Root of the Problem
While fingers are pointing in all directions to lay blame for the current financial calamity, and there’s plenty of blame to go around, it seems that most people agree — at least tacitly – on the root fo the problem. Getting some to say it out loud is difficult, however, since saying it DIRECTLY seems to be too much for some to handle. At the very least, it is an attempt to divert attention away from the CAUSE of the problem to one of the SYMPTOMS of the problem.
So, what caused this mess?
Simple:
Too many “bad loans”.
Everything else is just a symptom of the problem. And, yes, there were some abuses along the way BUT most were taking advantage of a system that was flawed to begin with. In other words, most of the “abuse” would not have been possible had the root of the problem not existed.
In any business, a certain amount of “bad business” will occur. Most have policies in place to manage it… yet, even with rigorous oversight, SOME business will be bad. For example, if you offer to let customers buy on credit, you base that offering on their ability to pay. Customers with a good credit history or a source of income are probably “good bets”… they will probably fulfill their obligation. Those who do not simply aren’t allowed to purchase on credit. If credit policies are managed well, you’ll get more business and most of it will be good… the goods purchased on credit will be paid for. If not, you’ll have a lot of costs associated with providing your goods and not get paid for all of it. In any business, a certain small percentage of “bad debt” can be accommodated… it’s not good but it doesn’t kill the business. Too much bad debt can be fatal to even a good, strong business.
So, there were TOO MANY bad loans… but WHY?
Again, it’s fairly simple. Historically, banks made mortgage loans to people who “qualified”… that is, had good credit, a reasonable down payment, manageable household debt, and sufficient income to make the home loan payments. Pretty reasonable, if you think about it. Would YOU loan money to someone with a poor credit history? Or had little to lose if they failed to repay? Or already owed too much to others? Or didn’t have enough income to repay you? Of course not!
An aside: Remember, banks do not loan THEIR money… they loan YOURS. If you’re a depositor at a bank, it is actually your money they are loaning to others. While your money is guaranteed by the government, banks are allowed to loan it based on their fiduciary duty to watch over your money appropriately. Banks must maintain certain loan to deposit ratios (and much more) in order to extend that government backing.
Anyway, once it was much harder to buy a home because the banks looked closely at whether the borrower qualified or not. Over the past 30 years or so, however, the “American dream” of home ownership became a political football, starting with the Community Reinvestment Act of 1977. As is all-too-typical of ANY government program, when it is started, you can EXPECT more of it.
Members of Congress increasingly began to apply legislative and bureaucratic pressure on lending institutions to based loans LESS on the qualifications of the borrower. In addition, large buyers of those loans were standing in line waiting for more (FNMA and FHLMC), so the banks weren’t going to get stuck with loans they KNEW to be of “lesser quality”. So, they jumped on the bandwagon and started to make loans “with vigor”… loans without down payments, loans without documentation, loans without income verification. You get the idea.
Further compounding the problem:
- Rising real estate values (fed by this whole cycle), producing equity in the home until such time values began to decline.
- Intermediaries, such as mortgage brokers, who pushed people who undoubtedly knew they couldn’t afford a home (or as expensive a home) to buy anyway.
- Exotic financial instruments traded much like stocks were created by Wall Street that, for all their complicated nature, were based ultimately on individual home mortgages.
- The understanding of buyers of the loans, whether directly or as a part of some financial “package” product, that there was the backing of the government through Fannie Mae and Freddie Mac.
The goal of owning a home is a worthy one… but homes cannot just be given away. That’s essentially what our government, in all their wisdom, attempted to do.
Congress started this mess.
How can we trust them to get us out of it?
