One of the worst things that ever happened to our economy was when the housing bubble burst and the stock market tumbled but I bet that most people would have a tough time explaining what happened. This is the shortest answer I could come up with that will hopefully provide good insight:
Financial brokers love it when they have more products to sell so anytime a new company pops up on the stock exchanges or a new fund comes available from someplace like Fidelity, it's great for them. It’s kind of like a store adding a new line of products thus getting incremental revenues. So along came this idea for mortgage backed securities where a financial institution would buy up as many loans as they could, bundle them into one financial instrument, and call it a product to sell on Wall Street just like they would G.E. stock. Mortgages were historically a very low risk money maker for banks because people rarely (like our parents), defaulted on mortgage loans because the last thing someone wants to lose is their home.
So it sounded like a great idea and the financial experts on Wall Street gave these new mortgage securities a AAA rating which made investors feel very safe jumping in and jump in they did to the tune of billions of dollars. The fat cats on Wall Street were loving life because so many people were buying in and of course they made money on each stock transaction. The funds began growing fast and providing great returns for investors. Then things started turning ugly and as usual it was fueled by greed.
The mortgage backed security funds were growing quickly because the companies that bundled them to sell on Wall Street were buying up as many mortgages as possible and adding it to their portfolio; because of this they began being less selective as to the quality of the loans they were buying.
This is exactly what mortgage companies wanted as they knew they were offering sketchy loans to people who barely, and in some cases didn't, qualify for loans but were given one anyways. These mortgage companies didn't worry about risks because they knew they'd quickly pass it on to some hungry mortgage security fund buyer. The funds were growing and the stock prices on these securities were rocketing but very few people realized that the quality of the loans were getting worse and worse.
Then the world comes crashing down. The housing market can compare in some ways to how the stock market works. Just like when we worry about the bubble bursting in the stock market because we don't have a clue why it's as high as it is, housing prices started going up tremendously with no rhyme or reason why they hit the levels they did other than people were willing to pay the exuberant prices so we could only assume it was stable.
Anyone with skin in the game wanted to build more and more apartment complexes, condos, housing developments, etc., while some of us were wondering where are all the people going to come from? How do all these people in the housing industry know when to slow down or stop building and let the population catch up? I thought they somehow knew but they didn’t. The market became over saturated and our home prices started coming down, some to ridiculous levels. So some people were finding themselves in a mortgage of let's say $300,000 but their home was only worth $225,000 according to potential buyers. A lot people in this situation (upside down mortgage), were willing to walk away and default on their loans which was never common in that industry before.
A large chunk of risky loans were being defaulted on especially those with variable rate mortgages. The reason for this is that someone might have been able to scrape buy and pay their monthly mortgage when it was at a 5% rate but as it moved up to 8% they couldn't afford to pay it anymore so they defaulted on their loans. It was bad all around. Developments were going under, some neighborhoods had foreclosure signs all over them, etc. Then there were all the jobs that went away because of the crash among them construction workers, developers, real estate agents/brokers, mortgage lenders, I could go on and on. With so many people out of work our tax revenues went down thus increasing our deficit. It hurt.
The end result is that mortgage based securities crashed because the value of each portfolio went down as housing prices dropped dramatically and the loans defaulted. At the same time, Wall Street analysts plastered the funds with terrible ratings (they took a beating for initially giving them a AAA rating), so everyone was trying to sell what they had with few buyers so of course the prices fell dramatically. It didn't just affect this particular industry as investors started pulling out of the stock market because of fears of instability so Wall Street in general took a huge hit. Democrats like to blame Bush for what happened to the economy but they’re wrong.
The concept of mortgage backed securities was initially a good one and everyone, top to bottom, were glad they came along. The problem is that mortgage companies realized the more loans they handed out the faster they’d make money and not have to wait over the life of a loan to collect revenues, by selling them to the brokerage firms pushing the securities on Wall Street. The bundlers of all these mortgages kind of turned a blind eye towards the quality of the loans they were getting, they just wanted to show that the funds they created were getting larger and were successful, thus running up the price and getting more money for increased stock transactions.
In my opinion, you’d have had to have been pretty smart to figure out when the housing bubble would burst so this was kind of an uncontrolled variable. The one agency that could’ve limited at least some of danger is the Security Exchange Commission. They didn’t involve themselves enough (my opinion), into understanding mortgage-backed securities to where they could’ve regulated the banking/financial industry on the quality of loans that would be allowed to be traded on Wall Street. It was a case of the wolf watching the hen house as mortgage lenders certainly weren’t policing themselves as they wanted to generate as many loans as possible. The SEC certainly could’ve had regulations in place that did monitor the quality of loans that were going to be traded.
To fix a problem, you have to admit you have one and in this case I’d say it was a huge wake-up call to the industry. It’s certainly not perfect now but there were many lessons learned during this crisis that have been addressed like stricter loan standards. Let’s hope we don’t feel that kind of pain again.
Financial brokers love it when they have more products to sell so anytime a new company pops up on the stock exchanges or a new fund comes available from someplace like Fidelity, it's great for them. It’s kind of like a store adding a new line of products thus getting incremental revenues. So along came this idea for mortgage backed securities where a financial institution would buy up as many loans as they could, bundle them into one financial instrument, and call it a product to sell on Wall Street just like they would G.E. stock. Mortgages were historically a very low risk money maker for banks because people rarely (like our parents), defaulted on mortgage loans because the last thing someone wants to lose is their home.
So it sounded like a great idea and the financial experts on Wall Street gave these new mortgage securities a AAA rating which made investors feel very safe jumping in and jump in they did to the tune of billions of dollars. The fat cats on Wall Street were loving life because so many people were buying in and of course they made money on each stock transaction. The funds began growing fast and providing great returns for investors. Then things started turning ugly and as usual it was fueled by greed.
The mortgage backed security funds were growing quickly because the companies that bundled them to sell on Wall Street were buying up as many mortgages as possible and adding it to their portfolio; because of this they began being less selective as to the quality of the loans they were buying.
This is exactly what mortgage companies wanted as they knew they were offering sketchy loans to people who barely, and in some cases didn't, qualify for loans but were given one anyways. These mortgage companies didn't worry about risks because they knew they'd quickly pass it on to some hungry mortgage security fund buyer. The funds were growing and the stock prices on these securities were rocketing but very few people realized that the quality of the loans were getting worse and worse.
Then the world comes crashing down. The housing market can compare in some ways to how the stock market works. Just like when we worry about the bubble bursting in the stock market because we don't have a clue why it's as high as it is, housing prices started going up tremendously with no rhyme or reason why they hit the levels they did other than people were willing to pay the exuberant prices so we could only assume it was stable.
Anyone with skin in the game wanted to build more and more apartment complexes, condos, housing developments, etc., while some of us were wondering where are all the people going to come from? How do all these people in the housing industry know when to slow down or stop building and let the population catch up? I thought they somehow knew but they didn’t. The market became over saturated and our home prices started coming down, some to ridiculous levels. So some people were finding themselves in a mortgage of let's say $300,000 but their home was only worth $225,000 according to potential buyers. A lot people in this situation (upside down mortgage), were willing to walk away and default on their loans which was never common in that industry before.
A large chunk of risky loans were being defaulted on especially those with variable rate mortgages. The reason for this is that someone might have been able to scrape buy and pay their monthly mortgage when it was at a 5% rate but as it moved up to 8% they couldn't afford to pay it anymore so they defaulted on their loans. It was bad all around. Developments were going under, some neighborhoods had foreclosure signs all over them, etc. Then there were all the jobs that went away because of the crash among them construction workers, developers, real estate agents/brokers, mortgage lenders, I could go on and on. With so many people out of work our tax revenues went down thus increasing our deficit. It hurt.
The end result is that mortgage based securities crashed because the value of each portfolio went down as housing prices dropped dramatically and the loans defaulted. At the same time, Wall Street analysts plastered the funds with terrible ratings (they took a beating for initially giving them a AAA rating), so everyone was trying to sell what they had with few buyers so of course the prices fell dramatically. It didn't just affect this particular industry as investors started pulling out of the stock market because of fears of instability so Wall Street in general took a huge hit. Democrats like to blame Bush for what happened to the economy but they’re wrong.
The concept of mortgage backed securities was initially a good one and everyone, top to bottom, were glad they came along. The problem is that mortgage companies realized the more loans they handed out the faster they’d make money and not have to wait over the life of a loan to collect revenues, by selling them to the brokerage firms pushing the securities on Wall Street. The bundlers of all these mortgages kind of turned a blind eye towards the quality of the loans they were getting, they just wanted to show that the funds they created were getting larger and were successful, thus running up the price and getting more money for increased stock transactions.
In my opinion, you’d have had to have been pretty smart to figure out when the housing bubble would burst so this was kind of an uncontrolled variable. The one agency that could’ve limited at least some of danger is the Security Exchange Commission. They didn’t involve themselves enough (my opinion), into understanding mortgage-backed securities to where they could’ve regulated the banking/financial industry on the quality of loans that would be allowed to be traded on Wall Street. It was a case of the wolf watching the hen house as mortgage lenders certainly weren’t policing themselves as they wanted to generate as many loans as possible. The SEC certainly could’ve had regulations in place that did monitor the quality of loans that were going to be traded.
To fix a problem, you have to admit you have one and in this case I’d say it was a huge wake-up call to the industry. It’s certainly not perfect now but there were many lessons learned during this crisis that have been addressed like stricter loan standards. Let’s hope we don’t feel that kind of pain again.
RSS Feed