We have looked at how this current economic crisis began before and as we like to say, "All this has happened before and all this will happen again." We looked at the creation of the Federal Reserve and how it has caused economic havoc many times over.
By now most people have the knowledge that the current financial crisis began in 2007 because a large number of homeowners began to fall behind on mortgage payments that they couldn't afford. But, how did a relative small number of people not making their mortgage payments bring about a global economic meltdown?
My opinion, as well as others such as, Michael Moore's, as seen in his documentary "Capitalism: A Love Story", the answer is GREED. Way too many people were interested in how to make a quick buck than making good financial decisions. "If you choose the quick and easy path you will become an agent of evil", as Obi-wan Kenobi once warned Luke Skywalker. Mortgage lenders began to stop verifying if borrowers actually qualified to buy a home. Loan were virtually being given to anyone who applied. Wall Street bankers and hedge fund brokers juiced up lenders to give out loans so they in turn could make tons of money off them with a new round of creative investing schemes. While most borrowers were too confused or too clueless to understand the types of mortgages they were getting into, others knew exactly what they were doing and didn't care they were buying homes they couldn't afford. So there was so much good old fashioned greed to go around.
It wasn't always this way. And in a very short amount of time people quickly forgot how things once were. In the not so distance past when you wanted a mortgage you went to the bank with your last two years tax returns, your last two paystubs to verify your employment, and your last three months bank statements to verify that you had savings that would allow you to put 20% down as a down payment. The lender would than review your finances making sure you had enough income to cover your mortgage payment comfortably, including property tax and homeowners insurance, and you weren't overwhelmed with other debt. You had two choices for a mortgage: a fifteen year fixed or a thirty year fixed mortgage. You wouldn't have to worry what your payment was going to be five years down the road. There were adjustable rate mortgages, but in rare circumstances. You either had an FHA or conventional fixed rate loan. If you were approved for the mortgage both you and lender new what your payments were going to be and chances were, as long as you didn't become unemployed or something, you were going to be able to make the payments. If the lender didn't feel you were going to be able to make the payment for the next thirty years or until you sold the home you were denied the loan. It was as easy as that. This protected the bank and it protected the borrower from foreclosure.
Things began to change between bankers and borrowers in the 1980's when Fannie Mae and Freddie Mac came into the picture. Fannie Mac was created in 1938 and Freddie Mac followed many years later in 1970. Both were government sponsored enterprises, known as (GSEs), they were not full fledged government agencies, but they had the impression of being government backed. Both of the GSE's had the mandate to increase the amount of money available for mortgages. They would do this by buying mortgages from lenders so the lenders could lend out more money. Fannie and Freddie would package mortgages that they had in their portfolios, as well as they would guarantee mortgages that Wall Street could package and sell to investors. This process promoted homebuying by allowing the lenders to have more money to lend to homebuyers, which in turn allowed more people to buy homes.
As this went on it became more likely that the original lender would not hold the mortgage, but would instead sell the loan packaged all nice and neat to Fannie or Freddie, or their cousin Ginnie Mae, and Wall Street. Mortgage securities were new income products that were backed by solid mortgages. lenders were still careful to make loans only to qualifying borrowers. The problem with all this began when Wall Street and greedy lenders began cooking up a horrific scheme, almost like a giant pyramid scheme, which turned into a ticking time bomb that the Federal Reserve helped put in place.
Remember the Technology stock boom in the late 90's? Well, when the tech stock bubble burst in early 2000, than Federal Reserve chairman Alan Greenspan attempted to keep the economy from slipping into what could have been a recession of the type we are experiencing now, by slashing the Federal Funds Rate. From 2000 to 2004 the funds rate fell from 6% to 1%. Currently it is at 0%. With rates being so low, Wall Street began to introduce an investment that appeared to be safe and offered higher yields than normal bank CDs and money market accounts were offering at the time. The so called brilliant minds of the financial sector had set their sights on mortgage backed securities. Not only were they packaging loans from qualified borrowers they decided to take on mortgages from not so qualified borrowers. Loans known as subprime mortgages were made to borrowers with what I would consider to be bad credit.
But this was only the first stage of their financial coup. Wall Street started churning out what is known as Credit Default Swaps or (CDS) tied mortgages. The CDS were insurance that promised investors who invested in mortgage backed securities that they would get paid even if your mortgage went into default. Wall Street was also able to take a huge gamble on mortgages using CDS.
But wait, the worst is yet to come. With their giant pyramid scheme in place, the only thing that Wall Street needed to get around was how to increase the amount of subprime borrowers. This is when the number of unconventional mortgages, like interest only, pay option ARM's, and 1 year ARM's with low initial payments increased. These loans were insane and had grown from 2% of the mortgage loans available in 2003 to 20% in 2005. When I was a loan officer back then, I remember thinking these borrowers should not be getting loans and we were going to have a big problem one day. The applicants qualified so there was nothing I could do. All these borrowers basically had to do to qualify was have a heartbeat. No tax returns or paystubs to prove your income. Even better, if you didn't have the money for a down payment it was no problem. We would just give you a loan for the down payment.
We pushed these loans left and right and the mortgage companies didn't care about these risky loans. Why? Because it wasn't their problem if the borrower didn't make their house payment. How can this be? The loans would be sold off to investors and the investors didn't care because the guaranteed they would be paid because of the Credit Default Swaps.
Lenders couldn't do the loans fast enough. We were doing some loans from start to finish in one day. Twenty-four little hours. Borrowers were also encouraged to take out the biggest loans possible. Everyone dived in to get a piece of the pie. Driving home values through the roof.
But in late 2006, cracks began to show in the foundations. Borrowers with Adjustable Rate Mortgages (ARMs) began to see their first rate increase and increased mortgage payments. Many were shocked to receive their new house payment that was beyond what they could afford to pay. Most people had thought if this happened that they would be able to refinance, but guess what. The Federal Reserve raised the Federal Funds Rate, which was 5% by mid 2006. What do you know? The good Old Federal Reserve as usual. New loans would now be higher than what they were now. Now to pour more salt on the wound, real estate prices began to stagnate and with no down payments on the homes borrowers had no equity. So, with no equity no matter what the interest was, borrowers didn't qualify for a refinance.
When 2007 arrived, there were even more people who couldn't afford their house payments. They couldn't refinance and they could not sell their homes since property values fell. This was the nail in the coffin as the bottom began to fall out from this giant financial scheme. A catch twenty-two that we are still suffering from. The foreclosure rate started to rise. With the increase in foreclosures came the increased drop in home values. This has continued on and on and continues to happen today.
So what actually happened? Lenders were making loans to borrowers who couldn't afford to pay them back. Wall Street egged on lenders and borrowers, telling them it was alright because the Credit Default Swaps were a golden parachute.
There is even more to all this, but this is it in a nut shell. Everybody drank the Kool-Aid. Wall Street pushed the lenders, the lenders and real estate agents pushed the borrowers, and borrowers egos were stuffed to the gills living in these huge homes they couldn't afford.
Others knew as I did, we had trouble brewing. I was often called the "judger" and I couldn't say who should by a home and who shouldn't, which is true. Lenders can't be discriminating. But it didn't take a rocket scientist to know what is wrong and what is right. And this whole thing wasn't right. But it may just take a rocket scientist to get us out. Or some good old common sense, which we lacked when we got into this mess in first place.
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