Built in 1927, an 1800 square foot bungalow is bought by Shawna and James for $445,000 in 2002. Reflecting sky rocketing home prices in the neighborhood, the house is resold for $1.2 million to Jin and Chong in 2006. Having borrowed $900,000 to buy the house, and hoping that their $1 million home becomes a $2 million home which they can sell, the new owners default when the economy collapses. Foreclosed, the owners leave and the house is auctioned to its current owners, Eric and Alison, for $765,000.
You can see the buyers’ side of the story. Easy to borrow money, soaring home prices, excited people who see their net worth multiply.
Meanwhile, behind the scenes, we have Washington Mutual providing easy loans (and then imploding), real estate agents facilitating sale after sale, Fannie and Freddie packaging mortgages into mortgage-backed securities, investors buying the securities, servicing firms collecting all of this money and passing it from party to party.
But still, when we get right down to it, it really is all about one house. And then another, and another, and another.
You might want to listen to Planet Money’s story of the mortgage-backed security they purchased, Toxie.
The Economic Lesson
Mortgage-backed securities enabled a financial bubble to inflate because they funded house sales with more money than otherwise would have been available. More dollars chasing the same number of goods inflates prices. As with all bubbles, eventually prices cannot move any higher. At that moment, the bubble pops and prices descend.