Foreclosures 101 – Part 1

Foreclosure 101 – Part I

The economic crisis we have been living through for the past six years had its origins in an economic “bubble,” involving mortgage rates and real estate trading, that started in the United States in 2001 and ended in mid-2006.

An economic “bubble” is a distortion in the economy that occurs whenever a major commodity or service becomes such an object of speculation that its price hyper-inflates far beyond its actual value. Such a trend will only continue for a certain amount of time before the bubble bursts, and prices begin to fall. Unfortunately, one of the characteristics of a true economic bubble is that it often sets off a chain reaction throughout the economy, causing unusual expansion while it is still growing, and massive losses when it implodes. That is exactly what happened with the real estate market.

Frenzied buying and selling of homes, combined with a shortage of available housing plus easy credit, led to rapid increases in the market prices on all available housing in the U.S.

For years the banks, real estate agents and investors in real estate securities on Wall Street were making money hand-over-fist. During that period, most ordinary people who owned a home, or at least were buying one, felt that they were also beneficiaries of this process

In the years leading up to the crisis, significant amounts of foreign money flowed into the U.S. from fast-growing economies in Asia and oil-producing countries. This inflow of funds combined with low U.S. interest rates from 2002-2004 contributed to easy credit conditions, which fueled both housing and credit bubbles. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.

As part of the housing and credit booms, the amount of financial agreements called mortgage-backed securities (MBS), which derive their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market.

As more and more investment poured into the housing market, especially into mortgage-backed securities, the competition between banks and investment firms heated up. Soon, the banks opened up credit on loans to more and more “sub-prime” borrowers—that is, borrowers who would not ordinarily qualify for loans because they didn’t have enough financial resources on hand to guarantee their ability to pay a loan off.

The banks felt secure that the seemingly endless flow of investment funds and the constantly expanding economy would cushion them against the likelihood of numerous defaults on these loans. Meanwhile, they would milk these sub-prime borrowers for every penny they could get. At the same time, by increasing the number of buyers on the market for homes, the banks artificially pushed up the prices on ALL available properties by adding more pressure to the balance of supply versus demand.

They did all this while pretending to break from their previous established history of gross discrimination and red-lining against the disproportionately non-white borrowers whose limited financial resources forced them into “sub-prime” status in the first place.

Approximately 80% of U.S. mortgages issued  to sub-prime borrowers in the 2001-2006 years were adjustable-rate mortgages. Adjustable-rate mortgages usually allow the homeowner to pay low monthly rates for a specified period of time (usually 1-3 years); after that, the monthly rates go up. The increased rates are usually based on increases in the general interest rates on the market. The borrower is the one taking the greatest risk in these kinds of loans, because even a small increase in interest rates can translate into a major increase in their monthly payment.

The borrowers usually convince themselves that they’ll be able to handle the increased rates by working more, cutting corners, or whatever. And, as long as the market value of homes keeps shooting up year by year, they may have the option of refinancing their original loan or taking out an “equity line of credit” (borrowing more money from the bank based on the increased value of the home, in order to help cover their costs), or, push-come-to- shove, selling the home based on its increased value, then re-buying a cheaper home with the profits, while paying off the original mortgage. This was how the game was really played—for those smart enough to figure out all of “the rules”.

Kwazi Nkrumah

Kwazi Nkrumah

Note: This is a revised version of a document Kwazi Nkrumah  wrote  for the Coffee Party of Los Angeles. It is posted here with the author’s permission. The Coffee Party has been organizing against mortgage foreclosures in North-East and North-Central L.A. Kwazi Nkrumah is an organizer who is active in the Coffee Party, co-founded Occupy the Hood, and supports other grass roots organizations.

This is the first in a series of 5 that will be posted over several weeks. . Part IPart I,  Part III, and Part IV of this series can be accessed here.

Kwazi Nkrumah

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Comments

  1. Lauren Steiner says

    Please publish this over several days not weeks. It is hard to remember these kind of details from one week to the next. I found this very easy to understand. Thanks, Kwazi for making a complex subject comprehensible.

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