Analysis of the Article about the Reasons that Lead to Housing Market Crash in 2007 - Term Paper Example

In an article published in Wall Street Journal on April 6, 2009, Steven Gjerstad, visiting research associate at Chapman and Vernon Smith,professor of economics at Chapman University and the 2002 Nobel Laureate in Economics, described in a great way the reasons that lead to housing market crash in 2007. They asserted that “Both the Clinton and Bush administrations aggressively pursued the goal of expanding homeownership, so credit standards eroded”. ( Gjerstad and Smith, in press, 2009). This erosion opened the door for sub-prime loans, in which mortgages were written to buyers with limited assets and income. Basically, loans were given to people that had low credit scores and, ultimately, were not able to keep up with their payments. This, in turn, lead to a wave of delinquencies and defaults. “Borrowers losses were limited to their small down payments; hence, the lions share of the losses was transmitted into the financial system and it collapsed”, concluded Gjerstad and Smith (2009). Historically, housing accounted for one third of household income in the United States. That changed under these new circumstances, where mortgages were written for a much higher percentage. Unfortunately, while income levels stayed the same, housing prices more than doubled in the timeframe from 2000 to 2007. Eventually, something had to give , say the authors (Gjerstad and Smith, in press). Sub-prime lending, the interest-only adjustable rate mortgages and negative-equity options at that point, were not able to sustain the flow of new buyers and the crash was inevitable. In an attempt to rectify the problem, Bush administration, lead by The Department of the Treasury and the U.S. Department of Housing and Urban Development encouraged the founding of an alliance between lenders, investors and non-profit organizations that would help homeowners facing foreclosures. The alliance was materialized under the name HOPE NOW. Hope Now website summarizes its goals: “This alliance will maximize outreach efforts to homeowners in distress to help them stay in their homes and will create a unified, coordinated plan to reach and help as many homeowners as possible. The members of this alliance recognize that by working together, they will be more effective than by working independently“. The alliance managed to bring on board the biggest mortgage companies in the country. It included big lenders such are Bank of America, Citigroup, Inc. (Citi Mortgage / Citi Residential),GMAC Mortgage, HSBC Mortgage Services, JP Morgan Chase, MetLife Home Loans, PNC Mortgage, Quicken Loans and Wells Fargo and Company (Wells Fargo Home Mortgage / Wells Fargo Financial). These institutions cover 60% of the U.S. mortgage market, thus, the expectations by all sides involved were great. At its core Hope Now, however, focused on being a communicator and mediator. Alliance action plan calls for a nationwide direct mail campaign to at-risk borrowers encouraging them to contact their lenders or credit counselors. Also, one of the goals was to strengthen communication and connection between borrowers and servicers. Finally, the alliance wanted to “develop common communications guidelines that will be used to respond to at-risk borrowers in order to offer them the best possible solutions, customized for each borrower”. Distressed homeowners, on the other hand, wanted a different kind of help. The most important for them was to save their homes. The alliance was off to a good start, after its inception in July of 2007. Loan Modifications:  July 2007 - January 31, 2008   Q3 2007 Q4 2007 Jan. 2008 Total Repayment Plans 319,793 331,746 106,136 757,675   Prime 119,808 136,567 57,892 314,357   Subprime 199,985 195,179 48,155 443,319 Modifications 75,646 141,437 60,714 277,797   Prime 30,084 37,174 15,394 82,652   Subprime 45,562 104,263 45,320 195,145 Total 395,439 473,183 166,850 1,035,472   Prime 149,892 173,741 73,376 397,009   Subprime 245,547 299,442 93,475 638,464 The report, issued in March of 2008 boasts that, in the first nine months, alliance managed to help over a million of homeowners stay in their homes. This number included 758,000 repayment plans being initiated and, also, 278,000 loans being modified. The latest report by Hope Now, announced earlier this year, and covering data up to May of 2010, claims that so far there was almost 10 million cases the alliance worked on and offered solutions. But the problem is far from being solved. On the other hand, the alliance faced a lot of criticism despite some success it achieved. Over time, the criticism concentrated mostly on slow assistance. In an Associated Press report from 4/22/2008 the claim is that 70 percent of homeowners who are two months behind on their mortgages still weren’t getting help. Also, borrowers receiving help were not able to complete their workouts with the alliance and lenders in appropriate time. The issue at hand here, one that hampered the whole process, is time. Banks and mortgage companies were getting more and more delinquent loans into the system, while the existing ones were not being resolved. Additionally, most of those new loans were sub-prime and other “exotic” loans hard to resolve in the first place. A report in Newsweek Magazine from 3/13/2008 found the same problems. The report claims that “The governments flagship program to give struggling homeowners relief from overwhelming mortgage payments has left hundreds if not thousands of callers frustrated by long wait times, lack of follow-up and relatively minor loan modifications that have failed to help“. In its defense the alliance, through Faith Schwartz, its Executive Director answered the claim: "We are doing everything we can to avoid foreclosure and work through the structures of these loans with the borrower and with the servicer," said Schwartz. "This is a loan-by-loan solution, and everyone is working very hard to make that a success." But, criticism came not only from the media. Washington and state officials, servicers, credit counseling agencies and homeowners themselves too found flaws and negativities in the alliance’s programs. Many emphasized issues with communication between homeowners and the alliance help line. For others, the problem was inability of homeowners to work out loan modifications. In contact with Hope Now they were told their credit scores were too low; their loans were bigger than the value of their homes; or they couldnt be helped because their loans were already in foreclosure. With all this criticism coming from all sides, it is clear that Hope Now Alliance did not reach its full potential. The problems many homeowners were facing when the alliance was founded and trumpeted by Bush administration in 2007, are also, the problems many more face today. In addition, the predictions for the future are bleak too. Many of sub-prime loans that greatly contributed to the problem are to be reset in 2011 and 2012. This will initiate another wave of mortgage delinquencies and increase the scope of the problem. Whether or not Hope Now Alliance was and is a failure is a topic for another research study. For the purpose of this one two questions, answers to which could prevent this from spreading and happening again, must be posed. Is government responsible for mortgage loans of its constituents? What is the role of government in regulating mortgage lending industry? These questions are a clear case of cause and effect, with second question causing an effect on the first one. In a wake of housing market crash, American economy went through tumultuous three years. Financial giants failed and vanished. Others were saved by the government. Millions of Americans lost their jobs, homes and life savings. New administration in Washington was handed a burning hot potato to deal with. It was hotter than any other since the Great Depression of 1930’s. President Obama, his close economic advisors and the Congress recognized that lack of regulation within financial and mortgage industries contributed in a significant way to the state of U.S. economy. President wowed that “never again will the American taxpayer be held hostage by a bank…” By using this populist approach, President joined the sentiment American public felt after learning of risky practices and unfair treatment by the financial sector. Obama repeated his standpoint many times over the last year and a half, but he is still aware that the battle he faces in this regard is not going to be an easy one. While Democrats in the House and the Senate support President in his efforts, Republicans are not. GOP is against wide governmental involvement and oppose too much regulation. They see both as a treat to private entrepreneurship and a sign of Socialism. This issue was pushed aside by a healthcare debate but is still lingering and requires attention from lawmakers. If learning from the past mistakes has any merit, the federal government should strive to more strictly regulate banks and other financial institutions. It is unacceptable for things to happen as they happened back in 2008 and 2009. The old system allowed banks and mortgage companies, including Fannie Mae and Freddie Mac, both government entities, to run amok and roam freely. The risks were taken that never should have been taken, mistakes were made that were never supposed to be made, the greed was rampant and prevailing. In the end, both banks and homeowners were casualties of this chaos. Sadly, ones that suffer the most are regular people who struggle to make ends meet. In that light answers to those above mentioned two questions are easy. Yes, government should regulate financial industry and put in place mechanisms that will prevent meltdowns like one that happened recently to occur again. Also, yes, by doing so government will show that it takes responsibility for our mortgages, at least indirectly. American public wants and deserves no less. As for suggestions for resolution and relief of the problem, many were mentioned in the past three years. The key is to regulate banks and mortgage companies, set the rules that will serve as a foundation for healthier lending practices. This would require government involvement, a measure that is not popular with some, but it seems favored by the majority. The Harris poll conducted in March of 2010, showed that 82% of surveyed believe that Wall Street and banks should be regulated more toughly. Same poll showed that most people think what Wall Street does is beneficial for the country, but their starkly change when it comes to bank and Wall Street executives. For majority the executives are not honest, would break the law for their personal benefit and should not be making money they do (Harris Poll, 2010) . These numbers clearly show public’s dissatisfaction with big banks and their practices. After regulations are enacted, the next step would be to put in place measures that would prevent people with poor credit scores and insufficient incomes from getting the loans they would default on soon after. For people that are already affected by the housing market crash the best thing would be to try and restructure their loans and offer repayment plans that would allow them to keep their houses. On the other hand, Obama administration revealed in March another program aimed to help struggling homeowners. The program is designed for not only seven million households that are behind on their mortgages but, in a significant expansion of aid, the 11 million that simply owe more on their homes than they are worth. The program as stated immediately met with opposition and became controversial. It is to be seen how it goes. “The housing market is the Vietnam War of the American financial system,” said Howard Glaser, a housing consultant. “The federal government is in so deep; they have to keep ramping up to find a way out.” These two sentences summed up pretty well the state of affairs in housing industry. After years of uncontrolled lending, after the market crash, after millions of people facing foreclosures and owing more than their houses are worth, it is left to the federal government to clean up the mess. Call it unfair, it is the fact. Government indeed has the obligation to resolve this issue. The victory is absolutely essential for the country, for its people and, ultimately for political survival of this administration. Read More