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What caused the mortgage crisis of 2008

what caused the mortgage crisis of 2008

The Three Root Causes of the Mortgage Crisis

By JLP | January 17, 2008

Here’s the opening paragraphs of the main front page story in today’s Wall Street Journal (emphasis mine):

To understand a root cause of the financial crisis shaking global markets, take a look at Kevin Schmidt’s paycheck.

Mr. Schmidt arranges mortgages in Shreveport, La. He earns his money upfront, taking a percentage of each loan once papers are signed. “We don’t get paid unless we can say YES” to loans, his firm’s Web site says.

The problem, which Mr. Schmidt says he sees clearly: Brokers have little incentive to say “no” to someone seeking a loan. If a borrower defaults several months later — as Americans increasingly are doing — it’s someone else’s problem.

At every level of the financial system, key players — from deal makers on Wall Street and in the City of London to local brokers like Mr. Schmidt — often get a cut of what a transaction is supposed to be worth when first structured, not what it actually delivers in the long term. Now, as the bond market wobbles, takeover deals unravel and mortgages sour, the situation is spurring a re-examination of how financiers get paid and whether the incentives the pay structure creates need to be modified.

I agree 100% with the statements in bold. However, that doesn’t quite cover all the causes of the crisis. Two other causes that were every bit as important were:

1. People’s inability to say “no” to taking on more debt than they could afford. Financial prudence clearly did not play a part in many of these decisions.

2. Wall Street’s packaging and selling of these mortgages to investors greatly complicated the situation because they created greater demand for subprime loans.

What absolutely blows my mind is the fact that we had lots of supposedly smart people thinking that this behavior was okay. Unbelievable.


30 Responses to “The Three Root Causes of the Mortgage Crisis”

I agree with JLP. Borrowers could have kept this whole mess from happening. Granted, there were lots of forces promoting these products, but it all starts with the borrower. I have a client who was a mortgage broker. He was one of the good guys. He would actually tell people when they couldn’t afford a home. He said in every case the people went to another mortgage broker to get the loan. So I have little sympathy for the troubled borrowers.

Regarding the structured products on Wall Street, I saw Jim Cramer, whom I recommend avoiding for the most part, on CNBC this morning, and he was even saying how Wall Street pushed these investments down investor’s throats for the fat commission. It was surprising to see such an insider recommend on national TV that greed controls Wall Street, not solid advice.

Brian B. Says:

Actually, we had lots of supposedly smart people thinking that this behavior was PROFITABLE. The concept of right and wrong had little bearing on the situation.

This type of behavior is regarded as okay so long as profits are up and valuations remain high. When they tank, that’s when the obligatory finger pointing begin. However, I personally attribute most of the blame to borrowers. Kirk is right…most borrowers probably will seek another broker if they get turned down the first time.

Add number 4 to the root causes:

People taking tours through immaculate new houses with 4 bedrooms, the big laundry room, the oversized kitchen/master bedroom/family room and the attached three car garage. Then a Realtor hands them a ‘financing’ sheet showing how they could buy this shiny new house for less than their old house or apartment.

If the mortgage readjusts, don’t worry we’ll just refinance into another. This house is a can’t miss investment, better than Wall Street.

There were several occasions where my wife walked me through sprawling 5000 SF Garage-Mahals trying to convince me to trade up houses. There but by the grace of God.

Traciatim Says:

I think there was really only one cause of the whole problem. Greed.

Consumers were greedy, not thoughtful.

Brokers were greedy, not helpful.

Mortgage issuers were greedy, not thorough.

Investors were greedy, not critical.

And everyone was greedy, not reasonable.

Kitty Says:

Also agree with JLP. Borrowers share a lot of the blame – people should know how much they can afford. I don’t have sympathy for people who bought what they couldn’t afford. I do have some sympathy for those who bought what they could afford but instead of getting fixed rate got ARM because they’d thought they could refinance or move. It was stupid, but sometimes people make stupid choices. For many this was a costly mistake, but I kind of can understand it. They thought real estate prices can only go up. Some young people haven’t been around during the 90s and thought real estate can only go up.

This was the way people thought in late 80s during a little mini-bubble. But at that time income verification prevented people getting loans they couldn’t afford.

Repackaging of loans removed the risk from someone who actually gives the loan. Who cares if they can’t pay, I’ll resell it anyway. It was like a cycle – easier to get mortgages, more people buy, price goes up, it becomes difficult for more people to afford anything, so more people get crazy mortgages.

@Traciatim – isn’t greed always the underlying cause of bubbles and crashes?

Sylvanus Says:

The 4th, and most fundamental reason, was greed in the real estate market on the behalf of sellers and real estate brokers.

I don’t think borrower’s were so “confused” or “greedy” as some have suggested. I don’t think borrower’s suddenly forgot what they knew about borrowing. Greed was not the reason to sign a variable rate sub-prime loan when fixed rates were also very low.

The reason buyer’s signed risky mortgages was that the run-up in housing prices outpaced incomes, and low variable rate mortgages were the only way to finance the purchase. Buyer’s hoped their income would rise to meet the anticipated increased mortgage payments. Without the inflated home prices, buyer’s would have been less inclined to take the subprime mortgages.

Real Estate brokers helped facilitate the over priced home market, no-inspection home deals and no-income verification mortgages helped fool the buyer and mortgage company, into accepting the deal.

In the future, the real estate market should be regulated to prevent or substantially reduce no-inspection, no-verification real estate transactions.

ESig Says:

At the crux of this problem is greed on behalf of the mortgage industry. Writing loans for people that their income would not support, this is a part of our economy that can not fail.

Mortgae companies should have guidelines for approval of loans, the industry in its greed started NO-DOCUMENT loans that they were loaning money based on STATED income and not actual.

G J Welcome Says:

I think the biggest responsibility lys with the financing institutions and realtors and brokers, Who systematically denied fully qualified buyers opportunity to purchase these homes with out needing subprime loans, especially in the Philadelphia region. As a veteran seeking to buy a decent home or new home in the region it was nearly impossible if you tried to use a VA loan to qualify. Many of the veterans who were employed with retirement pay from the military and

with additional income from current employers were flat out denied the oppotunity at fair lending and most diffently at new homes, sad, sad, sad. But instead folks with little or no income or qualifications were allowed to fail the system, which was orchestrated by good old American greed. America is truly in trouble when its greatest resources, human resources and especially qualified veterans are left out to dry. What happened to the G.I. Bill and it’s promises to it warriors.

EJP Says:

These explanations seem to simplistic to me. I think there was something else driving this, though I am not sure. Let’s take the face value comments here greed was the root cause. Then why were there no checks for the greed?

I seem to think some type of oversight was missing, not sure if it was there at one point and then sometime in the recent past dismantled. Almost like a loss of accountability.

Why was this oversight dismantled? I don’t know, maybe because some politician thought it was too much government and the system didn’t need oversight. Maybe they were pushed from a special interest group who wanted to allow more home loans for more commissions.

There will be a whole lot more pain before it gets better- probably 3-5 years.


I don’t think the explanations are too simplistic. To me they make perfect sense (especially the one in bold in the post).

But, you’re right. Something did change in order to bring this mess about.

RLLJ Says:

All the major players in the mortgage business are compensated,demoted or fired based upon the short-term results of making loans happen. The bursting of the mortgage bubble is a back-end phenomena. Thus, by the time a crisis hits, everyone involved in its creation has made lots of loot! There are so many complex forces at play that despite the billions in losses, defining a single culprit is impossible. The system is rigged to lull those unaware to sleep. Why would “big business” desire a systemic change when companies are strong enough to absorb billions in losses, and the Federal Reserve is always there to lend a helping hand in a crunch! Sounds like a scheme to me!!

[…] Read the rest of this great post here […]

mike Says:

The root cause of the mortgage meltdown is absolutely the Community Reinvestment Act CRA & its more recent amendments from 1993 thru 2005. The CRA forces banks to lend to what otherwise be high credit risk borrowers. Once again government meddling in the markets to force social equality.

[…] Read the rest of this great post here […]

Burt Says:

It is times like these that make me wish that our school system took children’s futures more seriously. High schoolers spend way too much time taking worthless classes such as English Literature,Art, and Drama, rather than Accounting, Financial Planning, Economics, etc.

The average borrower probably had no clue how much more homeownership costs than renting, in both time and money. They also had no clue that no market increases indefinitely. Many were talked into purchasing their homes as a “sure thing” investment by Realtors and Loan officers eager to get their commissions.

MW Says:

Why doesn’t anyone talk about the root cause–CHEAP MONEY, the discount rate in the past 10 years at times was .5% allowing borrowing to flow like water. So called economic experts at the FED screwed up or had a private agenda. From there the financial sharks went wild and main street joe was sucked in.

[…] Read the rest of this great post here […]

karen Says:

I agree with Mike. It is obvious that the government meddling in mortages to people who could not make a house payment combined with some other things like ARM’s are responsible for the problem. Mike do you know if this happened under the Clinton administration? Did Alan Greenspan have a hand in this? I am just curious. It is hard for me to understand all the economic terms that they use in the newspaper but I really want to understand. I think we the citizens of the US better balance our time better and think about finances and the state of our country instead of who the next American Idol will be.

Greed & stupidity. Greedy and/or stupid Borrowers thought some force of nature had changed all the rules and made big, new fancy houses that only ever go up in value affordable to all. I think I put more blame on the Borrower simply because, just because somebody offers you something doesn’t mean you have to take it (see “drugs”). The Lenders who lent to unqualified borrowers are no saints, but they didn’t FORCE anybody to sign.

Sounds like you are all correct! The Gov. set the macro environment

O The Fed keeping rates too low for too long.

O President Clinton and Congressman wanting all Americans to achieve the American dream of home ownership. Then using CRA to push the lenders

Sounds like you are all correct! The Gov. set the macro environment

O The Fed keeping rates too low for too long.

O President Clinton and Congressman wanting all Americans to achieve the American dream of home ownership. Then using CRA to push the lenders

Olishpushing Fannie, Freddie and CRA to take thi

[…] Read the rest of this great post here […]

Cruz Says:

I agree with all the posts here. There was no sound judgement being exercised for the creation and purchase of these loans. My husband and I purchased a home in 2004 with a low-interest FIXED rate loan. We had already owned a home prior so we were well aware of the costs involved. With our first home and with our second, we were told a crazy amount that we could afford loan-wise and the amounts were based on GROSS income, not net! Had we not been using common sense, we could easily have been suckered into taking on a home loan that was much more than we could afford. We bought the largest home we could AFFORD, and we have had no trouble making our payment. I can understand when someone loses their job or suffers injury and are unable to make payments, but when they simply signed up for something they shouldn’t have, then the blame rests on them for not saying NO! It shouldn’t take a college degree to figure out that more money going out than coming in is not a good deal. But as always, when there are large sums of money involved, you can believe sound judgement tends to fly out the window. What were these companies thinking? What happened to planning for the worst-case scenerio?

The problem was with American CEO’s hiding the mounting bad assets from the balance sheet. They did not realize that the effect would be so bad so soon. Why Citi survived and Lehman did not can be debated.

[…] Read the rest of this great post here […]

gabriel benet Says:

All of these messages are at least partially right.

But…What should we do?

The solution is simple:

Let capitalism heal itself.There are already laws to punish the crooks and squandrels.Let some pitbull like Giuliani take care of them.

Don’t let them scare us.

A crisis for some is an opportunity for others.

Let the scum go broke.Above all don’t reward them.

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