Following the 2,000 Dot Com crash, then Fed Chair Alan Greenspan brought Fed Funds rates down to ultra-low levels. Under 2% for 3 years, and 1% for more than a year.
Rates this low — and for that long — were simply unprecedented. They wreaked havoc with the traditional fixed income market. Bond managers scrambled for yield, and found it in investment grade, triple A rated residential mortgage-backed securities (RMBS). This better interest rate was created by securitizing mortgages with an unhealthy slug of higher yielding, riskier, sub-prime mortgages.
The demand for RMBS paper was nearly insatiable. Wall Street sucked up as much sub-prime paper as could be legitimately, then illegitimately produced. Lend-to-securitize-nonbank mortgage writers responded to the demand by abdicating traditional lending standards. 30 year mortgages were given to people who in no conceivable way could afford them. The hope was a non-default over the warranty period of the mortgage, typically 90 or 180 days.
The Greenspan Fed, in charge of supervising financial lending institutions, looked the other way.
The net result of this was a credit bubble and a housing boom. (A true housing bubble formed only in a handful of places). The credit bubble allowed 10s of millions of Americans to become, albeit temporarily, home owners.
In 1992, some 4 million homes per year were being purchased. A decade later, that number had risen 25% to 5 million. A mere 3 years later, annual sales were 7 million units — a 40% increase. From 2002 to 2007, the abdication of lending standards — who cares about credit scores, incomes, debt load, assets, even job! — created millions of new homeowners. And thanks to the ultra low rates, prices had exploded. The combination of brand new, unsophisticated buyers and rapidly rising prices was a dangerous combination.
Buyers of limited financial means who en masse overpaid for their houses at ultra low rates was a recipe for disaster. The Fed began its cyclical tightening, price appreciation slowed, then reversed. Sales plummeted, and prices fell. Five million of those buyers were foreclosed upon, with another 5 million likely to come.
Which more or less brings you up to date.
