It’s A Wonderful Life Revisited

What are the holidays without catching at least part of It’s a Wonderful Life, the timeless classic with Jimmy Stewart and Donna Reed. (little known fact… the movie was a complete flop when it debuted in 1946. It is only later that it became quintessential holiday fare).

And you no doubt remember the scene when George Bailey (Jimmy Stewart) and Mary (Donna Reed) are leaving for their honeymoon, and there is a run on Bailey Brothers Building and Loan. George has to scramble to the bank, and personally doles out enough money for the anxious depositors to get by. George explains that he does not have their cash in a safe, but rather their deposits have been lent out to the community, in the form of a loan on “Joe’s house, and in the Kennedy house, and a hundred others”.

I wonder what George Bailey would be saying today. It would probably go something like this:

(George) “You got it all wrong. Your money is not back here back in a safe. We took your deposits and made home loans. With your money, we were able to get Nick the bartender a loan with a 1% start rate for 6 months so he could qualify to buy his new home. Isn’t it great! He only makes $2600 per month, but we were able to get him in with only 5% down, and his payment is only $1500 per month. Sure, it is going to go up to $2200 per month next year, but by then his home will have gone up 10% or 20%, and he can refinance!

(Depositor) So you have his loan here?

(George) Well, not exactly. You see, we sold the loan for a big profit to Lehman Brothers. They take Nick’s loan, and pool it with hundreds of others to create something called a mortgage backed security. We get the money back, plus a profit, and so we can turn around and lend it to other folks who can’t really afford to buy a house either, and turn around and sell the loan again. Lehman Brothers said since they pool a bunch of loans together, there is very little risk, so no one gets hurt, and we all make a ton of money!

(Depositor) Who do they sell these mortgage backed securities to?

(George) Large, institutional investors both here and abroad such as pension funds, investment funds, and insurance companies. They have a bunch of guys from Wharton and MIT running endless spread sheets and doing extensive computer analysis, and they think these securities are great investments. And these financial geniuses have created a whole bunch of neat investment instruments like Credit Swaps and Collateralized Mortgage Obligations to make even more money. So see, there is nothing to worry about!

(Depositor) So who is saying these investments are safe?

(George) Why Moody’s, AM Best… all of the credit rating agencies. It is their job to rate investments and scrutinize these large institutional investors. They have staffs of analysts much smarter than me, and if they say it’s safe, then it certainly is. In fact, they give these mortgage backed securities a AAA rating!

(Depositor) But I know Martino, and there is no way he makes $2600 per month. How can he qualify for a loan like that?

(George) I know that. Everyone knows that. But it doesn’t matter. It’s called a “stated income” loan. He just has to “estimate” his income, and we will use that figure to make the loan. Everyone fudges a little bit, but since they are pooled with other loans, no one gets hurt.

(Depositor) But what if the house does not go up in value? If his payment goes up to $2200 per month, he will not be able to swing it for very long. Then what?

(George) You worry too much. Houses always go up in value. Besides, the Federal Government said in that case they will lend banks like ours money in order to “unfreeze” the credit markets. Heck our little bank is getting a cool $20 Million from the Fed this week!

(Depositor) Good. So you are going to lend it out so we can start buying cars and houses again? It’s really hard to get loans right now. The economy is kind of hurting here in Bedford Falls, and everyone is getting nervous.

(George) What are you crazy? We don’t want to make risky loans to you people any more. We are taking the Fed’s money and buying a controlling interest in a bank in South America! We think we can make a lot more money buying bank stock than lending money in the community.

(Depositor) I don’t know George. Something just does not seem right. What happens if you do lose money on these risky loans you made, and the bank folds, or you get fired?

(George) Don’t worry! Everything is Beautiful! If they fire me my contract says I get a cool $5 million executive bonus. Now you’ll have to excuse me because I’m running late for my trip to the airport. AIG is going to fly me out to Phoenix on a private jet to attend their conference at some fancy 5 star resort to talk about what to do with the government bailout money they are getting. I hear they are flying in oysters from Thailand, and putting everyone up in $5000 per night luxury suites! Good thing that bailout money is going to good use.

Sad but true. And say what you will about old man Potter, but he knew how to analyze risk…