The Bursting Of the Housing Bubble Followed By Foreclosure Crisis
The bursting of the housing bubble was closely followed by the foreclosure crisis. Most of the sub-prime borrowers had hoped that when their mortgage rates would go up they would be able to refinance into a traditional mortgage with reduced payment commitments. But when the value of property fell they could not do so because the loan amount was more that the worth of the house.
Foreclosures jumped from being below 200,000 during the third quarter of 2006 to over 600,000 during the first quarter of this year – 2008. By the time of the fourth quarter of 2007 delinquency numbers had increased to 5.8% – this being the highest since 1985. The alarming increase in defaults and foreclosures pushed down the price of mortgage-backed-securities because investors now began to worry that they would fail to realize their principal, let alone the interest they had been assured. What was astounding was that many financial bodies continued to dabble in risky mortgage-securities even after they had started facing trouble in selling them.
The phenomenal growth in these risky securities was like dry tinder piling up on the forest floor. All that was needed was a spark to set it on fire opined professor Richard Marston of Wharton. He added, “The spark happened to be in the sub-prime loans. If it hadn’t been there, it would have been some other security. Once you see the fire start, everyone starts to realize it’s going to spread to other types of securities that have nothing to do with mortgages.”
What is unique about today’s foreclosure crisis is that this is first instance in the history of America from the time of the Great Depression that there has been a national drop in the price of houses. It is an exceptional phenomenon. The use of the computer method was supposed to measure the risk factor but that too failed because there was not enough data to cover the number of cycles required. So it could not be correctly predicted how the new securities would function. The falling underwriting standards were not taken into account.
Investors found out that AAA rated mortgage-security did not equate in safety to AAA rated Treasury bonds. The ratings were entirely unreliable. Furthermore the losses had become too big for insurers to manage. Thus everything combined to allow the inevitable debut of the foreclosure crisis.
