LOS ANGELES, TORONTO, NEW YORK -- Patricia Ramirez's home, which sits on a ragged dead-end street at the edge of East Los Angeles in the shadow of an elevated freeway, cost $445,000 (U.S.) when she and her husband bought it in February, 2007.
Mrs. Ramirez, an office manager at a tortilla maker, and Mr. Ramirez, a truck driver, together make $48,000 a year. When a relative of theirs bought a house a few years ago, his real estate agent told the Ramirezes they could afford a house too. They had dreamed of owning a home for years, and jumped at the chance, scraping together a $5,000 down payment, or 1 per cent.
They moved into the one-storey, three-bedroom beige house in a working-class neighbourhood that was bid up in value during the boom, because while it's on the edges of the rougher parts of town, it's not too far from downtown or the ocean. A pleasant green cemetery is half a block away and the nearby main streets are colourful, lined by eclectic shops and strolling families, most of whom are Hispanic.
Today, the Ramirez home, with its rusted basketball hoop in the driveway and yellowed lawn, is worth just $360,000 - a drop of 20 per cent in less than a year and a half.
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Yet their monthly mortgage payments have moved rapidly in the opposite direction, escalating to $4,500 from the $2,500 payment they originally made - a sum they believed was fixed for five years.
Their mortgage, a type known as an Alt-A that became hugely popular in the U.S., allows borrowers to secure financing without providing proof of their incomes.
It may sound like a foolish business model, but for IndyMac Bancorp Inc. of Pasadena, Calif., it has been a catalyst for spectacular growth. Or at least it was, until eight days ago, when the bank was seized by the federal government.
It was the second-largest banking failure in U.S. history, and its collapse can be viewed as a cautionary tale: Not just of how America recklessly embraced subprime mortgages, but of how these questionable home loans have ripped through the wider economy, shredding confidence in the markets and inciting a global credit crisis.
Much of the problem dates to 2003, a pivotal time for both IndyMac and the credit markets in general. Unusually low interest rates had made large investors, like pension and hedge funds, hungry for higher-yielding products. At the same time, banks were more aggressively pursuing a new business model - one in which they originated loans, like mortgages, and then immediately sold them in products such as collateralized debt obligations, or CDOs, to these big investors to limit their risk.
IndyMac, seeing an opportunity, headed straight for this intersection. It developed new, custom types of mortgages such as the Alt-A, whose lax credit standards opened the door for a flood of potential new home buyers like the Ramirezes.
IndyMac could provide these mortgages to people with sketchy credit histories, and then pass off the risk by selling the loans to investment banks. The banks then packaged these loans with others of higher quality, and in turn sold chunks of these packages to large investors.
"IndyMac and others helped pioneer that market to bring those people into the fold and to allow them to buy homes, buy second homes, do a whole bunch of other stuff," says Guy Cecala, publisher of Inside Mortgage Finance.
The problem is, because each party was passing on the risk to someone else, the level of diligence and scrutiny suffered. That was fine as long as housing prices continued to climb, but when they reversed, the results were disastrous. Major banks and broker-dealers have already written off more than $300-billion worth of bad loans, and have been savaged in the equity markets. New lending has slowed to a crawl, threatening economic growth and forcing U.S. regulators to orchestrate several rescue plans for Wall Street.
Now, with IndyMac's failure - and news of a probe by the Federal Bureau of Investigation - there are fresh concerns. For one thing, many of the securities it backed are still lurking in investment portfolios - potential ticking time bombs.
As painful as this will be for some investors, the size of the bank's holdings aren't large enough to threaten the entire economy. But the replayed image of hundreds of customers, lining up outside IndyMac's branches in a classic run on the bank, just may be.
Confidence is the underpinning of the markets, and IndyMac's failure shows just how fragile this underpinning is - no sooner had it collapsed than shock waves reverberated, pounding the shares of regional banks, investment dealers, and government-chartered mortgage giants Fannie Mae and Freddie Mac.
Bank of Nova Scotia chief executive officer Rick Waugh, who helped spearhead an international report this week on reforming the financial system, says the real issue is contagion, and how, in such an interconnected market, one small problem can quickly beget a larger one, leading to calamitous effects the world over.
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