Readers Question: In 2008, did banks lend money to people who wanted to buy a house because they believed that the value of the housing market would keep rising? So even if people defaulted on their loan repayments then the banks could reposes the house as it was used as collateral. As the value of the house would be of greater worth than the loan so that the banks could make a profit. Is this correct? Thanks!
This is partially correct. The great housing boom lasted from 1994 to 2006/07. But, in particular the period 2000 to 2007.
Mortgage lenders in both the US, UK and Europe became very keen to lend more mortgages because of rising prices, but also other factors, such as over-confidence, ability to borrow short term money / resell mortgage bundles. There were also significant differences between US lending and lending in Europe. In the US, mortgage lending was the most aggressive. UK and Europe retained some controls, but even so, mortgage lending rose sharply.
US Housing boom in historical context
The US Housing boom
The US housing boom was caused by a number of factors, but extravagant mortgage lending was a key factor.
- Rising property prices created a positive wealth effect. This encouraged people to try and get on the property land (people who previously rented).
- Rising house prices also encouraged banks to lend mortgages because – as you say – even if people defaulted, the bank could make a profit on its mortgage lending by selling the house at a higher price. Usually lending a mortgage is quite a good investment for a bank, especially if house prices rise.
- The rising demand and rising supply of mortgages created a strong effect for pushing up house prices. It became a mutually reinforcing circle. Rising house prices encouraged banks to lend. More bank lending encouraged people to buy, pushing up prices.
- Over-confidence. This climate of rising house prices definitely encouraged over-confidence in the banking sector and amongst householders. There was a feeling that housing was one of the best forms of investment – you couldn’t go wrong with a house.
- Short-term bonuses. In the US, a feature of mortgage lending was that people were employed to sell mortgages who had no interest in checking whether it was suitable in the long term. There were very lax mortgage controls. Mortgages were sold with ‘teaser’ deals to make the first two years cheap and the later higher rates hidden from view. These mortgage sellers were not considering whether it made sense, they were just trying to sell the mortgages to get their commission. Financial bodies were happy to have these rogue salesmen because they thought house prices would keep rising. Also, bankers often got substantial bonuses from the mortgage boom; risky lending often paid high bonuses – encouraging a climate of risk taking.