How Did All This Happen to the Housing Market, and How Did So Many Investors Lose Money?
I was talking to a client yesterday and he asked the question, "How did this happen to the housing market, and how did so many investors lose money?" I realized that most people understood that people sold unrealistic mortgages but didn't know how the story began. It began by the initial low interest rates caused by the Federal Reserve's policies. This lead to a huge demand for housing and created a demand for mortgage-backed securities (MBS) with higher interest and higher risk.
The reason that this has never happened before is that banks had what is called "skin the the game." In other words, they kept the loans in house, and if the homeowner couldn't pay the mortgage, they would see how the result affected their bottom line. Now they didn't have to worry about what was written, because they were seeing the mortgages before they showed any signs of problems. Bank sponsors put together pools of mortgages which then were packaged into different interest rates.
During 2001-2005, the mortgage lenders were given higher bonuses and didn't worry whether the borrowers were able to pay or not. They gave out mortgages with no money down and no verification of income with a teaser rate as low as .25% interest rate. These borrowers never looked past the lowest rate which escalated quickly. It wasn't until 2008 that the FHA stopped insuring mortgages with no money down.
After these loans were written, they were sold to Wall Street who then proceeded to package and sell these MBS globally. Unfortunately, these subprime loans started defaulting at alarming rates and eventually led to the abrupt stopping of the sale of these securities but not before investors around the world lost money.
Even though they were created by federal agencies, Fannie Mae and Freddie Mac are owned by private shareholders. Both of these entities purchased more, and held onto more, of these MBS backed by subprime mortgages than any other group. They sold bonds to finance these MBS. In the mid 90's, the HUD secretary required that these two agencies devote more of a percentage of their business to low and moderate-income housing. But the year 2000, HUD praised these agencies for becoming involved in the subprime market and felt lower-income families and minorities would now be served. HUD forced these two agencies into that market to serve the targeted populations that HUD chose.
HUD was warned by consumer groups about these risky mortgages and their teaser rates but chose to do nothing. Many groups warned about the impending problems ahead. However, too many people were making money, including the banks, and therefore did nothing until they had no choice.
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