by Edgar Frost

Created on: August 31, 2008

The mortgage foreclosure crisis has been slowly gathering steam for years, and didn't surprise anyone with a basic knowledge of finance and economics. Historically, home prices tend to rise annually, but at a rather slow rate of 2% to 3%. Over the 5 years leading up to the foreclosure crisis, many, if not most real estate markets were seeing double-digit price appreciation. When rapid growth like this occurs in individual areas, it might be attributed to a booming local economy, or increased local investment. When it occurs on a large scale, that probably means the market is inflated for no good reason, which turned out to be the case.

If a local economy is booming with average wages rising, it's easy to see how home values would also be expected to increase. However, many markets ssowed little or no wage increases, but still saw double digit rates of home appreciation. Why did this happen? There were several reasons that we need to understand before we realize why there really aren't any solutions for the current mortgage crisis.

The biggest cause of the mortgage crisis were questionable lending standards. Basically, people who shouldn't receive mortgages were given loans. To find out why, you need to know who gave the loans. In most cases, it was mortgage brokers or institutions who would make loans that they didn't keep on their own books. Instead, they would make bad loans, collect the fees, then sell them to another lender. At some point, many of the loans would also be offered as securities to both domestic and foreign investors. Therefore, the person who made the loan had little or no interest in ensuring the money was ever repaid. What did they care, they made their money.

Next, we need to blame individual borrowers. They need to take responsibility for their own actions. Here are some questions they should have asked, but probably didn't: Do I understand how a mortgage works? Should I buy a house without a down payment? Do I have enough money to pay a higher payment when the mortgage rate resets? Borrowers need to take responsibility for their own actions and poor decisions, no one else.

Now that the smoke is starting to clear, we see that retail banks are having financial problems because of the bad loans they provided. Investment banks are suffering because of risky investments that have plummeted in value, and individuals are losing homes at a rapid rate. The government has been involved brokering buyouts, increasing liquidity, and helping borrowers keep their homes. From here on, the government needs to do as little as possible, particularly state and local governments. At the local level especially, attempting to solve the problem is like trying to drain a lake with a teaspoon.

At the end of the day, the market will correct itself. Banks will go out of business, shareholders will lose money, and people will lose their homes. It will sting, and it will take a while to rebuild. However, lessons will be learned. Banks will learn not to take on loans that don't have a high likelihood of being repaid, and consumers will learn to educate themselves and not take on more debt than they can afford. The only solutions I have aren't solutions for the past, but solutions for the future. Banks should be forced to keep loans on their books for 5 years before packaging them and reselling them, in order to make sure they have confidence in the borrower. On the other side, borrowers should be dedicated to educating themselves about lending and personal finance. These solutions won't solve the current foreclosure crisis, but they wiil prevent another crisis from occurring.

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