| | Luke,
I disagree that was even a factor. The thing was, people thought housing prices would go up no matter what, so even if a person defaulted on their mortgage, nobody cared, because they thought the bank could just foreclose the house and resell at a higher price. They weren't misleading financial investments. Its like Francisco d'Anconia's coal mine in Mexico. Nobody looked into whether the Mexican coal mine was worth anything. They never asked Fransisco how he expected they'd make profit. They just looked at Fransisco's track record and decided to invest for that reason.
Now let me explain the whole 2008 (and ongoing) financial meltdown in detail...
=== The Unwanted Houses Scheme ===
First as a prerequisite, you must understand some lessons from Austrian Economics. The first thing to know is that for any durable good, people are mostly interested in its monthly expense or rent, rather than a good's total purchase price. Factories decide whether to upgrade or expand their manufacturing equipment by whether the potential income would exceed the rental rates. Farmland is also rented out, and individual farmers look for as much land as they can rent and still make profit on... as the rent of some land decreases the more a farmer would want to rent it and farm on it.
The same goes for renting houses. If the rent for houses goes down, people who once couldn't afford to live by themselves, who shared living space with their relatives or friends would then be able to afford a place on their own. And people who could only afford a small living space would then be able to afford a larger living space.
The price of renting any durable good is primarily set by three factors: the market value of the good if sold outright, the market interest rate, and the reliability of the renter in fulfilling his end of the contract. This is because the owner of any durable good can always choose between renting his durable good out, or outright sell it and then loan out the proceeds and earn interest. If the interest rate is higher, he will sell. If the rental rate is higher, he will rent. Through the interest of durable good owners to maximize profit, rental profits equal sell & financial market interest rate profits.
Rental price per month for X year contract ~= [(market value of durable good) * (1 + market yearly interest rate / 100%)^X] / (X * 12)
If interest rate goes up, the rental price for a particular good goes up. If interest rate goes down, the rental price for a particular good goes down.
A house mortgage is very similar to renting. The difference is a person with a mortgage owns some portion of the durable good. Commonly since the year 2000 (I'm guessing), in 15 or 30 year mortgages, the person taking out the loan begins with only owning 20% or less of the home. Anyways, with a mortgage its like partial ownership and partial renting, and the ratio of ownership increases for the home manager as the mortgage nears its end of term. And... renting prices are directly set by a function of three things: market value of durable good, market interest rate, and reliability of renter.
Now there is something interesting about the housing market in recent times: Americans in general don't save anymore, instead they live paycheck to paycheck keeping spending balanced with income. If rental prices for houses in general go down, then Americans don't stay in their current house rental with a lower rent, which would cause them to save. Instead, they upgrade their living conditions. People who once rented rooms in a home or apartment now can afford renting a whole home or apartment, or at least upgrade some extent, and they do upgrade to keep their monthly housing spending at the same level in order to "live up to their means" and keep spending balanced with income. They have social security and medicare and the money is inflationary fiat and the stock market and future exchanges are all being manipulated... who would want to save in that environment? People who rented smaller houses upgraded to bigger houses. People who rented at a less desirable place upgraded to live closer to the action in the city or by the beach. And not just renters, but owners and mortgage holders too, because they all feel the same financial impacts of durable good rental prices going down due to a decreasing interest rate.
So as you can see, with a decreasing interest rate, in such an environment, there is a huge demand to build more houses and to build better houses. Because Americans want to live up to their means, which includes renting/owning-> living in a larger, more grand, higher market value living space. In fact, looking at my formula above for rental price, as you can see, if you keep, rental price the same, but DECREASE MARKET INTEREST RATE, to balance the equation MARKET VALUE OF DURABLE GOOD MUST INCREASE.
The Federal Reserve, Freddie Mac, and Fannie Mae, and their friend big banks (like JPM & BoA) all decided at once that they would like to decrease the market interest rate. They did this by buying homes for people. They collectively bought pretty much everyone in the USA a house, some people more than one house. They didn't just outright buy houses though. Instead they took a more concealed approach: The Federal Reserve and Federal Government offered Freddie and Fannie & the big bank owners a deal (The Unwanted Houses Scheme (UHS)):We will bail you out and/or not hold you accountable for defaulting. All you have to do is get people to start doing nonsense like building and buying unnecessary houses, and we'll all milk the whole process by: Government: gets to tax all sorts of financial transactions such as income that results from the worthless labor of building unwanted houses. Banks: get to be the middle men of financial transactions and get to pay their employees and owners lots of overhead middleman charges. So here's how its going to work: Big banks: you offer people lower interest rates than existing savers & owners of market value would loan their resources in order to kick off house building. You can just loan out depositor money like you already know how to do... just do it to such a scale like you've never done before that will eventually cause you to go bankrupt, but who cares! While it lasts, you can pay yourselves really high salaries. Freddie & Fannie: you guys buy mortgages from the big banks, and since you are even more government privileged and the public thinks your there to help them, nobody will hate you for your eventual default. Federal Government: don't hold defaulters accountable, and use tax money to bail friends out. Federal Reserve: Print money to bail out Freddie, Fannie, the big banks, and the Federal Government. As icing on the cake, nobody in the free market will accept a loan from savers, since the big banks are offering lower interest rates. So savers will be manipulated to buy something else, such as houses or US Treasuries. The UHS was approved by all involved, and in this way, interest rates were lowered, housing prices went up, and Americans went on a frenzy building houses when if left to the free market they'd rather have other things than more houses. They paid lots of income taxes and property taxes and all sorts of taxes oh my! They worked to pay huge sums to big bank owners. People who had savings in dollar backed financial instruments were ruined by the decreasing value of the dollar, a significant portion of their savings market value being redirected by inflation towards the ends of the Unwanted Houses Scheme: to build unwanted houses & to line the pockets of government & bank organization members.
To keep the frenzy going the gov & banks just kept on decreasing the interest rate... until the interest rate got down to pretty much zero. And then with the interest rate being almost zero the big banksters realized: "Oh no, we can't decrease the interest rate anymore, we've reached zero! We can't go negative! That would mean we'd be paying people to borrow our fiat!" So the interest rate went from decreasing to staying just above zero. And hence the market value of durable goods (such as houses) went from increasing to stable. This was right before the crash.
Now here's a funny thing. There are many investors in the market who invest not by looking at future expected earnings due to expected Price/Earnings ratios... instead they just like to plot trend lines on charts and expect the prices to follow the line, and they don't even try to consider underlying causes for price movements. Such is called a technical analysis investor. Such was the case with the price movement of the market value of houses while interest rates were being decreased through the Unwanted Houses Scheme. Many people bought houses only because via technical analysis they decided buying a house would result in the best rate of return, ignoring the underlying cause for the housing price increases. And ignoring that housing prices would eventually stop increasing when the interest rate stopped decreasing.
When housing prices stopped increasing, some technical analysis investors saw the flat line and decided they were not making profits any more on owning houses, so they sold their houses. This drove the housing prices from a flat line to a downturn. A downturn!?! This caught even more technical analysis investor's attention, and drove more of them to sell. What a shock to the financial system! Banks and businesses who were stuck with the hot potatoes of 80% of house ownership on the entirety of America's houses (given Americans only own ~20% of house principal) were devastated, many thrown from solvency to insolvency.
The story isn't over yet. The Federal Reserve still needs to print lots of money to hold the interest rate down, OR print lots of money to bail out the banks due to the shock of them not printing and the interest rate going up, OR let them default, which will completely destroy the US financial market throwing us back into the dark ages of using cash and coin instead of banks. Oh yea, and the Federal Government likes lower rates so that they can spend & borrow more instead of having a balanced budget.
You see, savers generally look to savings accounts at banks in order to earn interest on their monetary savings. But the big banks aren't offering savers very high interest rates on savings accounts, in fact right now the money market interest rate is practically zero, well bellow the (manipulated) CPI inflation rate (currently ~2% per year), and WAAY below the monetary base inflation rate (currently ~30% per year). Nobody wants to take loans from savers, because the big banks are offering interest rates way below what any saver would accept. So the savers look for the best place they can for higher interest rates. Many inverters find that US Treasuries give them the highest rate of return. This is the final aspect of the Unwanted Housing Scheme. Hence since the big banks are still offering interest rates which are lower than savers are willing to offer: more US Treasuries are purchased than non-manipulated markets would otherwise choose. Hence there is a bubble in US Treasuries too.
Today, and until the UHS is dismantled, until the big banks stop offering interest rates that are lower than savers are willing to offer, until then, the housing market and the US Treasuries market will be in a bubble. The beneficiaries of the UHS will continue to be able to feed off of the market through its various methods until it is dismantled.
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