Wednesday, October 06, 2010
Bursting of the Housing Bubble
A Filipina friend and I were talking about the loan business, home mortgages, first and second mortgages, and all that. I wandered into a story about a man I worked with at my last job. His name was Andy. He and his wife and their children had recently moved from Chicago. He bought a house in Torrance, near the plant. I don't know what he paid for it; at the time average tract houses were selling for about $30,000. Like most young people he and his wife didn't have any savings to speak of. He obtained a mortgage for part of the cost of the house and a second mortgage for the rest.
In those days (around 1970) what Andy did to acquire a house was very typical. Andy had a second mortgage with a balloon payment. That is, after five years the entire mortgage was due. Andy solved that problem as did his cohort. Before the five years was up, he was able to sell the house for substantially more than he paid for it. I don't know any particulars, so I will make up some typical numbers. After five years the house was sold for about $40,000. Andy paid off both mortgages and had $10,000 cash left over.
He used part of the cash as a partial payment for another house. Let's say he bought a house for $50,000 (a bit better than the house he'd just sold) with $10,000 cash and a loan of $40,000. No second mortgage this time. In a few years he sold this house for, say, $70,000 and put part of the cash into a third house. In this way he was able to take advantage of the housing boom to acquire equity and comfortable living accommodations.
At no point in Andy's rise from living from paycheck to paycheck to relative affluence did anyone question his credit worthiness. It didn't matter. All that mattered was that housing prices were rising. This situation prevailed until about 2005 or so, give or take a year. At that point housing prices peaked and started declining. Now all the young people like Andy were in a bind. They owed more than their houses were worth. There was no chance of selling the house and moving to another one with an increase in net worth. Their only choice was to abandon their houses.
Much has been said to disparage both the borrowers and lenders. Borrowers have been blamed for taking on debt that they couldn't manage. Lenders have been reviled for lending money to people who obviously couldn't handle that much debt. Do I think that my friend Andy should be held up to shame for what he did? No. Everyone did it. There was almost no risk as long as housing prices kept going up and up. If people are to be regarded with shame for gambling on increasing house prices in 2005 but equivalent people are to be regarded as clever for doing the same things in 1985, are we not then a bunch of hypocrites? Enough of blaming the people involved - that is the people who made and who took out the loans. Blame the system; blame the bankers who packaged the mortgages and created the "toxic assets." In the end, why blame anyone? It happened. It was a natural consequence of our world-wide economic system. We should pick up the pieces and go on.
In those days (around 1970) what Andy did to acquire a house was very typical. Andy had a second mortgage with a balloon payment. That is, after five years the entire mortgage was due. Andy solved that problem as did his cohort. Before the five years was up, he was able to sell the house for substantially more than he paid for it. I don't know any particulars, so I will make up some typical numbers. After five years the house was sold for about $40,000. Andy paid off both mortgages and had $10,000 cash left over.
He used part of the cash as a partial payment for another house. Let's say he bought a house for $50,000 (a bit better than the house he'd just sold) with $10,000 cash and a loan of $40,000. No second mortgage this time. In a few years he sold this house for, say, $70,000 and put part of the cash into a third house. In this way he was able to take advantage of the housing boom to acquire equity and comfortable living accommodations.
At no point in Andy's rise from living from paycheck to paycheck to relative affluence did anyone question his credit worthiness. It didn't matter. All that mattered was that housing prices were rising. This situation prevailed until about 2005 or so, give or take a year. At that point housing prices peaked and started declining. Now all the young people like Andy were in a bind. They owed more than their houses were worth. There was no chance of selling the house and moving to another one with an increase in net worth. Their only choice was to abandon their houses.
Much has been said to disparage both the borrowers and lenders. Borrowers have been blamed for taking on debt that they couldn't manage. Lenders have been reviled for lending money to people who obviously couldn't handle that much debt. Do I think that my friend Andy should be held up to shame for what he did? No. Everyone did it. There was almost no risk as long as housing prices kept going up and up. If people are to be regarded with shame for gambling on increasing house prices in 2005 but equivalent people are to be regarded as clever for doing the same things in 1985, are we not then a bunch of hypocrites? Enough of blaming the people involved - that is the people who made and who took out the loans. Blame the system; blame the bankers who packaged the mortgages and created the "toxic assets." In the end, why blame anyone? It happened. It was a natural consequence of our world-wide economic system. We should pick up the pieces and go on.
Labels: housing boom collapse
