Tokenizing real estate in light of the 2008 subprime mortgage crisis
by Zain Jaffer
As blockchain technology gets used for many applications, one trend that is coming is the tokenization of many real world assets. Simply put, the asset transfers and certificates of ownership are placed digitally online, and transactions and transfers are tracked and recorded on the blockchain. This includes its application for real estate.
However we need to remember that blockchain is only a technology and won’t fix many underlying issues associated with the asset itself.
In 2008, the traditional finance and banking system almost collapsed due to too many subprime mortgage assets in the system. This crisis started with a desire to democratize home ownership at the expense of proper due diligence that could have weeded out undeserving borrowers. There was an easing of requirements that degenerated into the No Income No Job and Asset (NINJA) mortgages which were sold so sales agents could get more trading commissions from the big banks.
These thousands of subprime mortgages were bundled together then stamped with a AAA by the ratings agencies, who were also afraid to lose out to their competitors. Note that a 1933 law called the Glass-Steagal Act, passed to prevent a recurrence of the Great Depression, could have prevented this because it did not allow retail banks to do investments. Unfortunately Glass-Steagal was repealed during the Clinton administration, which set the stage for the carnage that was to follow.
These securitized bundles were given a name - Mortgage Backed Securities. These were also packaged so that these were a mix of various types of mortgages. The less risky ones whose buyers would likely make their payments were given a lower interest return but were paid first. But the risky ones whose buyers had no job (and thus could not pay) were given a higher interest payoff to compensate for the risk. These bundled mortgages then became Collateralized Debt Obligations (CDO), which also had an infamous cousin - the Synthetic CDO. Both these instruments were extremely over leveraged, especially the Synthetic CDO.
Very few actually read what was in these bundles of mortgages except for hedge fund managers like Michael Burry and Mark Baum, and bankers like Jared Vennett who shorted these toxic instruments. These individuals predicted that the housing market would crash once the adjustable rate mortgage interest rates kicked in sometime in 2007. And indeed it did.
To make matters worse, the big Wall Street banks were trying to push this to their clients but then at the same time shorted these toxic assets. Furthermore, they took the added step of insuring these assets should they fail, which insurance giant AIG was only too happy to do to ensure a steady stream of fees. After all, no one defaults on their housing loan right? That massive miscalculation almost brought down the world’s financial system and destroyed both AIG and Lehman.
We are still paying for it today. Those toxic assets that the US government acquired through a massive bank bailout of Wall Street resulted in an overprinting of money that was continued with the COVID stimulus and now shows up as inflation due to an overexpansion of our money supply.
There’s a saying that history doesn’t repeat, but it does rhyme. So in tokenizing real estate, we need to remember that it is just a new technology. If you put garbage in, it will still give you garbage out.