People often say that as a result of the crash millions of people lost their homes before they could pay their mortgage off. However, it also seems that the housing crash was directly a result of millions of people defaulting on their mortgage payments. Are both true? Is it just a roundabout way of saying that irresponsible bankers offered mortgages to clients when they should have known they would default? Does this claim have anything to do with changing interest rates, unemployment or the depreciation of housing prices?
In: Economics
It was part irresponsible spending (taking a mortgage with balloon payments that they knew they couldn’t afford) and predatory lending practices by offering mortgages that the bank knew would default. It didn’t matter to the original bank because they sold it right after they made the loan, but someone eventually gets caught with the bill.
Pretty much your conclusion is correct iirc. They gave them the kind even though they knew they’d likely not be able to pay it off.
People were buying houses they really couldn’t afford and due to things like stated income and negative am loans, they were able to. Many would refi every two years or so and due to home values rising, were able to take cash out and get into another questionable loan.
When home values started to flatten and then drop, people could no longer get cash out and since they were upside down, they were forced to pay those ballon mortgages and such.
The general public consensus is probably a bit prone to a less than nuanced understanding of the matter – the narrative of “bad predatory banks” vs “naive borrowers”.
There was failure. The system was somewhat self regulating. Banks did not lend to “risky” borrowers. There are two major push factors – people want to own houses and, generally speaking, there was political weight behind this. Counter to this pressure were that banks and investors who had funds did not want to assume too much risk.
The 2007 breakdown had several “causes” and this varies depending on what narrative one would be more inclined to accept. Post 2000, there was a shift away from the stock market and there was money available. A lot of this money shifted into real estate and this caused a rapid increase in real estate prices. Rising home prices, “reduced” the risk of lending (this is what makes a bubble).
With more and more interested money, creative financial folks designed new security products (CDOs for example) to allow more institutions to invest in mortgages. These products were complex and highly leveraged – so much so that even these big institutions didn’t really know what they were buying into. Through these investment products, banks could quickly resell even lower quality (ie riskier) mortgages to these institutions – and so they did.
Now the banks had even more room to offer mortgages – sooner or later they were giving loans away and it seemed (to the populace and government) that there was this dream scenario, more people could buy homes, home prices rose, banks made money, institutions had some good financial products to invest in. Win-win for everyone.
It simply couldn’t last, there are just so many people who could afford these loans, there is just so much money available for investments. Once new money looked to slow down, it didn’t take too many people defaulting for home prices to stop rising. The house of cards started to crumble.
There is more than enough blame to spread around. Regulators who should have stepped in and scrutinized these “risk free AAA” products, banks that should not have relaxed their lending guidelines, institutional investors who should have better understood these complex derivatives (or at least limited their exposure), homebuyers who unreasonably borrowed off the fantasy that home prices are always justified and will always increase, speculators buying multiple homes trying to “flip” a quick profit.
This is a long and fairly complex story, below is a simplified version…
Taking a step back: When you take out a mortgage the bank doesn’t hold onto it. It’s not like in “it’s a wonderful life” where the Savings and Loan (btw – that’s another financial crisis to look up!) holds onto the mortgage and using incoming revenue to write new mortgages. Instead they bank promptly sells it to a bigger bank – if you ever take out a mortgage you’ll get a letter about 6-8 weeks later telling you it’s now owned by a different company, with instructions on any changes to where you send your payments. Your bank gets all their profits from the loan immediately and now has $$$ on hand to issue another loan. So their incentive is to write as many loans as possible.
The bigger bank might then sell a giant package of loans to an even bigger bank, and so on. Same deal. Eventually you run out of big enough banks. So in the late 90’s to early 00’s the financial sector came up with “mortgage backed securities” – giant packages of loans that they sold to pension funds (the biggest banks on the planet) or to the stock market. This kept money coming in to the bigger banks to keep buying loans from the smaller banks so they could keep writing new loans.
/ this is long, bear with me.
These offered really good returns for the risk profile so it was easy to sell them.
Problem was – they were lying about the risks. Along the way all these super high risk loans that should never have been written were being packaged up with ultra safe loans so the whole package got a really good risk rating. Then they’d slice and dice the packages again to put more and more high risk loans in – gaming the system to get AAA ratings for products that should have been C/D rated. The super high ratings meant that things like pension funds were under a lot of pressure to buy them because the risk profile pensions operate under means a significant portion of the fund has to go to the very highest rated assets and aside from Treasury Bonds almost nothing comes close to AAA, and treasury bonds give a really bad return on investment- which they can get away with because they’re a safe asset.
They were able to keep this up for a while because the house market was constantly rising so any loans that defaulted were easily sold for more than the loan value and everyone who was owed money got paid.
Then it got to the point that so many loans were defaulting that they couldn’t keep it hidden anymore and cracks started to show. House prices stalled out, and started falling. Now there wasn’t enough money from the sales to pay everyone so all these giant financial funds started to look closely at what they’d been sold and realized they were sitting on garbage loans that were going to default.
So they stopped buying loans.
So the big banks stopped getting money to buy loans from smaller banks.
So the smaller banks stopped getting money to write new loans.
So the access to credit to fuel the housing market boom vanished.
So house prices fell.
This meant anyone who’d bought a house and defaulted was basically out their life savings because their deposit was nuked. So they stopped spending money in the rest of the economy.
It also meant all these giant financial institutions at the top didn’t have any money to write loans for other types of business venture, which tanked a large portion of the economy. This resulted in even more people losing their jobs and having to sell their homes, which tanked the housing market further, and wiped out a huge portion of their life savings. This cycled a few times for about a year hitting various sectors of the economy and putting loads of people out of work and caused a lot of loan defaults so a lot of people lost their homes.
Looping back to the initial question you have on defaulting – one thing that helped fuel all this were “ARM” mortgages – these offer a short term at a very low interest rate and then the rates increase substantially. These were used to write mortgages to people who should never have been given loans – the low initial payments allowed them to be able to service the loan for a few years, but they would never be able to make payments once the rates started adjusting – but when the banks stopped writing loans as easily these people couldn’t refinance so were fucked and lost their homes.
There were other similar high risk products going on too – loans that were interest only for a few years, so the borrowers weren’t even clearing their loan balance, loans with “balloon payments” where large lump sums are due in certain years to enable overall lower interest rates, and a lot of “refinance” loans given to people who were facing financial difficulties so tapped into their home equity- borrowing against an inflated home value. All these groups ended up in a lot of trouble.
People lost their homes because they defaulted on their mortgages and the lending banks foreclosed on them, taking back the house for not making payments.
If home owners could afford their mortgage, they weren’t having homes taken back from them. But for a time, banks were making home loans with higher risk than typical, due to demand for mortgage-backed securities (bundles of loans which act like a bond, paying regular interest). Instead of the usual 10-20% down on homes no more than 3-4x income, there were all sorts of minimal down payment loans, loans without debt ratio guidelines followed. Even loans where buyers didn’t need to prove their income of assets!
But people was under the impression that real estate prices could never fall, so they hoped they could just hold on long enough to sell for more money in a few months. There were instances of people making $20k/yr taking on $700k mortgages, hoping they could make the mortgage by having a bunch of friends move in and pay rent, then sell for $800k next year and pocket the profits. Or new construction high rises with investor-friendly terms like 1% down, guaranteed rent for 2 years, no condo assessments for 2 year. Well you’d get some dentist who imagines himself a real estate mogul buy 10 or 20 of those units for les down than a modest new car, with idea he could just sell some units for profit when those incentives expire in 2 years, and keep rest as investments.
When prices leveled off or fell, many were screwed. They couldn’t make payments or sell for enough to break even. Banks were overwhelmed with foreclosures and banking system couldn’t lend on new loans due to loses. Home prices fell as there were no new buyers for this sudden glut of houses. Issue snowballed. Investors turned in keys, walked away from underwater investments. And so on.
The housing crash was basically
1. Banks gave loans to anyone who wanted them
2. Banks allowed ridiculous loans. Like negative interest loans. With this people owed more per month rather than paying the loan down
3. Housing prices were skyrocketing so everyone wanted to buy a house. Buying a house and holding it for 6 months was seeing huge returns. This made negative interest loans not so bad.
So you have that in place. Now suddenly the housing market dips.
1. Banks start for closing on loans because they aren’t being paid. They then sell the home asap. Banks usually sell for less than the loan amount
2. More homes means the price drops.
3. Banks foreclose on more homes because people didn’t pay their loan. Banks sell for way under the loan amount.
4. The price of homes tanks
5. People who could afford their loans are now owing $250,000 on a house worth $100,000 and choose to default on the loan instead.
6. banks foreclose on those homes and lose a shitload of money.
7. Banks stop loaning out money because they don’t have money.
Both are true. Mortgage brokers were selling subprime mortgages to unqualified buyers, subprime means the payments started out lower for a few years, normally this is done when money is expensive expecting that in 5 years the economy will be better and you can refi at a better rate.
But they started sneaking in a lot of unqualified people, sure just tell them you make 200k a year, borrow some money to put into a savings account, see you have money, then give it back.
They didn’t think it mattered because prices kept going up and up, so even if you defaulted in a year, the bank got the house back and could resell it for more….eventually it got so crazy that some farm laborer making minimum wage was sold a half million dollar suburban house.
The bad thing for ‘normal’ folks, those who could afford it, even folks who just wanted a 2nd mortgage to fix up the house, get a new roof etc, they were sold on these underfunded mortgages even if they didn’t need them…
Now, the banks wake up from this drug like cocaine binge, realize their in deep with a dozen hookers and back out as fast as they could.
Since everything was so toxic, banks weren’t touching anything. The subprime balloons, the huge amount that built up while they weren’t paying the full amount from the start, were becoming due, and nobody was willing to refi. So your half price mortgage goes up to more than normal price…. but….
The prices of houses dropped so much, half because the prices were inflated before as so many people were buying houses, not only for themselves but for investments, buy one, roll it over into a 2nd, then a 3rd house….prices crashed….
so regular working people not only couldn’t get their homes refianced, but were paying a mortgage on a house that was only worth half as much (underwater)
I had several friends who walked away from their houses because they couldn’t afford to pay the mortgage anymore and couldn’t refi…
Banks didn’t help either, there’s no bonuses for keeping people in their homes, it didn’t matter that they were going to loose more money evicting someone that if they cut them a deal and kept a paying customer in place.
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