Friday, January 30, 2009
THE DREADED HOUSING MARKET
I couldn’t really think where to start today, so I figured it would be a good idea to start with a little background information on one of the main events that occurred that lead up to our financial situation that we are in now. This event would be the fall of the housing market. This basically caused the decline in home values across America and caused families to be unable to pay their mortgages. This along with the loss of jobs caused the decline in the economy. That is the hand that we have been dealt, and I am here to explain this to you.
First it all, to set the scene. Its just about the turn of the century as we enter Y2K. Economy was doing pretty well, Clinton obtained a surplus in US funds rather than the traditional budget deficit. In addition to that, millionaires were being made on the stock market with online businesses. Things were going good. People started to upgrade houses, buying bigger and more of them. The adjustable rate mortgage allowed many people attain homes that would normally be considered out of their budget, but because of the low rates they were very appealing to consumers. A simple background idea for the adjustable rate mortgages were that they were really low, however they had a rate lock that was only temporary meaning they could change. Hence, adjustable rate mortgages could change.
During this time, roughly around 2001, we should have been using contractionary fiscal policy, increasing taxes, and lowering the money supply. By not doing this we set ourselves up for decline. This wasn’t really accomplished due to the fact that increasing taxes is not a very easy thing to do politically thus, it never occurred. With the economy booming, people started to buy houses not only for themselves but for investments. Housing values were on the rise, and people saw this as a vehicle to attain wealth. Which in most cases it was, however for the people that could not afford it but did it anyway, devastation occurred.
One of the major responsibilities of banks failed during this time as well. Banks were lending out extra loans so that people could purchase these houses that shouldn’t of. Items that are reviewed during a normal application were sometimes overlooked. Things such as credit score, income, debt-to-income ratio etc. were all overlooked. So people started to buy up all these houses, however when it came time for their adjustable rate mortgage to adjust, their rate wasn’t so low. Adjustable rates shot up, making them more costly to pay for each month. This caused many who could not afford these to default, or go into foreclosure. When that happens, the bank gets the house back, because the person could not afford the payments. As we know, banks deal with money, not houses, they don’t want them. With foreclosures increasing over the years, 2004/5-2007 home values dropped, causing people to become “backwards” in their loan, simply meaning that they owe more than its worth. With the economy in a downward spiral, more and more people could pay their loans. This caused the creditors to tighten up credit, making it hard for people to get loans. This is NOT good especially in a free market, because our economy functions on credit, we need it to buy and increase spending to raise GDP.
That is the housing market situation quickie. This will help you to get a preview of one of the biggest causes for the decline in our economy. Hopefully this helps to aid in your understanding of building the foundation of your knowledge of the economy as of now.