Sunday, October 19, 2008

Facts About the Current Housing Crisis

I am sure you've heard things like the "Housing Crisis", "Fannie Mae", "Freddie Mac", recession, depression, credit freeze, etc. being thrown about, but if you've tried to google it, it's hard to find something that just explains it in plain English. I am no expert, so I have just compiled a few articles which you can find the resource HERE, and HERE and HERE.

Fannie Mae (aka Federal National Mortgage Association) was originally founded right after the last depression in the 30's as a part of the New Deal (remember that, think back to US History in High School). It doesn't give loans, but instead it serves as a kind of guaranteeor for loans that lenders makes. In 1999, Fannie Mae came under pressure from the Clinton administration to expand mortgage loans to low and moderate income borrowers. At the same time, institutions in the primary mortgage market pressed Fannie Mae to ease credit requirements on the mortgages it was willing to purchase, enabling them to make loans to subprime borrowers at interest rates higher than conventional loans. Shareholders also pressured Fannie Mae to maintain its record profit. In 2000, due to a re-assessment of the housing market by HUD, rules were put into place that disallowed risky, high-cost loans from being credited toward affordable housing goals. In 2004, these rules were dropped and high-risk loans were again counted toward affordable housing goals.

*translation- Fannie Mae allowed people, who normally couldn't qualify to get a mortgage due to credit rating, no down payment, etc., to all of a sudden get a loan. Then they thought, oh crap, that might get us into trouble so they tried to set up a few rules to restrict it. But then in 2004, they thought those rules were too strict and EVERYONE deserved to get a home loan if they wanted one, so thus we are in the problem we are in right now. People began getting into "high risk" loans, such as ARM loans where after a few years your interest rate goes up. Because these people who should never have really gotten a loan in the first place, were already on their tippy-toes to make their regular mortgage payment, once their interest rate went up they would get foreclosed on. Which all of a sudden put all of these unpaid mortgages into the system and started overloading.
Before you start spouting off on an anti-republican tirade, note it is not entirely Republican's fault just because this happened on George W. Bush' watch (not saying he is completely innocent as free market trade might be a bit like thinking socialism works as well- in theory yes. But in practice people are inherently greedy). Even Bill Clinton thinks it's more on the fault of the Democrats, and I quote, "I think the responsibility the Democrats have may rest more in resisting any efforts by Republicans in the Congress or by me when I was President to put some standards and tighten up a little on Fannie Mae and Freddie Mac."
With that said, I think this current housing crisis really isn't Fannie Mae's fault if you ask me. I don't even personally think it's the government's fault. I don't think it's the Democrats fault. I don't think it's the Republican's fault. I think the blame lies with the mortgage lenders and bond rating companie's. They are the ones who approved these loans and secured them, knowing that these people would not be able to afford it once the interest rates went up. It was a greedy, money making scheme that we are now all paying the cost for.

Here are a few more facts about all the culprits who contributed to this downfall:
Mortgage brokers, banks and other lenders provided the funds so that unqualified applicants could buy homes. Brokers don't lend their own money but serve as middlemen, collecting commissions but sometimes without much regard to whether borrowers can make payments. Many banks weren't much better, selling loans to third-party investors while collecting fees. It didn't help that lenders unveiled innovative but risky mortgages, such as negative-amortization and optional-payment loans. Plus, many brokers and lenders never verified a borrower's job status, income or assets because they were passing the risk along.

Before the crisis hit, homeownership seemed more attainable than ever. Because many of the newest home buyers had borderline credit, they could qualify only for risky subprime loans. Many borrowers didn't understand their loan terms, especially the potential for payments to spike when low teaser rates expired. Nor were all borrowers honest, with some studies estimating most subprime applicants lied or omitted key information. Some borrowers may have tried harder to adjust to higher monthly payments but gave up when slumping prices left them owing more than their homes were worth.

Lenders packaged the subprime mortgages they generated for resale to investors on Wall Street, thus transferring risk down the line. These bondlike investments seemed appealing because they offered enticing yields for what buyers thought were low risks during a period of skimpy interest rates. Yet investors far removed from the mortgage-origination process didn't understand the risks they were assuming. Some hedge funds bought these securities with heavy use of leverage and got slammed when the market froze. The Bear Stearns collapse stemmed largely from the firm's hedge-fund exposure.

Many blame the central bank under Alan Greenspan for keeping interest rates too low and for boosting the nation's money supply too much. This created an easy-credit environment that encouraged less-qualified home buyers. It also created a period of such low yields that many investors sought better returns in securities backed by subprime mortgages. Critics also say the central bank encouraged investors to take too much risk because of its implied help in arranging bailouts — the “moral hazard” idea. A precedent was set when the Fed helped rescue a prominent hedge fund in 1998.

U.S. and state banking-oversight agencies, including the Fed here too, are accountable and probably deserve some blame for allowing excesses to multiply, from lax underwriting to the prevalence of mortgages with negative amortization and other risky features. Also, regulators didn't seem especially concerned by the concentration of some banks' lending portfolios in real estate — a problem that plagues Arizona. On the other hand, regulator attitudes are somewhat understandable considering residential real estate had never suffered a national slump like the current one. Few people saw the train wreck coming.

Firms including Standard & Poor's and Moody's rate bonds to help investors analyze the risk and return trade-off. Critics say the rating agencies masked the crisis by giving inflated grades to mortgage-backed securities underpinned by subprime loans. Critics also contend the rating agencies harbored actual or perceived conflicts of interest, because the investment banks that packaged those securities for sale to investors are the ones who paid for the ratings. Of note, the diversification created by linking dozens of mortgages to a given security didn't help lessen risk as expected.

So all of this leads us to the 700 billion dollar bailout we are hearing about.

The first thing to understand is that a bailout plan doesn’t have to cost anywhere close to $700 billion, so long as it’s designed well. The $700 billion number that you see everywhere is an estimate of how much the government would spend to buy deteriorating assets now held by banks. Eventually, the government will turn around and sell these assets, for a price almost certain to be greater than zero. So this $700 billion is very different from $700 billion spent on a war or on Medicare.
“Much of the discussion of the cost of the bailouts is getting it wrong,” David Colander, an economist at Middlebury College, says. “What matters is what price they buy the assets for and the price they sell them for. That’s where the real action is.” For a LOT more info on the bailout in plain english, read the NY Times article I got this from by clicking HERE.

Another thing you need to realize is this is a WORLD problem. Many countries all over the world were doing this exact same thing and now are having to have bailouts just like us. So it's not like our government was the only ones allowing the market to run free, it was all over the world. It was a trend that now most "progressive" countries are trying to pick the pieces up from. Many countries are going to have to insert much more than 700 billion (specifically into banks) to try and save their economy. This is a world-wide crisis, not just an American one.

Just because it's an election year, I am going to go all Republican on you and post this video. It is definitely produced by someone one far right, so of course it's biased. HOWEVER, there are pretty interesting facts in here that are worth taking a look at.

So the bottom line, what does this mean for you?

Well it will mean that the way you get a loan will largely go back to the way you've heard your parents and grandparents got loans. You will need a good credit rating, consistent and steady employment history and you will need at least 10% down. They say that the days of 100% home loans with no money down, roll in all fees are now a thing of the past.
Because of the financial strain, plus all of the Wall Street failures, banks are very wary to give new loans... so thinking of selling your house? You may not want to for awhile. You may want to ride it out for a few more years until everything rebounds.
HOWEVER, for those with good cash flow and great credit, this is prime real estate time for you. Houses are selling for 25% less than what they were selling for even just a year ago, so enjoy your pay day! This time will make a lot of people rich I'm sure.

I hope this helped you understand a bit more of what is going on. Feel free to comment and give me your opinion! I would love to hear it, though nothing you say will convince me that this is entirely the Bush Administrations fault. This crisis falls mainly in the laps of the private mortgage industry.


Aaron & Christina said...

I feel so educated now! Thank you for explaining it so well! And really, enough with the blame-game...lets just do something about all of this and move on! I can't stand listening to people who have a victim mentality...especially politicians! If you've got a better idea, lets hear it and get on with the remedy. I'm sure I'm a little naive when it comes to our goverment and keep these blogs a-comin' and I'll be the wiser for it!

Katie Leckie said...

I agree with you. I think that a lot that has happened is because of the lenders and such.

thanks for explaining it so well. There was a lot of information but very educational.

Brad Shull said...

I like this! Very Informative with just a touch of propaganda to spice things up.

It stinks that all of this happened at the tail end of President Bush's 8 years. Even though it is not entirely his fault he will be remembered for it always. It will be like what happened to Herbert Hoover during the Great Depression.

honeyjodie said...

very good post Des, you really laid it out in a way that simple people (me) can understand. I'm glad I have my house!

Riley said...

In the end, the rating companies are at fault for not being the gate keeper they are supposed to be. Greed is surely at the root, and on everybody's hands involved, but the door keeper opened the door by giving these a A+ rating as a commodity without a basis upon which to rate them.
But that's ok, you and I can pay their mortgages that they can't afford and pay all the parties involved for their screw-up... Thanks Congress!