The current housing crisis is rooted in the conscious decision by financial institutions to relax lending standards. As a direct result, consumers who could not otherwise afford a home, or as costly a home, could put themselves in a position to become financially overextended.
When I bought my first home in 1987, I had to make a down payment of 20 percent of the cost of the house and my annual income had to be at least four times my annual housing costs (mortgage, taxes and insurance). Today, the standard is a 5 percent down payment (or in some cases no down payment) and in some cases no income verification, let alone minimum income to cover housing costs.
Consequently, the risks of mortgage defaults increased significantly in recent years as credit standards became more relaxed. The situation got even worse when financial institutions packaged their mortgage loans and sold them to the public and Fannie Mae and Freddie Mac. The financial community made money from the origination of the loans — not from holding the loans.
If the financial community was not going to hold the mortgage loan for the long haul, the risk of default became less important to the originator of loans. As a result, more risky loans were originated and sold to investors. Over the short term, this meant that more homeowners felt that they were achieving the American dream. Over the long haul, it has created an economy that is wobbling precariously on false stilts.
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