Mortgage Meltdown: When The Middle-Class Gambled

Moody's President Ray McDaniel was recently reported in the press confirming that the mathematical models and data driven analysis behind the Triple A ratings of many MBS/CDO offerings in the past few years have failed as they did not factor in the impact of change in consumer behavior.

More specifically, what has confounded all the analysts is the high mortgage delinquency rates of not only the sub-prime but also the prime borrowers whose year-over-year delinquency rates have been rising rapidly, even though they trail the sub-prime delinquency rates.

Historically, American homeowners have chosen to default on their credit card debts and their auto loans but kept paying their mortgages so as not to lose their home but that is apparently not the case in recent years. As home owners saw their monthly mortgage payments start to climb while the value of the home went down, they have instead chosen to return the home keys to the bank (chosen to foreclose or simply walked away from their homes) but have continued to
make their minimum monthly credit card and auto loan payments.

What explains this sudden behavioral reversal? Gambling.

In pure and simple form, the real estate boom was the middle class' big gamble and they literally bet the house, no pun intended.

Fueled by low interest rates, the real estate boom generated fantastic 'paper' wealth for people and the search for 'home' soon became a search for 'property' that will increase in value. The focus on increase in future home value manifested itself in a growing acceptance of Interest Only and other exotic loans. Homeowners and investors essentially started betting that as long as they can make the minimum payment (IO loans) while the property value kept increasing, they were ahead of the game.

And for a while they were, until rising interest rates called the bluff. But when that happened, people found it easy to walk away because (in wall street lingo) it was a losing 'trading position' for the homeowners.

History will call this a credit crisis or real estate bust or something that equally misses the point: that this was the first time that middle-class America gambled.

And gambled big.