Home Blogs Chemicals and the Economy Every mania has its illusion

Every mania has its illusion

Economic growth, Financial Events, Leverage
By Paul Hodges on 10-Aug-2007

All the world’s media are now carrying accounts of the ‘liar loans’ and fraud that has accompanied the growth in US mortgage lending in recent years. How did this come about?

All manias gain their strength from a widely believed ‘fact’ that turns out to have been an illusion. With subprime mortgage loans, the ‘fact’ was obvious. Everyone wanted to believe that US housing could only ever go up in value. The mortgage brokers believed this when they gave $500k loans to truckers earning $50k a year. They knew the borrower couldn’t afford it, but were sure that increasing property values made the loan bankable.

Similarly the banks also ‘knew’ that if there were any problems with repayment, then they could easily sell the house for a profit. And the ratings agencies were happy to give AAA ratings to part of these loans, when securitised, because their models showed that US house prices hadn’t declined nationally since the Great Depression.

And, of course, there were plenty of buyers for these loans outside the US. With global interest rates so low, the returns to be made from lending to the US housing market looked very attractive by comparison. And they came with all the right paperwork to assure investors and the compliance officer that everything was okay.

The only problem is that the whole story may turn out to have been an illusion. The CEO of Countrywide, the largest US mortgage broker, said last month that `we are experiencing home price depreciation almost like never before, with the exception of the Great Depression’.