Events Leading to the Real Estate Market Crash of 2008
Although many analysts in the financial literature had warned of impending problems in the real estate market before the collapse of Fannie Mae and Freddie Mac, most of the general public were caught almost completely by surprise. It was almost as if catastrophe came out of nowhere, the proverbial bolt from the blue. However, in retrospect, the signs of danger had been there all along. They were just ignored by people who wanted to believe that housing prices could keep going up forever, irrespective of fundamentals, much as people in the last years of the 1920's wanted to think that stock prices could go up forever while real economic growth was slowing.
One of the major precipitating problems that led to the disaster of the real estate industry was the collapse of the subprime mortgage industry. Because these loans are typically made to people who don't have as strong a financial base under them as people who can qualify for traditional mortgages, they are more likely to default when things become tight -- and the sharp rise in gas prices during the summer of 2008 was just that sort of trigger. When people were caught in the position of having to decide whether to buy the gas to get to their jobs or pay their mortgages, gas won.
During the first few years of the 21st century subprime mortgages were making it possible for more and more people to become homeowners who previously had been shut out of the market. People who lacked strong credit history, particularly members of minorities, were able to qualify for these loans when a traditional mortgage would simply have been impossible because of the stringent requirements on income, stability in job, and the like. Subprime loans were also favored by self-employed individuals and owners of small businesses, who often couldn't get traditional loans even when their income was more than adequate, for the simple reason that their income was not in the form of paychecks from an employer. Because subprime loans were riskier than traditional loans, the banks charged higher interest rates that were more profitable on those loans which were paid faithfully. Furthermore, banks counted on being able to foreclose upon defaulted loans and sell the properties at a profit, so that even if a risky buyer did default, the bank would not be out any money in the long run.
The money which funded these loans came from a variety of sources. Because of the extremely low interest rates that prevailed at the time, banks could even make a profit by borrowing from other banks and lending it out at interest. Although some of these loans came from other commercial banking institutions, large amounts were borrowed from the Federal Reserve, the central banking system of the US. Some of the loans came from various Federal programs that were intended to make it possible for minority and other underprivileged families to buy homes. Other funds came from more complex sources, including the trading of mortgage-backed securities, a financial instrument that was presented as nearly risk-free, but was so complicated in its operation that many of the people buying into it couldn't understand what they were buying and had to take the word of the experts touting them.
During that period, the housing market was booming, with housing prices increasing rapidly, particularly in certain markets. On the surface, this situation seemed to be extremely desirable, since there were huge profits to be made in buying undervalued properties, making some relatively minor repairs and upgrades to better stage them for sale, and resell them. This process was known as flipping houses, and it was being touted in many business and investment periodicals as a great way to make money rapidly. There were even television shows dedicated to the process, such as "Flip this House." However, the rapidly rising housing prices meant that actual homeowners were taking on huge mortgages, with monthly payments that exceeded the 30% of income that is generally considered safe, often by considerable margins. Some people were spending 50% or more of their take-home income just to keep a roof over their heads.
Worse, people were assuming that these growth curves could keep going on forever. In fact, housing prices had become disconnected from the fundamentals of actual value, and were representing a speculation-fueled bubble. And while a bubble may be able to go on for some time on sheer momentum, eventually it will burst, with catastrophic results. The housing bubble of the early 21st century was no exception, even if people had previously thought it could be.
The first sign of trouble was a rash of defaults and subsequent foreclosures in markets in which housing prices had become extremely inflated compared to the actual fundamentals. These areas were actually quite small in relation to the entire United States, but because housing prices in those areas were some of the highest in the nation, the amounts of money involved were extremely large -- enough to endanger the stability of several banks that had large numbers of these loans in their portfolios.
Once doubts were raised about the financial solvency of these banks, the process became a vicious cycle that only accelerated itself with each iteration of fear. Banks began to shift to more stringent underwriting guidelines that made it difficult to get mortgages, resulting on people who had previously counted upon being able to refinance on better terms finding themselves unable to do so. Unable to continue to pay their mortgages, particularly if they had ARM's that would reset to significantly higher rates, many of these borrowers defaulted, leading to further foreclosures. Worse, because it was now harder to get a mortgage, it became increasingly difficult for banks to resell foreclosed properties, leaving them with an ever-increasing pool of houses they could not liquidate which were effectively liabilities rather than assets.
The result was a financial quagmire from which it became increasingly difficult to rectify, particularly when it began to create a generalized economic contraction. As other businesses began to cut back, the rounds of layoffs began, leaving people who had previously been current on their mortgages suddenly without the means to make their monthly payments. Even if they tried to sell their homes, the sudden collapse in housing prices meant that even if they could find a buyer, the sale would probably not be sufficient to satisfy the mortgage, leaving them owing money. Many of the newly unemployed also lost their homes to foreclosure as their other resources were exhausted -- and their newly straitened financial circumstances meant that they were no longer making the purchases that other businesses depended on, leading to further rounds of contraction and foreclosure.
Although the government has tried to shore up the troubled financial industry with various bailout programs, the degree to which those actions have resulted in actual improvement in the economic situation of ordinary Americans is extremely debatable. Many writers are now forecasting a long-term economic downturn, even a depression, and some are talking about a permanent shift to an economic situation characteristic of Third World countries, in which a tiny skin of elite lords it over the crushingly poor masses, with little or nothing in the way of a middle class in between.
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