Figuring out what happened to the housing market is simpler than it might at first appear. In essence, many of us were ensnared when human nature became intertwined with newly created financial instruments. It started innocently enough, as market bubbles historically do, when mortgages became easy to get and millions of Americans rushed to become homeowners.
Beginning in the 1980s, and accelerating into the new century, interest rates kept going down. This made loans easier and cheaper, which fueled the housing market. Both Presidents Bill Clinton and George W. Bush trumpeted the benefits of home ownership. Freddie Mac and Fannie Mae, federally-backed organizations that provide mortgage funds, helped open the gates by creating mortgage-backed securities and reducing their lending standards. Banks followed suit.
The Simple Story of Complex Financial Instruments and Mortgage Backed Securities (MBS)
A mortgage-backed security (MBS) is a complex financial instrument that slices up portions of home loans and bundles them. MBS proliferated throughout the global financial market. These instruments spread the risk among many investors, but the reduction of risk is not the elimination of risk. While the risk was distributed thinly it was also dispersed very widely.
Even top financial minds allowed themselves to be fooled in this regard as they threw caution to the wind. Both President Clinton’s and George W. Bush’s administrations removed many restraints that had been in place for decades. Lending became a free-for-all. Once-sleepy banks joined high-profile Wall Street firms as profits soared.
Nobody seemed to be looking at what these intricate loan baskets were actually worth. They were not traded publicly, which would have put them on the books at a clearly identifiable value. In mark-to-model accounting, firms named their price and affixed a number on their books, all but pulled from thin air.
Hidden Risks and Eager Buyers
With the true risk hidden, the cycle of over lending accelerated. Keeping their eyes on upgraded fixtures and stainless steel appliances, eager homeowners were all too willing to play along by taking out home equity loans, which also got bundled as mortgage-backed securities.
Overconfidence was so woven into the public consciousness that even Federal Reserve Chairman Alan Greenspan, seen as the financial genius of the age, once lamented that more homeowners did not have adjustable rate loans.
When interest rates spiked slightly, the whole loose structure of the housing market came tumbling down. Storied Wall Street firms like Bear Stearns, which had invested with abandon in those new financial instruments, were no more. Greenspan, for his part, even came to admit he had not properly understood the complex financial devices that brought so many to ruin.
When those like Greenspan and Bear Stearns are ensnared, there is no shame in what might have happened to you. Realize that markets brought down by intricate problems are not fully restored overnight. If you’re having trouble with your home loan, you need to act. Fortunately, there is a body of knowledge—and a good number of suitable options. You’re not alone.