Judy Chapman, an Illinois real estate professional, has presented some insight into the reasons the housing market crashed, taking along with it one financial institution, and crippling a few others. I think there could have been a drop in home prices without the legislative help that Judy cites, but not a full fledged crash as we have experienced.
The real estate crash didn’t just happen … it was orchestrated like a symphony.
Nothing as dramatic as seeing home values skyrocket seemingly overnight from the late 1990s until 2005, only to crash like a boulder, has happened just once before … in 1929.
Circumstances then were similar to now: banks were organized as unregulated conglomerates, money was treated like water, speculation was rampant, and unbridled greed was pervasive. Consequently, America along with the rest of the world descended into a Great Depression that lasted more than a decade.
In 2008, the financial markets nearly crashed as catastrophically as it did in 1929.
The crisis started with the bankruptcy of Lehman Brothers, then the fourth largest investment bank in the United States. The self-destruction of Lehman Brothers was no accident. The firm out-leveraged their investments 31 to 1, much of its exposure in subprime mortgages. Once Lehman Brothers failed, others toppled right behind it, setting up a worldwide monetary crisis.
When Secretary of Treasury Henry ‘Hank’ Paulson (and former Goldman Sachs CEO) got down on his knees and begged President George W. Bush and our elected representatives to save the country with the Troubled Asset Relief Program (TARP) Act of 2008, America and the world was saved from a complete meltdown.
Many, though, would argue that TARP did not save America. Ask the 4 million homeowners who lost their homes to foreclosure or short sale if it matters to them that Wall Street was saved. Then ask the nearly 14 million other homeowners stuck in their current homes because they’re either underwater or have less than 5% equity left in their houses. The combined 18 million homeowners — 30% of all homeowners — may have a different take.
So what … or who … caused the Big Real Estate Crash and Great Recession in the first place?
Was it homebuyers who bought more home than they could afford?
Or was it attributable to something much bigger? In fact, wasn’t the Great Recession caused by the systematic elimination of monetary protections that had been in place since the Great Depression and by laws enacted in the name of ‘deregulation’?
And was there a master conductor, if you will, waving his wand before the biggest symphony orchestra of all-time?
I’ll let you be the judge.
First, let’s cover the 3 laws that led to the Real Estate Boom And Bust.
3 laws responsible for the real estate boom and bust
Each of these laws served to deregulate the banking, investment and insurance industries but had far-reaching effects on the real estate market in particular and the economy as a whole.
Gramm-Leach-Bliley Act – Also known as the Financial Services Modernization Act of 1999, the Gramm-Leach-Bliley Act essentially took down the Glass-Steagall Act of 1933.
Glass-Steagall was enacted to prevent another stock market crash like the one in 1929. And it worked. There hadn’t been another instance of a Great Crash, Great Depression, or even Great Recession until 2008, nine short years after passage of the Gramm-Leach-Bliley Act.
Glass-Steagall was specifically designed to keep commercial banks, investment banks, and insurance companies as separate business. Clearly defined walls were established so that one large financial institution could not make loans to homeowners, for example, then package those loans and sell them to investors, and finally bet against any losses by insuring those investments through their insurance division.
Once the Gramm-Leach-Bliley Act passed, the rush was on. Like sharks in a pool of little fish, big financial companies swallowed smaller companies and rolled commercial banking, investment banking, and insurers into giant conglomerates.
From then on, one company could control everything, and greed rather than sound business judgment and wise investment choices took hold.
- The commercial banking division of a conglomerate could incentivize mortgage brokers to approve loans for homebuyers — many of them unqualified — in return for high commissions.
- Then the investment division could sell off the risks associated with any bad loans to investors as high-yield securitized bonds.
- Finally, the insurance division could arrange for reinsurers outside the company to cover losses.
Everyone was heady with the new business model that generated whopping profits, skyrocketing stock prices, and generous bonuses … until the entire upside-down pyramid built on funny money came crashing down on all of us.
Commodity Futures Modernization Act of 2000– This law deregulated derivatives trading, which fed into the securitization of mortgage loans into bonds. By bundling bad loans into large bond packages, then divvying them up and selling them off to bondholders through the investment divisions, the mortgage divisions could hedge their bets against losses at even greater margins.
Responsible Lending Act of 2005– Otherwise known as the Loan Shark Protection Act, this law was anything but responsible since it stopped individual states from enacting laws to protect consumers against predatory lending practices.
The Responsible Lending Act of 2005 also ushered in subprime loans.
By signing up for subprime loans, homebuyers who would otherwise be unable to secure a mortgage loan due to bad credit ratings, low income, and no cash for down payments could now move into the home of their dreams … or so they thought.
Subprime loans were tied to ARM loans and teaser rates that made it possible for homebuyers to afford monthly payments. For a while. Until the ARM rates reset.
The result? Within a year of passage, the Responsible Lending Act of 2005 precipitated foreclosures and Short Sales in such large numbers that it eventually took down the entire real estate market, including homeowners who never heard of subprime mortgages.
You might think these 3 laws just happened. They didn’t. One man was behind them all.
His name is Phil Gramm, who served as Senator (R-Texas) from 1978 through 2002. He was the 1) ‘Gramm’ of the Gramm-Leach-Bliley Act, 2) one of five cosponsors of the Commodity Futures Modernization Act, and 3) one of the chief lobbyists for the Responsible Lending Act. At the time, Gramm was with financial conglomerate UBS, which had acquired PaineWebber as a direct result of the Gramm-Leach-Bliley Act.
It’s Judy … your North Shore Chicago real estate agent.
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JUDY CHAPMAN | Live the life you dream
Residential Sales ∙ Residential Rentals ∙ Short Sales
Koenig & Strey | 1925 Cherry Lane | Northbrook, IL 60062
Judy@ChgoNorthShore.com | Office: 847.749.3811
Up until a year ago, I sold real estate in Orlando FL, explaining why you’ll see many, many posts related to the Orlando real estate market. Now I’m back home in ‘Sweet Home Chicago’, selling real estate primarily in the North Shore and West of North Shore Suburbs.
If you’re interested in relocating to Florida, contact me to get recommendations of some very fine Realtors® all over the state. I can also refer you to some of the hardest working Short Sale real estate agents throughout the country.