Josh Harmatz asked:


At the end of the dot com bust, we saw money-hungry investors worldwide thirsty for more. Their new fix came via mortgage-backed securities (MBS), lots of home loans, and the proceeding hangover is still lingering.

Rise of Home Loan Lending

The influx of money into the United States from the rising economies in Asia and oil-producing countries combined with low interest rates in the U.S. contributed to good credit conditions from 2002 to 2004, which created housing and credit bubbles.

The credit conditions were so favorable that there has been a significant increase in home ownership rate—from 64 percent in 1994 to 69.2 percent in 2004. The major contributor to the increase was the rise in subprime lending, a financial term that involves financial institutions extending credits to borrowers who did not qualify for loans at the prime rate. Subprime lending caused housing prices to increase. In fact, between 1997 and 2006, the price of a typical American house increased by 124 percent.

As home ownership rate rose, so did mortgage-backed securities. MBSs are debt obligations that represent claims to cash flows from mortgage loans, most commonly on residential properties. Simply put, MBSs get their value from mortgage payments and housing prices. Because of the housing and credit booms, institutions and investors worldwide invested in the U.S. housing market.

Homeowners were refinancing their homes at lower interest rates. Taking advantage of the appreciation in housing prices, some homeowners resorted to financing consumer spending by taking out second mortgages. What can be concluded from this pattern is that consumers were borrowing and spending more yet saving less, thereby increasing household debt from $705 billion at the end of 1974 to $7.4 trillion at the end of 2000, to $14.5 trillion in the middle of 2008.

The financial system enjoyed the housing boom for a while, but not for long.

Fall of Home Loan Lending

Housing prices began declining in the middle of 2006. As a result, the same institutions and investors that invested heavily in MBS suffered significant losses. Overall, the losses suffered worldwide are estimated to be trillions of U.S. dollars.

The housing crisis is greatly affecting Americans. President Obama said that it is “unraveling homeownership, the middle class, and the American Dream itself.”

One of the causes of the decline in housing prices is that policymakers did not recognize the fact that financial institutions (such as investment banks and hedge funds) are increasingly becoming important in the financial system. These institutions were not subject to regulations that cover commercial banks. Hence, they were not able to protect themselves from MBS losses. These losses affected their ability to lend, thereby slowing economic activity.

Others proposed the following causes:

- inability of homeowners to pay their mortgage, attributed mainly to the resetting of adjustable-rate mortgages

- borrowers overextending

- predatory lending

- speculation and overbuilding during the boom period

- risky mortgage products

- high personal and corporate debt levels

- financial products that distributed and perhaps concealed the risk of mortgage default

- monetary policy

- international trade imbalances

- government regulation (or the lack thereof)

An interesting thing to note is that the predatory lending practices of mortgage brokers are cited as one of the more important causes of the crisis.

Because of this ongoing crisis, many homeowners lost their homes and investments, and homes for sale are significantly increasing.

The Future

The future of the housing market is still obscure. However, the deteriorating housing market prompted central banks around the world to cut interest rates and governments to implement economic stimulus packages to prevent any more damage to the bigger economy.

To address this crisis, some leaders in developing countries met in November 2008 and March 2009 to find solutions. As of April 2009, however, many of the root causes of the crisis had yet to be addressed. Government officials, central bankers, economists, and business executives have proposed solutions, while various agencies and regulators have taken additional steps to best handle the crisis.

President Obama and his key advisors, on the other hand, introduced a series of regulatory proposals in June 2009, but the proposals have yet to be implemented. Whether it will work or not, only time will tell.



ERNESTO