Housing Bubble Causes - Why Did it Happen?

The Great Housing Bubble was caused by an expansion of credit that enabled irrational exuberance and wild speculation. The expansion of credit came in the form of relaxed loan underwriting terms including high debt-to-income ratios, lower Fico scores, high combined-loan-to-value lending including 100% financing, and loan terms permitting negative amortization.

Addressing the conditions of expanding credit is a legitimate focus for intervention in the credit markets. an additional one major lending question is unrelated to the terms: low documentation standards. The credit crunch that gripped the markets in late 2007 was exacerbated by the rampant fraud and misrepresentation in the loan documents underwriting the loans packaged and sold in the secondary mortgage market. It is indispensable to an evaluation of the viability of a mortgage note to know if the borrower absolutely has the income indispensable to make the payments. When investors lost reliance in the basal documents, the whole system seized up, and it was not going to work properly until the documentation improved to reflect the reality of the borrower's financial situation. Any remedy for the housing bubble must address the issue of poor documentation in order to facilitate the level carrying out of the secondary market.

Buble Home

There are some factors that created the Great Housing Bubble that cannot be directly regulated. One of these is the lax promulgation of existing regulations as described previously. Even though lenders and investors lost a great deal of money during the price crash, their behavior during the bubble was still predatory. Lenders peddled unstable loan programs to borrowers who could not afford the payments. They did not do this to obtain the asset as is ordinarily the case with predatory lending; they did it to obtain a fee straight through loan origination. Since they felt insulated from the losses to these loans being packaged and sold to investors, they were in a position to profit at the price of borrowers, the definition of predatory lending.

Another factor that cannot be regulated is the crazy behavior of borrowers caught up in a speculative mania. It is not inherent to stop people from overpaying for real estate, but it is inherent from preventing them from doing so with borrowed money. If people wish to risk their own equity in asset speculation, it is their money to lose, but when lender money is part of the equation, the entire financial system can be put at risk, which it was during the Great Housing Bubble. The fickle nature of borrowers became apparent during the decline of the bubble when many borrowers behaved in a predatory manner refusing to make payments on loans they could have afforded to make because the asset had declined in value. Borrowers who were grateful to receive 100% financing and what was perceived at the time to be convenient loan terms were not hesitant to betray the lenders when their speculative investment did not go as planned.

The 30-year fixed-rate conventionally-amortizing mortgage with a uncostly downpayment is the only loan schedule proven to contribute stability in the housing market. Many of the "affordability" products used during the Great Housing Bubble and many of the deviations from primary underwriting standards created the bubble. Mortgage debt-to-income ratios greater than 28% and total indebtedness greater than 36% have a proven history of default. Despite this fact, debt-to-income ratios greater than 50% were tasteless in the most ultimate bubble markets.

Limiting debt-to-income ratios is indispensable to stopping loan defaults and foreclosures. Lower Fico scores was the hallmark of subprime lending. Fico scores contribute a fairly definite profile of a borrower's willingness and capability to pay their debts as planned. Low Fico scores are synonymous with high default rates. Limiting availability of credit to those with low Fico scores was a historic barrier to home ownership because these people default too much. The free shop solved this problem. Subprime was dead.

High combined-loan-to-value (Cltv) lending including 100% financing is also prone to high default rates. In fact, it is more prominent than Fico score. Fico scores are very good at predicting who will default when down payments are large, but when borrowers have very limited of their own money in the transactions, both prime and subprime borrowers defaulted at high rates. Many prime borrowers are more sophisticated financially, and the unscrupulous recognized 100% financing as a excellent too for speculating in the real estate shop and passing the risk off to a lender.

The primary culprits that inflated the housing bubble were the negative amortization loan and interest-only loans where lenders qualified buyers on their capability to make only the initial payment. As the Great Housing Bubble began to deflate, Minnesota and some other states passed laws restricting the use of negative amortization loans and required lenders to qualify borrowers based on their capability to make a fully amortized payment. The Minnesota law is a good template for the rest of the nation.

Any proposal to preclude bubbles from reoccurring in the residential real estate shop must properly recognize the cause, contribute a clarification that is enforceable, and allow for the unhindered working of the secondary mortgage market. The solutions outlined below are both market-based, meaning it does not want government regulation, and regulatory based, meaning it entails some form of civil or criminal penalties to preclude inevitable forms of behavior prominent to shop bubbles.

All changes are difficult to implement and the solutions presented here would be no exception. Any policies which preclude future bubbles will be opposed by those who profit from these activities and homeowners who are in need of the next bubble to get out of the bad deals they entered during the Great Housing Bubble. Despite these difficulties, it is imperative that reform take place, or the country may taste an additional one housing bubble with all the pain and financial hardship it entails.

Housing Bubble Causes - Why Did it Happen?