FACTS
-2000+: housing prices rose enormously
-Second quarter 2006: steep decline in prices
-Third quarter 2006: mortgage defaults shoot up
-mid 2007: financial system, which had heavily invested in securitized mortgages, began to collapse.
-Foreign economic systems, which had also bought many of these products began to experience unprecedented losses
-government bailouts, nationalizations, etc
can't post links yet, so look up graphs on the price evolution since 1980s to current days to see how it progressed
Mortgage Failures: Occurred in a strong economy and before housing prices have fallen signifficantly
foreclosures occured at same time and at the same pace in both prime and subprime markets.
Anyway, to what really matters:
Market Failure?
4 central causes of financial crisis (which have nothing to do with free market):
-Fiat money
-Low interest rates
-forced loans to high risk borrowers
-government loan guarantees
Fiat money: in 1971 us dollar was taken off the gold standard, which means the dollars isn't backed up by nothing except government saying so. you cannot redeem it by gold or silver like it was once, and is essentially a piece of paper.
Low interest rates:
high housing prices+ artificially low interest rates (by the Fed) = rampant speculation (25% of house purchases were for "flipping")
Forced loans: if you're a banker you are conservative to whom you lend money, because if that person doesn't pay back, your business WILL collapse. So why have these high risk lendings occured?
In 1934, after the great depression, government created the Federal Housing Administration, which guaranteed mortgages and thus eliminated the bank's risk for high risk lendings.
in 1938 Fannie Mae was created to purchase these mortgages
then in the 70s, you have the Community reinvestment act, which "is a United States federal law designed to encourage commercial banks and savings associations to meet the needs of borrowers in all segments of their communities, including low- and moderate-income neighborhoods. Congress passed the Act in 1977 to reduce discriminatory credit practices against low-income neighborhoods, a practice known as redlining." This means they had to do business without taking into consideration of the geography, whether it was downtown, suburbs, etc
then you have the Home Mortgage Disclosure Act of 1975, where they had to reveal private information to whom they were lending this, and then the government would score that information on CRA compliance.
and in 1991 you have government requiring banks to submit racial statistics and then accusing banks of prejudice in case (and im in no way trying to collectivize people here) they were discriminating against blacks whom they thought might not be able to pay back the lending.
Anyway, how did the government force the banks to go by these new regulations?
"Liability for punitive damages can be as much as $10 000 in individual actions and the lesser of $500 000 or 1% of the creditors network in class actions"
So banks are no longer allowed to use credit history, ratios of income to mortgage payments, and have to accept "credit counseling" as proof of financial ability, as well as unverified income statements. They also have to accept gifts, welfare and unemployment benefits, and other one-time for short term "incomes" as collateral.
Speculation
As prices kept low, defaults stay low, because no one defaults when he can sell the house at a profit.
But as i've already explained, as soon as prices decline, defaults rise, and interest rates begin to increase, as well as variable mortgage payments.
When demand is artificially stimulated, resource allocators get the wrong price signals, and then labor and capital are invested in those sectors of housing and building.
I think this is a more detailed way of explaining how this happened instead of just saying: GREED CAUSED THIS, because if that were the case, wouldn't we be in perpetual crisis?
