Sorry for the length but really need a common sense approach to the problem.
There are multiple causes for the collapse of housing. The bottom line is that people who had mortgages did not have enough money to pay the bank or mortgage holder. Many people think that the Arms, MBSs, and alike were the ultimate cause.
An example: When a person has chest pain and shortness of breath, we think the patient is having a heart attack. These same symptoms can be caused by hyperventilation. You have to look at the root cause of the problem. Sometimes, a true heart attack can cause anxiety and thus lead to hyperventilation thus compounding the diagnosis. The root of the problem has to be determined whether it is a heart problem or a pulmonary/nervous problem.
Many people bought houses beyond their means not taking into account a change in interest rates, i.e. Arms, balloon payments, etc. I am by no means defending the buyers or mortgage backers that pushed these products on home buyers. Almost no one ever reads the fine print of mortgage papers, if one did before signing, you would be at the title company for a day or more.
In the 1990s, the Clinton Administration wanted to extend home ownership and passed laws to assist the lower income people to obtain mortgages for a home. ACORN was a sponsor for many of these people and would encourage banks to lend to lower income people. The country had just come out of a recent recession in the early 1990s and interest rates were low considering the rates of the early 1980s when mortgage rates were 18% or thereabouts. The high interest rates of the late 70s and early 80s were the work of Paul Volker, then the Federal Reserve Chairman, who is now Pres. Obama's chairman of his economic council.
The recession of 2001 was preceeded by the attacks of 9/11. People were scared and the economy slowed. Mr. Greenspan lowered the Funds rate to 1% to encourage people to spend and keep the recession brief. This drop in interest rates while well intended allowed more lower income people to purchase homes. This also allowed move up buyers to buy larger more expensive homes.
When a bank reviews your income and tries to determine your ability to repay your loan, they consider many things and it generally accepted that your mortgage payment should never exceed 40% of your income. Why is that? Does it take 60% of your income to survive your daily living expenses such as food, clothing, schools, raising children and leisure activities? Probably a little more than 60% depending on your criteria.
We all know that food prices vary, sometimes by seasons. Clothing can vary due to the trends that people migrate too. Colleges are constantly raising tuition and books also never seem to take a price break. Most of these are also linked in some way to Energy Costs. Food for example, oranges may double in price if there is a heavy frost in Florida during the growing season. Energy however is often controlled not only by supply and demand but also the weather and speculators. Recently the SEC fined a firm for pushing the price of oil over $100.00 prematurely in the mid 2000s.
What were you paying for a gallon of gas after the 9/11 attacks? How about $1.05-$1.15 depending on your state's tax on gas. Oil never went above $40 a barrel until 2004, the same time that we invaded Iraq. The world became jittery. Speculators jumped in. Oil continued to $147 a barrel which translated into $4.00 a gallon for gas. You had now a 400% increase in energy costs. Even oranges don't get that bad. There is nothing that we consume that does not require energy. Energy is a necessity.
When you have a explosive rise in energy costs, the daily living expenses can often not be adjusted accordingly. Hopefully the CPI would encourage your employers to provide a COLA. I forgot. During the Clinton Administration, the CPI was changed as his administration believed that the CPI calculations over stated the true cost of living. Saved them money on Soc Sec Colas.
When people have less money, they buy less discretionary items. Thus companies produce less and lay off workers. Mortgage companies make less loans and lay off workers. Real Estate agents can't sell houses and find other part time work. Local companies decide to move their facilities to areas less costly to produce their products. Layoffs increase and more mortgages go unpaid.
The mortgage payment is the largest payment each month. The best and easist one to extend with the hope of catching up someday. However the banks and Wall Street decided that they could increase their revenue through the use of MBSs, CDOs etc. Smart move to increase the bottom line and their stock price. However they did not realize that daily living expenses would cause such a problem. Then to really top things off, Wall Street sold these "A" rated investments to Countries, Cities, etc overseas and thus we had the making of a world wide crisis.
If you wish to look at the crisis graphically, go to economagic.com and plot the Prime Rate and the price of West Texas Intermediate oil from 1940 to present using a GIF Chart. Add the recessions in and the grids. You will see that even a small rise in oil back in the 50s would cause a recession as the prices continued to rise.
Last note, Mr. Volker in the 70s and 80s often rose interest rates to combat inflation, often due to energy prices and why now does he speak a different tune when the same things occur?
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