What Was the Cause of the Mortgage Meltdown?

Great Debates
41

I’d still like to hear how the government (any government) forced banks to issue risky loans.

What was the mechanism by which the government coerced banks to issue bad loans against their better judgment?

This is extremely hard for Americans to understand. The mortgage interest deduction creates a very strong incentive to buy, and at the same time creates a dis-incentive to rent.

As a contrast, in Canada, there are tax deductions for renting, but not owning. The result being that people in Canada will happily rent well into their 30s, where as my American friends were buying condos and townhouses at 25.

People were shocked that my wife and I continued to rent while everyone else was running off and buying those townhouses. They had calculators to show how much you could save on taxes by having a mortgage, then that savings offsets the cost of your monthly payments. You were a sucker not to own. And housing values just keep going up!

Those same people are now actually looking at foreclosure as a way to get rid of worthless townhouses and condos. Most of them either had to pass on new jobs in other cities, or are currently renting at a loss. I know anecdotes don’t count for much, but the number of people I know in that situation is not insignificant.

42

You make a number of excellent points. I place primary blame on the credit rating agencies since they were the theoretical gate keepers, but there is plenty of blame to go around.

The root cause, as you point out, is the lack of underwriting standards on the part of many banks. Normally this would be picked up by the investors when the originator attempted to resell the loans. Why this didn’t happen this time around IDK. I assume it was because they also intended to repackage the loans as CDO’s and therefore transfer the risk, whereas in the past, they would have been held to maturity.

43

Ah, okay - we were just tallking past each other. You were saying/meant to say that foreclosure is inevitable if you choose to vacate your home while having negative equity ( and presumably have no other assets you wished to close the gap with ).

I was saying that foreclosure is not inevitable because you may not choose to vacate your home ;).

44

Banks were accused of redlining if a certain proportion of their loans were not given to minority groups or those who lived in certain neighborhoods. The Justice Dept. actively went after these banks. So, were they FORCED to make risky loans? Technically no. But, forcing the bank to do business with people who fall below the bank’s credit criteria or forcing them to make loans to people in certain areas considered high risk is really just the same thing.

45

The two bolded sentences quite obviously contradict each other. If you realize that they’re totally contradictory you might see why the mortgage deduction affected this crisis.

46

There’s no contradiction. I guess I should have been more clear and said that the amount they are out of pocket annually would be the same. Cheaper house = lower payment. Mortgage deduction + more expensive house = same payment as cheaper house without deduction

47

Some people found it wrong that black people were redlined out of buying homes. They were redlined for auto insurance too. The thought was that for many people ,a home was the only real investment they ever made. So getting working class blacks out of eventual poverty could be done by encouraging them to buy a home that would increase in value. It was also necessary to compel lenders to loan for homes for blacks. Nobody wanted them to make loans to people who were not qualified but to make it a little easier since it was always harder in the past.
To suggest that it was black homeowners who brought the financial system down is absurd. It is the greedy bankers who spent decades trying to get the senators and congressmen to remove safeguards. They spent millions pushing dereg until they got it, then they went wild.

48

But that is not nearly the same thing. Buying a house with 30% more debt because you can get some of it back in lower taxes does not mitigate your risk from a decline in home prices. When home prices fall your deficiency is not tax deductible. You have to pay it in after tax savings.

49

Neither does buying a cheaper house. In a declining market you have a loss either way. True, if you default, and you are responsible for paying off the loan, it would be better to have the cheaper house. But, this is not the case since people can walk away from the house and the loan in many cases.

50

Oh c’mon. That sounds really noble but is a bunch of BS. The only color bankers care about is green. The fact that minorities have, on average, lower credit scores than whites and don’t qualify for mortgages at the same level as whites doesn’t support a charge of racism. Whites didn’t qualify for mortgages at the same level as asians but I doubt there is racism going on.

In order to make sure that blacks and hispanics got loans at rates equal to white folk the banks had to make riskier loans to these minority groups. The alternative was having Justice sue your pants off.

51

Mostly it was that greed thing. Two local banks that failed, Cape Fear Bank and Cooperative Bank in Wilmington, were among 6 banks that loaned a total of 21 million dollars to a couple of drug store owners that felt like they wanted to get into the real estate business. Here’s an interesting article with a timelinethe local paper did on the whole thing.

Nobody forced the banks to loan these guys, and dozens like them, millions of dollars. The government didn’t lean on them. The banks rushed out like suckers at a travelling medicine show to put their money down.

Look at this quote from the article “Even after BB&T refused to lend more money to John and Charlene Waggett, they were able to obtain loans from several other banks in Wilmington that amounted to more than $11 million all within one year. The Waggetts purchased a number of Carolina Beach properties totaling $18 million within a 14-month period, including this duplex at 1204 Canal Drive currently in foreclosure.”

Here’s another quote, "It’s highly unusual for banks to make more than a couple of loans at a time to novice investors – even those well known in the community as successful business people who had the wherewithal to make their loan payments, said Tony Plath, associate finance professor at the UNC Charlotte Belk School of Business.

“You only take on a few projects from a new developer at a time. You need to be able to generate operating cash flow,” Plath said. This enables the investor to sell a property to gain cash to pay on these short-term acquisition and development loans.

This, however, doesn’t appear to have been the banks’ practice in the Waggetts’ case. “It does not appear that the Waggetts sold any of the property that they invested in,” Stubbs said."

The article goes on and on for five pages, and it gives a pretty clear picture of how it happened.

The investors weren’t buying property to live in, they were speculating, and so were the banks. It wasn’t fraud, it was greed and laziness. Nobody wants to make money, they just want to get money.

Oh but hey, if you want to believe the bankers were swindled by Bill Clinton, go right ahead.

52

Alas, the poor bankers! Friendless, bereft. You would think that at least in a Republican administration the could find a sympathetic ear, but no, no, the corridors of power are closed to those who only have huge piles of money to recommend them.

53

I thought I’d chime in because there is one poster who seems to be just barely well informed enough to be dangerous.

Many of the facts are true but how these facts are applied to the mortgage crisis is patently ridiculous.

Fannie Mae has been around since the new deal providing a secondary market for home mortgages. Then in the late 60’s We created Freddie Mac and Ginnie Mae. Freddie mac was the kinda sorta private company that enjoyed an implicit federal guarantee and Ginnie Mae was an actual government agency.

They promulgated standards for conforming mortgages, which described everything about the mortgage from the down payment to the size of the mortgage to the creditworthiness of the borrower and their ability to pay. Conforming mortgages enjoyed better interest rates because banks were able to flip these mortgages to Fannie and Freddie and make a spread without tying up any of their capital.

They still made mortgages to folks who wanted larger “jumbo” mortgages but they generally required all the paperwork, credit scores, loan-value ratios, income verification, etc. that you would expect with a conforming loan but they charged a higher interest rate because they would have to carry your loan and that required tying up some of their regulatory capital and they charged you for that.

They also made mortgages to folks who didn’t quite meet the documentation criteria because there were cases where the verfiable income didn’t really reflect the person’a ability to pay a mortgage. For example, the local banker knew that the local car dealer could afford a million dollar home but didn’t have enough historical income to qualify for a mortgage because they were either not taking the money out of the business or they were cheating on their taxes. So they would let them write a mortgage on stated income without documentation.

Then in the late 70’s they passed the CRA which was meant to deal with things like redlining (which was actually started by the FHA). This pressured banks to start writing subprime mortgages in poor neighborhoods, they cherry-picked what they could but most of the borrowers failed at least one requirement for conforming mortgages. So then they passed another law that required Fannie Freddie and Ginnie to dedicate some of their resources to creating a market for these mortgages. They basically threw the credit scores out the window but they maintained everything else (from the loan to value ratio to the income and down payment requirements).

Then during the Clinton era, they started deregulating the banks and banks started to merge like crazy. One of the things that folks needed for these mergers was approval from the Department of Justice anti-trust department. One of the criteria that the Justice department looked at was compliance with the CRA. All of a sudden your mergers became more viable if you made subprime mortgages and everyone either wanted to buy someone or get bought by someone. Before you knew it, banks started lending in black neighborhoods and selling the mortgages to Fannie Mae.

Now I should have mentioned that Freddie Mac and Ginnie Mae basically created the securitization industry. They securitized their mortgage portfolios and used the money to buy even more mortgages. It was all conformings mortgages and it was sold to insurance companies and pension funds. It was more of a financing vehicle than a profit center.

Up until then the market for private label mortgage backed securities was a fairly small portion of the mortgage securitization market because the market for these securities was largely stodgy old pension funds and insurance companies. Then people started adding credit enhancement to their securitizations and all of a sudden these securitizations were producing tripleAAA rated securities and the market exploded.

Now, over time the banks had compiled data on how subprime mortgages performed and relative to the interest rates they could charge for these mortgage, it was profitable, default rates were not really very high and the underlying collateral always seemed to be enough to make the lender whole. This meant that if they took a bunch of this stuff and chopped it up just right, they would be able to collect their spread while creating enough tripleAAA rated securities to replenish their lending capacity. People just couldn’t get their hands on enough of the stuff.

The collapse was caused by several failures across the system but it was all driven by huge never before seen profits in this sleepy little corner of the finance world.

It wasn’t the CRA, the CRA had been around for decades and there were no legislative changes during the relative time period that would have contributed to the problems we saw. You would have to be on some sort of mission to blame the CRA to come up with an argument that blamed the CRA and that is exactly what folks who wanted to blame a Democratic construct did.

It wasn’t Fannie mae/Freddie mac/Ginnie mae. These organizations had been around more or less in their present form doing what they have always done for at least 30 years.

It wasn’t even securitization which has been around almost as long as freddie mac has been.

It was a confluence of non-bank mortgage lenders (like countrywide), a deep demand for even slightly higher tripleAAA yields, a relaxation of regulation and oversight, an administration with an unpopular war with an economy that seemed to be running solely on the housing boom, an Ayn Rand worshipping Fed Chair that didn’t see any problem with the situation and most of all greed and the lack of political will to temper it.

54

Later, in response to Voyager, you say, “No, the trigger wasn’t subprime loans, it was actually negative equity.” Ah, but why is there so much negative equity? Obviously, because prices collapsed. But why did prices collapse? Liebowitz doesn’t address this. As I said, my recollection is that it was because the credit market dried up. And a major cause of that was the subprime defaults. I’ll agree the problem soon became much broader, but the OP asked what caused the meltdown. If you’ve answered that question, I’m afraid I missed it. Please point me to the relevant post.

55

Negative equity was the result of prices falling. How could prices falling trigger falling prices?

People with balloon mortgages they could no longer pay (or refinance) got foreclosed on, which put more houses in the market and started the tumble, which did create negative equity - also for those whose indebtedness was very close to the original house value, and so were sensitive to any fluctuation. I’ll agree that the big problem today is negative equity, definitely.

56

There shouldn’t have been negative equity in the first place. Putting 15-20% down allows for the price of the house to fluctuate without putting the mortgage underwater.

It wasn’t that long ago that people en masse stopped putting money down, because they all expected the house value to go up and “create” equity for them. That single behavior (and not subprime borrowers) shifted the nature of mortgages.

All it took was for house prices to stop going up, check that, all it took was for house prices to stop going up as fast, for a massive number of mortgages to suddenly be underwater. I guess I shouldn’t say suddenly because the mortgages started underwater.

So as a borrower, if you mortgage is underwater, and you face a significant shortfall, you could either sell the house and pay cash out of pocket for the difference, or you could foreclose and walk away.

If we simply pretend that house prices moved in a nice smooth curve going up and up and up until finally cresting a bit, everyone that bought within two years of the top was underwater. And up until this point, foreclosure rates had been nice and steady. But now, all those buyers have an incentive to foreclose.

What’s important here is to realize that with the foreclosure process, the bank wants to liquidate the asset and get their money. Traditionally when their was positive equity it made the banks look like the bad guys, because they didn’t care about getting a high price for the house, they wanted to unload it and cover the loan.

When that starts happening after prices are already falling it’s going to accelerate the fall.

As a personal example, in 2008 a friend of mine was trying to sell a townhouse so he could move into a bigger house they had already bought. The day that the forsale sign went up, three other townhouses in this community were being foreclosed on. There was no way he could get even a reasonable price for his property, nearly eroding all of the equity he had put in.

Contrast this with a friend that owned a condo and needed to move for a job. Same scenario played out, but he ended up in negative equity and actually went through the process of foreclosure–depressing the value of the other condos in his building. The guy is making over $100K a year, and so the bank wouldn’t participate. Now he’s renting it at a loss.

So to recap: people buying houses without putting in any equity were dependent on the markets continuing to go up. When that started to slow it began pushing people into negative equity thus forcing foreclosure. This in tern further slowed price increases, pushing even more homes into negative equity.

It actually reminds me a lot of the lead up to the Great Depression. Where people had been buying stocks on margin–that is to say using credit to buy stocks.

It’s a great plan as long as the stocks are going up faster than the interest on your loan, and for a while a lot of people made a lot of money. It was the roaring twenties, from 1915 to 1930 the down went up 600% an average of 40% per year. Even a loan at 30% made good returns.

But when stocks stopped going up as fast, people found themselves owing money they didn’t have. Thus they have to sell their stocks at a loss, causing the stock price to stop rising. This means more people are getting margin calls, so more people are forced to sell, so the stock price starts to fall. Now even more people are getting margin calls, forcing them to sell too.

It wasn’t the balloon mortgages, they made up a very small number of the actual foreclosures, and research showed it took a change of 4% in the interest rate to push people over the edge. The balloon mortgages would have been fine people had bothered putting in some equity.

57

Prices didn’t have to “collapse” they just had to stop rising as fast.

As an example, house prices were going up so fast that people could simply buy then sell (aka flip) and make money. So this got factored into mortgage plans.

People figured house prices were going up 20% every year, so they could buy a $100,000 house for $120,000 without putting any money down. And that would be okay, because next year it would be worth $120,000 and the year after that it would be worth $144,000 (now they’ve got 20% equity).

Notice the way that worked: people were overpaying for houses on the assumption that the price would keep going up. They started with negative equity. Hell, even if they put money down they were still getting a mortgage for more than the house was valued at.

So prices didn’t need to collapse, if they only went up 10%* in a year that person was still screwed because they were counting on it going up 20%. They had a $120,000 mortgage on a $100,000 house, but it only appreciated to $110,000. At the very least they need it to appreciate faster than their interest rate.

Am I making sense?

And the most important point is that without any equity in the house, foreclosure is their only option (unless they can cough up the $20,000 shortfall).

I guess it was said a little better earlier, houses were being trading like stocks. So just like stocks, the price peaked and fell then caught a lot of people that bought on margin.

*don’t forget interest rates were a lot higher then.

58

You’re making sense, but I think you’re mistaken. :slight_smile: Using your numbers,they weren’t buying $100,000 houses for $120,000; they were buying $120,000 houses for $120,000 And to get each loan, the houses had to appraise for that value based on comparable sales. But all of this assumed a certain credit market, which vanished almost overnight when lenders got antsy (the real lenders, the ones buying the securities). My recollection is that it was the subprime defaults which caused that, but I’m open to having my ignorance fought. After all, I’m just going by recollectoin. But I was following this pretty closely at the time for the benefit of a friend who was/is one of those investors we hear so much about. Nice person, very responsible (sterling credit), but didn’t really understand the risk. I tried to get her to sell about six months before the market tanked. Unfortunately, she wouldn’t listen. And, yes, the value of her investment collapsed.

59

People were overpaying for houses in retrospect. For at least five years, in California at least, the overpriced houses one year seemed like bargains the next. With the small increase in wages during the Bush years, people who waited to save 20% kept on getting further and further behind.

Lack of increase per se doesn’t hurt anything, assuming normal mortgages. After all, house prices have risen only nominally for most of the past half century. A couple of things were different this time.

First, low introductory rates. Many of these mortgages were written to be difficult to get out of. Even before the total collapse, there was concern about how many of these were flipping to higher payments. I don’t see how having equity makes an unaffordable mortgage affordable.

Second was home equity loans written on the supposed equity increase. The ads for these made them sound like free money. I suspect most people don’t really understand cash flow. But these got written for positive equity, and just made the system more volatile when the crash did come.

You haven’t yet given a clear process of how the crash started. A combination of balloon mortgages blowing up, subprimes which couldn’t ever be afforded, home equity cash flow problems which couldn’t be postponed by getting another loan off more equity when the market slowed all pushed it over the edge. That caused true negative equity, which is where we are now.

60

So let me see if I got this right?

  1. Competition increases with Japan for electronic items not through outsourcing but through their own business they run more efficently with better quality over time, around in the 70’s and 80’s with a population of around 80 million.

It has some effect on similar business’s in the US, but is small number in the overall scheme. But is the first domino to fall no doubt.

  1. In comes Nafta, Bilateral Free Trade Agreements, WTO, Worker Visa’s etc which in conjunction with the past policies and a larger global work place, (India, China, Mexico, South America) ~ 3 Billion is bound to have a dent, and it has based on the stagnating wages in US.

Its about quarterly profits and making a fast buck. Not long term growth but Greed.

Corporations no longer have Americans nor whats best for America, since they are now global entities. So I ask, why should any policies in America benefit them since they are not for America? They most certainly should not have any say in our government.

  1. To keep up with the stagnate wages due to outsourcing, and since most of the money being made is being stuck into investments in casino’s like wall street and setting up companies off shore, rather than long term business growth in the US, easy and cheap credit is made available via Visa, Mastercard, American Express etc to bridge the income gap.

  2. Then comes the Housing Bubble as another former of easy credit. In 2007, The Median Household Wage in the US was 50,000 with the Median Housing Price at around 260,000, which violates the two to three year household income standard when buying a house. So they have a lot further to fall.

  3. But the government in collusion with the banks are fighting tooth and nail to keep the prices artificially high. The government benefits from the taxes they take in, the banks and Wall Street
    benefit in order to keep those investments and bonuses coming in.

  4. With credit dried up, people don’t have the money to borrow to spend, nor do business’s Cutting taxes will not help business’s to create jobs if there is no demand for their goods.

Business’s exist to make a profit, not to create jobs anyhow. The massive outsourcing we have seen in the last few decades was not some moral crusade to raise the standard of living as we have been told for Americans and others abroad, but for profits and greed.

With 1 billion in India, 1 Billion in China, another billion or so in Mexico and South America, Your job is not safe, and voices are already talking about austerity measures and how good we have had it, and to buckle down and know our place. Most of those voices come from those at the top whom have no intention of buckling down and were the ones that sold us down the river.

It’s all good though, since record bonuses are being passed around for those on Wall Street, Corporate CEO’s and crooked politicians in our government that pretend to be Democrat or Rebuplican in order to divide the country. The polices erected the last few decades all had a helping hand from both sides of the aisle.