October of 2007 ushered in a financial market peak that would lead to the most massive collapse since the Great Depression. Was this really a situation that no one could see coming as many claim? Or, was it a disaster that had been in the making for several years? The catalysts that finally culminated, leading to a near collapse of the US economy, are the explosive growth of the subprime and secondary mortgage markets combined with the explosive rise of consumer debt that had been occurring simultaneously with a persistent decline in consumer savings for over a decade. Read on to see how these key factors combined to result in the most horrific economic collapse since the Great Depression.
Explosive Growth of the Sub Prime Mortgage Market
The growth of the subprime mortgage market can be traced back to 1999 when Fannie Mae, under pressure from the Clinton administration to make home ownership more available to low income Americans, began an effort to encourage banks to grant mortgage loans to those with less than perfect credit. According to the New York Times,
“Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.”
(The roles of Fannie Mae and its sister company Freddie Mac are to purchase mortgages from the originating lenders, package them and then sell them on the secondary mortgage market.)
According to data from the U.S. Census Bureau, median home values soared 32 percent from 2000 thru 2005. As the housing market charged higher lenders seemed to grow more confident as they became more creative, willing to underwrite riskier and riskier loans which buyers were eager to take on. The Interest Only ARM and the Payment Option ARM were two of the most potentially dangerous of the creative loans. With both of these mortgages borrowers had the option to pay only the interest, or in the case of the Payment Option Arm, less than the actual interest due each month, for a set period of time. After the set period of time the loans reset and higher payments became due.
As long as the housing market continued higher the risks of resets to higher payments were minimal as home owners who could not afford the higher payments could either sell the home for a profit or refinance into another loan. However, there was great risk that an unforeseen downturn in the housing market could make it impossible for homeowners, now upsidedown in their loans, to just flip their way out of it. It is clear now that this was a disaster waiting to happen as it is not possible for the housing market to have continued higher indefinitely.
Explosive Rise in the Secondary Mortgage Market
As home prices continued to rise, interest in the secondary mortgage market followed suit. While enticing during a rising market, there was great risk of loss in these investments should the housing market turn lower. According to a 2005 article in National Underwriter Life and Health, titled, "Mortgage Backed Securities Growth Reflects Blazing Real Estate Market," the top 50 insurers had over a combined $76 billion invested in mortgage backed securities at the time. This level of what looked to be overconfidence in the housing market was alarming to many. Well known investor Jim Rogers was quoted by Reuters on March 14, 2007 stating, almost prophetically, “It’s going to be a disaster for many people who don't have a clue about what happens when a real estate bubble pops. It’s going to be a huge mess.....This time it'll be worse because we haven't had this kind of speculative buying in U.S. history."
Consumer Debt and Personal Savings
The speculative buying in the housing market may have been just compounding the pre-existing issues of consumer debt in general which had increasing at an alarming rate for well over a decade while the personal saving rate had been decreasing just as quickly. According to data available from the Bureau of Economic Analysis, in 1990 the personal saving rate was near 8 percent. As the great bull market of the 1990’s roared higher the personal saving rate persistently declined. By the end of that bull market in early 2000 personal savings had dropped to a record low at the time of .5 percent. By July 2005 personal savings dropped even lower, coming in at less than zero for the first time in history.
At the same time personal savings was declining to historically low levels consumer debt was increasing to historically high levels. According to Federal Reserve Data, outstanding consumer credit debt more than tripled from $211 billion in 1989 to over $700 billion by 2001. According to data at the Federal Reserve Board, in July of 2003 total consumer debt outstanding was $1.71 trillion.
Were the Answers there All Along?
Some argue that information detailing the potential problems with the subprime and secondary mortgage markets, consumer debt, and personal savings was freely available to all for years before the 2007 collapse. Most readers can likely recall hearing of at least some warnings of the potential problems as far back as 2001. Back then those who warned were many times labeled as negative and sometimes referred to as ‘doomsayers’.
This said, maybe this mess was as obvious as some have suggested. Perhaps the reason these problems went on unacknowledged by the majority for so long was the lethal combination of greed and overconfidence, combined with a lack of education on the part of the public (and many corporate and government leaders for that matter) as to how the economy really works. There is no question that Americans have created a catastrophe for themselves. However, with this catastrophe comes an opportunity to reflect and learn. Time will tell whether Americans will either take advantage of this tremendous opportunity or ignore it leaving the next generation of Americans destined to repeat it.
