Thursday, August 30, 2007

Mortgage Market Woes: How Did We Get Here?

by Amy Lillard

This year has been a year of ups and downs for the housing market. In our continuing series, we chronicle news affecting the housing market and its major players.

Subprime collapse. Credit crunch. Stock market craziness. Even the most astute industry analysts and insiders are confused and shocked with how quickly and thoroughly the economy has felt the tremors this summer.

For all of us looking at headlines and feeling only a vague sense of anxiety and befuddlement, we take a look back. How did we get here?

Greenspan and the Housing Bubble

In 2001, the economy was stifled and stilted after the dot-com bust. To stimulate the economy, the Federal Reserve Bank Chair Alan Greenspan lowered interest rates to unheard-of lows. Money became cheap and immediately available. Lenders were ready and eager to lend money to homeowners and business owners alike, and offered the funds at extremely low rates.

What about risk? Every time someone borrows money, whether it's for a family home or a multibillion dollar firm, there's always risk involved. That's the entire basis of lending, whether from banks, credit agencies, or other groups. But with the slashed interest rate, cheap money was everywhere. This led to a growing complacency about risk. Running into trouble paying back a loan? Just get another one. Getting deeper into debt? There's plenty of money to be had, so have no fear.

Housing Bubble

Today, people are blaming Greenspan's interest rate policies for bringing on the biggest housing bubble in national history. What defines a bubble?

For years the housing market only moved up. With money easy to obtain (even for folks with less than ideal credit) new homes and buildings exploded into being. Home prices continued to rise, because the demand was there and the belief that prices would continue to rise was there.

This rapid rise of real estate values soon outgrew reality. They reached unsustainable levels relative to incomes and other economic elements. That's the definition of a housing bubble. These bubbles historically are followed by severe price decreases (a "crash"). Many homeowners are left holding negative equity, meaning a mortgage debt higher than the actual, current value of the property.

Subprime borrowers, those that received money despite their lower credit ratings, were the first hit. The strange and often unfair loans they received became too much to bear as housing values decreased. They couldn't make payments, and entered loan default in droves.

Beyond the Housing Market

So how did these events result in giant companies declaring bankruptcy? Or the crazy rollercoaster ride the stock market has taken this summer? Why are banks across the world desperately trying to restore confidence in increasingly shaky global economies?

It's much more complicated than blaming Greenspan, as some pundits and angry analysts have done. Interest rate movement is only part of the story. What could play a bigger and more crucial role in this economic decline is the very nature of Wall Street. Built into the global web of economic movement are a shockingly unstable and confusing set of financial instruments, known as "structured finance." They've become the basis of markets worldwide. And they're in trouble.

For the rest of the story, read Part Two of this article - Tomorrow

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