Housing price conundrum (part 4) | Current Economics | Finance & Capital Markets | Khan Academy

I’ll now explain to you why,
from 2000 to 2005, we had very low defaults on mortgages. Let’s say that I buy a
house for $1 million. I buy a $1 million house. So let’s say the bank
gives me $1 million. And then I’m willing to pay
a percentage on it. So this is from the bank. This is me. And I use that to buy a house. I don’t know if these
diagrams help you. But you get the general idea. And the bank does that. And let’s say, I don’t know,
a year later I lose my job. I just can’t pay this
mortgage anymore. So I have a couple of options. I can either sell the house
and pay off the debt, or I guess I could just tell the
bank, well I can’t do anything, and I’m going
to foreclose. And that would ruin my credit. It would hurt my credit. And I would lose all
my down payment. So what are the circumstances
that I can sell the house? Well, if I borrowed $1 million,
as long as– and let’s say I didn’t put any
money down, just for simplicity. If I can sell the house for
$1.1 million, well I would do it, right? Let me sell for $1.1 million. If I sell for $1.1 million,
I pay the bank– let me switch colors. I pay the bank $1 million,
and I net $100,000. And everyone’s happy. The bank got their money back,
so they didn’t lose any money on the transaction. I made $100,000. And so the whole reason why this
worked out, even though maybe I was a credit risk,
is because the housing prices went up. So when you have rising housing
prices, the banks will not lose money lending you. Because if you can’t pay, you
just give back the house, the bank can sell it. Or, you won’t even give
back the house. You’ll sell the house and you’ll
pay it off, even though you can’t pay the mortgage
anymore. The only situation where I
would foreclose is if the market price of the house
goes less than my loan. And that’s actually
the situation that we’re facing now. So if, let’s say that
I can only sell this house for $900,000. Well, then I’m just
going to give the keys back to the bank. That’s actually called jingle
mail, because you just mail the keys back. And then the bank sells the
house for $900,000. And then they would
take a loss. So when housing prices go
down, that’s the only situation where really you
should have foreclosure. When housing prices soon. go up,
the person who borrowed it is just going to sell the house
and pay off the loan. And they are actually probably
going to make some money. So there was every incentive
to buy a house. So let’s think about this whole
dynamic over the last several videos that we’ve
been building. So we said, from 2000 to 2004
housing prices went up. Let me do it like this. Let me change it a little bit. We can even say, from
2000 to 2006. So we know that housing
prices went up. And why did why did housing
prices go up? Well, we saw the data. It wasn’t because people
were earning more. It wasn’t because the
unemployment rate went down. It wasn’t because the population
increased. It wasn’t because the supply
of houses were limited. We disproved all that. We realize it was just because
financing got easier. The standards for getting a
loan went lower and lower. Financing got easier
and easier. And because housing prices went
up, what did that cause? We just said when housing
prices go up, default rates go down. You could give a
loan to someone who’s a complete deadbeat. But as long as housing prices go
up, if they lose their job, they can still sell that house
and pay you back the loan. So housing prices going up
makes sure there’s no foreclosure, so defaults
go down. So then the perceived risk
goes down, of lending. Perceived lending
risk goes down. So that makes more people
willing to lend. And the corollary of more people
willing to lend, is you that the actual standards
go down. That’s financing easier. We could actually write that. Standards go down. So you had this whole– I guess
you could argue whether this is a negative or
a positive cycle. But you had this whole cycle
occurring from the late ’90s, but especially, it really got
a lot of momentum at around 2001, 2002, 2003. That financing got easier,
despite the fact that people were earning less, population
wasn’t increasing that fast, that there were all of
these new houses. And that caused housing
prices to go up. Housing prices went up, then
we had a lot fewer people defaulting on their loans. No one would default on their
loans if they could sell it for more than the loan. Then a lot more people said,
well these are super safe. And so the ratings agencies,
Standard and Poor’s and Moody’s, were willing to give
AAA ratings to more and more, what I would argue,
are risky loans. So the perceived lending
risk went down. Then more and more people
liked this asset class. They said, wow, this is great. I can get a better return than
I can get in a bank, or in Treasuries, or in a whole set
of securities, even though these are very low-risk
or perceived low-risk. So I want to funnel more
and more money in here. And so the mortgage brokers and
the investment banks said great, the only way we can get
more volume to satisfy all these people who want to lend
money– the only way we can find more people to lend
money to, is by lowering the standards. And this cycle went round
and round and round. And it really started because
this whole process of being able to take a bunch of people’s
mortgages together, package them up, and then turn
them into securities and then sell them to a bunch of
investors– this was a quote-unquote innovation in the
mid-’90s, or early ’90s. I forgot exactly when. And it really started to take
steam in the early part of this decade. So that’s essentially why
housing prices went up. And why kind of all of this
silliness happened. And in the next video, I’ll talk
a little bit more about maybe who some of these
investors were. And I’ll tell you what a common
hedge fund technique. And I think it’s very important
not to group all hedge funds together. There are some good ones. But what a common hedge fund
technique was, to take advantage of this virtual cycle,
to make the hedge fund founders very wealthy. I’ll see

42 thoughts on “Housing price conundrum (part 4) | Current Economics | Finance & Capital Markets | Khan Academy

  1. He forgot to mention Adjustable Rate Mortgages. Which I heard is a big factor to this mess. I would like to know more about that.

  2. Some of you guys don't get the point of these videos. I doubt hes "forgetting" anything, and instead is leaving it out for simplicities sake, while still maintaining the fundamental base.

  3. Because The Federal Government guaranteed the loans, so the banks could lend to more people without assuming the same level of risk. Basically the idea was that politicians figured that it is a good thing to own a home. Homeowners cause less crime, make more money..etc. So to increase the home ownership, especially for minorities, the standards had to be lowered and financially backed by the government. Seemed like a good idea at the time…

  4. kev3d: "politicians figured that it is a good thing to own a home. Homeowners cause less crime, make more money..etc."

    Typical politician think. More likely, those who caused less crime, as a lifestyle, got better jobs. They managed their money responsibly and a result were able to afford a home.

  5. more people wanted to invest into these securities because the rate of return was high and home prices were going up up up. the brokers see that more and more people want to invest and the only way they could allow it was to lower requirements. by allowing easier finance everyone could make money: the mortgage broker, the investment banks, and the investors (only for so long as we now see). wrong to suggest its because of the federal governments mistakes. it is greed + mistakes of everyone

  6. now i understand why in the location were i moved you can see people with very low income owning huge houses…..and rusted cars parked on the driveway!

  7. Why the banks pretending they lost money when they actually made huge volumes of money. The only people who lost money are the investors who the banks sold the schemes to. Why are banks reporting huge losses and asking for government to rescue them with public money. How does it go forward from here for property prices.

  8. It might sound naive, but I think the main reason for all this is that people wanted to live beyond their means…Because they wanted borrow a tone of money to pay for a house that they couldn't really afford.

  9. In part 3, you said, financing got easier because housing prices went up and here you say housing prices go up because financing got easier. Isn't this logic recursive ?

  10. @TheMailprasad I remember watching this series a while back. I think he meant that financing got easier because of lax lending policies, like no down payments, extended mortgages and bad credit lending. While housing prices went up because of excessive lending mean't that everybody could own a house and the demand skyrocketed for housing. Demand = prices rise. I'm sure he just made a small slip if that's even what he said.

  11. But now the banks have stuck it to the person in forclosure and said "okay we will take back the house and ruin your credit and in return you have to pay all the taxes on our loss". The bank sold you the loan with no risk since it was sold to investors and now you have to claim that as earned income on your taxes. This is a really messed up way of doing business and you wonder why people are hesitant on buying a house.

  12. He touched on the root cause of the issue, but never explicitly said it . The main reason the investors were looking for these higher returns is because of the Fed lowering interest rates to (then) historic lows, so things like savings accounts, US treasuries and traditional "safe havens" for investors were giving returns that weren't even keeping up with inflation. The Fed artificially lowering the interest rate caused a mass allocation of resources that caused the bubble.

  13. It's March 2008, so it's after the housing bubble popped but before Lehman brothers went under and it really became apparent in the job market.

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  15. I'm new to this topic but I couldn't think of one thing that increases in value or more so price, solely because it increases in availability. Shouldn't the opposite occur. I'm slightly confused at that concept I mean I could see how the banks would intensionally inflate the prices of housing they already owned to add equity in return for profit once the houses forecloses and interest is collected, and that fueling the cycle as the primary cause of the increase in housing prices. Answer please.

  16. Sal, great analysis, but please Google the Austrian Theory of the Business Cycle, the Community Reinvestment Act, and the Boston Fed's "Closing the Gap."

  17. Don't forget a federal Reserve lowering rates into increasing home prices of 10-20% a year. Please tell us what the consequences for zero percent interest rates and printing 1 trillion a year for 6 years and counting . Government once again screwing the people. We all know government not only loves inflation but needs it to avoid bankruptcy. Everything they do is not for the people but to create inflation. Minimum wage increases help no one but the government for example.

  18. u were saying that the housing prices went up , eventhough the borrower defaults on his payment the cwc or whoever will get their money back by selling the houses whose prices have increased.

  19. At 6:40 , Sal says that in the next video, he will explain a technique on how this made Hedge Fund founders wealthy . Does anyone have a link to that video ?
    Thanks !

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