Sunday, July 29, 2007

Cheap Money

While it's rather obvious, sometimes I think the "how'd it happen" of the housing bubble isn't explained clearly. The short answer is that cheap money was made available to more and more people.

Potential home buyers for the most part don't really care what the sticker price is on the house; they care about the monthly mortgage payment. In the early days of the house price boom, the "culprit" was simply low long term interest rates. People with good credit were getting cheap 30 year fixed rate mortgages, allowing them to buy a more expensive home for a cheaper monthly payment. As housing prices started to go up, subprime lenders started to jump in and widened the pool of people for whom cheap money, at least temporarily, was available. Uncle Alan Greenspan blessed the use of ARMs, and lenders began offering very low teaser rates that would balloon after a few years. People either didn't understand what they were getting, other than that promised home, or assumed that they'd be okay because continuing positive housing price trends would always give them a way out. Later, more corrupt lending practices grew, with lenders handing out high rate no doc loans to anyone who asked. And then, of course, there were the flippers, the amateur investors who dove in towards the end of the boom, as always happens in bubbles, further driving up prices.

Housing is a bit different than financial assets are - they're illiquid and also something people use and not simply investments - and the bubble's decline won't really seem like a "burst" (though the bursting in related markets, such as financial assets spun off from mortgages, might come with a tremendous popping sound). Still it looks like we're heading towards bad.

But I thought this would happen a couple of years ago, so what do I know.

...and here's Barry's version of this post.