1. Weaken lending standards to increase home ownership. Mortgage underwriting standards have been undermined by virtually every branch of the government since the early 1990s. The government had been attempting to increase home ownership in the U.S., which had been stagnant for several decades (see chart above). In particular, the government had tried to increase home ownership among poor and minority Americans. Although a seemingly noble goal, the tool chosen to achieve this goal was one that endangered the entire mortgage enterprise: intentional weakening of the traditional mortgage-lending standards.2. Celebrate the success of weakened lending standards, as home ownership surges to historical high levels. The weakening of mortgage-lending standards did succeed in increasing home ownership (from 64% to 69%, see chart above). As home ownership rates increased there was self-congratulation all around. The community of regulators, academic specialists, and housing activists all reveled in the increase in home ownership and the increase in wealth brought about by home ownership. The decline in mortgage underwriting standards was universally praised as an “innovation” in mortgage lending.3. Increased home ownership creates a speculative housing bubble. The increase in home ownership increased the price of housing, helping to create a housing “bubble.” The bubble brought in a large number of speculators in the form of individuals owning one or two houses who hoped to quickly resell them at a profit. Estimates are that one quarter of all home sales were speculative sales of this nature.4. Investors use ARMs and low(no)-down payment mortgages to speculate in housing. Speculators wanted mortgages with the smallest down payment and the lowest interest rate. These would be adjustable-rate mortgages (ARMs), option ARMs, and so forth. Once housing prices stopped rising, these speculators tried to get out from under their investments made largely with other peoples’ money, which is why foreclosures increased mainly for adjustable-rate mortgages and not for fixed-rate mortgages, regardless of whether mortgages were prime or subprime. The rest, as they say, is history.Unfortunately, it seems likely that our governing bodies have learned little or nothing from this series of events. If the proper lessons are not learned, we are likely to have a reprise sometime in the future.From the article "Anatomy of a Trainwreck," by Professor Stan Liebowitz, featured previously on CD here. MP: We could add step #5: Easy monetary policy by the Fed in 2000-2002, which brought the Fed Funds target rate from 6.5% to 1%, and lowered mortgage rates to record-low levels in 2002-2003 (see chart below, click to enlarge).
