What basically has gone so amiss in the housing market?
Of course, primarily it was the rapid and deep decline in prices. Then, however, cracks appeared in the financial markets that served that sector. Now, as a result, no one knows who owns what.
As the housing market went into a tailspin, borrowers started to default on their mortgages.
A nasty surprise ensued for investors who bought products that were exposed in complex ways to the housing market.
The current mortgage market has become more of an "unknown unknown." There were several layers of lenders between those who believed that they were direct participants in the housing mortgage market and house buyers.
That situation was worsened as many borrowers had an incentive to exaggerate the value of their house so they could take out more cash. Their ability to repay later was called into question.
In previous decades if one took out a mortgage, the local banker was approached. He probably was a neighbour and knew you and your family, and quite likely was familiar with the property for which a mortgage was sought. That is past history.
Nowadays in order to obtain a mortgage, the prospective borrower in all likelihood has to travel to a nearby metropolis. Then at an institution there a lending officer is unacquainted with the borrower or the property to be used as collateral. He can be expected to approve the loan regardless of the gaps in the background, as he gets credit for the transaction, and later moves on to another position in the bank. No one then supervises the loan.
The lenders tried to diversify their holdings as they were unaware of the credit worthiness of the borrowers. The mortgages then were combined with others and various debt instruments.
That package of mortgages and assorted debts were peddled to a large financial institution. In turn they were combined with other mortgages and debts into a package, a bond, that was sold not only in North America but in financial markets throughout the world. No one could possibly know the status of the individual borrowers. There were layers on top of layers as the bundle of loans, now bonds, went through many hands, large financial organizations. They sold these bonds to hedge funds, pension managers, mutual funds, and the like. Many switched around their bonds to second or third parties.
Looking back at credit cycles, no one can see any reference points. There never was anything like this way of combining mortgages and other debt and then reselling them in the form of bonds.
Others have followed this route, so the markets became more of a muddle. Few are able to spot weaknesses or dangers. No one knows even what is unknown. Is it any wonder that our markets are in a state of confusion?