What Was the Cause of the Mortgage Meltdown?

Great Debates
21

The pressure on the relevant institutions to do this started with the Clinton Administration. At least… hell, it might go back before that, but it was certainly pushed hard by Clinton’s.

The relevance of a 20% down payment… I’m not sure. If a person’s good for the payment and has the income to support it, they’re good for it. We’ve had 5% down payments in Canada for a long time and we didn’t have a massive foreclosure crisis. But what we didn’t have here were NINJA loans. The theory was, and it makes sense to me, that if a person has plenty of income and no credit history that would suggest they’re bad for paying loans back, the down payment percentage isn’t so important. All that really matters is the person’s ability to carry the loan.

I hate to say it but I think a big part of the problem is the mortgage interest writeoff the USA allows.

  1. The simple fact is that allowing mortgage interests deducation encourages bigger and higher interest loans. You get what you pay for.

  2. I don’t really understand what the purpose of the deduction is EXCEPT to encourage people to incur more mortgage debt.

Why would anyone be surprised that people are incurring more mortgage debt when, in a very real sense, the government’s paying them to do it?

22

First thing to consider is that Canada’s housing market is still going up.

Second thing to consider is that the data in the article shows that 51% of foreclosures are prime mortgages, ie people you describe as having the ability to pay the loan. Clearly, that group has no problem making monthly payments, but there is no way in hell they’ll be able to cover the missing equity.

I really don’t think credit worthiness factors in at all. If your house value is less than the loan value, that shortfall needs to be paid in cash by the borrower should the house ever need to be sold. And if the loans started with little to no equity, the amount of shortfall will far exceed a person’s cash reserves.

23

I would argue that if mortgages hadn’t been securitized, no bank would have allowed no money down mortgages.

24

Credit Default Swaps.

The main problem was the people writing shitty loans were not the ones incurring the risk.

A mortgage broker had an incentive to write as many loans as possible. Once they wrote the loan they would immediately sell it off essentially transferring the risk away from themselves. So far this is not, in itself, a problem. The sale should reflect the risk inherent in it which would affect the price and the return so should be self-correcting.

What they did though was bundle these loans into tranches. So, take a pile of low risk mortgages, medium risk mortgages and high risk mortgages and bundle them together. On paper, as a statistical means, you can say a given tranche would carry X-risk (i.e. a certain percentage would be expected to go bad). Knowing that, say, 10% would default still left you with 90% good ones and you can figure your overall risk and profits.

Now when riskier and riskier mortgages were made they were not wholly unaware of this but even increasing the risk from (say) 5% to 10% the things were still deemed profitable.

This became a spectacularly lucrative market. The feeling was based on two underlying assumptions:

  1. Property values always rise (yes a given property may depreciate but overall property values rise).

  2. Even if someone defaults there is the property asset standing behind it which can be sold…couple that with #1 and your risk is not bad at all.

Even here we are not in real trouble although getting there.

Now make it that not just one person can buy the risk of your mortgage but 1,000 can (any number really). Who owns it now?

Then add credit ratings agencies were beholden to the investors. Investors would “shop” the ratings agencies to get the best rating. As a result the ratings agencies eventually were ranking high risk investments as AAA. Thing is no one wanted to point out the emperor had no clothes. Everyone was making money.

As a final bit add in massive leverage as icing on the cake. Banks could borrow money from the Feds incredibly cheaply and make great returns elsewhere. They were leveraged to their eyeballs and then some.

This state of affairs cannot continue indefinitely. Sooner or later everyone realizes the property is being sold at greatly inflated prices and you have written about all the bad mortgages you can so no one really left to keep the ball rolling.

House of cards comes crashing down. Defaults skyrocket and property prices crash and no one really knows who actually needs to bear the risk they bought because it has been sliced and diced and moved around so much.

Tl;Dr version:

There is nothing wrong with writing risky mortgages in and of itself. As long as investors understand the risk it is their choice to take it on and the price/profits should reflect the reality. When you start hiding that risk and mushing it up and spreading it around till it magically does not seem risky is when the problems happen.

25

Why do you suppose that? Because they were passing off the risk?

26

I also want to add that I reject the notion that the problem came from the government forcing banks to write risky mortgages.

The banks were not complaining at all and believe you me if they had the risk it wouldn’t have happened.

There was a LOT of money chasing the CDS. There were buyers waiting in line and at some point there were no more mortgages to sell. What do you do if you are the bank? Ease lending rules so you get more people then push the risk off your books.

Eventually it got to truly absurd levels with predictable results. I cannot believe these savvy bankers were unaware of it but they are incented to achieve short term profits and not worry about long term risk. In the short term these bankers making these decisions were walking away with stupendous paychecks…they had no reason to stop it. Once the inevitable implosion occurred what did they care? Hell, even after the implosion these guys were collecting millions in pay. Even if they got fired they are fabulously wealthy…big deal.

27

This. There was a lot of potential profit with no downside for the banks if they made poor lending decisions. It’s like going into a casino, and putting money in the slots, and if the slot pays off, great, and if not…you get your money back anyway. The banks would have been foolish NOT to take advantage of the rules.

28

I’m amazed that no one has mentioned the true villain in all of this, which is, of course, ACORN.

29

Exactly.

30

It wasn’t during most of the fiscal crisis.

You bandy that number as if it’s a good thing. “Look! Just a shade more than half of all foreclosures aren’t ridiculously risky mortgages!”

From my perspective, that’s a HORRIBLE number. The percentage of foreclosures that are so-called “prime” loans, e.g. loans given to people who demonstrated an ability to pay their mortgages, shouldn’t be 51%. It should be more like 98%, because those are the only people who should be able to get mortgages.

The missing equity doesn’t matter unless you have to sell the house. I’m obviously not going to deny that some people get stuck; your $750,00 purchase in Sunnyvale is suddenly worth $500,000, which you could ride out were it not for the fact that you need to move to Boston. Whoops, you’re fucked. But that wasn’t the central problem. The problem was that loans were made to people who simply could not pay them, either because they never could to start with or because of escalating interest rates 1-3 years down the road.

And as other have pointed out, the reason this was allowed to happen is that the risks were being shuffled away from the lender; it was becoming speculation too many steps away from the actual point of the loan.

Canada avoided this in large part because this shit isn’t allowed.

31

How does someone with positive equity even get foreclosed? If your house is worth more than you owe on it, you can always sell it and pay off the mortgage. Negative equity should account for 100% of the foreclosures, not “nearly 50%.”

32

I’m not quite getting this. Why is foreclosure inevitable? If the person who took the loan can afford the payments and doesn’t choose to walk away from a negative equity situation ( i.e. they bought their house to live in, not as an investment ), what difference would it make? If you can make the payments it doesn’t matter if you have negative equity - you’re not going to lose your home to foreclosure. And eventually you’ll pay off your loan, however many decades down the road. You may or may not reap any serious equity value over the next 5-30 years, but so what? Homes are for living in :).

33

But they could pay them at the time of the loan. Perhaps the wage earners lost their jobs and then couldn’t pay. Perhaps their income fell such that they could no longer afford the payments on a $750K house now worth $500K. In the old days, they would sell and move to someplace cheaper (I’ve known people who did that) but that is no longer possible.

The trigger of the bust was the subprimes, but the victims span a much wider range.

34

Funny if a poorer person walks from a house, he is gaming the system. When a rich guy walks from a big mortgage ,he is being a good businessman making an intelligent financial decision.
Yet neither one caused the mortgage crisis. They are the residue. Those who did are doing very well . They are the wealthy bankers sitting on pots of gold and dictating financial rules to the politicians they have bought and paid for.

35

Just to be clear…subprime and zero down are two different animals. Perhaps subprime mortgages were destined to fail as soon as home prices quit rising. Zero down mortgages made it MUCH easier for those who were having trouble paying to just walk away. The purpose of a large down payment is for the buyer to have some skin in the game and to face a significant loss by just leaving the keys on the kitchen counter.

36

Actually the pressure started during the Carter administration. It ramped up considerably during the Clinton years with Justice threatening banks to lend in underserved communitites. Bush pushed the zero down HUD mortgage.

I don’t see how the interest deduction has any bearing on this situation. Without the deduction people would have to buy cheaper homes. The amount that they owe the bank would be the same at the end of the day. How does this have any effect?

37

Have you considered that credit default swaps may have been the result of being forced to write riskier loans? CDS were created in the '90s around the same time the Clinton administration forced banks to make riskier loans. I don’t know the answer to this but it did allow lending institutions to shield themselves from the the risk.

38

An important part of the story was that banks had no incentives to hold local mortgages…they simply collected a fee and resold the notes to the investment banks, who repackaged them into “Mortgage Backed Securities”. So loan officers at banks figured out, “hey, who cares if the properties are junk…as long as I get my cut, repackage it and sell it to some sucker”.
Aided by this attitude, massive fraud invaded the market-houses would be “flipped”-that is sold from one party to another, then resold-each time bumping up the mortgaged amount. The last buyer was screwed-but the previous buyers all made money. That is why a $75,000 40 year old ranch house in LA became a $500,000 “estate”.
the jig was up when the final range of buyers couldn’t make their payments…and the whole rotten house of cards collapsed…leaving the US taxpayers to pay the losses.
In a word, the whole system failed-the lawyers who wrote the P&S agreements, the loan officers, and (in many cases) the shill buyers. But, with a Congress that is so easily bribed (Rep. Barney Frank, D-MA, said there was “nothing wrong” with Fanny mae, two weeks defore the crash!
Stealing from the taxpayers was never so easy, nor socially acceptable!:smiley:

39

It’s because our perception of foreclosure has changed over the past 5 years. Foreclosure used to be an active process by the bank, when a customer stopped paying. Most of the time, this involved both a loss of income, as well as mounting debt from other sources. The bank would foreclose on the house, sell it to recover the loan, and then pay off other leans. Negative equity was almost unheard of–unless a person took out secondary loans against the house, or had significant damage to the house (let it run down).

Also note, that in the study, “nearly 50%” were negative equity, but that doesn’t include houses that had equity because of a secondary loan (like a line of credit).

No, the trigger wasn’t subprime loans, it was actually negative equity.

In cases of negative equity, foreclosure is inevitable because the alternative is to produce enough cash to cover the loan (not blood likely)–regardless of their credit rating. So as I said above, foreclosure used to be a tool (of last resort) for the bank to get it’s money. But now it’s become a tool for the borrower. He/she bought a house with no money down (expecting the value to go up), and can now use the foreclosure process to walk away with only a slight ding to their credit rating.

And you are right, it’s only an issue if you ever need or want to sell the house. As was mentioned, people used to sell if they needed to lower their cost of living. Now they foreclose.

Remember too that a lot of people in the run up to the burst were buying property for investments, and not to live in.

40

This statement is incorrect. There is no inherent reason for subprime mortgages to fail. They may be statistically more likely than prime mortgages, but house values aren’t relevant to the loan itself.

With that said, I imagine that a failing economy is statistically more stressful for a subprime borrower than a prime borrower. But even still, the designation of prime vs subprime does mean “rich vs poor” or “good vs bad.”

As an example: when my wife and I moved from Canada to the US we found out that we had zero credit, we were below subprime. Someone actually advised us to get a store credit card, make a purchase, then not pay it so that our score would go up from zero to 550.

When we bought our house we were technically still subprime. Never missed a payment, never screwed up a bill, never bounced a check. But we didn’t have enough credit history to be considered prime.

The moniker of “subprime” is being used as a way to demonize people, and the data isn’t there to show “subprime people” caused all this mess. The numbers do show that prime loans were also part of the meltdown.

Further to that, 1 in 7 million dollar mortgages are currently in delinquency. Would you consider someone in a million dollar home prime or subprime?

This is exactly true. One borrowers stopped having a stake in their house foreclosure just made sense. It’s a big “fuck you” to the bank, “take this worthless McMansion and shove it.” Oddly enough, it almost seems like a backlash from centuries were foreclosure was a big “fuck you” to the home owner. It was the big bad bank that foreclosed on the hard working American down on his luck.