The Real (Easy Credit) Debacle II: All About Bad Mortgages!
The real estate debacle was really a debacle of bad mortgages and because investors need to take out mortgages in order to secure real estate, you can’t have a real estate debacle without having a mortgage debacle. Nevertheless, if a mortgage represents a loan or a promise to pay; then the real culprit in this whole real estate debacle could, very well, be attributed to the financial instruments that were used to obtain said real estate.
The Traditional Mortgage
To say the least, the way mortgages were viewed prior to the whole real estate boom-bust period isn’t the way it was viewed when the debacle was at its height: the traditional U.S. mortgage went from something that was admired and patterned by the rest of the world, to something that all of a sudden defied the laws of classical lending economics. The various lenders of these so called “sub-par credit standard” long-term debt instruments—aka, subprime mortgages, went against the grain of both conventional wisdom and conventional lending practices. Namely, driven by a sublime case of fiduciary self-indulgence, lenders began extending credit to borrowers—who under a normal economic environment—wouldn’t have been able to meet traditional banking lending protocol. In its heyday, U.S. conventional lending was quite different whereby if a borrower wasn’t credit worthy enough to qualify for a conventional mortgage, he either: 1) Waited until he became credit worthy; or 2) Had to settle for a FHA government backed loan.
The Creation of FHA/HUD
What’s a FHA loan? A FHA loan is a loan issued by The Federal Housing Administration which is a United States government agency created as part of the National Housing Act of 1934 (wikipedia). The initial objectives of this organization were: 1) To stabilize the mortgage market; 2) To improve housing standards & conditions; and more importantly 3) To provide an adequate home financing system through insurance of mortgage loans. Because of widespread financial tolls taken on by the U.S. banking sector during The Great Depression—causing a virtual financial impasse in the U.S. financial sector—the government, at that time, felt that it needed to provide some kind of fiduciary safe guard in order to mitigate the risk of carrying conventional mortgages. At its very bare minimum level, in regards to FHA, essentially what the government did was create a domestic market for home mortgage insurance.
Since 1934, the FHA and HUD have insured well over 34 million home mortgages. Nevertheless, an FHA loan bridged the gap between a middle-income American who couldn’t quite make the conventional mortgage cut thus demanded a financial product that covered his/her risk of payment default. Fact is, when the government started backing these FHA loans, it provided a false sense of security to commercial lending institutions that these loans were good investments—when in a classical lending economic sense they weren’t. Also, not only were these loans “bad business” for banks but they became a small case of “bad economics” for the economy at large. Economically speaking, anytime government enters a market, it could only mean one thing: “bad news.” Put simply, when the government tampers with markets, they slowly begin to make way for a lot of market distorting.
The FHA and Mortgage Insurance
Through the mortgage insurance issued by the FHA, the government justified its involvement on the basis that home ownership increased from 40% in the 1930s to nearly 70% in 2001. Again, herein lay the problem at hand, whereby, over the years, we’ve seen government push this idea that every American should gravitate towards home ownership—which was a complete market fallacy. What we painfully found out in the real estate debacle was that this agenda came with major consequences to the overall health of our economic engine. Fact is, this idea of the “American Dream” is just what the name implies: a dream—perpetuated by post WWII American soldiers coming home to a 3bedroom 2bathroom single-family dwelling with a white picket fence, a wife and a newborn baby in her arms. In a classical economic lending sense, home ownership wasn’t a direct right: it was a privilege to the select few that did what they were suppose to do in order to earn that right. The commercial lending market never asked the government to provide extra security in this matter.