Ten years ago in September, the U.S. financial system delivered a shock felt round the world. In the U.S. alone, an estimated nine million homeowners were forced from their homes. The market excesses and regulatory failures leading up to the crash have been documented in several books and movies, most notably The Big Short by Michael Lewis. Ten years later, questions remain.
Have homeowners fully recovered from the subprime mortgage crisis?
The short answer to the first question is no. Ten years after the subprime mortgage crisis, millions of American homes have mortgages that are seriously underwater, meaning the market price of the home is at least 25 percent less than the unpaid mortgage balance. As reported by Reuters, coastal markets recovered well from the crash, but the bedroom communities of the Midwest, mid-Atlantic, and Southeast regions did not. Nationwide, the five counties with the highest percentage of mortgages that are seriously underwater are in Illinois, North Carolina, Virginia, and Georgia.
These homeowners face painful choices. Selling at current prices would require finding enough cash to help pay the excess mortgage debt. Leasing generally does not yield enough monthly rent to cover monthly ownership expenses. Defaulting will ruin their credit. The answer, for most, is to stay put and keep working in the hope that home prices and mortgage balances ultimately line up.
Apart from displacing nine million homeowners, what other impacts did the crisis have on American society?
Millions of Americans without underwater mortgages have been affected by the crash in other ways, some of which are only now able to be measured. According to new research published in the Harvard Business Review, the drop in real estate prices, followed by a boom in the stock market, have combined to create the largest spike in wealth inequality since World War II.
Authors of the report base their findings on the fact that wealthy and less wealthy people own different types of assets. The middle class has a high share of wealth from homeownership, but the wealthy own more stock. As a result, “wealth inequality is essentially a race between the housing market and the stock market.” Between 1971 and 2007 the housing market kept pace. During that time, for example, the bottom 50 percent of households ranked by income experienced little or no income growth, but doubled their wealth.
That all changed in 2008. When housing prices collapsed, the wealth of middle and low income earners collapsed along with it, but the subsequent stock market boom boosted wealth at the top. The continued rise of income inequality, already underway for many years, became even more pronounced. A longstanding economic problem started to emerge as a hot-button political issue.
Do we have safeguards in place to reduce the likelihood and limit the scale of future financial shocks?
A new briefing by The Economist concludes that our financial system is safer now than in 2008, but that not all the right lessons have been learned. On the plus side, in both America and Europe, banks are holding higher percentages of equity to fund their operations. The resulting decrease in profit has caused banks to cut back on highly leveraged and volatile businesses, and has made them more cost-conscious as well.
A more cautious attitude by banks has been accompanied by more assertive behavior by regulators. The Federal Reserve, in particular, was credited with helping American banks recover more quickly than others, and came away from the crisis with more authority than before. The imposition of “stress tests” on banks, meant to measure the ability to withstand financial shocks, has added new focus to the Fed’s oversight activities and new employees to its payroll.
On the minus side, as the banks have pulled back, more credit has been coming from outside the traditional banking system. Corporations are issuing more long-term bonds, and private equity firms have entered the lending business as well. These changes carry their own set of risks, and may or may not be more resistant to runs.
Also, despite talk of unwinding, privatizing, or dissolving them after 2008, Fannie Mae and Freddie Mac are still in business as conduits between mortgage firms and the capital markets. Both were, in effect, nationalized in 2008 because their capital was too low to cover the risky assets on their balance sheets.
If anything, their management is more politicized now than in 2008. Both institutions have been granted rights to issue loans based on down payments as low as three percent and debt to income ratios of up to 50 percent. Critics say new lending practices have led to sharp increases in prices for low-cost homes, 84 percent of which are guaranteed by the two institutions. What all of this means, in effect, is that American taxpayers are still in the business of guaranteeing mortgage debt.