Housing Market Checks 4 Out of 4 Boxes That Caused The 2008 Crisis

• The U.S. housing market is vulnerable today in all the same ways it was leading up to the 2008 financial crisis.
• It checks all four of the boxes that led to the housing bubble in the January 2011 Financial Crisis Inquiry report.
• Add to that the extreme economic stresses of the coronavirus pandemic and drastic measures to contain it.

In January 2011, the Financial Crisis Inquiry Commission (FCIC) ordered by Congress published its findings and conclusions regarding the 2008 financial crisis . The Commission gave a detailed accounting of the systemic problems in the housing market.

Today’s housing market is financed by the same byzantine lending practices that left residential real estate investors holding toxic assets.

Housing, a Risky Business

The 2011 report summarized the housing bubble and 2008 financial crisis:

When subprime and other risky mortgages—issued during a housing bubble that many experts failed to identify, and whose consequences were not understood— began to default at unexpected rates, a once-obscure market for complex investment securities backed by those mortgages abruptly failed.

The four critical factors leading to the housing bubble were:

• 1. Shadow banking
• 2. Securitization and Derivatives
• 3. Deregulation
• 4. Subprime Lending

Today, all four elements are still at work in the housing market. In some ways, their current manifestation has led to even more perverse lending practices than before 2008.

As a result, stresses in the housing market could lead to another financial crisis.

By the end of April, over 4 million mortgages representing nearly $1 trillion in unpaid principal went into forbearance. Mark Zandi, the chief economist for Moody’s Analytics, expects that number to reach as high as 15 million.

As borrowers hit by the coronavirus fallout fail to meet their loan obligations, the stresses on a system overwrought with risk will increase. This massive stress on a market that checks all four boxes that led to the last crisis could lead to another tipping point.

Conditions Ripe for Another Financial Crisis

The 2011 crisis inquiry pointed to shadow banking or non-bank lending as a factor in the housing bubble. “Shadow banks” don’t have the same degree of regulatory oversight as banks, which makes them more flexible. But they can also take on more risk.

In 2018, the Brookings Institution warned:

the nonbank mortgage sector remains vulnerable to a significant and sustained macroeconomic shock.

Two months later, MSNBC’s Jim Cramer called on the Fed to “crack down” on shadow banks .

By 2019, non-bank lending had become a $52 trillion industry worldwide. U.S. shadow banks made up $15 trillion or 29% of the global industry. Bond-rating agency DBRS sounded the alarm about systemic risks from shadow banking last year.

The FCIC said securitization of mortgages was the second factor leading to the housing bubble. Bundling mortgages into securities to sell to investors fueled housing market demand for subprime loans:

An investment bank, such as Lehman Brothers or Morgan Stanley (or a securities affiliate of a bank), bundled loans from a bank or other lender into securities and sold them to investors, who received investment returns funded by the principal and interest payments from the loans.

By last December, U.S. banks had a record $2 trillion in mortgage-backed securities on their books, leaving them downstream of a housing market cash crunch.

The third factor in the housing bubble was deregulation. The inquiry report pointed to deregulation, allowing the consolidation of finance in 74 “megamergers” from 1990 to 2005.

These massive, “too big to fail” banks became opaque, unmanageable behemoths, a perfect breeding ground for the housing bubble to emerge. Since the financial crisis, many of these institutions have grown even bigger and more opaque .

It All Leads to Subprime Mortgages

Finally, these systemic failures in combination unleashed a flood of subprime lending to borrowers who were eventually unable to meet their loan obligation.

A decade after the housing market crashed, banks have loosened underwriting standards , lowered interest rates for subprime mortgages , and began to offer the unthinkable: subprime jumbo mortgages .