It may be almost a decade after the 2008 financial crisis shook the US economy, but economists and financial managers are still trying to snuff out the causes of this pandemic. The idea of a “housing bubble” has been used to describe the confusion and ignorance around the risks of the housing market leading up to the collapse. This concept connects many different pieces within the US housing market, from borrowers to lenders to big players on Wall Street. But it is difficult for economists to pinpoint one key cause of this crisis. So the magnifying glass has been placed on factors that encouraged Americans to own a home and banks to provide them loans.
Time magazine takes a look at figureheads that played a part in developing an American mentality that placed emphasis on owning a home. The Sandlers’ World Savings Bank supported this trend in the early 1980s when they introduced the option ARM home loan, which made owning a house (or rather a mortgage) easier. Then, during Bill Clinton’s presidency and economic prosperity there was deregulation and loosening of “housing rules.” The rewriting of the Community Reinvestment Act reflected the policies of Clinton’s tenure and put “pressure on banks” to lend to low-income neighbors. All of this was most likely of good intention, but consequently supported a culture of more the merrier in terms of houses and loans.
This view of financial crisis has been somewhat accepted in the past few years as concerned economists and politicians look to right the wrongs. But there are still questions around the source of this economic collapse. Realclearpolitics.com wrote an article on new studies produced by economists of Duke University, the Massachusetts Institute of Technology and Dartmouth College. These studies looked at loans and borrowers from the years leading up to 2008 and actually showed that many of the borrowers were not poor, but rather richer than initially perceived. New points and arguments are still being presented today on a crisis that occurred 8 years ago. But it is important to keep all of these economic factors into account as they will continue to shape the housing market and US economy. Not only is this important for us as economists, but home owners as well. Is it necessary to own a home? Is it the right time to own a house? One thing that the 2008 financial crisis has taught us is that the housing market is not risk free.
The federal government has encouraged home ownership since 1913 through the personal income tax code by providing a tax deduction for home mortgage interest payments. Unteasing the cultural, institutional, and economic forces is the challenge.
There were so many moving pieces to the mortgage market collapse that it is hard to keep count, let alone consider how much influence or responsibility each component had. One thing to consider is that mortgage delinquency rates and losses on mortgages and mortgage-backed securities reached a point where they were historically low, something approaching 1 percent in the run-up to the crisis.
No matter what kind of mortgage was originated or securitized, losses remained low, encouraging the continued loosening of underwriting standards by investors and lenders. Small or no down payment? No problem! Poor credit? No problem! No paperwork? No problem! Can’t even cover all the interest due in your monthly payment? No problem!
As the risks of losing money were small, and with poor-credit (and other) borrowers willing to pay higher rates, the opportunity for an investor to earn a premium investment yield at a time of otherwise low market interest rates was very compelling, so money kept coming.
Moreover, even when loans did fail and the incidence of loss began to rise, the severity of such losses to the investor were nearly non-existent; private mortgage insurance and quickly-rising home prices easily covered losses, and it might even have been possible to earn a profit if the home could be quickly re-sold after a loan failure.
In the days before the crisis, and as these conditions intensified, certain mortgage products began to show signs of stress — some mortgages had fully floating interest rates, and when the Fed began and continues to raise interest rates on a regular basis, some loans began to fail within months of being originated — it was noted at the time that some failed even before a single monthly payment was recorded.
Once it became obvious that some borrowers could barely afford to make payments at minimum, interest-only or even negatively amortizing, introductory interest rates, and with interest rates rising, a wholesale review and assessment of loans already on books began, and credit availability for the buyers powering the market dried up quickly. No credit meant no sales, and the corresponding fall in demand sparked the beginnings of home price declines, and more loan failures. Credit conditions prevented even marginally viable homeowners from refinancing, creating more loans failures… and “”down the rabbit hole”” we went.