The Mortgage Industry

The press has been paying attention to the unexpected sub prime mortgage meltdown. It's not a melt down and as anyone with either a recollection of banking history or a rudimentary understanding of math can attest, its not unexpected.

Lets review. In the late 1970's and early 1980's interest rates shot through the roof. Back then the adjustable rate mortgage wasn't the prevalent product. In those days fixed rate mortgages were often only of 5 to 15 years lengths. As they customarily had been in the US before the advent of Fannie and Freddie. If you wanted a 30 year loan, it was generally offered as a 5 year balloon.

Here's how the old 30 year loan worked. You wanted to buy a house. The first thing you did was save up 20% of the purchase price as cash, plus 6 months housing expenses, plus 2 to 6 months worth of escrow for taxes and insurance. In all likelihood you had about 30% of the purchase price on deposit in the same bank you were going to get the mortgage from. Then they evaluated your ability to repay the loan. If you had enough monthly income from your normal 40 hour work week to make the payment and if your total debts (remember not many people had credit cards) including your utilities and any other recurring expenses didn't exceed 25% to 30% of your total gross income, AND you had sufficient disposable income to live on, they would take the time to evaluate your credit. Credit scores were a evolving thing at this point and most of the scoring systems were not as uniform as they are now. What happened was the loan officer had to get letters of reference and call up people you had accounts with to see if you paid your bills on time. Today you have to be 30 days late to get a late on your credit report, under the old system the LO knew if you were always just a few days behind. If that checked out you got the loan.

The way the loan worked was your payment was amortized over 30 years with a fixed interest rate. Every fifth year the total principal amount came due as a balloon payment. Some paid it off, most refinanced at what ever the new interest rate was. Under Jimmy Carter's admin folks got a big surprise, when that 5 year balloon came due instead of a seeing a 1/4 or 1/2 point interest rate hike they were seeing 10 to 16% interest rate hikes. They couldn't make the payments. Some lost their homes, others had local banks that would work with them. To keep the roof from collapsing on the nation, several things happened. The government sponsored several different buyouts and some banker thought up bringing back a practice that was generally regarded as unethical. Thus we saw the re advent of the negatively amortized and the interest only mortgage. After Regan's election banking got back to "normal" and interest rates and home mortgage rates bounced in the 7 to 9% range for most of the 1990's.

This is getting long. I see a part 2 coming down the road.