On Housing

What caused the speculative bubble in housing?  People point to loans to the uncreditworthy, to low income households, low or no down payments, interest only loans, adjustable mortgages, low interest rates, loan fraud, appraisal fraud, and a myriad of other causes.  While most of these were involved, the core problem was lending to people who could not afford to repay the loans.  This was due to the failure to verify incomes and qualify the loans on fully adjusted market rates.  Without the income to back up the loans there was no security for the loans other than the property and no constraint on prices other than the eventual shortage of speculators and funding for them.  What caused the speculative bubble in housing was what caused the speculative bubble in stocks, the decoupling of prices from income.  Without this decoupling, no bubble can form, with it, one is inevitable.  

This was a lending problem.  One must expect borrowers to deceive, to gamble, to look only at initial payments, and to do whatever it takes to acquire a speculative asset.  Lenders possess the money and must be held to a higher standard.  Lenders are normally much tighter in their lending, anticipating this, but the resale, repackaging, and securitization of loans separated the borrowers from the lenders and not only allowed deception and fraud but encouraged it.  Adjustable rates with low teaser rates, interest only or interest optional features were designed to enable borrowers to obtain loans they could not afford.  If borrowers had to qualify at full market rates there would be little need or want of them.  A few might prefer them, but if they received them they would still be able to afford them, come what may.  Lenders greedy for higher returns accepted, even preferred, higher risk loans to provide them, as long as they could hide it and pass it along to others.  

Other factors, good or bad credit, rich or poor, high or low downs, affect the likelihood of default and that risk may be over or under priced, but these cannot affect overall prices greatly.  If one is capable of affording the property but not willing, another can and will.  

Why did this happen?  Anytime incomes and prices can be decoupled, immediate and substantial short term profits can be made and are irresistable.  Rationales are invented to justify these desires.  Even though unsustainable and even though recognized as such, it may be rational to play the game and hope to leave ahead of the crowd.  Instead of how much it costs, the question becomes how much gain is possible.  Instead of asking whether one can afford to buy, the question becomes whether one afford not to buy.