Here we are, in an economic situation that far overshadows the savings and loan (S&L) crisis of the 1980s, which warranted a bailout to the tune of $150 billion. After a real estate boom between 1997 and 2006 that increased home values faster and far beyond many people’s dreams, a bust ensued that is turning out to be more devastating than the commercial real estate fallout, which was a big contributor to the 1980s S&L crisis.
So, how did we get here? How did we arrive at such scary circumstances? What was it that caused the recent real estate bust and our current economic condition?
On the heels of the Fair Housing Act of 1968, the Equal Credit Opportunity Act of 1974 and the Home Mortgage Disclosure Act of 1975 (HMDA) came the Community Reinvestment Act of 1977 (CRA). Basically, the intent of the CRA was to require banks to make lots of loans to those who lived in the immediate areas of their facilities, and to do so in a fair and unbiased manner.
Although the first three acts were similar in their goals to address discrimination in the areas of credit letting and fair housing, the CRA took it a step further and outlawed redlining. Initially, redlining meant refusing credit for those living in specific geographic areas, typically African-American or low-income neighborhoods. Later, the term was also used relative to discrimination against a people group of a certain race or gender, regardless of where they lived.
Community activist groups advanced the use of the CRA to ensure home loans for low- to moderate-income families. Based on the newly enacted CRA law, these groups began to pressure banks into lowering their standards in making home loans to disadvantaged individuals.
In response, banks buckled under the pressure and lowered their lending qualification standards. The result was the birth of the sub-prime real estate loan market. According to many critics, the CRA has led to the greatest economic crisis since the Great Depression.
That was not the end, however, of the fair lending measures pushed by community activists. In the late 1980s, they took it a step further pressuring banks to make even more loans. Although the banks were willing, they responded that they could not comply, because Fannie Mae and Freddie Mac would not buy them.
Lobbyists for community organizations then began pressuring Fannie and Freddie to lower their lending standards … and they complied. Of course, following those changes, sub-prime lending became even more rampant.
Fast forward to the end of the Clinton Administration. In 2000, nearly half of every major mortgage company’s portfolio was made up of risky, sub-prime loans issued to low- to moderate-income borrowers.
Industry professionals began cashing in on this new prospect presented by the sub-prime market. Predatory lending, liar loans and other opportunities for, and manifestations of, fraud arrived on the scene, many of which are just now being discovered due to foreclosures.
Home values continued to increase dramatically during 1997 to 2006, some into the 124 percent range. Interest rates declined and borrowers were not only buying, but homeowners were refinancing, many included the equity in their homes to pay for home improvements, vacations or college for their kids.
Some borrowers were being approved for home loans that they could not afford. Others were buying homes for inflated values that would later nosedive due to the housing bust. At the same time, prominent employers were conducting major layoffs with increasing measure.
Sometime during the end of 2006, beginning of 2007, foreclosure signs began popping up in neighborhoods and home values started to decline. We were seeing the first signs of fallout of the sub-prime market; although, we had no idea at the time how deep its roots would run.
The stock market was booming, however, still boosted by securities that included sub-prime loan packages. Speculators were reflecting a perception of future value to real estate securities. The rise in stock values overall continued until they peaked out at all-time highs somewhere until September of 2008 when the bottom fell out. Stock prices plunged, some dropping several dollars in a day.
In mid-2008, the sub-prime market died a painful and dreadful death. By third quarter 2008, banks were failing globally. Domestic banks were scrambling in order to avoid bankruptcy, and a U.S. bank bailout ensued. Surprisingly, a large percentage of that bailout has already been paid back by many banks. Around $70 billion of the $200 billion bailout has been reimbursed to the U.S. Government.
If all that was not enough, in December of 2008, former Chairman of the NASDAQ stock exchange Bernie Madoff was arrested and charged with fraud. He was later sentenced to serve 150 years in prison. He bilked billions out of unsuspecting investors through his hedge fund, operating what is thought to be the biggest Ponzi scheme in history.
So, bottom line, what is the cause of the recent real estate bust and the current state of the economy?
Although, the initiators of the CRA had good intentions, once it was enacted, it opened up a whole new world of risk and issues for the lending industry in the form of sub-prime loans. Fannie Mae and Freddie Mac jumped on the band wagon in lowering lending standards, succumbing to pressure by community activists.
Securities that included sub-prime loan packages boosted the stock market. Home values became overinflated. Thrown into the mix, speculators and fraudsters added a perception of value to securities that included sub-prime loan packages.
Real estate values hit the ceiling hard and started to decline. Unemployment numbers were rising significantly. Foreclosure signs began popping up in neighborhoods. The stock market hit bottom. Banks had to be bailed out. Sub-prime lending died.
No, it was not just one thing that brought us to where we are in our economic history, but several factors, many that worked as a domino effect in causing other entities to fall.
History of the Recent Real Estate Bust and the Current US Economic Condition
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