The Failing of the American Economy, part 2.

The question I left you with last time was this:

Why couldn't people afford to pay their mortgages?

There are a variety of reasons for this, but I'll focus on the ones that shouldn't have happened.

Risky Loan Practices

Owning a home is not a right. It is not something that must be provided for you. It is a privilege, that requires responsibility to function.

When banks gave out mortgages with no money down, households that made under $50,000 a year had access to a $500,000 loan. That is doable, if you are willing to live frugally, and you get a good interest rate, etc... However, this is a domino that can very easily start a cascade. If every loan was like the one I just made up, and people were responsible, the system would work. The system can withstand some failure. The system cannot withstand the storm of foreclosures that hit in 2008. People who could not be reasonably expected to pay for the homes were given mortgages. These people did not pay, because they could not pay. As explained in the last post, this meant the financial institutions that owned the bundles of mortgages lost a lot of capital, pushing some institutions towards insolvency or bankruptcy. This meant they needed a quick source of cash, so the people who were falling behind on their mortgages started receiving more forceful letters. These people, who could not pay, were foreclosed on which, ironically, intensified the problems within the institution. The institution goes bankrupt, and it's creditors demand their money, so they foreclose more people who are behind on their mortgages. However, the glut of open homes on the market drives down prices, so the bank now has more creditors than credit. If the banks had been allowed to fail, stockholders would have suffered. However, that's what bankruptcy court is for. It determines the rights of the creditors and doles out the capital accordingly. As soon as the government stuck it's nose into the system, and started declaring that some institutions are "too big to fail", the stockholder was screwed.

Check back on Friday for the next entry in this series.