By Tony Jiao, Staff Writer
As every young Canadian knows, these days housing isn’t exactly affordable. However, it would still be a stretch to call our current prices a “bubble”. A bubble typically occurs when a dramatic rise in price is not correlated with consistent demand, such as the housing bubble and the subsequent infamous crash of 2008. Looking back, it is easy to see that what occurred in 2008 wasn’t due to foreign investors buying up property or even much to do with anything related to the real estate market at all. So, what happened all those years ago?
It all began with Lewis Raneri, dubbed the “Godfather of mortgage finance”, who in the 1970s, invented the Mortgage-Backed Security (MBS). In essence, the MBS combines thousands and thousands of home mortgages into a single bond, which lowered the overall risk of the investment while maintaining a decent yield. Mortgages were already considered fairly safe investments, and even if a few mortgages defaulted, the bond would still endure. This not only gave banks another avenue for purchasing and financing individual mortgages but also allowed individual investors to dabble in the mortgage market without having the hefty amount of money required to buy an entire mortgage for the first time ever. Lewis’s idea was genius, and he was hailed a hero alongside other American innovators like Bill Gates and Henry Ford.
Lewis’s idea, which came from good intentions, created a ticking time bomb for the world economy. Because of the massive popularity of the MBS, banks were scrambling to find new mortgages to fill those bonds. This led to a huge number of mortgages being approved for individuals who had no business taking on debt. Employment records, credit scores and even financial status were not being verified, in what became known as “NINJA” loans, or No Income, No Job & No Assets. Slowly, what initially was a highly secure and stable investment grew toxic, unbeknownst to the millions of people worldwide who had financed a mortgage at incredibly attractive rates thanks to these loans.
Before we go any further, it is important to understand the two types of mortgages: fixed and variable rate. Fixed-rate mortgages are seen as more “stable”, where you typically negotiate a rate that will endure for the duration of your loan with the bank. Variable-rate, on the other hand, could potentially net you savings in the form of lower rates. However, your rates would be subject to changes due to market conditions and other factors, which means that your payments could significantly increase at a moment’s notice. This is exactly what happened to all those NINJA loan holders in late 2006- early 2007.
Because of a massive jump in interest rates, many people suddenly could no longer afford to pay for their mortgages. Therefore, their mortgage would enter into default for nonpayment. Herein lies the heart of the 2008 financial crisis. What Lewis Ranieri never foresaw was millions of defaults simultaneously happening across the country, which completely shattered the value of his precious MBS bonds. To make matters worse, banks were often using these bonds to create a new synthetic type of asset, the Collateralized Debt Obligation (CDO). The CDO was essentially a collection of MBSs and was known as a “derivative” security, meaning that its value was based on another security, and not on concrete goods. Banks often abused these CDOs to pad their assets, so that they could take out more and more loans using these CDOs as collateral. To make matters worse, banks then created the Synthetic CDO, which was basically a CDO of a CDO. Because of the popularity of these derivatives, the global derivatives market grew from USD$72 trillion in 1998 to USD$684 trillion in June 2008, When the MBS’s became worthless, so too did CDOs and synthetic CDOs, causing trillions of dollars to vanish from almost every bank’s balance sheets worldwide overnight. From here, economic disaster ensued, leading to the closing of two major American banks, Lehman Brothers and Bear Stearns.
Since 2008, legislation has been drafted and passed in the United States to protect consumers from another economic downturn like 2008. The Dodd-Frank act of 2010 forces banks to be more transparent with their assets, as well as further regulates the mortgage security market. However, President Trump reformed this act in 2018, exempting several banks from the restrictions placed upon them by the law.
So what does this mean for future generations? While we will likely not see a total repeat of the 2008 crisis, there is no question that housing is a major issue in Canada. With inflation at record-breaking levels, swift action needs to be taken by the government to ensure that home ownership is a viable goal for all Canadians, not only the wealthy.