I committed the cardinal sin of arguing with a client recently over what happened in the housing bubble of 2008. He owns a number of rental properties, and insists that greedy banks caused the mortgage collapse by writing bad loans. My take is a bit different – okay – a lot different.
The “greedy banker” explanation requires us to believe that beginning in the mid-2000’s, bankers either forgot how to properly underwrite a loan – or competition was so intense that once one bank lowered their lending standards – all followed out of fear.
What happened was that years earlier – Congress – in an attempt to artificially make home ownership more accessible to more people, “forced” their quasi-government agencies – Fannie Mae and Freddie Mac – to lower their lending standards.
Once the commercial banks learned that they could package and resell mortgages back to Fannie Mae and Freddie Mac – at the new – lower qualification standards – they naturally took advantage of the opportunity, shifting the default risk onto Fannie and Freddie.
That’s what caused the collapse. It was a government created bubble that burst. Congress blamed the banks – and many Americans bought the finger pointing hook, line, and sinker.
The real question is why – now six years later – have home prices not rebounded more in many parts of the country? The answer lies in the law of supply and demand.
Nearly 40% of mortgages were sub-prime in 2008. Many of those buyers were forced out of the market when lending standards once again resumed a level of reasonable prudence. Fewer qualified buyers means lower demand. At the same time, foreclosures created artificially high supply. When a market is characterized by an over-supply of something – and a depressed demand – prices fall – and remain there until supply and demand resume equilibrium.
Making the problem worse – today’s 20 and 30-somethings – the very people who buy starter homes, are so saddled with student loan debt, many cannot qualify for a mortgage. Without inventory turn at the lower end of the housing market – the higher strata of the housing market can’t move either.
Things will get better – slowly. But the lesson should be – regardless of your politics – let’s keep our government officials out of the business of artificially manipulating markets – no matter how good, worthy, or justified the cause.