There is a lot of finger pointing over the economic woes we face in the world today, especially in America. Much of it centers on the housing bubble and its consequences—the mortgage crisis which has produced default and/or foreclosures on every hand. But what are the real causes of the home mortgage crisis?
Understand the Housing Collapse
When looking at the housing bubble (as with many issues), it is easy to focus in on one issue while blindly ignoring others that are equally or even more important. This is obviously apparent in this case as economists, politicians and ordinary people on the street express their concerns.
Unfortunately, even people whose profession is dealing with real estate investments made decisions, and continue to make them, without knowing what they were and are getting into.
NOTE:
On Scott Adam's blog I read this comment from a reader that demonstrates this fact clearly:
Ahh, I work for a company that got horribly burned by investing in mortgage backed securities and had to sell off a big part of the company to survive. The stock lost 95% of it’s value. They bet the farm and they lost. It’s clear the people buying these financial instruments did not understand them.
There is an old saying that describes one of the fundamental problems in nearly all the recommendations for a cure to these financial ills: “It is hard to see the forest for the trees.” People everywhere look at some small aspect of a problem like the mortgage crisis and come to different conclusions, often missing the overall picture.
The Home Buyer and the Mortgage Crisis
It is not just blaming the victim to start with the individual who buys a home. Naturally everyone would like to own their own home. It is a good thing. But no one is entitled to own a home just because they want one. And no one should buy a home unless they can afford to do so.
The housing bubble happened partly because many individuals made poor decisions by overextending themselves, buying more than they could afford. They took out variable rate loans at a time when interest rates were at an all time low and could only go up. They took zero percent loans for a short term based on expectations that in a few years they would have more income when they had no sound basis for that expectation.
This penchant for overspending is at the heart of the mortgage crisis. The housing bubble is the culmination, first of all, of a growing trend over a number of years for people to buy what they want whether they can afford it or not.
The lesson is clear. If we cannot learn how to earn a decent living for ourselves and our family, if we cannot earn a decent credit rating by paying our bills on time, if we cannot save some money for a down payment, we should wait until we can before we take on the responsibility and the obligations of home ownership.
Perhaps even more important, as individuals we need to be sure we don’t do anything of financial importance without understanding what we are doing. If we don't, the next mortgage default may be ours.
Financial Institutions and the Crisis
Our financial institutions have largely failed us. We need to understand why so we do not allow their thinking and behavior to affect us adversely. And believe me, in spite of the horrific experience we have gone through, many of them are continuing their irresponsible behavior. Is it possible they believe the government (that is us in the end) will bail them out if they get in trouble?
The heart of the problem is a lack of any sense of responsibility. Banks sell their mortgages, primarily to Freddie Mac and Fannie Mae. From there they migrate to pension funds and insurance companies as well as all kinds of bundled financial products pushed onto unsuspecting mutual fund buyers and others by unscrupulous investment companies.
They may not intend to be evil. Nevertheless, the consequences of their practices is devastating to their customers.
No one along the way cares. They all think they will never be held responsible for their part in making unstable loans. Home buyers haven’t cared much because they put nothing into the deals. The banks haven’t cared because they were going to sell the loans off anyway. No one along the way cared for the same reason.
In the end the final buyer of the loans is just assuming that real estate is surely a stable investment. There is nothing with more of a potential for disaster than unfounded assumptions, no matter how logical they may appear on the surface.
In this case there is a general assumption all along the way that the rules and regulations of the financial institutions and government oversight are assuring that these are good investments. Obviously, neither is the case.
And since the end buyer is usually someone like the manager of the 401k fund for your retirement, not you, the manager expects to get paid whether you do or not! So he/she doesn’t care that much either. Again, probably no evil intention, just a certain level of incompetence and a willingness to invest in things they don’t understand.
Government and the Mortgage Crisis
Finally, the government has its hand in the pie. Instead of passing and administrating banking regulations that would prevent the problems we are having, they give in to the temptation to pander to public pressure, to the influence of the financial institutions to make more money and to the desire of people to own their own homes whether they are prepared for ownership or not.
Politicians talk about everyone experiencing the American dream and affordable housing. They brag about helping everyone own their own home. And they pass bills they do not understand and often have not even read. Rarely do they consider the unintended but in this case obvious unintended consequences.
They get re-elected, sure, but at whose cost in the long run? Not their own. They may talk about how terrible it is for those financial folks to draw their big salaries while hurting the public but they don’t talk the same way about their own pay! The truth is, they probably don’t even recognize their own culpability.
Again, I do not intend to throw too many stones. Many of them may have good intentions, but in the end good intentions are not always enough.
Conclusions About the Mortgage Crisis
The lessons we can learn from this economic catastrophe are many. The most important is this: learn how to direct your own financial life with wisdom and common sense.
Determine to accept responsibility for your own finances. I never depend fully on the advice of anyone, no matter what their credentials.
That doesn’t mean I do not listen. I read and listen a lot. But I ultimately depend on my own knowledge and judgment.
Then, and in many ways this is the most important of all, never do anything you do not sufficiently understand. Most of the truly successful investors only involve themselves in a few areas and refuse to invest in anything they do not understand. Follow this good model.
Finally, always think long term and always ask the key question, “What if?” How many people would have taken a 5% variable rate home loan when the prime was around 2% if they had asked the question, “What happens if the prime rate migrates up to 9%? What would my interest rate and payments be then?”
Fortunately, fixed rates have now dropped back below 6% (new 15 year fixed rates hovering around 3% at the end of 2012) so home owners with variable rate loans who have survived to date, and who qualify may, be able to refinance to a fixed rate now and escape from a potential disaster in the future (expect to pay a refinance rate a percent or so higher than for a new loan). If, that is, they can find a bank with some money that is willing to loan to them.
Down With the Housing Crisis!
The mortgage crisis should never have happened. The housing bubble occurred only because of irrational thinking on all sides. Hopefully it will never happen again. If it does, do not participate.
