The real estate bubble and inevitable crash was fueled by several factors that in retrospect should have been crystal clear. However, greed is a blinding force that allows people to ignore the obvious.
The incredibly rapid climb and equally as rapid crash and burn in the real estate market got its start with President Bush’s desire to keep his campaign promise of expanding home ownership, especially amongst lower income families and minorities. In June 2002, he unveiled his plan called “Renewing the Dream," which would give nearly $2.4 billion in tax credits over the next five years to investors and builders who developed affordable single-family housing in distressed areas. Along with this, he created the "American Dream" down payment initiative, which provided down payment assistance to approximately 40,000 low-income families.
President Bush also issued
New buyers flooded the market, now able to get down payment assistance and an inexpensive loan. This sudden demand drove up the prices of properties on the market. Financial institutions responded by creating new loan packages to accommodate the higher prices – 100% financing became the norm. This unfortunately drove prices even higher since it allowed even more buyers in the game. As expected, lenders responded and came up with 106% financing (6% to cover closing costs). Prices climbed even higher – basic supply and demand. The feeding frenzy was on!
Current homeowners saw the equity in their homes skyrocket to obscene amounts (in some cases 500%). Homeowners began to pull that equity from their properties refinancing as much as every three to six months. In 2005, homeowners extracted $750 billion of equity from their homes (up from $106 billion in 1996), spending 2/3 of it on personal consumption, home improvements, and credit card debt.
Lenders excited about the money pouring in would lend to almost anyone that stated they had money and a decent credit score which quickly exhausted the market of qualified borrowers. When the banks ran out of creditworthy borrowers, they had to turn to “sub prime” borrowers; and to avoid losses from default, they moved these risky mortgages off their books by bundling them into “securities” and selling them to investors. To induce investors to buy, these securities they were then “insured” with credit default swaps (see “The Truth about How We Got Here” part 1).
They also enticed greedy buyers with low teaser interest rates on adjustable rate mortgages (ARMs) offering as little as 2% fixed for the first two years and 28 years adjustable based upon the prime rate. With greed blinding the consumers into thinking the market would continue to grow and they would be able to refinance out these loans were readily accepted.
The growth was unsustainable. Some of the cities that had experienced the fastest growth during 2000–2005 began to experience high foreclosure rates as those adjustable rate mortgages adjusted. The sub prime market fell first followed by the mainstream market. As refinancing suddenly ground to a halt, the economy saw a sudden loss of the consumption that had been driven by the withdrawal of mortgage equity. Real estate related industries began to crumble and consumer retail markets saw an instant drop in sales revenue.
The massive defaults on foreclosures caused insurers not to be able to cover CDS defaults. Banks and business failures occurred in a dramatic fashion. The credit card industry quickly followed behind the real estate industry and the rest is history – Recession 2009!
No comments:
Post a Comment