 million, or minimum income. 16:46.600 --> 16:50.300 And so, if you are an accredited investor, you can 16:50.300 --> 16:51.550 invest in a DPP. 16:55.490 --> 17:01.400 And then, the income of the property flows through to you 17:01.400 --> 17:03.140 as your personal income. 17:03.140 --> 17:08.350 It's not corporate income, so it's taxed only once. 17:08.350 --> 17:08.920 Think about that. 17:08.920 --> 17:11.570 Well, why would anyone want to form a corporation? 17:11.570 --> 17:13.960 Because I don't want to be taxed twice. 17:13.960 --> 17:17.980 So, why don't we do all business as a DPP, as a 17:17.980 --> 17:19.360 partnership? 17:19.360 --> 17:21.980 The problem is that the government doesn't want you to 17:21.980 --> 17:25.480 do that, and so they have rules about what can form a 17:25.480 --> 17:28.230 partnership. 17:28.230 --> 17:32.260 One of the rules is that they have to have a limited life. 17:32.260 --> 17:35.310 So, a corporation goes on forever. 17:35.310 --> 17:38.260 And it derives a lot of its value from the fact that it 17:38.260 --> 17:39.920 lives forever. 17:39.920 --> 17:41.290 There's no end date. 17:44.340 --> 17:47.800 So, we talked about that when I when I brought up the first 17:47.800 --> 17:50.980 real corporation, the Dutch East India Company. 17:50.976 --> 17:54.646 The reason it got so valuable is, people could see that this 17:54.650 --> 17:56.890 was growing as the first multinational -- 17:56.890 --> 18:00.270 It is this huge company that had all kinds of deals and 18:00.270 --> 18:03.360 alliances and business arrangements. 18:03.360 --> 18:05.280 And no one wanted that to end. 18:05.280 --> 18:08.600 The value came in the growth prospects for that. 18:08.600 --> 18:12.910 But a DPP has to end. 18:12.910 --> 18:14.170 It's well-designed for a building. 18:14.170 --> 18:18.080 You buy the building, and you depreciate it over the life of 18:18.080 --> 18:19.710 the contract. 18:19.710 --> 18:22.030 And then there's an end date, and at the end date you sell 18:22.030 --> 18:24.810 the building to someone else, and then you 18:24.810 --> 18:26.910 close down the DPP. 18:26.910 --> 18:30.440 You don't hear about these partnerships as much. 18:30.440 --> 18:33.290 You hear about corporations all the time. 18:33.290 --> 18:35.150 You don't hear about DPP's. 18:35.150 --> 18:37.030 First of all, because they don't get so big. 18:37.030 --> 18:38.810 They're typically one building. 18:38.810 --> 18:41.670 360 State, for example. 18:41.670 --> 18:47.750 And it only lasts for 10, 20 years, then it's gone. 18:47.750 --> 18:51.930 So, it doesn't get advertised in the public, because it's 18:51.930 --> 18:54.080 not available to the public. 18:54.080 --> 18:57.500 They can't go around trying to bring you in as an investor, 18:57.500 --> 18:58.960 because they have to verify that you're 18:58.960 --> 19:01.240 an accredited investor. 19:01.240 --> 19:05.500 So, it tends to be a project for wealthy people. 19:05.500 --> 19:07.470 Now, I mentioned that corporations 19:07.470 --> 19:10.150 have limited liability. 19:10.150 --> 19:14.350 Partnerships do not, in general. 19:14.350 --> 19:18.830 But you can have a partnership that involves 19:18.830 --> 19:20.960 two classes of partners. 19:20.960 --> 19:24.850 There's a general partner that runs the business and does not 19:24.850 --> 19:27.100 have limited liability. 19:27.100 --> 19:29.760 In other words, if the business goes bad and loses 19:29.760 --> 19:33.150 money, the general partner can get sued. 19:33.150 --> 19:36.560 But there are other partners, called limited partners, and 19:36.560 --> 19:38.960 they have to be passive investors. 19:38.960 --> 19:41.960 And they have limited liability. 19:41.960 --> 19:47.980 So what often happens, is a DPP is created by someone who 19:47.980 --> 19:50.000 understands and knows real estate. 19:50.000 --> 19:53.050 Let's get 360 State Street built. 19:53.050 --> 19:55.010 You're going to know that eventually, because once they 19:55.010 --> 19:58.070 open, they're going to open a supermarket on the first floor 19:58.070 --> 19:59.510 of 360 State. 19:59.510 --> 20:02.280 And I bet some of you will be over there. 20:02.280 --> 20:04.580 It would be the closest supermarket to Yale 20:04.580 --> 20:06.690 University. 20:06.690 --> 20:08.420 But it's all part of somebody's plan. 20:08.420 --> 20:12.550 There was some general partner who thought up this structure, 20:12.550 --> 20:21.630 and got limited partners in, and is managing the building, 20:21.630 --> 20:25.100 or hires a manager for the building, and has a plan and a 20:25.100 --> 20:26.440 close out plan. 20:26.440 --> 20:28.290 The building won't disappear, but they'll sell 20:28.290 --> 20:29.710 it to someone else. 20:29.710 --> 20:31.830 I really don't know the financing 20:31.830 --> 20:33.350 structure of 360 State. 20:33.350 --> 20:35.110 But I'm just pointing out, it's likely 20:35.110 --> 20:37.390 what's happened there. 20:37.390 --> 20:42.710 So, that has been the modern structure of real estate. 20:42.710 --> 20:48.250 And if they mortgage the building, the DPP would 20:48.250 --> 20:51.290 mortgage the building on behalf of the partners. 20:54.310 --> 21:05.210 So, real estate finance in the United States -- 21:05.210 --> 21:07.560 I might as well write it down. 21:07.560 --> 21:19.360 DPP is a Direct Participation Program. 21:22.950 --> 21:28.230 And it's direct, in the sense that you as an investor are 21:28.230 --> 21:31.520 participating directly in the profits of it. 21:31.520 --> 21:33.840 You are a partner, you are not a shareholder. 21:37.280 --> 21:45.560 The DPPs became criticized in the 20th century, because 21:45.560 --> 21:49.340 small investors couldn't access these. 21:49.340 --> 21:52.540 Small investors were confined, because they weren't 21:52.540 --> 21:55.640 accredited, they weren't big enough or important enough. 21:55.640 --> 21:58.250 They were not allowed to invest in these. 21:58.250 --> 22:02.330 It was supposed to be to protect them, I guess. 22:02.330 --> 22:05.270 But how does it protect them to subject them to 22:05.270 --> 22:06.840 double-taxation? 22:06.840 --> 22:11.710 So, it became a cause that why in the United States do we 22:11.710 --> 22:15.950 have most of our investors closed out of these lucrative 22:15.950 --> 22:18.820 investment opportunities? 22:18.820 --> 22:22.010 Basically, individuals couldn't invest in commercial 22:22.010 --> 22:22.600 real estate. 22:22.600 --> 22:25.490 And people said, well people are supposed to diversify, 22:25.490 --> 22:27.020 they are supposed to hold different kinds of 22:27.020 --> 22:29.250 investments. 22:29.250 --> 22:35.330 So, why would this be limited to them? 22:35.330 --> 22:40.660 So, Congress in the United States, in 1960, created 22:40.660 --> 22:43.910 something new called a real -- 22:43.910 --> 23:00.970 [SIDE CONVERSATION] 23:00.970 --> 23:09.460 PROFESSOR ROBERT SHILLER: Real Estate Investment Trusts. 23:13.170 --> 23:17.330 Or abbreviated REITs. 23:17.330 --> 23:23.710 These were created in 1960 by an act of the U.S. Congress. 23:23.710 --> 23:27.110 And it was another example of the 23:27.110 --> 23:30.030 democratization of finance. 23:30.030 --> 23:33.000 And I believe it started here in the United States. 23:33.000 --> 23:37.590 Now, they're being copied all over the world. 23:37.590 --> 23:40.630 They got off to kind of a slow start after 1960, but they 23:40.630 --> 23:42.340 have grown dramatically. 23:48.450 --> 23:58.690 The idea is that we will allow a trust to create investments 23:58.690 --> 24:02.360 for the general public, for small investors. 24:02.360 --> 24:06.410 And they won't be double-taxed, either. 24:06.410 --> 24:10.920 So, a Real Estate Investment Trust has to follow the law, 24:10.920 --> 24:12.770 and then it can invest in buildings. 24:12.770 --> 24:15.650 So, maybe 360 State is owned by a REIT. 24:15.650 --> 24:16.900 I don't know. 24:23.190 --> 24:26.530 But they are not subject to the corporate profits tax. 24:26.530 --> 24:31.220 Now once again, once Congress creates a vehicle that's not 24:31.220 --> 24:34.370 taxed, everyone is going to ask, well, I want my company 24:34.370 --> 24:36.150 to be a REIT. 24:36.150 --> 24:38.570 So, they had to define it so that 24:38.570 --> 24:41.710 isn't generally available. 24:41.710 --> 24:43.190 It's limited to real estate. 24:43.190 --> 24:48.040 So the law says, 75% of the assets of the company have to 24:48.040 --> 24:51.230 be in real estate or cash. 24:51.230 --> 24:56.860 75% of the income has to be from real estate. 24:56.860 --> 24:59.990 90% of their income must be from real estate dividend, 24:59.990 --> 25:03.390 interest, and capital gains. 25:03.390 --> 25:06.080 This is all, I think, in your textbook Fabozzi et al. 25:06.080 --> 25:11.710 95% of the income must be paid out. 25:11.710 --> 25:14.230 And there has to be a long-term holder. 25:14.230 --> 25:18.680 No more than 30% of the income can be from the sale of 25:18.680 --> 25:21.910 properties held less than four years. 25:21.910 --> 25:26.350 They don't want real estate churning companies. 25:26.350 --> 25:27.310 So, if you define [correction: satisfy] 25:27.310 --> 25:30.860 all of that, you've got a REIT. 25:30.860 --> 25:36.000 So, that invention, which goes back to 1960 -- 25:36.000 --> 25:37.120 It's one of those things in finance. 25:37.120 --> 25:41.250 It starts out slowly, and most people don't hear of it, and 25:41.250 --> 25:44.010 then it starts to grow. 25:44.010 --> 25:47.550 And now they're everywhere around the world. 25:47.550 --> 25:49.050 Well, maybe not everywhere, but in many 25:49.050 --> 25:50.960 countries we have REITs. 25:50.960 --> 25:55.100 The U.S. REITs grew in a succession of booms. The first 25:55.100 --> 26:00.760 boom was in the late 1960s, when the interest rates in the 26:00.760 --> 26:03.120 United States rose above deposit ceilings. 26:03.120 --> 26:05.830 There used to be ceilings that the government imposed on 26:05.830 --> 26:08.690 savings banks deposit rates. 26:08.690 --> 26:10.780 And so suddenly, the REITS were paying better than the 26:10.780 --> 26:13.570 savings bank, and the public flocked to them. 26:13.570 --> 26:18.550 There was a second boom, after the tax reform of 1986 26:18.550 --> 26:25.130 eliminated some tax advantages of DPPs, partnerships. 26:25.130 --> 26:28.060 It used to be that the government allowed generous 26:28.060 --> 26:30.840 depreciation allowances for partnerships. 26:30.840 --> 26:34.490 And people would invest in buildings just as tax dodges. 26:34.490 --> 26:37.340 Because if you're allowed to depreciate the building very 26:37.340 --> 26:40.930 effectively, you can kind of cook your profits, so that 26:40.930 --> 26:42.630 it's not taxable. 26:42.630 --> 26:46.990 And so, people we're investing in buildings too much. 26:46.990 --> 26:50.910 The government created a distortion that encouraged too 26:50.910 --> 26:53.700 much investment in DPPs. 26:53.700 --> 27:02.260 So in 1986, the government eliminated a lot of the 27:02.260 --> 27:04.170 advantages of partnerships. 27:04.170 --> 27:08.070 And that caused the second REIT boom. 27:08.070 --> 27:11.290 And then, it was starting in the 1990s with the real estate 27:11.290 --> 27:18.790 boom that suddenly lots of new kinds of REITs appeared. 27:18.790 --> 27:20.790 And REITs that involved specialized 27:20.790 --> 27:22.040 properties, and the like. 27:23.630 --> 27:28.120 Now they're big, and everyone talks about them. 27:28.120 --> 27:30.870 But it's interesting to me that it took 50 years to get 27:30.870 --> 27:34.020 as big as they are now. 27:34.020 --> 27:39.740 And the recurring theme here -- a couple of them -- 27:39.740 --> 27:43.310 One is that the finance industry finds it difficult to 27:43.310 --> 27:47.030 innovate, and innovations take many years to happen. 27:47.030 --> 27:51.020 And secondly, that there there's a trend toward the 27:51.020 --> 27:53.380 democratization of finance. 27:53.380 --> 27:55.550 That if you go back in history, you'll find these 27:55.550 --> 27:59.220 same mortgages and partnerships and the like, but 27:59.220 --> 28:02.420 they were limited to a small number of wealthy people. 28:02.420 --> 28:03.780 And we're moving. 28:03.780 --> 28:06.190 With the invention of REITs for example, more and more 28:06.190 --> 28:07.440 people are getting involved. 28:10.630 --> 28:12.070 So, that's commercial real estate. 28:12.070 --> 28:16.650 I want to talk now about residential real estate, which 28:16.650 --> 28:18.330 is actually bigger. 28:18.330 --> 28:21.830 There are more houses than there are office buildings in 28:21.830 --> 28:23.640 this country. 28:23.640 --> 28:25.350 Or there's more value in houses. 28:25.350 --> 28:28.350 So this is bigger. 28:28.350 --> 28:32.500 In the United States, about 2/3 of households 28:32.500 --> 28:35.280 own their own home. 28:35.280 --> 28:37.710 It varies across countries, but there are many other 28:37.710 --> 28:41.670 countries with similarly high home ownership rates. 28:41.670 --> 28:45.330 And this home ownership is a product of government policy 28:45.330 --> 28:49.790 that encourages mortgage lending. 28:49.790 --> 28:53.090 So, I want to talk a little bit about the history of 28:53.090 --> 28:56.880 mortgage lending, and the history of problems in 28:56.880 --> 28:57.710 mortgage lending. 28:57.710 --> 29:01.330 I already took you back to the silk trade in the Tang 29:01.330 --> 29:04.100 Dynasty, but I'm going to be less so far back. 29:04.100 --> 29:08.900 I'm going to talk about the United States and the Great 29:08.900 --> 29:10.340 Depression. 29:10.340 --> 29:11.330 So, the Great Depression. 29:11.330 --> 29:18.780 The United States in the 1930s after the 1929 Stock Market 29:18.780 --> 29:23.440 Crash was faced with a severe housing crisis. 29:23.440 --> 29:27.800 Home prices were falling, and people were defaulting on 29:27.800 --> 29:31.980 their mortgages in great numbers. 29:31.980 --> 29:35.090 In fact, the government had to create what they called the 29:35.090 --> 29:38.230 Homeowners Loan Corporations to bail people out, and they 29:38.230 --> 29:42.070 ended up bailing out 20% of American homeowners. 29:42.070 --> 29:46.050 It was a terrible crisis, and so, what was happening? 29:46.050 --> 29:48.100 I am pointing this out, because it's important in the 29:48.100 --> 29:52.810 history of real estate finance. 29:52.810 --> 29:58.300 Before the Great Depression, mortgages were growing. 29:58.300 --> 30:02.270 Before the Great Depression, they tended to be two to five 30:02.270 --> 30:08.770 years, and they were balloon payment. 30:08.770 --> 30:10.410 What do I mean by that? 30:10.410 --> 30:14.650 When you bought a house in 1920, you would go to a bank 30:14.650 --> 30:18.080 and they would give you a loan for two to five years. 30:18.080 --> 30:22.300 So, if you bought a house for $10,000, they would typically 30:22.300 --> 30:23.380 lend you half the money. 30:23.380 --> 30:25.390 They would lend you $5,000. 30:25.390 --> 30:29.970 And the loan would say, you pay interest every month until 30:29.970 --> 30:37.640 two years has ended, and then you'd repay the $5,000. 30:37.640 --> 30:40.040 And then, you can try to get another mortgage. 30:40.040 --> 30:42.250 You come back to us and we'll do it again, if 30:42.250 --> 30:43.370 we feel like it. 30:43.370 --> 30:44.700 That was the deal. 30:44.700 --> 30:47.610 Banks offered that, and it was becoming an increasingly 30:47.610 --> 30:48.350 common thing. 30:48.350 --> 30:51.540 When we say a balloon payment, what we mean 30:51.540 --> 30:53.570 is, it's really big. 30:53.570 --> 30:55.230 Balloons are big. 30:55.230 --> 30:57.860 So, you're paying monthly interest, but then in two 30:57.860 --> 31:02.740 years you have got to come up with the whole $5,000. 31:02.740 --> 31:05.300 But people thought, it's all right, I'll just go back to 31:05.300 --> 31:07.130 the bank, or maybe I'll go to another bank. 31:07.130 --> 31:13.010 You know I can go wherever I want and I can borrow $5,000. 31:13.010 --> 31:15.900 So, this was the way things were done. 31:15.900 --> 31:18.250 But what happened in the Great Depression? 31:18.250 --> 31:19.610 Two things happened. 31:19.610 --> 31:25.910 Unemployment rate went up to 25%, A. B, home prices fell in 31:25.910 --> 31:28.010 many cases by more than half. 31:28.010 --> 31:33.040 So, if you borrowed $5,000 against a $10,000 home, your 31:33.040 --> 31:36.450 home might be worth only $4,000 now. 31:36.450 --> 31:37.990 So, what do you do now? 31:37.990 --> 31:40.360 You go to a bank. 31:40.360 --> 31:41.870 Two years is up. 31:41.870 --> 31:43.540 I have got to refinance my mortgage. 31:43.540 --> 31:46.110 I go back to the bank. 31:46.110 --> 31:49.000 I show up and I say, A, I'm unemployed and my house is 31:49.000 --> 31:50.790 worth $4,000. 31:50.790 --> 31:54.310 The bank says no dice, you're not going to get renewed. 31:54.310 --> 31:56.050 So, what happens? 31:56.050 --> 31:58.830 You're forced to dump your house on the market. 31:58.830 --> 32:00.180 You declare bankruptcy. 32:00.180 --> 32:01.270 You've lost everything. 32:01.270 --> 32:05.840 You've lost your $5,000 down payment. 32:05.840 --> 32:10.380 If you buy a $10,000 house, and you borrow $5,000, then 32:10.380 --> 32:12.810 the other sum is called your down payment. 32:12.810 --> 32:13.900 So, that's what happened. 32:13.900 --> 32:15.490 It was happening to millions of Americans. 32:19.030 --> 32:22.810 So, the Roosevelt Administration decided that 32:22.810 --> 32:24.060 there was something wrong with the old kind of mortgage. 32:28.390 --> 32:37.270 So, in 1934, a year after Franklin Roosevelt became 32:37.270 --> 32:46.460 President, they set up the Federal Housing 32:46.460 --> 32:47.710 Administration. 32:50.040 --> 33:00.050 And it was trying to get lenders back in to lend to 33:00.050 --> 33:03.130 homeowners, because it was a catastrophe in the country. 33:03.130 --> 33:06.540 [SIDE CONVERSATION] 33:06.540 --> 33:08.080 PROFESSOR ROBERT SHILLER: So, in order to get lenders back 33:08.080 --> 33:12.280 in, the FHA started insuring mortgages. 33:12.280 --> 33:17.220 And that meant that if you're a mortgage lender, and the 33:17.220 --> 33:20.630 person you lent the money to doesn't repay you, and the 33:20.630 --> 33:21.910 house isn't worth enough -- 33:21.909 --> 33:23.749 you can get the house, but sometimes you might lose 33:23.750 --> 33:26.080 money, because the house has lost value -- 33:26.080 --> 33:28.060 the government will make it up. 33:28.060 --> 33:31.000 So, the government came in with what's 33:31.000 --> 33:33.710 called mortgage insurance. 33:37.719 --> 33:41.329 And at the same time, the government said all mortgages 33:41.330 --> 33:48.430 that are insured by the FHA must be 15 years or longer. 33:48.429 --> 33:53.219 And so, the U.S. government imposed the long-term mortgage 33:53.219 --> 33:56.079 on the mortgage industry. 33:56.080 --> 33:57.430 And they said, this is better. 34:00.790 --> 34:04.800 And secondly, it cannot be a balloon payment mortgage. 34:04.800 --> 34:08.580 The government said, this is really imposing too much on 34:08.580 --> 34:12.240 ordinary people that they have to come up with a huge sum of 34:12.240 --> 34:14.930 money at the end of the mortgage. 34:14.930 --> 34:18.690 So, they required that the mortgages be 15-year 34:18.690 --> 34:19.940 amortizing. 34:25.150 --> 34:28.910 Such mortgages had been offered already by some banks 34:28.910 --> 34:32.700 in the United States in the 1920s, but it was innovative 34:32.700 --> 34:35.740 finance, and too complicated for most people. 34:35.740 --> 34:39.480 They never caught on. 34:39.480 --> 34:44.290 To amortize means to pay down the balance. 34:44.290 --> 34:49.460 So, an amortizing mortgage has no balloon payment at the end. 34:49.460 --> 34:54.910 A 15-year amortizing mortgage has a fixed monthly payment. 34:54.910 --> 34:57.110 You make it every single month. 34:57.110 --> 34:59.360 And at the end, you're done. 34:59.360 --> 35:03.550 You take your spouse out to dinner and you say, we paid 35:03.550 --> 35:05.560 off our mortgage, we're done. 35:05.560 --> 35:08.470 So, there's no family crisis at the end. 35:08.470 --> 35:11.350 It's a fixed monthly payment. 35:11.350 --> 35:14.310 Now the arithmetic of amortizing mortgages is a 35:14.310 --> 35:19.580 little confusing to some people, and in 1934, it took 35:19.580 --> 35:21.170 some education. 35:21.170 --> 35:25.020 But I want to just describe the 35:25.020 --> 35:28.660 amortizing mortgage system. 35:32.230 --> 35:40.120 So, we're going to have a mortgage of maturity -- 35:40.120 --> 35:48.560 The maturity of the mortgage is in M, and that's in months. 35:48.560 --> 35:53.010 So, in 1934, they started out with 15-year mortgages, which 35:53.010 --> 35:55.700 I thought was pretty aggressive, but by the early 35:55.700 --> 36:01.240 1950s, the FHA was emphasizing 30-year mortgages. 36:01.240 --> 36:03.610 That's a long time to pay off on your house. 36:03.610 --> 36:07.850 But the idea is, you know, you're typical family, they 36:07.850 --> 36:10.440 get married, and they're buying their first house, 36:10.440 --> 36:12.420 they're 25 years old. 36:12.420 --> 36:15.840 So, let's give them a full 30 years to pay off the mortgage. 36:15.840 --> 36:17.420 They'll be 55. 36:17.420 --> 36:20.540 Kids will be going off to college. 36:20.540 --> 36:21.670 They'll still be working. 36:21.670 --> 36:23.200 That's a comfortable length of time. 36:23.200 --> 36:26.420 Why not give them 30 years? 36:26.420 --> 36:28.980 And we guarantee the interest rate for 30 years. 36:28.980 --> 36:30.320 No surprises. 36:30.320 --> 36:34.580 You just know you have this monthly payment. 36:34.580 --> 36:37.810 The question now is, how do we decide on the monthly payment? 36:41.130 --> 36:46.380 The idea of an amortizing mortgage is that you have a 36:46.380 --> 36:49.010 fixed payment every month. 36:49.010 --> 36:50.720 You have an interest rate. 36:50.720 --> 36:55.940 And you want to make sure that the present value of the 36:55.940 --> 36:58.500 monthly payments equals the mortgage 36:58.500 --> 37:00.180 balance at the beginning. 37:00.180 --> 37:07.620 So, the initial mortgage balance, that's the amount you 37:07.620 --> 37:15.080 borrow, has to equal present discounted value of all the 37:15.080 --> 37:15.960 monthly payments. 37:15.960 --> 37:19.340 So, what will I call the monthly payment? 37:19.340 --> 37:22.690 Let's call the monthly payment x, it's the 37:22.694 --> 37:23.964 monthly payment in dollars. 37:27.140 --> 37:35.040 So, the mortgage balance is equal to x all over r over 12, 37:35.040 --> 37:47.400 where r is the annual interest rate, times 1 minus 1 all over 37:47.400 --> 37:55.310 1 plus r over 12 to the Mth power. 37:55.310 --> 37:58.370 That's just the annuity formula. 37:58.370 --> 38:00.730 So, that's the formula that's used to compute -- 38:07.160 --> 38:08.410 I've shown you that formula before. 38:12.290 --> 38:18.730 It's the present value of a stream of payments equal to x. 38:18.730 --> 38:19.790 Did I write r over 2? 38:19.790 --> 38:25.970 I meant r over 12. 38:25.970 --> 38:29.520 So, what you have to do if you are calculating an amortizing 38:29.520 --> 38:35.290 mortgage, if the person is borrowing the mortgage 38:35.290 --> 38:42.190 balance, and I quote a rate r per year, I have to plug that 38:42.190 --> 38:45.840 into the present value formula, and find out what 38:45.840 --> 38:49.610 monthly payment x makes the present value equal to the 38:49.610 --> 38:51.350 amount loaned. 38:51.350 --> 38:53.880 Now, that is a little bit of arithmetic that mortgage 38:53.880 --> 38:56.050 lenders would have had trouble doing. 38:56.050 --> 38:58.340 It is not that hard to do, right? 38:58.340 --> 39:03.550 But I have here a page from a mortgage table. 39:03.550 --> 39:06.800 I found this in the Yale Library. 39:06.800 --> 39:09.340 Can you read that? 39:09.340 --> 39:11.700 This is from a 50-year-old book. 39:11.700 --> 39:15.080 This is before they had computers. 39:15.080 --> 39:17.490 And so, it was too hard to do this calculation. 39:20.310 --> 39:21.880 Can you read it in the back? 39:21.880 --> 39:23.720 Sort of. 39:23.720 --> 39:26.220 This is for a 10-year mortgage. 39:26.220 --> 39:28.060 I just picked 10 years. 39:28.060 --> 39:30.040 That was uncommon, that's rather short. 39:30.040 --> 39:32.080 Some people would get shorter mortgages, 39:32.080 --> 39:33.210 especially older people. 39:33.210 --> 39:35.130 You know if you're 60 years old, you don't 39:35.130 --> 39:37.790 want a 30-year mortgage. 39:37.790 --> 39:39.550 You probably won't live that long. 39:39.550 --> 39:41.430 So, they did give out shorter mortgages as well. 39:41.430 --> 39:47.110 So, this is the page from a mortgage book for 10 years, 39:47.110 --> 39:49.580 and this is for a 5% mortgage. 39:49.580 --> 39:59.050 So, it shows the monthly payment for $1,000. 39:59.050 --> 40:03.290 If someone's borrowing $5,000, you'd multiply this by five. 40:03.290 --> 40:08.150 They show it for around $1,000. 40:08.150 --> 40:15.830 And the monthly payment per $1,000 is $10.61. 40:15.830 --> 40:21.420 So, what they've done is they've found out $10.61 is 40:21.420 --> 40:24.930 the x that makes this present value for r 40:24.930 --> 40:28.070 equal 5% equal to $1,000. 40:28.070 --> 40:31.640 They've done exactly this calculation. 40:31.640 --> 40:36.360 Now, they show the payments schedule. 40:36.360 --> 40:40.420 The payment every month is $10.61. 40:40.420 --> 40:44.260 But what this table shows, is the break down between 40:44.260 --> 40:50.340 amortization and interest. So, it shows the principal for 40:50.340 --> 40:51.320 each month. 40:51.320 --> 40:55.440 So, at the beginning you borrow $1,000 on this 40:55.440 --> 41:03.640 mortgage, and you're paying $10.61 per month. 41:03.640 --> 41:06.090 So, each month your balance goes down. 41:06.090 --> 41:09.080 In this balance column, they subtract -- 41:09.080 --> 41:11.970 well, the question is, how do you figure it out? 41:11.970 --> 41:15.370 You're paying $10.61 per month, but part of that is 41:15.370 --> 41:17.580 interest. What part of that is interest? 41:17.580 --> 41:24.760 Well it's 5% divided by 12 of the $1,000 41:24.760 --> 41:26.140 balance at the beginning. 41:26.140 --> 41:32.390 Your initial interest is $4.17, so your principle is 41:32.390 --> 41:37.320 the $10.61 minus the interest. So then, that 41:37.320 --> 41:39.190 reduces your balance. 41:39.190 --> 41:43.820 So, the initial interest is $4.17, the principal is $6.44, 41:43.820 --> 41:49.960 then the balance is $993.56 after one month. 41:49.960 --> 41:53.150 The next month, they figure what fraction of your payment 41:53.150 --> 41:58.160 is interest by multiplying 5% over 12 times the balance, 41:58.160 --> 42:07.960 $993.56, and then that comes out to be $4.14 interest. You 42:07.960 --> 42:10.310 see the interest is going to be going down, because you're 42:10.310 --> 42:11.630 paying off the loan. 42:11.630 --> 42:15.720 But your payment is fixed, so the payment against principal 42:15.720 --> 42:16.810 is going up. 42:16.810 --> 42:21.630 So, the first month was $4.17 interest, the next month is 42:21.630 --> 42:23.880 $4.14 interest. 42:23.880 --> 42:29.350 Offsetting that is in the first month, the $6.44 being 42:29.350 --> 42:30.890 used to pay off your mortgage. 42:30.890 --> 42:35.940 The second month it's more, $6.47. 42:35.940 --> 42:40.730 I couldn't show the whole page here, but here after six years 42:40.730 --> 42:45.900 six months your interest is down to $1.74, because your 42:45.900 --> 42:50.190 balance is down to $407.61. 42:50.190 --> 42:53.790 And so, your payment of principal is much higher. 42:53.790 --> 42:57.220 The reason this table is important is that people move 42:57.220 --> 42:58.930 and they sell their house early. 42:58.930 --> 43:01.190 They don't hold it for the full 10 years. 43:01.190 --> 43:04.560 So, you have to figure out when someone sells his house 43:04.560 --> 43:08.220 after six years six months, what do they still owe? 43:08.220 --> 43:14.400 Well, they now owe, instead of $1,000, they owe $407.61. 43:14.400 --> 43:17.080 So, that's the idea of a long-term mortgage. 43:17.080 --> 43:20.100 Your interest payments are changing all the time, your 43:20.100 --> 43:22.520 principal payments are changing all the time, but 43:22.520 --> 43:25.440 your total payment is fixed. 43:25.440 --> 43:34.290 That was an invention, a financial innovation in 1934. 43:34.290 --> 43:37.690 This is called a conventional fixed rate mortgage, and it's 43:37.690 --> 43:41.010 now offered in many countries of the world. 43:41.010 --> 43:46.490 However, there's only two countries where it's the major 43:46.490 --> 43:47.960 kind of mortgage. 43:47.960 --> 43:50.370 United States and Denmark. 43:50.370 --> 43:53.980 This is a strange thing. 43:53.980 --> 43:58.550 This invention has not caught on around the world. 43:58.550 --> 44:01.890 It's unique to only two countries, although you can 44:01.890 --> 44:04.970 get it in other countries. 44:04.970 --> 44:07.800 It's not available in Canada in any number, I guess you 44:07.800 --> 44:14.550 could find it, but it's not common elsewhere. 44:14.550 --> 44:17.160 Every time I go to a foreign country, I ask the people 44:17.160 --> 44:22.530 there, why don't you have fixed rate mortgages? 44:26.040 --> 44:27.500 I don't necessarily get good answers. 44:27.500 --> 44:30.410 I've been trying to understand why it hasn't caught on. 44:30.410 --> 44:37.380 Then I recently saw that Alistair Darling, who was 44:37.380 --> 44:38.630 under the Labour government -- 44:45.642 --> 44:49.122 [SIDE CONVERSATION] 44:49.120 --> 44:50.790 PROFESSOR ROBERT SHILLER: Alistair Darling was 44:50.790 --> 44:54.950 Chancellor of the Exchequer in the United Kingdom until the 44:54.950 --> 44:57.310 Conservative government took over. 44:57.310 --> 45:02.260 He issued a statement saying that U.K. should finally adopt 45:02.255 --> 45:03.505 the long-term mortgage. 45:08.690 --> 45:13.020 The problem is that any country, that doesn't have a 45:13.020 --> 45:16.620 long-term fixed rate mortgage, runs the risk of falling into 45:16.620 --> 45:19.210 the same problem that the United States did in the Great 45:19.210 --> 45:20.230 Depression. 45:20.230 --> 45:22.760 Some kind of crisis like that could mean that people would 45:22.760 --> 45:25.940 lose their homes in great numbers. 45:25.940 --> 45:30.730 So, he said he'd like to see the U.K. get people borrowing 45:30.730 --> 45:35.150 at 10, 20, or even 25 years for their mortgages. 45:35.150 --> 45:37.430 But instead what happened was, the Conservative 45:37.430 --> 45:39.440 government took over. 45:39.440 --> 45:42.920 But you can, in the U.K., get long-term mortgages. 45:42.920 --> 45:45.900 I think it's true in most countries of the world. 45:45.900 --> 45:47.940 They're just not common there. 45:47.940 --> 45:49.480 It's a bit of a puzzle. 45:49.480 --> 45:53.660 Why is it that only two countries do this generally? 45:53.660 --> 45:58.320 I have a couple of reasons to offer why it is. 45:58.320 --> 46:02.360 One of them is that the general public is resistant to 46:02.360 --> 46:05.640 long-term mortgages, because they charge a higher interest. 46:05.640 --> 46:13.580 If the lender is going to guarantee it for 30 years, 46:13.580 --> 46:15.320 they're going to have to charge you a higher rate, 46:15.320 --> 46:18.180 because that guarantee costs something to them. 46:18.180 --> 46:24.500 And consumers are resistant to paying the higher rate. 46:24.500 --> 46:26.140 And that's part of the problem. 46:26.140 --> 46:28.890 The other part of the problem is that bank regulators might 46:28.890 --> 46:32.920 not encourage banks to make these loans, because it's 46:32.920 --> 46:34.550 risky for banks. 46:34.550 --> 46:38.590 If banks tie their money up for 30 years, and then they 46:38.590 --> 46:40.690 have depositors who can withdraw their money at 46:40.690 --> 46:44.310 anytime, the banks could go under, if there was ever a run 46:44.310 --> 46:44.780 on the banks. 46:44.780 --> 46:48.500 They can't liquidate these mortgages fast at all. 46:48.500 --> 46:51.250 So, you need a coordinated effort of a government to 46:51.250 --> 46:57.720 first make sure the regulators accept these concepts. 46:57.720 --> 47:01.270 And it puts some risk on the public of the possible bailout 47:01.270 --> 47:02.520 of the banking system. 47:08.540 --> 47:11.120 And then, you have to get past public resistance. 47:11.120 --> 47:14.070 You have to make the public understand that, when you get 47:14.070 --> 47:17.390 a fixed rate mortgage, it's a clean contract. 47:17.390 --> 47:21.080 We have no worries for 30 years. 47:21.080 --> 47:24.780 As opposed to problems that have sometimes occurred. 47:24.780 --> 47:33.730 In Canada, in 1980, the interest rates shot way up, 47:33.730 --> 47:37.630 and we had a duplicate of the problem that we saw in the 47:37.630 --> 47:41.530 U.S. People couldn't afford to refinance their mortgages, and 47:41.530 --> 47:44.570 a lot of people lost their homes. 47:44.570 --> 47:47.910 And so, it was a big problem. 47:47.910 --> 47:51.020 But they somehow got through that, and they're not really 47:51.020 --> 47:53.290 thinking about fixed rate mortgages in 47:53.290 --> 47:55.270 Canada even now, today. 48:00.825 --> 48:05.945 I wanted to go on talking about innovation in finance. 48:05.950 --> 48:11.190 Another very important innovation is securitization 48:11.190 --> 48:18.410 of mortgages, and government support of mortgage markets. 48:18.410 --> 48:25.770 In the United States, in 1938, the federal government, this 48:25.765 --> 48:30.735 is also the Roosevelt Administration, set up the 48:30.740 --> 48:43.760 Federal National Mortgage Administration, which was a 48:43.760 --> 48:49.000 government agency that would buy mortgages to support the 48:49.000 --> 48:51.480 mortgage market. 48:51.480 --> 48:57.120 On Wall Street they couldn't pronounce Federal National 48:57.120 --> 48:58.570 Mortgage -- 48:58.570 --> 49:00.010 or is it Association? 49:00.010 --> 49:06.580 I'm sorry, it's Association not Administration. 49:10.730 --> 49:12.480 You know what they called it on Wall Sreet? 49:16.140 --> 49:17.410 They called it Fannie Mae. 49:22.490 --> 49:26.900 That was just an irreverent short name for the 49:26.900 --> 49:28.280 Association. 49:28.280 --> 49:29.530 It was run by the government. 49:33.220 --> 49:40.790 However, in the year 1968, the U.S. government privatized 49:40.790 --> 49:46.270 Fannie Mae, and it became a private corporation. 49:49.270 --> 49:50.830 So what did Fannie Mae do? 49:50.830 --> 49:53.490 It would buy mortgages from banks. 49:53.490 --> 49:55.890 They were trying to encourage the mortgage market. 49:55.890 --> 49:59.720 So, a bank would lend money to someone to buy a house, and 49:59.720 --> 50:00.380 then they're done. 50:00.380 --> 50:01.820 They can't loan any more money unless 50:01.820 --> 50:03.440 they raise more deposits. 50:03.440 --> 50:07.260 Well, Fannie Mae would buy the mortgage from them, and they'd 50:07.260 --> 50:08.890 have money again to lend again. 50:12.600 --> 50:14.900 They did this in '38, because we were still in the 50:14.900 --> 50:19.340 Depression, and the housing market was still depressed. 50:19.340 --> 50:20.450 They weren't building homes. 50:20.450 --> 50:22.690 There were lots of unemployed construction workers. 50:22.690 --> 50:25.750 And so, Roosevelt was just thinking how can we stimulate 50:25.750 --> 50:26.970 the economy? 50:26.970 --> 50:29.900 And this was one of their ideas. 50:29.900 --> 50:34.990 So, Fannie Mae was the mortgage finance giant that 50:34.990 --> 50:36.900 was created in 1968 [correction: created in 1938, 50:36.895 --> 50:39.955 privatized in 1968]. 50:39.960 --> 50:46.160 [SIDE CONVERSATION] 50:46.160 --> 50:51.800 PROFESSOR ROBERT SHILLER: In 1970, the government created 50:51.800 --> 50:54.130 another Fannie-Mae-like institution. 50:57.350 --> 51:01.240 Its official name was Federal Home Loan Mortgage 51:01.240 --> 51:03.580 Corporation. 51:03.576 --> 51:06.886 Wall Street had to invent a name for it. 51:06.890 --> 51:12.760 So, they called it Freddie Mac. 51:12.760 --> 51:15.180 They thought, well, we gave a girl's name to Fannie Mae, 51:15.180 --> 51:16.410 let's give a boy's name. 51:16.410 --> 51:19.610 I guess that's a boy's name. 51:19.610 --> 51:25.150 Both of these organizations are private companies now, 51:25.150 --> 51:30.100 created by the government, and they both use these names 51:30.100 --> 51:30.930 officially now. 51:30.930 --> 51:32.560 So, that's their name now. 51:32.560 --> 51:34.850 Fannie Mae and Freddie Mac. 51:34.850 --> 51:37.120 Freddie Mac was initially different. 51:37.120 --> 51:40.590 Because what the government asked Freddie Mac to do, was 51:40.590 --> 51:45.590 buy mortgages, and then repackage them as mortgage 51:45.590 --> 51:50.510 securities, and sell them off with a Freddie Mac guarantee. 51:53.040 --> 51:55.720 So, once Freddie Mac started doing this, Fannie Mae said, 51:55.720 --> 51:58.080 well, can't we do that too? 51:58.080 --> 51:59.910 So, they both do it. 51:59.910 --> 52:03.540 So, what the government had done is create two private 52:03.540 --> 52:04.870 corporations. 52:04.870 --> 52:10.320 You kind of wonder why did the government even do that? 52:10.320 --> 52:11.310 Anyone can create -- 52:11.310 --> 52:12.850 Remember we have a corporate law. 52:12.850 --> 52:15.020 I can start my own Freddie Mac. 52:15.020 --> 52:16.610 My own Fannie Mae. 52:16.610 --> 52:19.870 But the government did create them by privatizing Fannie Mae 52:19.870 --> 52:23.880 and by creating Freddie Mac. 52:23.880 --> 52:25.870 And they are both in the mortgage 52:25.870 --> 52:28.210 securitization business. 52:28.210 --> 52:31.170 So, they would buy from mortgage originators -- 52:31.165 --> 52:32.875 the people who lend the money. 52:32.880 --> 52:34.800 They'd buy the mortgages. 52:34.800 --> 52:37.280 In other words, they would take the IOU from someone. 52:37.280 --> 52:42.040 They'd repackage them into securities, and sell them off 52:42.040 --> 52:47.810 to the public with a guarantee from Fannie or Freddie, that, 52:47.810 --> 52:52.140 if there were a default, the mortgage extra balance would 52:52.140 --> 52:56.170 be made up by Fannie or Freddie. 52:56.170 --> 53:00.860 Well, they did then get other companies, called mortgage 53:00.860 --> 53:04.540 insurers, to insure at least part of the balance. 53:04.540 --> 53:06.560 It's a complicated financial agreement. 53:06.560 --> 53:09.890 But what we had was private companies created by the U.S. 53:09.890 --> 53:13.700 government, that created securities for investors that 53:13.700 --> 53:15.970 were guaranteed against default, 53:15.970 --> 53:20.250 and based on mortgages. 53:23.370 --> 53:30.530 So, the government then also stated that these are private 53:30.530 --> 53:33.770 companies and the U.S. government does not stand 53:33.770 --> 53:35.030 behind them. 53:35.030 --> 53:37.700 People started to say the government created these two 53:37.700 --> 53:42.350 corporations, and now they're securitizing and guaranteeing 53:42.350 --> 53:45.860 trillions of dollars of mortgages. 53:45.860 --> 53:47.870 Is this going to come back and end up being 53:47.870 --> 53:51.220 paid for by the taxpayer? 53:51.220 --> 53:55.050 So, the government stated clearly, these are now private 53:55.050 --> 53:55.710 corporations. 53:55.710 --> 53:57.250 Fannie Mae started out as part of the 53:57.250 --> 53:59.250 government, but no longer. 53:59.250 --> 54:01.100 Now, it's a private corporation. 54:01.100 --> 54:04.270 And if Fannie Mae goes bankrupt, woe be tied to 54:04.265 --> 54:07.035 anyone who bought their securities, because their 54:07.040 --> 54:10.670 guarantee is not backed up by the federal government. 54:10.670 --> 54:13.200 So people complained, though. 54:13.200 --> 54:17.320 They said, you're saying that it's not backed up by the 54:17.320 --> 54:20.600 federal government, but do you really mean that? 54:20.600 --> 54:23.700 If Fannie or Freddie goes bankrupt, will the U.S. 54:23.700 --> 54:26.940 government just let them go under? 54:26.940 --> 54:29.430 Well, the official statement was, yes, the government will 54:29.430 --> 54:31.010 let them go under. 54:31.010 --> 54:34.140 Guess what happened? 54:34.140 --> 54:38.810 In 2008, the real estate market crashed and we had our 54:38.810 --> 54:42.410 first housing crisis that was similar to the Great 54:42.410 --> 54:43.670 Depression. 54:43.670 --> 54:47.820 And in that housing crisis, both Fannie and 54:47.820 --> 54:50.700 Freddie went bankrupt. 54:50.700 --> 54:52.330 And now, what do we do? 54:52.330 --> 54:53.890 We're in the Bush Administration. 54:53.890 --> 54:54.800 Republican. 54:54.800 --> 54:58.090 They don't particularly like bailouts. 54:58.090 --> 55:01.880 So you think, of course, George W. Bush would just -- 55:01.880 --> 55:03.100 it's the law, right? 55:03.100 --> 55:06.050 The federal government's not going to bail them out. 55:06.050 --> 55:10.160 But then some people said, wait a minute, you know all 55:10.160 --> 55:12.980 over the world people are investing in these, thinking 55:12.980 --> 55:16.530 that Fannie Mae was created by the U.S. government. 55:16.530 --> 55:19.370 In particular a lot of Chinese, those poor innocent 55:19.370 --> 55:23.790 Chinese, are trusting the Americans, and they put many 55:23.790 --> 55:26.870 billions of dollars into Fannie Mae. 55:26.870 --> 55:29.120 Are you going to go and tell the Chinese? 55:29.120 --> 55:32.010 Sorry, we won't back it. 55:32.010 --> 55:34.920 Well, someone can say, sure, go tell them that. 55:34.920 --> 55:37.270 It's what we've been saying all along. 55:37.270 --> 55:40.140 But then the Chinese could come back and say, well, 55:40.140 --> 55:42.050 you've been saying that, but nobody believed you. 55:42.050 --> 55:44.230 Everyone knew that that wasn't right. 55:44.230 --> 55:47.970 And the federal government didn't take all the right 55:47.970 --> 55:50.020 steps to make it really clear. 55:50.020 --> 55:54.420 For example, the Wall Street Journal used to list Fannie 55:54.420 --> 55:57.710 Mae bonds and Freddie Mac bonds in a section of the 55:57.710 --> 56:02.740 newspaper entitled ''Government Securities.'' And 56:02.740 --> 56:03.940 that's the Wall Street Journal. 56:03.940 --> 56:05.680 That's not the government talking. 56:05.680 --> 56:09.080 But, the U.S. government should have come in and told 56:09.080 --> 56:11.200 them, no, those are not government. 56:11.200 --> 56:14.710 So, we poor, innocent, Chinese investors, we've read your 56:14.710 --> 56:18.110 paper and it said Government Securities. 56:18.110 --> 56:21.060 Now George Bush could've said, tough luck. 56:21.060 --> 56:25.820 You guys should have read the fine print, but he didn't. 56:25.820 --> 56:26.420 Why not? 56:26.420 --> 56:29.020 Because it jeopardizes too much. 56:29.020 --> 56:32.170 If the U.S. government lets these agencies that it created 56:32.170 --> 56:35.810 go bankrupt, and it lets all those people all over the 56:35.810 --> 56:38.620 world down who invested in those securities. 56:38.620 --> 56:39.870 They're going to be mad. 56:42.150 --> 56:43.790 We have a reputation. 56:43.786 --> 56:47.696 The United States is able to raise so much money from all 56:47.700 --> 56:51.880 over the world, because they think that it's safe here, and 56:51.880 --> 56:55.500 if we just let these fail it's not going to look right. 56:55.500 --> 56:57.840 So, the U.S. government took them both under 56:57.840 --> 57:01.890 conservatorship, and is paying their debts, so 57:01.890 --> 57:03.620 those do not default. 57:03.620 --> 57:07.560 What we've learned from this lesson is that you can say a 57:07.560 --> 57:10.730 million times that you're not going to guarantee something, 57:10.730 --> 57:14.150 but eventually you end up guaranteeing it. 57:17.930 --> 57:19.380 I wanted to say something about other 57:19.380 --> 57:20.890 countries a little bit. 57:20.890 --> 57:26.580 Canada has something like Fannie Mae and Freddie Mac 57:26.580 --> 57:29.520 called the Canada Housing and Mortgage Corporation. 57:32.260 --> 57:37.420 And so, I'll just talk about other countries. 57:37.420 --> 57:45.060 The Canada Housing and Mortgage Corporation. 57:57.390 --> 57:59.360 It was created by the government of Canada, and it 57:59.360 --> 58:02.780 does work that resembles the FHA and that 58:02.780 --> 58:05.530 resembles Fannie Mae. 58:05.530 --> 58:07.280 But it's owned by the Canadian government. 58:07.280 --> 58:10.060 It's not privatized. 58:10.060 --> 58:14.410 And so, you might say, well, it's the same in Canada. 58:14.410 --> 58:17.420 But the big difference is, it's smaller. 58:17.420 --> 58:19.960 They didn't let it get as big as Fannie and Freddie. 58:19.960 --> 58:24.480 So, it isn't heard as much from. 58:24.480 --> 58:29.330 I was a keynote speaker at a conference on February 3 58:29.325 --> 58:30.355 [addition: 2011], 58:30.360 --> 58:33.760 that the Financial Times organized in New York called 58:33.760 --> 58:36.030 Focus on Canada. 58:36.030 --> 58:40.230 And I had to give a talk about Canada to New York investors. 58:40.230 --> 58:43.250 They told me there were hardly any Canadians in the audience. 58:43.250 --> 58:46.240 What are we doing here in New York talking about Canada? 58:46.240 --> 58:47.670 Well, it's because the Americans 58:47.670 --> 58:49.600 invest heavily in Canada. 58:49.600 --> 58:53.280 So, I was up talking to all these American people, and I 58:53.280 --> 58:56.700 was looking at Canada, and the Canada banking system. 58:56.700 --> 59:02.690 And I said to the group, Canada and America are just so 59:02.690 --> 59:04.540 similar I can't see much of a difference. 59:08.470 --> 59:10.900 Canada didn't have Fannie and Freddie. 59:10.900 --> 59:13.920 It didn't have these housing problems. But the worldwide 59:13.920 --> 59:16.990 recession hit Canada pretty hard. 59:16.990 --> 59:20.290 And so I said, Canada and U.S. are kind of like 59:20.290 --> 59:23.550 two peas in a pod. 59:23.550 --> 59:25.410 They are so similar. 59:25.410 --> 59:28.160 People like to make much of differences, but the Canadian 59:28.160 --> 59:31.950 economy just moves up and down in lockstep. 59:31.950 --> 59:36.200 And I also said, Canada was saved by the oil crisis, being 59:36.200 --> 59:38.500 an oil exporter. 59:38.500 --> 59:42.210 In 2008, remember when the oil prices shot up? 59:42.210 --> 59:45.150 But little to my knowledge, there was a reporter for the 59:45.145 --> 59:47.725 Financial Post in Canada in the audience. 59:47.730 --> 59:55.070 And my talk got reported in the Financial Post. And then I 59:55.070 --> 59:57.100 went on their website and there was 59:57.100 --> 59:59.960 angry blogs from Canadians. 59:59.960 --> 1:00:02.300 I don't think it's so insulting to Canada to say 1:00:02.300 --> 1:00:03.600 that we're just basically similar. 1:00:10.930 --> 1:00:14.920 And I have say this for Canada, they did not get so 1:00:14.920 --> 1:00:18.520 gung-ho on supporting mortgages as the United States 1:00:18.520 --> 1:00:22.030 did, so they didn't have such a big housing bubble 1:00:22.030 --> 1:00:24.400 that the U.S. did. 1:00:24.400 --> 1:00:27.110 Part of the reason the U.S. had a housing bubble as big as 1:00:27.110 --> 1:00:31.750 it did is that these guys really weren't independent. 1:00:31.750 --> 1:00:33.530 They were taking orders from the government. 1:00:33.530 --> 1:00:36.920 The government was telling them to increase their lending 1:00:36.920 --> 1:00:41.250 to low-income, underserved communities. 1:00:41.250 --> 1:00:42.730 They were promoting the bubble. 1:00:42.730 --> 1:00:46.900 And so, Fannie and Freddie were told to promote lending 1:00:46.900 --> 1:00:49.940 to houses during the real estate bubble that preceded 1:00:49.940 --> 1:00:51.250 the crisis. 1:00:51.250 --> 1:00:54.230 That didn't happen, at least not so much, in Canada. 1:00:54.230 --> 1:00:57.380 So, they've had less of a bubble. 1:00:57.380 --> 1:01:02.140 But still the two countries are basically very similar. 1:01:05.960 --> 1:01:09.140 The textbook talks a lot about mortgage securities. 1:01:14.030 --> 1:01:17.560 I expect you to read this out of Fabozzi et al. 1:01:17.560 --> 1:01:21.900 I actually got complaints in past years. 1:01:21.900 --> 1:01:25.470 Students found this the least enjoyable part of the readings 1:01:25.470 --> 1:01:27.200 for this course. 1:01:27.195 --> 1:01:30.785 But you should know about these things. 1:01:30.790 --> 1:01:34.530 We have securities called Collateralized Mortgage 1:01:34.530 --> 1:01:36.740 Obligations. 1:01:36.740 --> 1:01:42.270 These are mortgage securities that 1:01:42.270 --> 1:01:44.850 are sold off to investors. 1:01:44.850 --> 1:01:50.300 And they hold mortgages, but, as is explained in Fabozzi et 1:01:50.302 --> 1:01:55.722 al., they will divide them into separate tranches, or 1:01:55.720 --> 1:02:02.020 separate securities, in terms of prepayment risk. 1:02:02.020 --> 1:02:04.530 That is that there's a risk that the mortgages will be 1:02:04.530 --> 1:02:07.810 paid off early in times when it's adverse to 1:02:07.810 --> 1:02:09.510 the investor interests. 1:02:09.510 --> 1:02:13.210 So, they would divide up the risks into different classes 1:02:13.210 --> 1:02:14.370 of securities. 1:02:14.370 --> 1:02:18.340 And some of them were rated AAA by the rating agencies, 1:02:18.340 --> 1:02:20.510 because they thought there was almost no risk to those 1:02:20.510 --> 1:02:22.440 securities. 1:02:22.440 --> 1:02:25.830 And others were rated differently. 1:02:25.830 --> 1:02:33.770 And these CMOs were sold to investors all over the world. 1:02:33.770 --> 1:02:36.810 Another kind of security, which the textbook talks 1:02:36.810 --> 1:02:41.910 about, is a CDO, which is a Collateralized Debt 1:02:41.910 --> 1:02:43.110 Obligation. 1:02:43.110 --> 1:02:47.000 These are issued to investors, and they typically hold 1:02:47.000 --> 1:02:50.360 mortgage securities as their assets. 1:02:50.360 --> 1:02:53.800 Many of them held subprime mortgages in recent years, 1:02:53.800 --> 1:02:57.750 mortgages that were issued against subprime borrowers. 1:03:01.850 --> 1:03:05.290 A lot of these securities that were rated very highly by the 1:03:05.290 --> 1:03:10.960 rating agencies, rated AAA, ended up defaulting and losing 1:03:10.960 --> 1:03:12.780 money for their investors. 1:03:12.780 --> 1:03:14.980 And the investors were all over the world. 1:03:14.975 --> 1:03:19.535 The United States is a leader in mortgage finance. 1:03:19.540 --> 1:03:26.260 And companies in the United States, not just Fannie and 1:03:26.260 --> 1:03:28.760 Freddie, but lots of companies were issuing mortgage 1:03:28.760 --> 1:03:33.840 securities that had AAA ratings, which meant that 1:03:33.840 --> 1:03:36.240 Moody's and Standard and Poor's and the other rating 1:03:36.240 --> 1:03:38.350 agencies were telling you basically 1:03:38.350 --> 1:03:40.320 there's no risk to them. 1:03:40.320 --> 1:03:45.000 And so, people in Europe, in Asia, were investing in these, 1:03:45.000 --> 1:03:47.750 and they thought they were perfectly safe, and then they 1:03:47.750 --> 1:03:49.000 went under. 1:03:51.790 --> 1:03:54.120 Part of it was bad faith dealings 1:03:54.120 --> 1:03:55.470 by some of the issuers. 1:03:55.470 --> 1:03:59.900 Some of the issuers themselves doubted that these mortgages 1:03:59.900 --> 1:04:01.800 were so safe. 1:04:01.800 --> 1:04:04.090 But what do I care? 1:04:04.090 --> 1:04:06.320 This is what happened. 1:04:06.320 --> 1:04:11.490 It's gotten to be a complicated set of steps. 1:04:11.490 --> 1:04:13.730 Somebody originates the mortgage. 1:04:13.730 --> 1:04:15.680 That means I talk to the homeowner. 1:04:15.680 --> 1:04:18.110 I have the homeowner fill out the papers. 1:04:18.110 --> 1:04:21.810 Then, after they've originated the mortgage, they sell it to 1:04:21.810 --> 1:04:26.090 an investor, like Fannie or Freddie or some private 1:04:26.090 --> 1:04:29.220 mortgage securitizer. 1:04:29.220 --> 1:04:32.460 And the private mortgage securitizer finds a mortgage 1:04:32.460 --> 1:04:35.890 servicer, it may be the originator, who will then 1:04:35.890 --> 1:04:37.250 service the mortgage. 1:04:37.250 --> 1:04:39.530 What does it mean to service the mortgage? 1:04:39.530 --> 1:04:41.640 It means to call you on the phone if you've missed your 1:04:41.640 --> 1:04:43.360 payment, for example. 1:04:43.360 --> 1:04:45.720 Or if you have questions about the mortgage, there should be 1:04:45.720 --> 1:04:47.110 someone you call. 1:04:47.110 --> 1:04:49.120 So, the mortgage servicer does that. 1:04:49.120 --> 1:04:50.670 That's a separate entity. 1:04:50.670 --> 1:04:55.430 And then we have the CMO originator, then we have the 1:04:55.430 --> 1:04:57.150 CDO originator. 1:04:57.150 --> 1:05:00.190 It's gotten to be a very complicated financial system. 1:05:00.190 --> 1:05:03.320 And then the whole thing collapsed. 1:05:03.320 --> 1:05:07.950 So, there's been a lot of reform to try to see, what can 1:05:07.950 --> 1:05:10.510 we do to prevent this kind of collapse? 1:05:10.510 --> 1:05:12.840 Some people would say, let's end the whole thing. 1:05:12.840 --> 1:05:14.610 Let's go back to 1778. 1:05:14.610 --> 1:05:17.400 Let's not have mortgage securitizers. 1:05:17.400 --> 1:05:21.150 But that's not the steps that have been taken. 1:05:21.150 --> 1:05:24.230 I think that we are making progress. 1:05:24.230 --> 1:05:27.920 But I want to just conclude with just a little reference 1:05:27.920 --> 1:05:32.850 to one important change that was made in both Europe and 1:05:32.850 --> 1:05:35.460 the United States. 1:05:35.460 --> 1:05:44.930 The European Parliament passed a new directive that requires, 1:05:44.930 --> 1:05:52.040 or incentivizes, mortgage originators to keep 5% of the 1:05:52.040 --> 1:05:54.750 mortgage balance in their own portfolio. 1:05:54.750 --> 1:06:01.060 That means, if you originate mortgages, you can sell off 1:06:01.060 --> 1:06:04.390 95% of the mortgages to investors, but you 1:06:04.390 --> 1:06:06.990 have to keep 5%. 1:06:06.990 --> 1:06:11.400 So, this 5% limit was then later incorporated into the 1:06:11.400 --> 1:06:14.830 Dodd-Frank Act in the United States. 1:06:14.830 --> 1:06:17.980 So, we again have the same requirement. 1:06:17.980 --> 1:06:23.350 And this is supposed to reduce the moral hazard problem that 1:06:23.350 --> 1:06:26.760 created the crisis, and retain the mortgage 1:06:26.760 --> 1:06:29.680 securitization process. 1:06:29.680 --> 1:06:34.320 So, the idea is this -- 1:06:34.320 --> 1:06:36.330 And I know, I heard people tell me. 1:06:36.330 --> 1:06:39.290 Mortgage originators sometimes got cynical. 1:06:39.290 --> 1:06:41.260 They thought, OK, I'm helping this 1:06:41.260 --> 1:06:43.690 family fill out a mortgage. 1:06:43.690 --> 1:06:45.790 What do I care? 1:06:45.790 --> 1:06:48.010 This family doesn't look like they're not 1:06:48.010 --> 1:06:49.260 going to pay this back. 1:06:52.056 --> 1:06:53.346 But what do I care? 1:06:53.350 --> 1:06:54.460 I'll fill it out. 1:06:54.460 --> 1:06:55.970 I'll sell the mortgage to someone else, 1:06:55.970 --> 1:06:58.260 and I'm out of here. 1:06:58.260 --> 1:07:00.170 In fact, it got bad in some cases, with 1:07:00.166 --> 1:07:02.056 some mortgage brokers. 1:07:02.055 --> 1:07:06.395 A family would come wanting to buy a house, and the mortgage 1:07:06.400 --> 1:07:10.940 broker would say, what is your income anyway? 1:07:10.940 --> 1:07:13.240 And they would tell him the income. 1:07:13.240 --> 1:07:16.140 And he'd say, you're trying to buy a $300,000 1:07:16.140 --> 1:07:17.920 house on that income? 1:07:17.920 --> 1:07:20.390 I don't know if I can do this. 1:07:20.390 --> 1:07:22.410 But then he'd say. 1:07:22.410 --> 1:07:22.970 Wait a minute. 1:07:22.970 --> 1:07:23.790 Think about this again. 1:07:23.790 --> 1:07:25.900 Is that really your income? 1:07:25.900 --> 1:07:28.960 You told me your income is $40,000 a year. 1:07:28.960 --> 1:07:30.960 Are you sure? 1:07:30.960 --> 1:07:33.270 Why don't we say $50,000 thousand a year. 1:07:33.270 --> 1:07:35.110 Or say $60,000 a year. 1:07:35.109 --> 1:07:39.069 And the couple would look at him in disbelief and say, no, 1:07:39.069 --> 1:07:40.949 we only have $40,000. 1:07:40.950 --> 1:07:42.360 He would say, well, think about it. 1:07:42.359 --> 1:07:46.339 You have other sources, don't you? 1:07:46.340 --> 1:07:48.490 Everybody does this, you know. 1:07:48.490 --> 1:07:50.650 So, OK, we have $60,000. 1:07:50.649 --> 1:07:51.899 He says fine. 1:07:54.180 --> 1:07:56.300 And they thought, well, the mortgage broker gave me 1:07:56.300 --> 1:07:58.670 permission to do this. 1:07:58.670 --> 1:08:00.430 And he doesn't care, because he's not 1:08:00.430 --> 1:08:02.840 going to take the loss. 1:08:02.840 --> 1:08:05.800 So, the new law is supposed to discourage that kind of thing. 1:08:05.800 --> 1:08:08.190 And there's lots of new laws that are trying to tighten up. 1:08:08.189 --> 1:08:10.959 For example, mortgage brokers in the United States now have 1:08:10.960 --> 1:08:12.090 to be licensed. 1:08:12.090 --> 1:08:15.030 It used to be just five years ago, you could be an ex-con, 1:08:15.029 --> 1:08:17.939 fresh out of jail, and you could take up a business as 1:08:17.939 --> 1:08:19.299 mortgage broker. 1:08:19.300 --> 1:08:20.740 You can't anymore. 1:08:20.740 --> 1:08:22.870 So, what's happening all over the world is that we've 1:08:22.870 --> 1:08:26.400 learned from this experience, but we're retaining this basic 1:08:26.399 --> 1:08:29.249 system of mortgage securitization. 1:08:29.250 --> 1:08:31.690 Mortgage lenders that are professional. 1:08:31.689 --> 1:08:34.429 The basic industry has been retained. 1:08:34.430 --> 1:08:36.800 And we're hoping and thinking that maybe we 1:08:36.800 --> 1:08:38.750 have a better system. 1:08:38.750 --> 1:08:43.210 So I will stop there, and I'll see you on Monday.