A Look back at the Mortgage Meltdown

We’ve looked at the case against “strategic walkaways”; let’s now look at the central cause of the mortgage meltdown.

The failure of the mortgage system began during the period from 2000 to 2005. Most major financial institutions are regulated in part by the Federal Reserve, and at that time it adopted a hands-off oversight policy. The theory was that lenders would not make risky mortgages because risky loans produce losses, and, therefore, lenders as a matter of self-interest would not offer such financing. As a result, government regulation should be as minimal as possible. The Fed could have prevented the mess; under the Home Ownership Equity Protection Act of 1994, the Fed has the authority to stop mortgage products and practices that it considers unfair or deceptive.

Had the Federal Reserve said “no” to option ARMs, no-doc loan applications and interest-only residential financing, millions of problem mortgages would never have been originated. Today there would be far fewer foreclosures, and home values would be stronger.

So why did so many people and institutions accept the increased use of toxic loan products? Money. Increasing the pool of potential buyers through the use of nontraditional loan products meant more people could buy real estate and also that people with a given income could borrow more. The result was a quick increase in home values and millions of people suddenly seemed richer – as did lenders, brokers, appraisers, lawyers and title companies.

But home prices cannot rise eternally no matter how the system is fudged because it requires income to make payments — and incomes have been going down. According to the U.S. Census Bureau, real median household income was $49,445 in 2010, down from $52,587 in 1999.

Slow and steady long-term mortgages protected families during tough times in the past. Now millions of traditional mortgages had been replaced with toxic financing. We now face a financial crisis that was preventable. It was caused not by a lack of regulation but by the failure to use the rules we had in place.

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