Although I dislike the use of buzzwords, I think "perfect storm" describes why we are in the current situation. Generally, we like simplicity, but there is no single factor which caused the current mess. A few considerations:
1) The Fed -- Interesting to see the Alan Greenspan references above. I believe the unsustainably low interest rate environment which was initiated after the dot com/Enron troubles is partially to blame. Housing led the recovery (and it never has before). The majority of jobs created were in housing-related industries (lending, home improvement, real estate, etc). On an interest only loan, you can equally afford the payments on a $500,000 loan at 8% or a $1,000,000 loan at 4%. The result: money was abnormally cheap.
2) Exotic mortgage products -- I remember learning that, shortly before the market crash in '29, it was common to only require a person to put down $5 to buy $100 in stock. This was previously unheard of and led to a huge increase in the volume of trading (and equity pricing). When I was at a cocktail party a couple of years ago and the general consensus was you were an idiot if you didn't have a 100% financed, interest-only loan, I began to sense the end was near. The result: much more risk taken by borrowers.
3) Sophisticated financial instruments -- This is what happened to those loans after they were made. Our bankers got so good at slicing and dicing risk that they could take a piece of dog poop, combine it with a bunch of other pieces (no offense to dogs), cut it into enough slices, put it back together and call parts of it filet mignon. The rating agencies simply couldn't keep up with this and signed-off on the filet mignon characterization. The net result: the risk of investments in loans was understated in the market.
As with most other financial crises, the signs were there. They always seem to be.
1) The Fed -- Interesting to see the Alan Greenspan references above. I believe the unsustainably low interest rate environment which was initiated after the dot com/Enron troubles is partially to blame. Housing led the recovery (and it never has before). The majority of jobs created were in housing-related industries (lending, home improvement, real estate, etc). On an interest only loan, you can equally afford the payments on a $500,000 loan at 8% or a $1,000,000 loan at 4%. The result: money was abnormally cheap.
2) Exotic mortgage products -- I remember learning that, shortly before the market crash in '29, it was common to only require a person to put down $5 to buy $100 in stock. This was previously unheard of and led to a huge increase in the volume of trading (and equity pricing). When I was at a cocktail party a couple of years ago and the general consensus was you were an idiot if you didn't have a 100% financed, interest-only loan, I began to sense the end was near. The result: much more risk taken by borrowers.
3) Sophisticated financial instruments -- This is what happened to those loans after they were made. Our bankers got so good at slicing and dicing risk that they could take a piece of dog poop, combine it with a bunch of other pieces (no offense to dogs), cut it into enough slices, put it back together and call parts of it filet mignon. The rating agencies simply couldn't keep up with this and signed-off on the filet mignon characterization. The net result: the risk of investments in loans was understated in the market.
As with most other financial crises, the signs were there. They always seem to be.