The Credit Crunch: How Did it Happen?

The credit crunch didn't happen overnight, and many factors contributed, but one of the most visible reasons for financial collapse is the housing market.

We all know now that low teaser rates were offered to buyers who could barely make payments at 1% - and thus lost their homes to foreclosure when the introductory period ended and their rates escalated to 8%, 9%, and in some cases double digits.

Some of those borrowers were further dismayed to learn that the interest they hadn't been paying had actually been tacked on to the principal of their home loans - often meaning that after paying for 3 years, they owed more than they did at the outset.

Should the borrowers be blamed for not reading the fine print? Should they be blamed for not insisting upon knowing what their payment would be when the teaser rate expired? Should they be blamed for signing for an obligation they knew they could not fulfill?

Should the loan officers be blamed for not making everything painfully clear to borrowers? Or should the mortgage companies take responsibility for willingly giving loans to individuals who quite obviously could not fulfill the obligations?

A recent article in the Wall Street Journal suggests that less-than-honest lenders and appraisers must also shoulder some of the responsibility.

The January 3 article tells the tale of a 576 square foot "shack" in Arizona. This little 2 bedroom house, with windows boarded up, carries a notice stapled to the wall: "Unfit for human occupancy." And yet, less than 2 years ago, an Arizona lender gave a $103,000 loan to the home's unemployed occupant. Her adjustable rate mortgage, which started at 9.25%, was capped at 15.25%.

This occupant, who had not held a job in about 13 years, has owned the home for over 40 years, and wanted to pull out money to pay other obligations.

Records show that the lender collected $6,153 in broker fees, underwriting fees, loan origination, application fees, etc. When the loan was transferred to Wells Fargo a few days later, the lender earned an additional $3,090.

Meanwhile, one of the fees the borrower paid was for the appraiser, who was hired by the lender for $350. He valued the house at $132,000 and stated that he had found comparable like-sized homes nearby that had sold in that price range that year.

A real estate agent who was hired to sell the house after foreclosure stated that he had only found one comparable house - and it had sold for $63,000.

When shown photos of the home, the lender expressed shock - saying that when he made the loan he did not realize what poor condition the home was in.

Legitimate appraisers do adjust for condition, age, and "effective age" of a home. And legitimate lenders do read the appraisal report and look at the photos. Underwriters also read and analyze appraisals, so had everyone been honest, the loan would not have been made. This is a loan that was pushed through - and was just one of many that contributed to the downfall of financial institutions world-wide.

Here's why: The loan was sold to Wells Fargo, which sold it to a unit of JSBC, which packaged it with thousands of other risky mortgages and sold it in pieces to scores of investors.

The ultimate loss is in the $90,000 range, because neighbors have now purchased the house for a whopping $18,000 - just so they could tear it down. After selling costs, investors will recoup about $15,000.