Here’s a concise essay (excerpt thereof) by Barry Ritholtz on the housing bubble and how it led to the credit crisis.
How Lending Standard Changes Led to the Housing Boom/Bust
Excerpt: "There is a general lack of understanding as to how the Housing boom and bust occurred, and why it led to the subsequent credit freeze. The situation is complex, and that is why we are still explaining this 3 years into the housing bust.
Let me take another shot at clarifying this:
Underlying EVERYTHING — housing boom and bust, derivative explosion, credit crisis — is the enormous change in lending standards. I am not sure many people understand the massive change that took place during the 2002-07 period. It was more than a subtle shift — it was an abdication of the traditional lending standards that had existed for decades, if not centuries.
After the Greenspan Fed took rates down to ultra-low levels, home prices began to levitate…
…What do rational, profit-maximizers do? They put people in houses that would not default in 90 days — and the easiest way to do that were the 2/28 ARM mortgages. Cheap teaser rates for 24 months, then the big reset. Once the reset occurred 24 months later, it was long off the books of the mortgage originators — by then, it was Wall Street’s problem.
This was a monumental change in lending standards. It created millions of new potential home buyers. Why? Instead of making sure that borrowers could pay back a loan, and not default over the course of a 30 YEAR FIXED MORTGAGE, originators only had to find people who could afford the teaser rate for a few months…
…Contrary to the cliche, failure is not an orphan in the current crisis — it has 100s of fathers. But these four are the primary movers, the key to everything else. The perfect storm of ultra-low rates, securitization, lax lending standards and triple AAA ratings — these are the key to how we ended up with the previous boom, followed by a bust, and ultimately, the credit freeze."
