When the subprime mortgage crisis struck, everyone was looking for someone else to blame. It is very simple to blame members of Congress, banks, and even borrowers with less than perfect credit. The fact of the matter is there is more than enough blame to be passed around.
In order to understand how the subprime mortgage crisis started you first have to understand what the rules were For obtaining a standard mortgage. Most lending institutions required those who were purchasing homes to put down upwards of 20 percent of the purchase price of a new home. Unfortunately in many instances, the value of some homes were falsely inflated by not only the existing market but by real estate agents and appraisers.
Understanding property values
The first step in valuing a home is to determine the value of the homes. This is done by checking homes that are nearly by obtaining a fair market valuation. When market valuations are done they are typically based on recent sales, and adjustments are made based on what size the lot is, what amenities are offered, and other differences in the property.
In many cases, a real estate agent in setting property values would contact the local appraiser and tell them they were putting a home up on the market and asking them what the maximum price it could be listed for. This often started a cycle that was almost impossible to break. Buyers were paying too much for properties, lenders were lending money based on fake values, appraisers were misrepresenting numbers, potential new homeowners wanted their piece of the American dream and subsequently everyone paid the price.
While it may be simple to explain how the housing market got so out of control, none of this would have been possible without the lack of oversight that was created through deregulation. Lending institutions also played a significant role in the mortgage meltdown. Many did this by ignoring the simple mathematics that previously had allowed them to safely make mortgage loans.
A normal debt to income ratio is about 30 percent. This should mean that no more than 30 percent of your income would be needed to pay your housing expenses. Housing expenses include mortgage payment, insurance payment, and taxes. The the premise behind this is really quite simple – if no more than 30 percent of your income is going to housing expenses chances are very good you will never default on your loan. As more loan products became available (since banks are in the business of loaning money) more creative ways of ensuring somebody could obtained financing were created.
Adjustable rate mortgages
ARMS became the buzzword of the nineties. These lower interest loans allowed more people to qualify for mortgages. In effect an adjustable rate mortgage is much like your credit card, the rate starts off low and over time increases. Initially, adjustable rate mortgages were intended to be short term loans, allowing a potential homeowner to qualify for a loan, build up their credit reporting history, then go to their local bank for a standard mortgage. Unfortunately, all too often these adjustable rate mortgage notes contained fine print that included prepayment penalties, frequent changes in rate, and other hidden clauses.
For those borrowers who were first time buyers, those who were self employed, or those buying their first home these mortgages were extremely attractive. Many borrowers discovered very quickly that these loans were nothing but nightmares. In many cases the interest rate increased three months after the start of the loan. For those homeowners their mortgage payments took a significant jump shortly after the start of their mortgage. In the event that the borrower lost their jobs, became ill, or had other significant life changing factors what should have been the American dream turned into the American nightmare.
Sadly, in this day and age people spend more time reviewing their car loan contracts – which typically only last three to five years – than they do reviewing their mortgage documents which they are going to be paying for twenty to thirty years.
It would be unfair to suggest that every loan that did not have a fixed rate is a problem. There are thousands of homeowners who have successfully navigated the adjustable rate mortgage market. Unfortunately however, these mortgages were not always offered to borrowers who were financially savvy. Instead, unscrupulous mortgage brokers made their interest closing the loan versus considering the interests of the borrower. All too often these mortgage brokers had one goal in mind get the loan closed regardless of the potential long term consequences.
Enabling financial institutions
It is not unfair to place some of the blame on Congress. While the housing market was forming a bubble, Congress in their infinite wisdom encouraged additional lending and recommended to many institutions that they consider loosening their lending standards. It is however important to note before you blame Congress entirely that loosening lending standards was not the main cause of the subprime mortgage crisis. Not that Congress is without blame mind you, with a lack of oversight on how banks reported assets, liabilities, and income it certainly was a factor in this crisis.
The main cause of this crisis started with banks who loaned millions of dollars on home mortgages and then leveraged those loans to make their bottom line look better. The ultimate result of this leverage was that thousands of financial institutions who actually held billions of dollars in mortgage loans, thought they had it made. No one anticipated the bottom falling out of the housing market. Sadly, our society – when it comes to money – often wears blinders. We have a tendency to believe that the value of everything goes up and when it does start going up we refuse to accept the possibility that it can also come down.
When property values started decreasing, banks began having problems with their balance sheets. These problems were caused because the value of the properties which were so heavily leveraged was decreasing at rates that we had not seen in many years. When the dust started settling, banks quickly discovered that their leverage was gone. The ultimate result was banks were all but broke.
Fixing the blame
It is possible to blame Congress, Wall Street, the banks, unqualified borrowers, or anyone else that you feel might be responsible for the mortgage mess. The fact of the matter is that there is more than enough blame to go around. Congress, Wall Street, banks, and society, are all to blame. We are all too often an instant gratification society. This often means we must have the latest, the best, and the biggest. All of these things play a role in any financial mess.
Fixing the mess
It will take some time to recover from this mortgage crisis. In fact, it may take more time than even the experts are telling us. Because builders continue to build, developers continue to buy property, and because our banking regulations still have not been corrected, there is a good chance that this mortgage crisis will continue for a few more years. With housing inventories so high housing values may continue to decline. When housing values decline, those who need their home as an asset, that can be borrowed against, will soon find they are unable to leverage their home further causing them to have less money to spend. Too many people for too long have treated their home as a built in credit card.
Just as there is no single entity to blame for the sub prime mortgage crisis, no single group can fix it either. There must be a change in mentality – we don’t have to keep up with our next door neighbor – by society as a whole. Banks, Wall Street, Congress, and all our regulatory agencies must be held accountable. However, we will only do that when we decide to hold ourselves accountable for our own futures.