How Government Created the Mortgage Mess, II
How did the government help create the current financial mess? Let me count the ways.
In addition to federal laws that pressure lenders to lend to people they would not otherwise lend to, and in places where they would otherwise not invest, state and local governments have in various parts of the country so severely restricted building as to lead to skyrocketing housing prices, which in turn have led many people to resort to "creative financing" in order to buy these artificially more expensive homes.
Meanwhile, the Federal Reserve System brought interest rates down to such low levels that "creative financing" with interest-only mortgage loans enabled people to buy houses that they could not otherwise afford.
But there is no free lunch. Interest-only loans do not continue indefinitely. After a few years, such mortgage loans typically require the borrower to begin paying back some of the principal, which means that the monthly mortgage payments will begin to rise.
Since everyone knew that the Federal Reserve System's extremely low interest rates were not going to last forever, much "creative financing" also involved adjustable-rate mortgages, where the interest charged by the lender would rise when interest rates in the economy as a whole rose.
In the housing market, a difference of a couple of percentage points in the interest rate can make a big difference in the monthly mortgage payment. For someone who buys a house costing half a million dollars— which can be a very small house in many parts of coastal California— the difference between paying 4 percent and 6 percent interest would amount to more than $7,000 a year. For people who have had to stretch to the limit to buy a house, an increase of $7,000 a year in their mortgage payments can be enough to push them over the edge financially.
In other words, government laws and policies at federal, state and local levels have had the net effect of putting both borrowers and lenders way out on a limb.