We all of us wonder what caused the financial meltdown that we are now referring to as “The crash of 2008” or “The Subprime crisis.” So, what do you think caused it? I have my own theories. Part of it stems from knowledge I gathered here and there, part from keeping my finger on the pulse of the financial markets. First and foremost, the financial markets are fickle at best. Wall St.’s darlings one day are the scapegoats the next. Sometimes there’s no rhyme or reason for a stock or a company to be on a tear so to speak. I suspect these days that day traders have some impact on the market.
But, what caused the meltdown? It’s not a simple thing to figure out, but briefly what we’ve been told is that Financial Institutions (banks and lenders) made “risky” investments in mortgages they should not have. That’s a cop out to be sure, but what I think happened is that the Real Estate folks (realtors) and the lenders (those making money available for mortgages) got together and decided they needed to 1.) Convince us that our homes were our best investment, and then 2.) That we should “max out” what we invest in our homes so that we get the greatest return on our investment. Simple math, right? If you invest more, you should get more in return, right?
WRONG! Dead wrong! OK, so what happened? Briefly, those lenders and realtors needed to keep the market going, to “prime the pump” so to speak, so that money kept churning in the market. Money changing hands in that business drives prices up, in a “never ending” upwards trend. While that may be true in the long run, in the short run, it can create all kinds of problems that they never seemed to want to recognize or even acknowledge existed. They “kept hidden” certain facts that are very dangerous to hide.
First, they were making “risky” investments to keep the churn going, they were approving mortgages for borrowers who should never have been in houses. Let’s look at some examples. I heard this was happening as far back as 2004, and probably longer ago than that. Fannie Mae, and Freddie Mac were going around giving 110% and 115% loans to “underprivileged” (poor) folks who never had a hope of making their mortgage payments. Some of those folks were taking advantage of the system, and never had _any_ intention of paying their loans back, they were only interested in about 18 months of “free rent.” When those folks left their foreclosed homes, they left them wrecks, gutted, no fixtures, no appliances, not even carpet or wiring or plumbing in many cases! But, those were the exception, certainly not the rule.
There were crooks, and there were folks who just weren’t ever going to have a chance of paying their mortgages. So, Fannie Mae and Freddie Mac happily enrolled those folks into mortgage assistance programs. Don’t get me wrong, I don’t necessarily think those programs are “bad” it’s just that they had so many folks in those programs, that it was a terrible drain on cash available for anything else. It’s a terrible drain on cash period you should say. Assistance programs should be available for everyone, on a temporary or emergency basis, but folks should never be enrolled in those programs from the first day of their mortgages! That’s what was happening. They were financing the “churn” and the upwards trend with borrowed money, money borrowed from you and me, from our homes, on the “speculation” that prices will keep going upwards – forever!
So, how do “short term” corrections affect that scenario we’ve outlined above? The trouble arises because of the amount of homes “under assistance” and homes that are financed with ridiculous loan programs where the ARM (Adjustable Rate Mortgage) comes due and the owners cannot possibly hope to ever make the payments at the now adjusted interest rates. I know, I had one of those ARM type mortgages one time, and it nearly killed us (my first wife and I) trying to make those payments every month. We were paying well in excess of 1/2 our salary on the monthly mortgage payment! That should never be the case!
But that’s what happened to a LOT of folks about 2 years ago. Those folks started to let their mortgages go – in ever increasing amounts, because the short term “correction” began to be a snowball rolling downhill. Losses due to foreclosures caused decreases in home prices, that in turn caused folks to be “under water” and then more ARM mortgages coming up for interest rate adjustments caused (in turn) more foreclosures.
What did Goldman Sachs do that was so bad? Well, financial institutions, the BIG players, were packaging and selling these mortgages. They were traded and labeled: “Mortgage Backed Securities.” There grew up whole institutions to trade in these things, those were called “Real Estate Investment Trusts” (REITs). Those folks got into the “scamming” of America big time. They engaged in trading of these things until the market was so diluted, and the amount of actual capital underlying any investment was less than $0.10 on the dollar. It was likely far less than that. I remember reading an article by a fellow who predicted the meltdown a few months before it happened, he said the dilution of assets was too great, there was no “balance” in the balance sheet in other words – it was all liability. The only thing backing the mortgages was no longer the “value” of the real estate, but the borrower’s perceived ability to pay!
When enough borrowers cannot pay, or they’re so dependent on “assistance” programs that the market is heavily weighted towards debt, then you have a precarious boulder waiting for the tip to start it rolling downhill. Then, you have a crash. So, again, what did Goldman Sachs have to do with this? Not much really. They were guilty like everyone else of trading in securities that were not really securities, but simple debt instruments. Mortgages should never be traded like securities (equity). That’s the fundamental flaw in the system: A mortgage is a liability, not an equity. You simply cannot treat it the same, because it’s a debt!
So, in reality, Fannie Mae, Freddie Mac, and all those financial institutions who got in on this thing, they ALL conned America. We all had our part to play in it. And now, it’s affected all of us. I have no job. We lost our condominium that Cheryl bought before we got married. The “value” of our house is less than we paid for it – and we bought it over 10 years ago! Will the market come back? Probably. Will it meltdown again? Not if we reign these guys in and force them to stop financing mortgages with money made from air.
In reality, what caused the crisis was greed. The realtors and lenders figured out a way to get money from folks who really didn’t have money. Those dudes made their money (they get commissions off their “sales” not from the residual stream of interest collected). So, the lenders, and the realtors are the real culprits in my book: They figured out how to make money from folks who had none.