In May 2007, the financial sector replaced the energy sector as the largest component of the U.S. economy. Banks, notably Wachovia, Citigroup, Lehman Brothers, Bear Stearns, Bank of America, JP Morgan, and a few others, began employing “high-grade structured credit strategies” in building the real estate portfolios on the bank’s balance sheets.
What that means is this: A bank like, like New Century Financial, would lend $150,000-$200,000 to borrowers with shaky credit histories in order to purchase a $200,000 home. But New Century Financial didn’t just sit on these mortgages and collect the high interest + principal on the payments from the families that had taken out mortgages. Instead, what they would do is bundle these mortgages together—with the thousands of other low-credit quality mortgages in their portfolio—and sell little slices of them to the banks mentioned above. During ordinary and good economic times, and when property values were rising, these loans proved extremely lucrative as these bundled loans would earn returns of 11%, 12%, or 15% per year.