The Mortgage Mess and Who is Responsible

Sitting there behind the economic melt down and financial sector collapse is the sub-prime mortgage mess. Let me briefly lay out the chicken and egg scenario that was created over a decade and collapsed in the last 36 months.

Sub-prime mortgages were developed as a response to both demand and government policy. On the demand side there are both potential and existing homeowners and the housing/financing industry (developers, builder, Realtors, mortgage companies, lenders, lawyers, inspectors, etc.). On the social policy side there was a desire to have increased home ownership by non-traditional homeowners such as minorities, single-parent families and lower income households.

The key ingredient to the fluidity (relative ease) of obtaining mortgages in the US, is the ability to convert a mortgage (the actual legal obligation) into a mortgage-backed resalable financial product. Fannie Mae and Freddie Mac are the independent but federally backed institutions for doing this but private financial institutions do so as well. With this system in place a lender writes a mortgage, sells the future stream of income and receives back the assets needed to write another mortgage.

To achieve its social policy, the government implemented lowered standards for qualifying for a mortgage (in terms of income & creditworthiness) and allowed mortgages to be written at less than repayment value (sub-prime) for the first few years of the loan. They did this rather than merely providing direct assistance to the intended beneficiaries of the social policy.

When you hear sub-prime; remember that it means repayments at less than the cost of the bank borrowing the money. It facilitates a sale predicated on either, the increased equity in the home or the increased ability of the homeowner to repay being sufficient to make up the difference at a time in the future. Once in place, this became a self-perpetuating crap shoot.

Many people, not just the intended beneficiaries, bought homes they could not afford to repay because they bought the maximum they could finance rather than take responsibility for only buying what they could afford to pay back.

The industry knowingly built/sold more homes and wrote even more mortgages (through repetitive refinancing) to people whom they knew could NOT eventually repay the mortgage. (They knew this from their collective historical experience. Which is where the original rules came from to begin with.)

In the short term it worked because housing prices were artificially boosted by the increased demand, as demand was temporarily delinked from the ability to repay the mortgage. But eventually, as the mortgages themselves adjusted to actual repayment levels and the relative supply and demand of housing cooled to rebalanced the value of homes to the real rate of GDP growth, people began to default on these mortgages with no new equity to bail them out.

As the defaults grew, the house of cards built upon it began to collapse. Congress has oversight responsibility for both Fannie Mae and Freddie Mac as well banking in a broader sense and repeatedly denied the severity of the problem and refused to change the policies or practices which created the dynamic until the new housing industry began to collapse.

Who is responsible in order:
1) the authors of the legislation/regulations that lowered standards to achieve a social home ownership goal.
2) speculators who used the short-term "free" money created by the dynamic to churn the equity in real estate into a stream of cash for spending.
3) the industry which took short term transaction-based profits with full knowledge that the mortgage involved in the transaction was "at risk".
4) people who bought more home than they could afford hoping that it would work out somehow. 5) every oversight committee in government and industry corporate boards of directors for failure to exert proper governance in the face of greed, corruption, ideology or expediency.

and.... the house of cards extended into the broad economy due to the linkage of all sorts of financial products that were backed by either real estate equity or mortgage repayment.

Where did the money go:
1) some of the equity only existed on paper because real estate backed equity was first inflated and then deflated with the collapse of the real estate market.
2) some to people and companies that spent billion & billions of dollars of equity ratcheted out of real estate on consumption.
3) some to the industry and individuals who made money on specific transactions.