First of all: what does "Loose credit and Easy Money" mean?
Credit is financial word for borrowing. In economics, credit is used to transfer resources and create opportunities. This provides a mutually beneficial opportunity in that those who need money and don't have it, can have it. And those that have money and don't need at (at that specific moment) can lend it, making interest on that money.
To say that credit is "loose", means that it was too easy to borrow money. The consequence of this is that too many people qualified for credit cards, advances, loans etc. And over a decade or two of unqualified borrowing, a mountain of debt can build, which will eventually have to crash on itself. In theory, you're supposed to lend to only those who can repay the debt, which we sometimes fail to accomplish.
Freddie/Fannie and the American Dream
At some point during the last 50 years of American history, we decided that the American Dream meant owning a home. It seemed to become an increasingly important task for our government. We made it a goal to make as many Americans as possible home owners... The result being the birth of the subprime mortgage market. Throughout the 90's the federal government incentivized the housing market to give mortgages to less than ideal candidates. The government promoted programs like HUD and became the biggest player in the industry by sponsoring Freddie Mac and Fannie Mae. They guaranteed the value of subprime mortgages sold by private enterprises. This meant that a bank like TCF could grant a mortgage to a subprime candidate knowing that if the candidate failed to make the the payments, the federal government would bail them out. The result: Mortgages brokers, banks and the rest of the industry were granting subprime mortgages without regard to the risk. And I don't blame them. They knew that if the mortgage fell through, The U.S. GOV would pick up the bill.
Due to this, mortgages became easier and easier to come by. This policy may be the single most important reason for the financial meltdown, but it also had an effect on housing prices, a BIG effect.... they went up and up. Why? When more and more people qualified for mortgages, more and more people can afford houses. And when there are more people can afford houses, then there are more looking for and bidding on houses. When this happens, prices goes up. If you are selling your house and are dealing with 1 potential buyer, you don't have much of an opportunity to increase your price tag. When there are 10 buyers, you can easily increase that price. This caused housing prices prices to rise across the entire market. And they seemed to rise faster and faster each year.
Below is a graph that reflects actual data, despite it being drawn using a free paint app on my iphone. It compares the increase in GDP to the increase in housing prices. GDP is used a standard measure of how our entire economy grows. You notice how housing prices raise exponentially faster than GDP until the collapse, at which point they return to a growth similar to GDP. I say that the exponential growth before the collapse was a simple result of easy credit, or subprime mortgages. And unless we return to those standards, housing prices will never increase like they once did.
POST on Behalf of Cindy Sundberg:
ReplyDeleteThe American Dream of owning a house is one that came over from the other side of the ocean way back when the pilgrims came. People didn't get to own houses in Europe unless they were royalty or gifted one by royalty. The peasants were not landowners. Slaves were not landowners. Women were not land owners. Instead, people were born to their land or took it (and held it) by force.
So when we began to populate a new country, one of the perks was that there was enough land for everyone to have their own and build their own home on their own land. And the government liked that because it helped obtain and retain the land from the people who were here before us.
My only point is this: The American Dream of home ownership is far older than 50 years. In fact, I believe that the desire to own ones abode is likely to date back to the period of individual ownership of anything. Perhaps it was the government that changed 50 years ago, in how they contribute to home ownership. But the dream itself is as old as money.
I fully agree with the above post. In fact it's the politicians attempt to capitalize on that dream that may have contributed to the bursting of the the housing bubble and economic collapse of 2008.
ReplyDeletePrivate home ownership has always been teh hallmark individual success. The politicians, recognizing this, have used private home owneship has a measurement of the effectivness of their economic plan. Every presidential administration that I remember, dating back to Jimmy Carter, has used the increase in private home ownership is a benchmark of the success of administration and campaingn fo rthe future. Naturally, this situation lends itself to artificially tinkering with the free market through well intended but ultimately misguided legislation. These ultimately resulted in unintended consequences, some of which may have contributed to this situation Collin describes.
One example, is a Community Reinvestment Act of 1977. This well intended act, that enjoyed bipartisan support, ultimately put a downward pressure on the qualification requiements in order to comply with federal guidelines. No sooner where the lenders realizing thier vunerablity resulting these increasingly risky loans, that the financial world began to package the loans with other more favorably risked loans to more evenly distributed and absorb the default loans. Then, the next wave of high risk landing began. All of this encouraged if not indirectly required by the federal government.
So what happened 50 years ago? We began to rely far too heavily on the arbitrary index of home ownership as a sign of economic well-being. We allowed our elected officials to manipulate banking regulations under the threat of non--FDIC participation, and this began a cascade unintended consequences the contributed to the bursting of the housing bubble.