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    2007/2008 Lessons

    I wanted to give you some context on what happened during the 2008 housing and financial crash as I understand it and what we can learn from it.

    Following the dotcom bubble, values in real estate began to creep up, fueling a rise in homeownership among speculative buyers, investors, and other consumers. A perfect storm of events occurred that allowed for such a catastrophic event.

    1. Subprime Loans: The federal government went on a crusade to make home loans accessible to individuals with low credit scores and dispossessed groups that were traditionally left out of home ownership. Lenders began to extend loans to high-risk individuals without verifying income or employment with unconventional loan types. Many self-employed individuals were able to lie about their income and get approved for loans they were not able to pay for. Low and no-money down loans were available that again allowed for unqualified buyers to purchase homes with no responsible path forward to re-pay their debt. There were stories of borrowers applying and being approved for loans in the name of their pet. This lead to a flood of new buyers entering the housing market, driving prices up and creating a bubble.

    2. CDO (Collateralized Debt Obligation): Thousands of loans were being packaged as low risk, high quality AAA rating and being sold and resold to investment banks. In reality, the CDO were full of subprime loans with high risk borrowers. When the economy turned and jobs were lost and less wealth was in the system, many borrowers could no longer afford their homes. This created a massive amount of borrowers defaulting and losing their homes, creating instability and eventual crash of the housing market.

    3. Adjustable-rate mortgages: More than $750 billion of option ARMs were originated in the U.S. from 2004 to 2008, according to Inside Mortgage Finance of Bethesda. When rates turned unfavorable, it was easier for many home buyers to simply step away from their home. Banks had to repossess homes in a market that did not have any buyers willing or able to purchase them. This cycle lead to the precipitous drop in home values.

    This “perfect storm” of events lead to the demise of the housing market. Many speculative investors stopped buying because the risk was getting too high or huge losses they were taking as the market shifted suddenly. Mortgage-backed securities were sold off in massive quantities, while mortgage defaults and foreclosures rose to unprecedented levels. As buyers fled the market, properties remain sitting unsold, stagnant, vacant. Prices dropped off and the entire ceiling collapsed.

    Fortunately, we have learned from many of our mistakes. Buyers now have to go through a rigorous application process and prove income, source down payment funds, provide a full debt profile matched with a borrowers credit score, and employment is verified and must be expected to continue. In general, self employed individuals must have two years of work experience to qualify.

    Loans are being regulated and detailed. Very few ARM’s are being originated. This is causing a much healthier, capable demographic of borrowers that is stimulating the economy.

    Prior to 2008, there were several lender practices that were being used that created great instability and risk in the economy. Those practices are no longer being used today. Every buyer I work with is upset with all the amounts of paperwork and additional requests they get to explain something from the underwriter. While it is frustrating, its a positive signal to me that we are still on the right track.

    This is very general and in no way do I wish to portray this as a comprehensive history of what happened or as a defense on why we will not crash like before. These are some thoughts. I would love to hear more thoughts or opinions on this matter.

    Call it like you see it.

    -Brett

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