The real culprit was the ARM (adjustable rate mortgage) that became accessible to the subprime borrowers. The belief was that house prices would continue to appreciate and the below market interest-only payment on those ARMs was what made them so attractive and the immediate option for many borrowers (until the principal + interest kicked in). Borrowers who would not be able to make the higher payments once the initial grace period ended, would simply refinance their mortgages after a year or two of appreciation but once the market plummeted as fast as it did (which many people did not think would happen) the refinancing option became impossible because the value of the house dropped below the ability and value of refinancing it.
Actually the ARMs werent the problem, but the ARM borrowers became victims. The subprime ARM rates were higher than prime fixed rates so they were only attractive to a small portion of borrowers. Subprime loans comprised between 9 and 11% of all mortgage loans the their height.
The subprime ARM hepled the subprime borrower get a little bit lower payment (a very small percentage were also interest only) while repairing their credit during a 2-3 year (sometimes but rarely 5) fixed period. Until the meltdown they would never see the adjustment.
Those borrowers, at least those of them that did not repair their credit, were left out in the cold when it came time to refinance because there were no longer any subprime lenders. The disappearance of subprime loans happened so quickly that the ARM borrowers who could not get out of the ARM when it adjusted came after the blowup, rather than contributing to it.
Subprime loans were gone before the Real Estate market crashed.
It wasn't just self-employed, but also minority and community related. This was part of the Clinton era push on making housing more affordable, and during the housing boom, spun out of control and became abused as a lack of what I like to call "moral responsibility."
I think you misunderstood me. Lending guidelines were expanded to service the self-employed, based uponj the reality that their proof of income was not a true indication of their financial standing, and that was a good business decision, as those loans performed. What followed was loosening credit standards, asset requirements, equity, and then eliminated the self-employed restriction of the program. At the end you could literally get 100% financing with absolutely no income documentation, even if you were paid a salary (the only reason to not require proof of income on a salaried employee is to endorse them lying about their income) with no assets, with the seller paying your closing costs, i.e. a total investment of $0.00 in the property with no money in the bank, and all of this with a credit score of 580. (Today it is virtually impossible to get any mortgage loan with a credit score under 620 and the average credit score is about 690).
Of course the laws have changed- that isn't my point. My point is the principle that lies underneath that. My whole argument is that the housing crisis was just a mask that Wall Street's shadow banking system put on. A lot of people think the blame is on the mask without understanding the creature who put on that mask.
I dont disagree but I think it is impossible to have an economy such as we do in this country without risks such as this. There are many easy restrictions that could be put on Wall Street to prevent the risk of future setbacks, but they would cripple the economy. Any investment, at its most basic level is a gamble. When you project that over an entire economy as large as ours it is basically impossible to not have crises.
A lot of those deregulation and changes happened without due diligence or stringent oversight because policymakers had no idea of the impact that the shadow banking system would have on the entire process. The run on the housing crisis enabled the shadow banking system to double and triple in size (the same behavior occured prior to the Great Depression) and this is where the core of the crisis lies, because not only did they borrow short term liquid to buy long term risky illiquid assets, they also shorted, bought on margin, even engaged in naked short-selling (the leveraging and re-leveraging I was speaking of). So the inevitable disruptions in the credit market (the rapid collapse in mortgage payments that caused the 'clawback' default on those swaps) caused those spectacular flameouts (Lehman Bros, et al).
But at the heart of the issue were poor loan decisions. Not just poor loan decisions but lending policies that were made up of criteria guaranteed to create poor decisions. The largest originators in the country were not lending their own money or keeping any skin in the game. On the subprime end they were literally selling off the loans in weeks to net 3-4% and be out of the transaction. Volume outpaced quality. By the time the poor performance of the loans caught up (they were charged back on defaults) they had made their millions, closed up shop, the execs walked away with millions and the workforces mostly found new careers.
There is no doubt that the shenanigans on Wall Street, including the package of subprime securities to be sold as prime contributed much to the problem, but had lending guidelines of say, 2002 never loosened to the idiocy they did, there would not have been the volume of bad loans to create the blowup.
I have no doubt that the subprime crisis will not repeat itself. My question here is without outlawing the ability of Wall Street to leverage many times its real value, what other market waits to be imploded?
I think there will be implosions in the future, and I think they are a necessary evil to be able to run the financial markets we have in this country without strangling them.
Bad things happen in any economy, its just a matter of how much risk you are willing to accept to create the ability for reward.
