What Really Caused the Mortgage Crisis of 2008?

(note: this is a blog message that I posted back in October of 2008 when the market was truly in a crisis mode. I wanted to re-post it on here because I think it still has relevance, especially looking back to (2) years ago. Note my comment toward the end:

"In the future I guarantee that banks will make wiser decisions and there will be more oversight into how banks loan money."

I couldn't have been more prophetic. The Federal Government enacted sweeping bank regulations affecting mortgage lending that took affect on January 01, 2010. I wonder what else I said (2) years ago still resonates at the end of 2010?)

SNIP>>>>>>>>>>>>

October, 2008

Sure, you’ve heard all kinds of reasons why Wall Street is in crisis mode right now. Everybody has a reason as to why several prominent banks have failed. But I think it’s a little more complex than people think. Most people seem to be blaming it on “greedy executives.” I’ve got another take on this.

No doubt you’ve heard about “bad loans” and loan officers giving out some of these bad loans to “unsuspecting home buyers.” I am sure there are unscrupulous loan originators and mortgage people out there. Am I am also sure there some loan originators who were “casually” explaining the terms of their loan programs glossing over things like “adjustable” and “balloon payment” and the like.

So, many loan originators made mistakes, that's a fact. But who also should shoulder the blame? Maybe the consumer? That’s right, that “unknowing, innocent victim” that was taken advantage of by the loan officer with a pitchfork and a spiked tail. This crisis that is befalling Wall Street is partially caused by consumers who were getting loans but had no real ability to pay that mortgage. “You mean consumers knowingly got loans that they knew they couldn’t pay back?” (FYI, many of the buyers I have worked with had a budget and knew exactly what they could afford.)

I didn’t say the borrowers knew they couldn’t pay back the loan itself but I'm sure some of them knew that the amount of the loan and the payment "seemed kind-of high." I am also sure some loan officers and the underwriters knew that many of these borrowers were questionable. So even though the loan officers knew there was a risk involved with giving a loan to a questionable borrower, was the borrower actually “duped” into agreeing to a mortgage they didn’t understand? Did the loan officer hypnotize the borrowers and then make them sign something that would put them into ruin? Or did the borrowers maybe, just maybe, have a feeling they were getting in over their head? Did the borrowers read what they were signing?

We already know that many of the loans that were defaulted on were initially given to borrowers that were considered “risky” or even very risky. So why would the banks loan money to these people? First, because they could. This is because of the loosening of regulations that banks must follow in order to lend money to people. You’ve already heard about this. But what is the other reason that banks gave loans to people who may never pay them back? Because people wanted them. "If you'll give it to me, I'll take it."

Look, I’m not saying that there were not people who were mislead or outright lied to. There were. But there were many borrowers who knew what they were getting into. To be fair, lenders are required to give borrowers a “good-faith” estimate so that they understand things like interest rate, payment, closing costs, points, etc. If these borrowers didn’t understand the terms of their loan they could have asked. So, borrowers are given a good-faith estimate when they apply for a loan and then sign papers at closing that tell them what kind of loan and what kind of terms they are getting. Did somebody pull a fast one? Buyers can actually back out at closing if they do not agree to the terms of the loan. If a buyer signs something they don’t understand or don’t agree with I’d say that’s on them. Again, this is assuming that the lender didn't do something completely deceptive.

Mortgage people get a bad rap because of a few bad apples. But we have to remember that many of these people who defaulted on loans already had a history of credit problems and were “marginal” borrowers from the beginning. It’s not that hard to understand when the loan officer says “this loan is adjustable, that means your payment may go up.” Many buyers have a “buy now pay later mentality” these days. They see their friends buying big homes and they want one, too. So why would they want to risk loosing a house later for something like an adjustable rate mortgage or a balloon mortgage? Because it’s all about the here-and-the-now. “I want it, now find a way for me to get it. If the rate adjusts and my payment goes up I’ll find a way to deal with it.” Unfortunately, they way many of these marginal buyers dealt with the huge increases in their payments was by just not paying any more. And that is partially why we are where we are now.

I know there were legitimate, hard-working buyers who were probably misled by unethical mortgage brokers and they are now paying the price. But there are many buyers who got just what they bargained for. And now we all suffer the repercussions of loosening regulation, opportunistic mortgage people, and borrowers who made bad choices. We will dig out of this mess eventually. In the future I guarantee that banks will make wiser decisions and there will be more oversight into how banks loan money. I can only hope that buyers will also begin to make better choices as well.