It has been estimated that between 20% and 25% of all homeowners with mortgages owe more than their home is worth. This percentage is even higher in some areas; like Nevada, Arizona, Michigan, Florida and California. The overall range among states is estimated at 5% -67%! (Oklahoma is lowest; Nevada highest.) The situation has become a dilemma for the banks as well as the homeowners, and for the government and general economy, which is now sluggish at best. Who's responsible, and what should be done?
A Simplified Explanation
How did we get into this awful situation? The answer is complex but I'll try to simplify it. The answer is: The banks loaned more than they should have! They loaned at the top of the market, often with terms that were excessively generous. They loaned to buyers of questionable credit-worthiness often with little income and marginal capacity to repay the debt. They frequently relied on fantastical appraisals and poor documentation. They were the homeowners' partner in a speculative business venture based on flawed analyses and projections. They fueled the housing "boom" and a consumer spending orgy. And their actions largely contributed to the ensuing mortgage crisis and consumer "bust." Because housing is such a significant portion of the overall economy the crisis reverberated throughout the economy contributing to excessive unemployment and a severe recession.
Who's Responsible?
Now some might say it wasn't that the banks were irresponsible, rather it was the borrowers who exercised poor judgment. But think for a moment. Who are the financial experts? The banks and other lending institutions or the typical retail loan consumer? Who has the legal, ethical, business, and moral obligation to make sound investments based on accurate information and adequate documentation? The answer is: the banks.
The home purchaser or refinancer can't be held to the same standard of expertise and sound business decisions as a financial institution bound by regulatory and capital requirements, and with an obligation to ensure prudent risk/reward ratios and decisions. So, it is logical and reasonable to accept the bank's good judgment. If the loan officer and underwriter say I can afford to buy a home with no money down, low interest rates and flexible/adjustable terms, who am I to argue? They're the professionals. If I'm told I can purchase a $250,000 property with $45k yearly income should I disagree? They obviously wouldn't allow me to "get in over my head?" Or would they?
The banks were engaged not so much in a conspiracy, as an intentional plan to "package" sub-prime paper (mortgages) into more highly rated investment vehicles called CMS (Collateralized Mortgage Securities), and then sell them to other investors seeking secure high return investments backed by solid real estate assets. Money was made all around.
When homes were financed the banks immediately received pricey loan origination fees, processing charges, etc. Then, they sold over valued loan obligations at inflated prices to third parties who (as mortgage owners) ultimately assumed primary risk.
The Outcome
This financial merry-go-round worked for years until the whole thing collapsed in a house of cards. Eventually reality set in. Houses could not be sold at a profit, or even break-even. Over-extended mortgagees couldn't continue to make payments. Housing prices began to decline. When defaults began investors realized that their collateral was not as sound as they believed. And, when banks could no longer sell their repackaged mortgage securities to skittish investors, they tightened lending standards. Not nearly as many prospective buyers were able to qualify for loans and the pool of buyers dried up. This further drove down real estate prices, and the downward spiral continued. The party is over, and most of the partygoers have gone home. Now it's time to clean up the mess.
What Can We Learn?
What can we learn from this painful fiasco?
--First, the government regulators need to be far more vigilant and proactive. It is clear that financial institutions may take more risk than is advisable, and that their actions can have far-reaching implications, for their borrowers, investors, and the economy at large.
--Second, the financial institutions must be held accountable for their actions, and implement appropriate remedies for those who are harmed by their reckless actions. Short-term profits should not override social and moral responsibility.
--Third, the government should reconsider sponsoring bank bailouts, which may moderate risk/reward decisions, and encourage poor business practices. Like the doting over-indulgent parent, if the child can behave irresponsibly knowing the parents will always bail them out, what's the incentive to clean up their act? The banks will behave more responsibly if they understand the consequences of their decisions, and assume risk without rescue.
--Fourth, troubled homeowners should be assisted. Many financial institutions have been bailed out. Investors in most cases have also been covered. But nobody is bailing out distressed homeowners. Government assistance in this area is woefully lacking, and relief efforts are spotty at best.
--Fifth, the individual consumer must make more responsible and informed decisions. Part of the business relies on consumer ignorance. How many borrowers read and understand the contracts they sign? Don't consumers know how much they can really afford? Deep down I suspect that almost everyone does.
--Finally, financial literacy education should be part of school curriculums, and made available for adults. It is important that this education be unbiased and, if offered by banks or credit unions, not be self-serving.
Copyright 2011, Dr. Ben A. Carlsen, MBA. All Rights Reserved Worldwide for all Media. You may reprint this article in your ezine, newsletter, newspaper, magazine, website, etc. as long as you leave all of the links active, do not edit the article in any way, leave my name and bio box intact, and you follow all of the EzineArticles Terms of Service for Publishers.
Dr. Ben A. Carlsen, MBA, is author of "Bites of Business" http://bitesofbusiness.com/, and "Personal Financial Survival: A Rescue Plan." He is an experienced consultant, leader, management expert and educator. Carlsen was Chairman of the Los Angeles County Productivity Managers Network, Chair of the Marketing Managers Association, and President of the Association for Systems Management (So. California Chapter). For more info visit: http://drben.info/
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