Maybe it is time for a new acronym for the financial industry. How about WALLOP, Wild A—-d Lending Loan Originator Products? The overall economy has been WALLOPed.
Historical findings indicate that when interest rates drop and financial restrictions ease, the average price of homes peak at 28%. When credit is restricted and interest rates edge higher, the price drops an average of 20%. The information is from a 40 year study of 18 industrialized countries.
I was amazed at how low the interest rates dropped. Solicitations came in the mail, telephone calls, in the periodicals, and on the Internet. First time homebuyers incentives expanded to include people that had not owned their home for 5 years.
Low interest rates were logs that fueled the fires of the economy. These fires generated the illusion of prosperity. Rates already at all-time lows would stabilize and then drop a little more. When principal and interest fit within the potential borrowers budget then there was the possibility to purchase the highly desired home, refinance into a more affordable payment, or cash out.
A sale to a first time buyer meant more demand for durable goods. The bigger the house, the more demand. The economy relied on the subsequent sales involved with furnishing the home. Refinancing in order to reduce payments gave homebuyers more disposable income. They were able to make new acquisitions and maintain their lifestyle. In order to keep the cycle going, home prices needed to drop or interest rates reduced.
At some point, the only way to reduce interest rates was Adjustable Rate Mortgages. The initial rates were lower than fixed rate mortgages and encouraged investors that the return would adjust and eventually close the gap with future interest rates paid to investments.
The phenomenon of the Home Teller Machine began. People would refinance and receive cash out from their equity. The capital received could be used for home improvements or repairs, to consolidate and pay other debts, or (heaven forbid) saved. Savings created a safety net and comfort zone for the homeowner, but did not stimulate the overall economy.
Banks have lower risk to mortgage loss because the debts are securitized into Mortgaged Backed Securities (MBS) and sold to investors. The recent failure of New Century and American Home mortgage was due to defaulted mortgages being returned or exchanged from MBS created within the past 2 years and being unable to sell the packaged mortgages. Eventually the warranty will expire or the initial lender will collapse and the investment companies will be unable to return the risky mortgages.