Buyers who should have known better than to take out loans they could not afford. But they did.
Bankers and financiers who should have exercised due diligence when making high-risk loans or buying into financial instruments related to them as a means of improving their bottom lines. But they didn’t. Add to this a government which failed to act when it should have and you have a powerful time-bomb waiting to explode.
That, in a nutshell, is the sorry tale of the still-unfolding sub-prime fiasco, scandal, debacle — take your pick — in the United States.
And now, what began as a uniquely American problem has rattled stock markets from Europe to Asia in recent weeks and sparked fears that a full-blown American recession — with all its attendant ramifications for the global economy — is on the horizon.
And to think that the sub-prime lending scheme started with the best intentions, at least at the start: To help millions of Americans with below-average incomes or poor credit to buy their own homes.
Many of the recipients of what are typically 30-year loans — sub-prime loans are especially popular in the African-American community, where the home ownership rate is less than 50 per cent — weren’t even asked to supply documentation showing how much they earned.
Not surprisingly, when “teaser” rates of, say, 7 per cent expired after two years and rates of 11.5 per cent kicked in — boosting monthly payments by a third — huge numbers of mortgage-holders found themselves unable to afford the homes they had only just bought. The price of such wanton disregard for basic economic sense?
Beyond the current worldwide credit crunch, early estimates suggest that as many as 2.2 million sub-prime loans worth a total of US$164 billion ($252 billion) will go bust, leaving untold millions of new US homeowners bankrupt, with their houses in foreclosure and with even worse credit records than they had when they started out.
At minimum, new home sales can be expected to drop by as much as 40 per cent and real estate prices to plunge by as much as half in some areas, striking a crushing blow to the housing and construction industries that are among the key drivers of the US economy.
Many analysts have likened the situation to a national scandal, with the number of defaults and foreclosures still to peak and the extent of the financial fallout — including billions of dollars in potential lawsuits by homeowners, investors, mortgage company shareholders and investment banks — yet to be fully assessed.
While it’s tempting to lay all the blame for the mortgage crisis and its spin-off effects at the feet of ignorant borrowers who got in way over their heads, greed-driven US financial institutions and misguided — or non-existent — government policies played a central role.
Until a few years ago, the rules of fiscal responsibility still held sway in the US home-loan market, with lenders approving mortgages for applicants with reasonably good credit histories and with documented proof that they could cover their mortgage with about 35 per cent of their gross salary.
Then, in 2004, persistent calls from the US government to boost stagnant home ownership rates prompted then-Federal Reserve Chairman Alan Greenspan to encourage lenders to provide a wider range of alternatives to the traditional fixed-rate mortgage.
With the Fed keeping interest rates low and Wall Street primed to take greater risks, the stage was set for lenders to go into “Let’s Make a Deal” mode.
And so began the era of “low-doc” and “no-doc” loans, where borrowers were asked to provide little or no documentation of their ability to repay.
In short: No job? No income? No assets? … No problem! Well, no immediate problem for lenders, that is.
While sub-prime borrowers — roughly half of whom are from minority races — were locked into risky adjustable-rate loans, investment houses sold them as high-risk securities that offered eye-popping returns of as much as 20 per cent.
By last year, sales had reached US$503 billion — a five-fold increase from 2003, according to Bloomberg.com.
But even as the profits were piling up, the bottom began to fall out as the adjustable rate loans began being reset to the higher monthly premiums.
Predictably, loan default rates promptly shot through the roof and the Wall Street behemoths that had capitalised on the boom, such as Goldman Sachs and Morgan Stanley, began taking heavy losses.
The resulting domino effect hit even companies and people with no connection to the mortgage scandal, but who are suffering nonetheless from their inability to get credit amid the ongoing squeeze.
As for homeowners who may lose everything as a result of signing up for mortgages they should have known they could never afford, there’s not even the solace of knowing their government did everything it could to avert the crisis.
In fact, as the situation came to a head, the Fed and State regulators which supervise lenders either gave ineffective guidance or none at all.
Admittedly, a bipartisan group in the US House of Representatives did champion a regulatory bill in late 2005 and early last year, but it was promptly killed by laissez-faire Republicans who claimed the market would correct the problem.
Finally, in June, the Fed and other regulating agencies issued new guidelines for adjustable rate mortgages which require borrowers to prove they can repay the loan even after the teaser rate expires.
To use an old American adage that is as applicable in the world of finance as it is in farming, it was a case of closing the barn door after the horses had escaped.
More worryingly, however, the late response was also symptomatic of a deeper and all-too-common disease — that seems to afflict Wall Street and Washington in equal measure — where good sense and due diligence are put aside in the name of amassing the funds necessary to leverage ever-bigger deals.
Never mind that the limitless greed of the financial world’s Gordon Geckos inevitably leads to the collapse of their schemes, damages the system they exploited and makes victims of the people they claim to serve.
Already in America, the mortgage meltdown is further depressing housing prices and making cash-strapped consumers less likely to buy goods imported from overseas, while around the globe it has taken a huge bite out of the holdings of small investors.
Concerns about how far the crisis could go hang over world markets like a black cloud.
The US faced a similar crisis in the 1980s when hundreds of savings and loan companies went belly-up, and it’s telling — and terrifying — to realise that 20 years later, the world’s biggest economy still hasn’t cleaned up its act.
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