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Sunday, August 8, 2010

Did home loans cause the financial crisis?

Today, on Fareed Zakaria GPS, one of the guests was O'Neill. He was a treasury secretary during the Bush (2001-????) years.

O'Neill laid the blame for the housing crash on home loans with little or nothing down. According to him, the crash would not have happened if all home loans had required 20% down.

This seems silly to me. I saw many loans issued that only made sense if you assumed that the value of the house would go up, and then require you to sell or refinance to pay off the loan -- in other words, the loan assumed that the house would pay for itself. Loans that had a low interest rate during the first few years (5 to 7), and then either a large interest increase, or a balloon payment. Loans where your interest rate was higher than your payments (so your balance would increase; in theory, your house value would go up faster).

Why is this bad? If you require that a loan is only issued if it is likely to be paid off, then a high house price will not sell -- no one that wants it can afford the loan. If a house is priced so high that the loan is not likely to be paid off, and therefore cannot be issued, then the house needs to come down in price.

That's how a market makes sense. When prices go up, up, up, people stop buying, and the prices have to come back down. That's functional.

Instead, we had a market where prices went up, up, up, and bankers proceeded to make loans on the assumption that not only would they continue to go up, up, up, but someone else later would buy a loan thinking that it would continue to go up, up up.

Blaming the people who wanted a house loan with little or no down is crazy.
Blame the lenders who decided to issue loans that could only be repaid if the house was sold at a large profit.

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