The housing market has buoyed the economy in recent times. But this growth has been spurred in part by increasingly risky loans. What happens when the bubble bursts?
by Darrel Keisel
The American economy has grown without a major recession for a long time. The booming housing market is a big part of why it has done so well. When the Federal Reserve dropped its lending rate from 6 percent to 1 percent in one year, it started a frenzy of home building and buying. Banks have made a vast number of loans and have done well financially.
Banks, like other businesses, are never satisfied with how much they make. Pressure from management to make more the next quarter than they did the last is always present. Banks must keep their mortgage rates competitive. They also must decide which loans are good risks and which aren't.
The more liberal lenders have been the most successful in recent years. If we would have had a hard recession along the way, banks would have tightened their lending practices. But without a recession, banks have become more lenient about whom they loan to and more creative in their logic in justifying loans.
In a recent Wall Street Journal survey, about 20 percent of leading economists surveyed said a possible housing burst is their biggest worry for the economy. Let's look at what the banking business has done.
No money down: The precarious status of Fannie Mae and Freddie Mac
In the 1970s and '80s, home buyers needed a 20 percent down payment. If the bank had to take a house back, the bankers were quite sure they could get at least 80 percent back from reselling it. Now, due to the ever-rising real estate market, they feel they can recover the full value. So today they allow some first-time home buyers to buy a home with no money down.
Some banks, in bigger cities, will lend 120 percent of the value of a house. This enables the purchaser to furnish the house as well. Banks reason that the value of the house will increase faster than the value of the furniture will depreciate. And, of course, banks make more interest.
