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Trulia Austin, Home Buyer in Austin, TX

Housing 101: How did sub-prime mortgages cause the housing market collapse?

Asked by Trulia Austin, Austin, TX Mon Feb 18, 2013

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The sub prime mortgage collapse and subsequent recession were just the final act in the tragedy known as Government trying to help. It began with Jimmy Carter's pipe dream called the Community Reinvestment Act (CRA) but because it was ill conceived and not very well implemented it never caused too much trouble. The ostensible reason for the CRA was to help people who couldn't otherwise afford/qualify for a home be able to purchase one.

It just kind of lay there during the Reagan and Bush 1 years, then the Clinton Administration with all their meddlesome tendencies decided it was time to "strengthen it and make it work". You can read that as Government intervention in the free market, which virtually never works out. Clinton's Attorney General Janet Reno was given marching orders to "make banks lend to people who couldn't qualify," because the additional teeth that Clinton's HUD folks put in, were largely ignored. Reno sued several banks for "racial bias" because they wouldn't loan to people with lousy credit and/or work histories, causing old bank in Delaware to go under in the beginning of the crisis.

As luck would have it, the ill conceived Graham, Leach, Blyley act happened at that time and the removal of the Glass-Steagall act allowing commercial "bankers" to own regular banks began the next tsnuami of bad lending. Essentially, because Clinton's Justice Deparment forced banks to make bad loans, the new "bankers" (who are nothing but sharks), figured out how to sell these bad loans by disguising them in tranches (packages of "mortgage backed securities" which normally had strong characteristics.

Congressional oversight was completely missing during this era. Barney Frank's lover was a high ranking officer in Fannie Mae, and Barney kept all heat off of him. Chris Dodd, in the Senate got sweetheart loans from Angelo Mozillo (chairman of Countrywide mortgage) so he didn't do his duty either. In fact, both went out of their way to discourage the attempts by the Bush II administration from doing anything about this unfolding mess.

There were many other players producing loans for people who never had a chance to pay them back in those days. One of the most aggressive and scurrilous was Penny Pritzger and her husband. Now, she's being considered for Commerce Secretary. Anyone want to guess how that will work out?

In short, Government messing around to "do good" in free markets makes an absolute disaster out of the free market, then the very Government administrators and politicians that caused it all skate free and blame the banks for doing what they told them to do, and it's especially upsetting since the politicians were completely derelict in their oversight responsibilities.

Now we have Dodd-Frank hampering the free market and causing all sorts of bad behavior as people try to avoid running afoul of the often contradictory aspects of that ridiculous piece of legislation.

Ron Cullinan
Avalar Austin
GRI, CRS, ABR, CLHMS, e-Pro
512-799-3239
austin_realtor@earthlink.net
http://www.austintxonlinehomes.com
2 votes Thank Flag Link Mon Feb 18, 2013
The simple answer is that loans were made to borrowers who were bad credit risks. The risk was then passed along in the form of bundled securities purchased by other investors. When mortgage loans were easy to acquire, the buyer pool increased tremendously. Increased demand drove increasing prices. When those borrowers began to default, many of them just walked away from properties because they had little invested in them and saw no alternative. The investors took huge losses very quickly, houses were sold at low prices in an effort to recover some value, prices plummeted, new construction was stymied, and we had a market collapse.
0 votes Thank Flag Link Tue Mar 5, 2013
Subprime mortgages alone did not cause the housing market collapse. Subprime along with all other mortgage credit help to fuel the virtuous cycle of price increases and vicious spiral down from the top. But the collapse was just the inevitable response to a speculative bubble caused as always by greed.

The explosion in the availability of sub prime mortgages was in large part a response to rapidly rising home prices which led investors to believe that borrower credit was unimportant because the collateral would always be worth more than the loan. At the same time borrowers felt certain that they could sell or refinance if there income did not grow into the loan. The increased availability of sub prime loans help fuel even further increases in prices and when prices quit rising these vulnerable borrowers were often the first to go since the only hope they had of paying off the loan was sale or refinance. The originate to distribute model which separated ultimate lenders form originators and delegated the investment due diligence process to conflicted rating agencies served to further grease the skids.
0 votes Thank Flag Link Wed Feb 20, 2013
Putting all of the politics aside, the fact is: the pricing did not reflect the risk.

That was step 1: underpricing sub-prime mortgages.
Step 2 was a liquidation system where the mortgages were not inspected before being bundled. This is because one genius quantitative analyst came up with a dense mathematical "proof" that maintained that the garbage in a bundle would actually be cleansed by the better loans in the bundle, or some such rot. In any event, one bundle containing over three hundred million dollars of mortgages owned by the San Francisco Federal Reserve Bank was examined (after the fact) and more than half of the contents did not meet the originator's own underwriting standards.
Step 3 was that there wasn't money to pay the holders of the bonds derived from these bundles of mortgages, and the primary insurer (AIG) had a "liquidity crisis" - they couldn't pay the insurance claims.

I disagree with my colleague from Austin; in my opinion, the problem had nothing at all to do with the CRA - as Aaron Pressman wrote for Bloomberg in 2008. The problem in fact was that government was too "hands off" and didn't actually "govern" in an arena where lack of oversight and enforcement brought the financial world to its knees.
0 votes Thank Flag Link Mon Feb 18, 2013
By allowing people who would not undernormal circumstances ever been able to qualify for a loan getting a loan with little or no proof of true income. The bar must stay somewhere in the middle never to either extrmes and we have seen both of those in the past several years to where now more stable borrowers.

Vanessa Nunez
512-750-5716
0 votes Thank Flag Link Mon Feb 18, 2013
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