Remember the dark ages of 2008? The entire globe went through the single most cataclysmic economic disaster since the Great Depression in the 1930s, its effects rippling through every country on the planet like an astronomical earthquake. Millions of homeowners and breadwinners lost their sole source of income. Millions more were driven into homelessness, living instead in their cars, under the poverty line. Thanks to major cuts in healthcare, the years between 2008 and 2010 also saw an additional 500,000 deaths caused by cancer. All this because of the careless introduction of risky property mortgage loans in America.
Just when the world has finally regained its equilibrium (more or less), real estate experts posit that history might soon repeat itself. Despite what happened the last time, risky, subprime loans seem to be making a comeback—albeit rebranded with a shiny, new name this time. Have we learnt nothing from the recent past? Well, to be fair, most of us probably didn’t fully understand what happened in 2008. The majority of us laymen didn’t even know the entire snafu originated in America’s housing market. For those who are still in the dark about the whole debacle, here’s a primer to get you up to speed.
Back in the day, the housing market in America was rock solid. At least, that was what everyone believed. It meant that the most dubious of investments, as long as they were backed by mortgages, were seen as safe. Because who doesn’t pay their mortgage, right? So thus enters mortgage-backed securities, which are basically shares of a property mortgage loan that are sold to investors.
It starts with a smaller bank selling bunches of loans to a larger bank, which groups these loans and turns them into a mortgage-backed security. Shares of this security, also known as tranches, are sold to investors. The remainder of unsold tranches are repackaged and sold as collateralized debt obligations (CDOs). And it goes on and on and on, to the point where you’ve got CDOs of CDOs (or CDOs squared).
The problem with all this is that the banks were dealing with subprime loans. It essentially means that they were lending huge sums of money to people who would probably struggle with the monthly repayments. People with no income, no job, and no assets. Most of the time, the lenders themselves make no effort in verifying the details of the applicants. While the banks were making an insane amount of money from these securities and CDOs, they were also blissfully unaware of its repercussions.
Not only did it result in an avalanche of property mortgage loan defaults, the biggest investment banks in America ended up going into bankruptcy because they were unable to absorb the monstrous losses. To prevent the entire banking industry from collapsing, the Federal treasury department printed $700 billion out of thin air, under the Emergency Economic Stabilization Act of 2008—the big bank bailout—that was passed and signed into law by the US government. Of course, you can’t solve real-life problems with just a flick of the wand. Because the US currency is a global currency with which most international trading is done and to which many foreign currencies are pegged, if the US currency drops, the entire world economy will combust as well (more than it did when the crash of ‘08 happened). The rest of the world thus had to support this bank bailout, the biggest lender being China who now owns about $1.11 trillion in US debt.
From the American housing market to the world economy, this fiasco escalated in a way that no one had anticipated (save for a few eagle-eyed hedge funders and Wall Street mavericks). Their mistake was not paying attention and taking an obviously ‘too-good-to-be-true’ situation for granted. Well, once bitten, twice shy, right? Perhaps not, considering that the market has decided to reintroduce subprime loans under the disguise of a different mask, a move spurred by a slowing industry and businesses looking for ways to earn more.
They call them non-qualifying loans, which refer to property mortgage loans that deviate from the standards of the Consumer Financial Protection Bureau. This, in itself, should raise some eyebrows. Under these non-qualifying loans are the interest-only adjustable rate mortgage, and the income verification (or “ability to repay”) loan. The former allows the borrower to pay just the interest owed each month, instead of the actual mortgage, for a period of time. The latter seeks out people without a steady paycheque, receiving money in big chunks instead.
Claiming to cater to those with non-traditional sources of income, rather than folks without one to begin with, these brokers assert that they’re working with higher standards now. Yet, such malleable, unclear definitions may lead to exploitation, whether it’s borrowers taking advantage of these alternative schemes to buy lavish houses that they can’t afford, or unethical lenders shoving these plans onto borrowers for a quick buck. That was what created the housing bubble, prior to the 2008 collapse, and it could happen again today.
While affluent buyers may benefit from these non-qualifying property mortgage loans, issues such as a supply-demand imbalance in high-end properties or a housing decline (jacking up prices massively) could come up in the future and jeopardise their investments. The last thing you’d want is to have a mortgage that’s higher than the value of the property. At least with a traditional fixed-rate mortgage, your monthly principal payments will help boost your equity as a homeowner. Not with an interest-only adjustable rate mortgage (especially if you ignore your principal payments during the interest-only period), which will only spell trouble.
To sidestep another housing (and economic) crash, brokers and lenders can’t get greedy. They need to do their due diligence, take extensive steps in verifying the borrowers, and know which types of borrowers are best suited for these alternative loans in the first place. Peter Boomer of PNC Bank recommends borrowers who are not going to stay in their homes for the entire 30 years of an average mortgage’s term, whose salary includes a bonus that comprises the majority of their income, and who treat the mortgage as a type of debt in their investment portfolio. Borrowers have to be astute as well and know what they’re getting into before they sign the contract, instead of getting swept away by overly enticing schemes. At the end of the day, the biggest losers will still be the common folk, the underprivileged, and the gullible. It’s time we all wised up and paid attention.