Loan Modifications: Why Did The Mortgage Crisis Occur

08 12 2009

Loan Modifications: Why Did The Mortgage Crisis Occur

Posted by: admin in mortgage industry

When looking at a crisis it often pays to see what got you there if you are to learn anything from it. The current mortgage and credit crisis was either unavoidable or a surprise depending who you ask. Loan Modifications are now being sold as the solution to the crisis as if changing the interest rate, tenure or principal of loans were the heart of the problem. But what is at the heart of this worldwide crisis?

History tells us that depressions, recessions and crisis are as part of the free market economy as free trade and private enterprise. Take this example; in 1908 a financial crisis spread panic “in every part of the globe. It was as if a volcano had burst forth in New York, causing a tidal wave that swept with disastrous power over every nation on the globe”, as reported in the The Wall Street Journal.

In 1929 there was a Great Depression, earlier there was the Long Depression (1873), a Panic in 1837 which has been described as “an American financial crisis, built on a speculative real estate market.

Any of that sound familiar? If it didn’t it soon will. But how did the current mortgage crisis occur? To answer that we need to go back a little over a quarter of a century.

Since the Reagan Administration in 1980 America has been pioneered globalization of free trade. This opened the U.S market to new products and investment unparalleled in any other economy. America’s entrepreneurial spirit combined with political freedom and a trend of economic deregulation fuelled a rapid expansion in new types of investments that also spurred an increase in international finance and commerce.

Unfortunately America’s growth came to rely on debt. The economy needed more consumers that could only buy on credit. The largest debt and purchase for many was their own home. Credit was easily available so buying wasn’t a problem; this fueled home prices in particular.The result was a housing boom that created the feeling that prices could only rise.

In 2007, as we know, the housing boom finally collapsed showing the fragile structure that had held it up behind the glossy veneer. Loans had been provided to families that couldn’t afford them, especially if the economy weakened. Most had purchased homes they couldn’t really afford. As housing prices fell, homeowners could no longer sell their homes to pay their mortgages. These bad loans were the foundation of an international web of speculation on mortgage securities and financial contracts which were toppled by the housing collapse.

The catastrophe revealed weaknesses in the U.S economy. Savings had been outpaced by spending and reckless consumption. Financial regulators underestimated the risk and fell into a dangerous state of complacency that led them to forget the lessons learnt from previous crisis.

So will loan modifications solve the problem of millions of households that risk losing their home? Some might take advantage for them but most will have to look for alternative solutions. Ultimately we will all have to relearn the lesson that we need to save more than we spend to keep our head above water.

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