The current economy is thriving, stock market at ultimate highs, unemployment as low as ever, but is housing still a risk? The world has moved on from the 2008 housing crisis which was caused by unethical lending and investing by the big investment banks.
Even though housing looks excellent, some scars from the crisis still show. Leading up to the crisis, lenders were giving loans to anyone with a pulse. Now, lending is stricter. So strict, that some experts believe it is causing a housing shortage which has pushed prices to unbelievably high amounts. This trend has caused a generation of renters.
Shady Mortgage Lending
In the early 2000s, there was a surplus of supply and not enough demand for the houses that were being built throughout the country. Usually, homes were built by small building companies, but, at the time, larger companies started to build homes at a breakneck pace which led to the significant surplus. This activity gave the lenders incentive to give out as many loans as possible, even to unqualified buyers.
Lenders don’t just hold the mortgage and make money on interest; they usually sell the mortgage to a government-sponsored entity such as Fannie Mae and Freddie Mac, or a big investment bank. Those government agencies or big banks then repackage the mortgage with thousands of other mortgages and rename them Mortgage Backed Securities (MBS). And, another reason why lenders were writing an insane amount of loans was that the big banks would buy anything that they wrote.
Lenders came up with creative ways to give out loans such as the “teaser rate” mortgage. The 2/28 subprime adjustable-rate mortgage (ARM). It gave borrowers a below-market “teaser” rate for the first two years. After two years, the interest rate “reset” to a higher rate, which often made the monthly payments unaffordable. The idea was to refinance before the rate reset, but many homeowners never got the chance before the crisis began and credit became unavailable.
Ethical Misconduct by the Investment Banks
The MBS wasn’t where the banks stopped though; they started to bundle up the MBS along with different kinds of debt (car loans, credit card debt, corporate debt, etc.) to create a Collateralized Debt Obligation (CDO). They would sell these CDOs to thousands of investors. This wasn’t the shady part though; the banks wouldn’t buy the loans from the rating agencies (Fannie Mae, Freddie Mac, etc.) unless they gave them the credit rating they wanted (“AAA” being the highest and “B” being the lowest). Some of the loans that were being rated “AAA” were actually “B”s. These type of loans are called subprime loans.
The banks kept on selling these CDOs and loans and made millions and millions through this unethical activity. This created a massive housing bubble that led to the big crash in 2008.
The teaser loan that the lenders gave out caused major havoc in the subprime department because homeowners couldn’t refinance their mortgage before it became unaffordable. As soon as homeowners stopped making payments, the bonds started to fail, and the banks began to take significant losses.
Delinquency rates for subprime loans sprung to 25-30% in the late 2000s. When homeowners stop making payments on their mortgage, the payments also stop flowing into the mortgage-backed securities. The securities are valued according to the expected mortgage payments coming in, so when defaults started piling up, the value of the securities plummeted.
In 2007, two prominent hedge funds at the investment bank Bear Stearns imploded due to substantial exposure to MBSs and derivatives backed by MBSs, and the bank was purchased in March 2008 by JPMorgan Chase for a bargain-basement price of $2 per share. This catastrophe let the world know that a disaster was looming.
Due to the uncertainty in the market, Rating agencies’ stocks plummeted and the Bush Administration had to step into Wall Street and do something.
As the world waited to see which bank would be next, suspicion fell on the investment bank Lehman Brothers. Companies stopped doing business at the bank, and while the government helped broker the sale of Bear Stearns to JPMorgan, it let Lehman Brothers fail. In 2008, the bank filed for bankruptcy. The next day, the government bailed out insurance giant AIG, which in the run-up to the collapse had issued staggering amounts of credit-default swaps (CDSs), a form of insurance on MBSs. With MBSs suddenly worth a fraction of their previous value, bondholders wanted to collect on their CDSs from AIG, which sent the company to failure. This disaster took its toll on the country, and the world itself.
How Is Housing Now?
A lot has changed since the housing market collapsed, including lending. Mortgage lenders have become so strict that younger generations have turned to rent. The housing market is currently stable, and delinquency rates are low, but there are still some problems with the supply and demand of housing. There are still some concerns about how quickly homes are being built. The fast-paced building was one of the causes of the crisis in 2008. But, as of right now, there are no major concerns in the housing market.