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The math of the mortgage meltdown

10:32 AM, Jun 15, 2012   |    comments
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ATLANTA -- If you want to understand why so many houses are in foreclosure, you have to understand a highly complex financial instrument called a "derivative." 

"A derivative is an investment that's derived from another investment," explained Ty J.Young, a metro Atlanta financial advisor. "For example, a mortgage derivative may be a part of a mortgage, so a bank or investment house could buy the mortgage and sell off a piece of it or pieces of multiple mortgages as a derivative investment."

But if you're more of a numbers person, you might want to check out the Black-Scholes formula. Indeed, experts say the formula has worked well as a predictor of derivatives in the past. But despite its track record for empirical accuracy, it was unable to predict the mortgage meltdown.

"They didn't really know what they had (with these derivatives)," Young said. "The government didn't really know what they had; the banks didn't really know what they had because these derivatives were small pieces of many different mortgages, maybe 10,000 different mortgages, and one tenth of 1,000 different mortgages in one derivative. It got very very complicated, very very quickly."

Those mortgage derivatives were sold on Wall Street in giant bundles by the thousands. But ultimately the math didn't add up.

And so on your street, many houses ended up vacant, boarded up, in probate, or just abandoned, a threat to the value of the entire neighborhood.

"They're falling apart," said West End resident Lucille Henry. "They're just like human beings, if you don't nurture them, they dry up and they just fall apart."

With prices so low, Henry wants to buy another house. But she says there are still too many restrictions.

"Make it more easy and more accessible so we can get these houses," she said. "I don't want an empty house sitting here. I have a business, the lady there has a business, and there's an empty house right here beside me."

In fact, neighbors say on Oak Street alone, there have been 31 empty houses over just the last few years. And most of them are worth a tenth of what they were going for when the market was good.

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