This is America in 2009.
Wall Street’s gambling and greed led to the deepest financial crisis
this century has seen, and it echoed all around the world.
Just a decade later we had… 2020.
Home prices have skyrocketed over the last few months. The dream of owning a home, which
became a possibility for many families is evaporating with an overwhelming demand for
homes, which has driven the price up.
But this isn’t a game. It’s people’s dreams and livelihoods.
So, is the current real estate market a reflection, or a warning of what happened in 2008?’
I’m one of them, one of those millennials who needed to come into this game of mortgages
Now, I love playing Monopoly. We bought this board as a prop for our video on bankruptcy.
And I figured we needed to get another video out of it before defiling it by playing a
match. So finally. OK. Let’s start with the basics.
Most people don’t have… $120 to buy a house. They need to borrow that from a lender.
To get a loan on that missing cash, you need to put on a down payment. The lender then
provides the funding for the rest, pays the previous owner, and charges you a monthly
interest rate on the money that you owe them. In exchange for that loan the lender gets
a Mortgage: a piece of paper that says the owner agrees to give the house to the lender
if they fail to pay them. Executing a Mortgage means the lender sells the asset to collect
the missing debt, which is simple precisely because of the down-payment: 20% or 30% of
the debt is covered from day one, so they could liquidate that asset fast.
Now, in the world of investing- putting your money on Bitcoin is probably at the very top
of speculative/gambling. Anything could happen. We made a video about it.
But the other extreme is a boring Certificate of Deposit which yields about 0.00%/year.
For institutional investors, putting money in mortgages is a relatively safe bet- because
who doesn’t pay their mortgage. Also if they don’t, you take ownership of
the property, and you’re covered. In the 70s, legislation was passed to allow
lenders to bundle these mortgages together into a Morgage- Backed Security. This pack
of mortgages is a very cool investment: it pays better than a single mortgage and it’s
also safer, you are betting on thousands of mortgages, so the risk is diluted: if one
or two individuals fail to pay, you are still covered.
For the next couple of decades, mortgage-backed securities fueled the profits of banks and
Wall Street investors. And they got greedy.
More investors wanting to put money into these securities means more money available to lend.
But there are only so many families or individuals who want to buy a house, and who have a perfect
credit record. So requirements loosened up. This meant that your credit score no longer
had to be perfect, and you could still get a loan. Required down-payments decreased as
well. Now, to make up for the risk, (2D) hose weren’t 3% 30-year mortgages. These individuals
got offered sub-prime loans, which is a loan that has a low, fixed interest rate for a
few years, and then it spikes up to a much higher interest ratet, that’s adjustable-
meaning, it changes based on different market indicators.
All of that money flowing also led to a boom in housing: fancier houses in bigger residential
complexes all over the country. Not only that, but houses themselves increased
in value. Buying a house became a shorter-term investment because its value could go up 20%
or 30% within a few months.
Naturally, people took advantage of these conditions to buy multiple houses, each one
with a separate mortgage. While this is all happening, Wall Street investors
doubled down on their bets. Quite literally.
This gets really complex- but essentially banks took bets on their bets. They packaged
mortgage-backed securities into bundles called CDOs. They took loans to buy more of these
assets. They insured the securities using an instrument called a credit-default swap,
which allowed some investors to make money if the security failed (meaning if people
didn’t pay, they would make money because the mortgage failed).
So investors took bets on bets on bets- but the first bet was this mortgage that someone
took, on a house with an inflated price, on a low down-payment, on a subprime loan, on
a salary that wasn’t enough to pay the loan. If you can’t afford to pay a loan, then
the owner of the mortgage needs to sell it to recoup their capital. But suddenly, all
those extra houses that had been built were all back in the market at the same time. And
nobody was buying. More supply and less demand means that prices drop. Suddenly the asset
was not enough to cover the mortgage. More so, you might have had a mortgage for a house
that cost you $700, but is now worth $200. So you still owe the $700, are struggling
to pay interest on that, but the house is not worth what you are paying for. So you
just walk. As people couldn’t pay their mortgages,
lenders went bankrupt. The banks that had insured the mortgage-backed securities with
credit-default swaps didn’t have enough money to pay either, so they went bankrupt
as well.
The stock market plummeted, which left people unemployed, which left more unpaid mortgages and more chaos.
The median home price in the US reached an
all-time high earlier this year. That is higher than 2008 just before the other bubble burst.
And things got pretty crazy earlier this year: bidding wars between home buyers, fighting
for the few houses on sale in the market.
A simplistic look at this situation could drive us to the same conclusion: there’s
a new bubble approaching. But the reality of today is quite different. It’s not Wall
Street gambling or speculation (thankfully we learned a lesson and regulated that after
2009). First, you need to look at mortgage rates-
which are lower because of the various stimuli the government has approved to keep the economy
active. Pre-pandemic, March 2020- the average interest rate for a mortgage was 3.45% on
a 30-year loan. That dropped to 2.9% by July 2021, which means getting a mortgage on your
new house is now cheaper. On a $200,000 house, for example, this interest rate means that
you pay $1,827 vs $1,935- so $100/mo that you can use towards a bigger house.
Secondly, various studies agree that the US has underbuilt houses over the last 20 years-
apparently by 5.5 million houses. This means that there’s a smaller supply
of houses, combined with higher demand.
And this higher demand comes from various factors also associated with the pandemic.
Many people chose to move to a house (single family) because they now work from home and
want the extra space. They also spent a year stuck at home and if they kept their jobs,
that meant fewer expenses, less travel, and a couple of thousand dollars in stimulus checks.
These are people who might have considered buying a house in the next few years- and
are moving faster because they suddenly have the cash.