One simple word " greed".  I will try to keep this brief and simple.  Let's first start with a little history.

In 1999 the Financial Services Modernization Act was signed .  In a nut shell this bill allowed the banks to directly deal on Wall Street.  This bill was known as the Bank deregulation act of 1999.  Also during this time frame members of the Democratic party in particular Chris Dodd and Barney Frank started to apply pressure to Fannie Mae, Freddie Mac, HUD as well as the major Banks to lower the guideline standards to allow more low income borrowers to be able to purchase homes.

This was also the time that the housing boom started in key States such as Florida, Nevada, Arizona and California.  Investors started to purchase building lots or land at a very low price, then sold the property to another investor a couple of months later for sometimes double the price.  Investors saw the income opportunety and moved in full force.  Buying and flipping; until over a span of about 7 years 1/4 acre building lots that sold in 1999 and 2000 for $3000 ending up being valued at over $120,000 or more.  This in itself helped cause an over valuation of property.  If the cost of dirt to build a home in your neighborhood costs $120,000 then it adds the same value to the dirt your house is built on.

Builder's started to buy large acreage and build sub-divisions in phases.  Every investor knew that if they could purchase a home in the first phase the build time was 12 to 18 months.  Many of the builders allowed you to purchase a home with only $1000 down and the balance would be due when a certificate of occupancy was issued. Over a span of 18 months they knew that the value of the property would increase about $50,000.  There were a large number of smaller investors that got involved that would purchase multiple homes.  Many of these homes were sold before they even were built by having someone assume the contract.  The builders did not care because it was to there advantage to allow an assumption of there contract.  And the builder did not care because when it came time to start phase 2 they could sell the homes for much more money and make a bigger profit.  This also happened with condominiums as well.

In late 2005 the peak was reached and property values started to come down.  Property was way overpriced and there was a large inventory of unsold homes.  The smaller investor who tried to make money did not see this coming and could not sell the investment homes so they let them go back to the bank.  Builders who sold multiple properties to investors for only $1000 down were stuck with the homes.

Now since we have some of the factors that caused the property values to sky rocket in some areas around the country; lets get into the mortgage mess.

In 1999 and 2000 because of the pressure from congress Fannie and Freddie and the Banks started to loosen up on the guidelines.  Stated income was allowed for self employeed people, a few years later Lenders started to allow W2 income earners to go stated income.  Since the Banks were doing more loans and packaging the loans up and selling them as Mortgage Backed Securities on Wall Street, they started to make more money.  The Wall Street Banks saw this and decided to get in the game as well.  Many if not all the Wall Street Banks became Mortgage Lenders.  They set up there own guidelines and performed the underwritting on the loans and packaged them into MBS and sold them to investors around the world all as "AAA" rated securities. 

 Hundreds of smaller Mortgage Lenders sprang up around the country as portfolio Lenders; again with very weak guidelines.  These Lenders were primarily non-prime Lenders offerring loans at 100%.  To help them sell the loans to investors they offered adjustable rate mortgages verses 30 year fixed most had a 2 year or 3 year prepayment penalty.

Because of the proporty values being so high in areas like California and some parts of Florida there were alot of folks who took the pay option arm with an initial rate of 1%.

The non-prime adjustable rate mortgages and the pay option mortgages began to recast in 2007.  The interest rates went up on all of the mortgages and the payments increased.  People could not make the increased mortgage payments.  They could not refinance because the property value had decreased, so they let the Lender foreclose on the property.

When a pool of MBS are sold there usually is a benchmark involved meaning that if a certain percentage of loans go bad then the original selling investor has to buy back the loans.  This caused many smaller and some major Mortgage Lenders to go under because they did not have the liquid cash to purchase the loans back.

The large Banks as well as Fannie and Freddie and the Wall Street banks all saw the huge profit so they in turn purchased large amounts of the MBS and added them to there portfolio.  Many banks placed them in a "CDO", they used there own valuation models to place a value on them instead of using a "mark to market value".  This caused the Banks, Fannie, Freddie and Wall Street executives to get millions and millions of dollars in bonus'. Then they used the asset as collateral to get other loans.  In June of 2007 it all came crashing down around them.

Basically this whole mess was caused by the greed of the Bankers and the Excecutives on Wall Street as well as the investors themselves.  The rating agencies should also take some blame for allowing the MBS to be sold as "AAA" securities when infact they were not.  Lenders pooled together the good paper with the bad trying to spread the risky loans thin and thought that because of the loans being bundled together that the over all percentage of a givin MBS would have a lower foreclosure rate.  This did not happen;  many folks thave tried to refinance to a lower rate but because of the falling value of there home they could and can not refinance.  Good people have no choice but to foreclose.  Also those self employed people who did a stated income loan can not refinance to a lower rate because they still can not prove there income. This is where the loan modification is coming into play.

I feel that before all this is over we will have a few more Banks go under.

Lenders across the country are now performing make sense underwriting.  There are no longer any Stated Income loan products or non-prime Lenders.  You have to have good credit to purchase a home

I hope I gave you a decent understanding of what caused this mess.  It would actually take a book to explain all the complexities and who was involved and to what extent.

But let me assure you it was not the MORTGAGE BROKERS fault as the Bankers and Barnet Frank would want you to believe.

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What essentially took place was a perfect storm that created the current situation. There is no one single factor that created the crisis, rather, many factors contributed to what has become our current situation.

First and foremost was the proliferation of mortgage products designed for an increasing housing market with little regard for long term risk levels. In hindsight, anyone should be able to see that offering a loan with no money down to someone with a sub 600 credit score is dangerous to say the least. The fact was that investors pointed to ever escalating home prices to justify the fact that what was 100% financing today, would become 90% financing in 6 months as the value of the property appreciated.

Also disguising the risk of these loans was the fact that as values rose, any borrowers who had gotten in trouble were easily able to refinance into a new loan, or sell for a profit. This continued to fuel home prices higher, which in turn helped loan performance data. Foreclosure numbers were very low because there was an out for most anyone facing foreclosure. Because of this, Wall Street was able to point to how safe the investment products backed by these loans were. They had very little delinquency, appearing to be safe investments.

Ultimately a combination of easy credit, consumers living beyond their means, and escalating home values created a closed circle that continued to fuel eachother. You can start with any one of those 3 items, move to the next and the next and follow the circle around.

Consumers like to spend money, they like to buy things. This alone fueled the desire for a bigger better house. On top of that, homeowners who already owned, used their homes like piggy banks, spending on credit cards only to refinance the debt later. An improving housing market was bolstered by ever higher sales, which then fueled appraised values for refinance loans. As this perpetuated itself, the appetite of foreign and institutional investors for mortgages grew. They saw low delinquency numbers and much higher returns than government bonds etc, and began investing heavily in mortgage backed securities. This appetite led Wall Street to create new, riskier loan products that offered even higher returns. Banks and brokers in turn sold those products to consumers who needed a way out of their debt payments, or wanted to buy with no money out of pocket.

Eventually, home prices got to a point where they could not rise anymore. Supply (homes for sale + new construction) had completely surpassed demand for the homes. As this happens, people begin to lower prices to sell their home. Once this happens once it creates a new home price level for that neighborhood. Repeat that process hundreds of thousands of times and you can see how home prices begin to fall. As the fall worsened, the borrowers who were outspending their income were unable to draw equity from their homes as it had disappeared. Additionally all the ARM borrowers who had been promised a refinance could no longer refinance due to being upside down. As this happened delinquency numbers began to rise on mortgage backed securities. Rising delinquencies curbed investor appetite for MBS, and as such programs began to disappear. This became a new circle, however instead of upward, the spiral was downward this time. Falling home prices and tightening credit led to defaults, which led to more credit tightening, which led to more defaults and lower prices.

Eventually we will reach a point where values stabilize. That is the first point of recovery. Once that happens, credit will begin to open up, which will allow more borrowers to qualify. Once that happens demand will move back towards supply. Once supply and demand sync again we should begin to return to a much more normal market. We are likely to not see another bubble like we've recently experienced, however at the same time it should be an improvement over the 2008 market.

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This is an excellent question and there are undoubtedly a myriad of answers.  Here is my take on the mortgage crisis.

After 9/11 mortgage rates tumbled to possibly the lowest level since President Kennedy was in office.  This fueled home ownership by making it more affordable to more people and the subsequent rapid and unprecedented increase in home values. 

As time went on mortgage guidelines relaxed as a result of Fannie Mae and Freddie Mac's willingness to back these new relaxed mortgages.  With that backing lenders were more than willing to write these loans, such as what became know as Alt-A mortgages. 

After that Wall Street created another avenue for the purchase of mortgages in the form of Mortgage Backed Securities.  Now the lenders had a place to sell sub-prime loans.  Many of these loans were offered to borrowers with little consideration of their credit worthiness and even less consideration regarding their ability to repay these loans.  In other words, loans were given to borrowers with far less than perfect credit with no income or asset documentation. 

On top of this many of these loans equaled 100% of the purchase price or home value.  These same types of loans were also offered to buyers purchasing investment properties.  A large number of these loans were adjustable rate mortgages fixed only for the first two years.  Others were "option ARMS" with one of the payment options resulting in negative amortization, which means the payment wasn't large enough to service the interest on the loan and the difference was added back into the loan balance.

Then the inevitable happened.  Actually, several things happened and converged at around the same time.  The buying frenzy slowed down, causing a downturn in housing prices and many of the adjustable rate mortgages adjusted causing much higher payment requirements.  Since so many of these loans were originally written at 100% of value these loans could not be refinanced because now many borrowers were "upside down".  Meaning that they owed more than their property was worth.  As a result many borrowers could no longer make their higher payments and once the lenders started getting "burned" on these loans they started tightening mortgage guidelines.  The borrowers were stuck, with many of them just walking away from their homes, the lenders were stuck and property values tumbled further.  It was a vicious cycle and here we are today.

Of course this is probably a very simplified version of the reasons for the mortgage crisis, but as with all things in life the pendulum will swing from one extreme to the other and will continue to do so.

 

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OK, so now we have the reasons behind the mortgage crisis.  Now what?  Loan modifications have been proven to be a dismal failure, with 36% re-default rate after three months.  Why, because the homeowner realizes that their modification no matter how low the payment or interest rate doesn't address the fundamental problem that they are underwater in their home and cannot sell or refinance without taking a loss or writing a huge check.

They realize that it is going to take 10 to 15 years to break even given the current market conditions.

The root cause of the mortgage crisis comes from Lenders, Wall Street and Government Agencies who created a market for their special or creative lending products for profit.  Ever looked up "Fraud for Profit", the answer on Wikipedia nails the mortgage mess.

When they promoted these lending products, they induced a flood of buyers who could not qualify under traditional guidelines to enter the market.  Simple Econ 101, increased demand with low supply equals higher prices.  Prices not supported by the buyers real income levels without the special or creative financing.  All provided by the Lenders, Wall Street and Government Agencies.  Convenient don't you think.

FNMA and FHMLC's own appraial guidelines require the appraiser to mention "Special or Creative Financing" if it creates an undue influence on the price or value of the subject property.  I don't recall one appraisal during the boom years that even hinted at this condition.  Why, because the Lenders, Wall Street and Government Agencies were making to much money to pay attention to their own guidelines.

The result is that there will be 2.25 million foreclosures in 2008 and an estimated 12 million household "Underwater" still.  Equity losses are in the trillions.  And house prices are declining in all the major markets with no end in site.

We need an accross the board loan modification reducing the interest to ZERO for any homeowner or investor who bought or refinanced from January 1, 2000 as these homeowners were induced for profit to pay more than the home was worth.  The Lenders, Wall Street and Government Agencies responsible for this mess don't deserve to earn a dime of profit from this worldwide scam.

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