The New Mortgage Crisis – S&L Revisited

When things go wrong we sometimes look to blame someone else. When things go wrong for a company, it sometimes blames the government. But it's often the government that has to bale us out - take the mortgage meltdown we experienced last year. Perhaps this was the trigger that started the cascade of events leading to our current economic recession.

There are certain negative forces at work in the mortgage market, not all of which can be blamed on our government. Many banks are over extended with loans that are now less desirable than they were 12, 24, 36 months ago when they were originated. Perhaps they were anxious to please shareholders, avoid accusations of redlining, or any number of a dozen other reasons.

Those banks that made prudent lending decisions are more likely to be in better shape now than those that went out on a limb originated mortgages waiving sound loan-to-value ratios (for example 100% and 125% mortgages) and offering products like interest-only adjustable rate mortgages to borrowers and qualifying them on the lower monthly payment without consideration to future rate adjustments and income-to-debt ratios after the adjustment. This practice by some banks may have put borrowers in a position where they simply will not be able to afford the mortgage product when the rate increases.

Many prudent borrowers and lenders understood the risks and the rewards of these products. But many consumers did not and their lenders didn't clearly explain the risks to them - the risk should interest rates rise suddenly and sharply, the borrower might not be able to make the payment. It's almost as if the banks unintentionally set up these consumers for failure, default and foreclosure. As a result they set themselves up for increases in mortgage losses.

I'm not sure what it's going to take to turn this all around. Banks will need to return to making good lending decisions by tightening mortgage loan guidelines. Borrowers are going to have to buy lower priced homes using more conservative mortgage products - especially marginal borrowers who will need to just say no to interest only adjustable rates mortgages!!!

Like the S&L crisis of the 1980s and 1990s where more than 1,000 savings and loan institutions (S&Ls) failed resulting in a costly venture estimated at around $160-plus billion of which $125 billion was paid for directly by the U.S. Government. This resulted in a large budget deficit in the early 1990s - which we all paid for. The slowdown in the real estate market may have been the cause of the 1990-1991 recession. Between 1986 and 1991, new construction dropped 800,000 units to 1 million units per year, a historical low. Does this sound familiar? If not, perhaps it should.

The Wall Street Journal reported on January 17, 2008 that housing starts decreased 14% to a seasonally adjusted 1.006 million annual rate. The level of 1.006 million was the lowest since 996,000 in May 1991. The mortgage industry has been in melt-down mode for nearly a year. As stable economic conditions regress to recession (someday to be called the 2007-2008 recession), The President's agenda for tax relief is too little and too late. The 2008 Presidential candidates are too busy battling each other so their solution to our situation is not clear.

Are there parallels we can draw with the S&L crisis of the 1980s? Will the U.S. Government need to step in with a mortgage bail-out package? Will the government, the banks, the borrowers be able to halt our economic spiral downward? What would Alan Greenspan say about our current situation? Tune-in next week for the next episode to learn the answers to these and other important questions!!!