Thought Leadership | Mortgage | How To & Education
There's an awful lot of debate about who is to blame for the current foreclosure crisis and who should or should not, be bailed out. Some folks are downright angry. My father was a logic and philosophy professor. As a kid growing up I was allowed to do almost anything I wanted so long as I could make a valid argument for doing it. This was much harder than you might expect thanks to the many fallacies that rendered my arguments invalid in my father's eyes. That my teacher said it was true didn't make it so (the appeal to authority fallacy). But of all the fallacies that my father used to thwart my plans, the one I remember best is the post hoc ergo propter hoc fallacy - which says that just because something happened first doesn't mean it CAUSED what happened next.
Subprime loans were the first to foreclose, but that isn't enough to prove subprime lending caused this crisis. Speculation is correlated with foreclosures, but is it really the cause? The truth is that there were a lot of things at play and we are unlikely to ever see a root cause analysis on the subject that would satisfy my father. But among all the arguments, I do see a theme... an ever-increasing willingness to trade tomorrow for a better today.
Let's take a quick look at a few of the things I like to point to as potential causes of today's foreclosure crisis, and see if perhaps you agree:
1. Federal Reserve effectively lowers reserve requirements in the early to mid-nineties, likely in response to the housing crisis. Allow banks to lend a greater percentage of their deposits pumping money into the economy (and perhaps fueled the dot com bubble), but increased the risk of bank failures.
2. Congress passes the Taxpayer Relief Act of 1997 allowing homeowners to exempt up to $500k ($250k if you're single) in capital gains on the sale of a primary residence. Helps get the real estate market restarted after a significant downturn, but highly incentivizes everyone to speculate with their primary residence.
3. After the dot com bubble collapses the U.S Federal Reserve lowers rates 11 times from 6.5% to 1.75%. According to Greenspan, this didn't help put money into the economy until the invention of the Structured Investment Vehicle, which essentially allowed banks to make highly leveraged investments by moving them off their balance sheet avoiding regulations. This helped free up credit to stimulate the economy but encouraged riskier lending.
4. Lenders invent new products in ever-increasing competition for new customers. All types of financial engineering are employed to lower payments - adjustable mortgages with teaser rates, negative amortization, high debt-to-income ratios, etc. All of which increases the loan amount a borrower can afford on a given income... at least to start. This created unprecedented demand for housing and increases in prices, but higher prices decrease home affordability, and low initial payments ultimately have to adjust upwards.
5. Counties and cities see unprecedented growth in revenue from building permits and property taxes and race to approve ever more development to fund the expansion of services. Yet over-development was one of the most cited causes of the last real estate downturns.
6. Rather than slowing development as demand falters builders continue building at record paces. Yet the Boston Fed found that declining prices play the dominant role in generating foreclosures.
7. And through it, all consumer debt continues to rise as people increasingly make the decision to pay Tuesday for a hamburger today. In each of these cases, I'd argue that we have chosen instant gratification today without regard for the future. Perhaps every once in a while it would be better for us to trade a little pain today for a better tomorrow.