If you learned anything from The Big Short, hopefully, it was that there were a whole lot of people responsible for the financial crisis and subprime mortgage calamity in 2007 and 2008. Yes, the banks and ratings agencies played an integral role and managed to profit handsomely for a while, but those organizations couldn’t have done so without people — you, your neighbors, families, and friends — agreeing to take on home loans and mortgages they couldn’t afford.
It’s obviously a bit more complicated than that, but that’s the gist of it. The government wanted more people to be able to afford homes, so they made it easier for people to qualify for mortgages. People, unaware or uncaring about their ability to pay, signed up. Then, everything fell apart and caused a global recession.
It was a nightmarish time, and we’re still feeling the lasting effects, in some respects. But it’s not something we’d want to do again. Clearly, we’ve learned from our mistakes.
It doesn’t seem that way. Many of the underlying structural issues that led to the past crises are still in place, and given that hardly anyone was punished for their roles in the subprime mortgage meltdown, there’s little incentive for anyone to change their behavior. And it seems we might be heading right back down the road to where it all started.
That’s because Freddie Mac is going to start experimenting with looser mortgage standards, making it easier to qualify for a home loan. In short, the program involves reducing the income and documentation requirements. Home buyers will also be able to count income from people living in the house, and not necessarily on the mortgage. Some borrowers also won’t have to provide bank statements to prove how they saved for a down payment. What could go wrong, right?
The financial crisis fueled by bad mortgages
The government has good intentions here, so allowing for looser income and documentation requirements for mortgage applicants, via this new Freddie Mac pilot program, isn’t meant to do harm. But this is more or less how we ended up in a very bad situation the last time around. People who shouldn’t have gotten mortgages did, they couldn’t make their payments, and the whole overly-leveraged system fell apart.
Again, here’s the dilemma from the government’s perspective — we want more people to be able to afford their own homes. So, we incentivize homeownership by making it easier to get a mortgage. The problem is that we end up lowering the standards to get a mortgage, and then end up giving loans to people who wouldn’t have otherwise qualified for them.
Before you know it, these people — who failed to recognize, or overestimated their ability to make their mortgage payments — miss payments or stop paying altogether. These loans are now categorized as “subprime,” but in the mid-2000s, were purposely mis-rated and sold to investors as parts of securities. It’s all very complicated and intricate, but the thing you should know is that it all started at an individual level.
The banks responded to incentives, people who wanted a house (regardless of their ability to afford it) bought one, and the whole system crashed.
Just because you can, doesn’t mean you should
The new Freddie Mac program probably shouldn’t send us all into panic mode, but it is something to keep an eye on. Other lenders have already loosened their standards, including Wells Fargo, which did so in 2015. With the economy on relatively solid footing, it can be easy to become overly optimistic or miscalculate what you, as a prospective homebuyer, can afford.
It all comes down to this: We can avoid societal meltdown if we start at the individual level. The subprime mortgage crisis wouldn’t have been as severe, or may not have happened at all, had individuals made better choices or had a clearer picture of their own finances. There were some shady tactics utilized by lenders to convince people they could afford more than they could, but if you have a good grasp on your financial picture, it simply requires the ability to say “no” to something you can’t afford — no matter how tempting it may be.
That’s not to let the banks, rating agencies, and regulators — all of which dropped the ball in order to further their own interests during the last crisis — off the hook. But if you’re wondering how you yourself can stay out of trouble? Know what you can and can’t afford, and be aware that the economy is a cyclical thing. Just because you’re doing well now, or think your job is secure, doesn’t mean that things will be the same a year from now.
Take stock of your situation, and learn from the mistakes of others. It’s going to get easier to get a mortgage, but that doesn’t necessarily mean you should sign up.