Sunday, October 12, 2008

5 Steps To A Housing, Credit and Financial Crisis

1. Weaken lending standards to increase home ownership. Mortgage underwriting standards have been undermined by virtually every branch of the government since the early 1990s. The government had been attempting to increase home ownership in the U.S., which had been stagnant for several decades (see chart above). In particular, the government had tried to increase home ownership among poor and minority Americans. Although a seemingly noble goal, the tool chosen to achieve this goal was one that endangered the entire mortgage enterprise: intentional weakening of the traditional mortgage-lending standards.

2. Celebrate the success of weakened lending standards, as home ownership surges to historical high levels. The weakening of mortgage-lending standards did succeed in increasing home ownership (from 64% to 69%, see chart above). As home ownership rates increased there was self-congratulation all around. The community of regulators, academic specialists, and housing activists all reveled in the increase in home ownership and the increase in wealth brought about by home ownership. The decline in mortgage underwriting standards was universally praised as an “innovation” in mortgage lending.

3. Increased home ownership creates a speculative housing bubble. The increase in home ownership increased the price of housing, helping to create a housing “bubble.” The bubble brought in a large number of speculators in the form of individuals owning one or two houses who hoped to quickly resell them at a profit. Estimates are that one quarter of all home sales were speculative sales of this nature.

4. Investors use ARMs and low(no)-down payment mortgages to speculate in housing. Speculators wanted mortgages with the smallest down payment and the lowest interest rate. These would be adjustable-rate mortgages (ARMs), option ARMs, and so forth. Once housing prices stopped rising, these speculators tried to get out from under their investments made largely with other peoples’ money, which is why foreclosures increased mainly for adjustable-rate mortgages and not for fixed-rate mortgages, regardless of whether mortgages were prime or subprime. The rest, as they say, is history.

Unfortunately, it seems likely that our governing bodies have learned little or nothing from this series of events. If the proper lessons are not learned, we are likely to have a reprise sometime in the future.

From the article "
Anatomy of a Trainwreck," by Professor Stan Liebowitz, featured previously on CD here.

MP: We could add step #5: Easy monetary policy by the Fed in 2000-2002, which brought the Fed Funds target rate from 6.5% to 1%, and lowered mortgage rates to record-low levels in 2002-2003 (see chart below, click to enlarge).


7 Comments:

At 10/12/2008 9:42 AM, Anonymous Lars said...

Home "Debtorship" is a more apt description of the last 3 or 4 years expecially.

 
At 10/12/2008 2:48 PM, Anonymous Anonymous said...

I think it's important to add that this immediately followed the tech bubble of the late 90's and 2000 that many Americans were left out of. While most Americans didn't have the means to invest in the stock market in a profitable way, HOUSING was seen as an easy, no money down way to get in on the action. Home buyers were able to use what the most successful hedge-funds use - LEVERAGE. No money down mortgages and interest only loans with minimal monthly payments allowed 'ordinary' Americans to buy what amounted to 'options' on homes that seemly wouldn't stop increasing in value.

 
At 10/12/2008 3:41 PM, Anonymous Potato Chef said...

There might, and I am cautiously optimistic about the "might", be a silver lining to all of this.

Perhaps now people will be forced to live within their means.

The average person or couple can't afford a 300k or up house. They just can't. Now they won't be able to get one.

Of course the average person can't afford a $30,000 car either. Maybe the idiot banks will stop lending money for this undue expense.

Of course the average person can't afford to carry $10,000 in credit card debt. Perhaps the banks will stop letting people use more credit than they can handle.

Of course...(fill in the blank)

 
At 10/12/2008 6:12 PM, Blogger Walt G. said...

Sadly, too many people are led astray by those who only have their own interests in mind. I’ve had quite a few acquaintances in the market for real estate the last few years. Many of these people do no understand money very well. These are not stupid people—just uninformed buyers.

When they tell me they are looking at $300,000 houses, I ask how they think they can afford that. Invariably they respond, “My real estate agent qualified me for that, and she said there would be no trouble getting a loan.” Of course, she never tells them that they can’t afford that large of a payment. Regardless, she still gets her 6% of $300,000 instead of 6% of the $60,000 – to $80,000 the buyers could actually pay. Her ass is out the door and on her way to Bermuda.

I realize in a perfect world everyone would be able to run their own financial affairs. The past few months, however, show that we do not live in a perfect world. It’s not all greedy people who have caused this problem. And it’s not all greedy people who have been adversely affected.

Personally, I’m on the Walt G bailout plan nowadays with my severely reduced 401(k) plan and dependence on a shaky General Motors future, so it’s three jobs for me for a while alongside two graduate classes. I am optimistic everything will be OK in the near future, but at the same time pragmatic that I can control my own destiny.

 
At 10/13/2008 5:08 AM, Blogger Arman said...

You guys just don't seem to understand, that the only way to get money into the system is for the bank to lend it out, and when the bank loan is repaid, then the money is out of circulation. The huge problem today is not that there were too many loans 5 years ago, but there are not enough loans today! This cash contraction precipitates in price value contraction (deflation), which causes the collateral held loans to be recalled, which causes additional cash contraction.
The economy will be in turmoil until the Fed hike rates again, and thereby makes it profitable for the local banks to create some circulating money on what must always be a risk.

 
At 10/13/2008 4:55 PM, Blogger spencer said...

WOW, and to think that it was only two years ago that your were arguing that the massive increase in the home ownership rate showed how all the data showing economic stagnation for the middle class was wrong.

Really changed your tune haven't you?

 
At 10/14/2008 1:13 PM, Blogger notnidiot said...

" Anonymous said...
I think it's important to add that this immediately followed the tech bubble of the late 90's and 2000 that many Americans were left out of. While most Americans didn't have the means to invest in the stock market in a profitable way, HOUSING was seen as an easy, no money down way to get in on the action. Home buyers were able to use what the most successful hedge-funds use - LEVERAGE. No money down mortgages and interest only loans with minimal monthly payments allowed 'ordinary' Americans to buy what amounted to 'options' on homes that seemly wouldn't stop increasing in value."

Makes me want to coin a term:

"Sub-Prime Americans"....maybe the equivalent of tpt.

How elitist of me.

 

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