Everyone is well aware of what is happening with the mortgage backed securities market. 'Subprime' and 'predatory lending' have become household terms in the wake of recent news. Where did all of this begin? Where did we go wrong? Well, I believe much of it is Alan Greenspan's fault and here's why: You see, recession and expansion are a natural part of the economic cycle much like forest fires and the regrowth that occurs afterwards. For whatever reason, Greenspan decided to try to avoid a recession that started in 2000 by the dot com bubble bursting. From 2001 to 2003 Greenspan, revered as the god of economics, plunged the Federal Reserve rate from 6% to 1%. At no other time in recent history have we experienced such a drastic decline in rate. Greenspan effectively put out the forest fire that should have occurred. One created by the natural ebb and flow of a free market. By delaying the inevitable however, he created a tinderbox that is now burning out of control.

Giving the banks artificially low lending rates set the stage for a wild party. We've all heard of the lottery winners who end up penniless 10 years later. That's exactly what happened here and now the bills are coming in from the spending spree with dad's credit card. Cheap credit encourages risky behavior because the consequences are perceived to be less. This filtered down, stimulating the real estate market to red hot levels by making more people than ever able to qualify for a loan. The money flowed in, the lenders got rich. That invited more competition until everyone was in the mortgage lending business. The only way to compete was to make your underwriting guidelines looser than then next guy. No income? No assets? No job? No problem!

Since now even illegal immigrants without money, FICO scores or social security numbers could qualify, everyone wanted a house or two. This unnatural demand devoured all the supply causing prices to skyrocket. The culture of wanting bigger and bigger homes was created. Everyone trying to keep up with the Jones's until the only way they could squeeze into that 9 bedroom mansion was to get a loan with a short term teaser rate. 'So what' they thought 'my house will be worth a lot more in two years and I'll just refi with another two year teaser rate'. That philosophy was also driven by lenders trying to keep the pipeline full. That trend continued until inflation demanded that rates be raised again to prevent it from getting out of control. The feds response was to crank the rate back up at an even faster rate than they had dropped it. By June of 05 it was up to 3%, a level which began to affect mortgage rates.

Now it’s been two years and everyone who used teaser rate loans to squeeze themselves into a home they shouldn’t have are ready to refinance. Only now the reserve rate is at 5.25% making teaser rates somewhere around 7.25% and they can’t afford that payment. So they have no choice but to give the house back to the bank or get the lender to agree to a short sale. The need to sell urgently to avoid foreclosure has pulled values down, further exacerbating the condition for those trying to buy more time with a refinance.

The worst thing the Fed could do right now is interfere with the process. These companies need to go down in flames and learn from the experience so this never happens again. Even though many of the families now in foreclosure should have never been given a home to begin with, it’s heartbreaking to see them displaced. When all is said and done, people are people and everyone did exactly what you would expect them do to with free money. Hopefully everyone has learned their lesson...until the next time.