“Because with house prices tumbling, more people in Stockton face the repossession of their homes than anywhere else in the U.S.” There are several reasons, which are:

Lending Frenzy. At the height of the buying frenzy, which occurred in 2006, one developer was having potential home buyers playing a bingo-style lottery. The rules were they would put in ping-pong balls and if your number came up you could then pick out the home you wanted. Home buyers weren’t the only people who were obtaining bank loans. Equity loans peaked as well. People in Stockton were finding that they had equity in their homes and would go to the bank to get a loan against that amount and go and spend that money on furniture, jewelry, etc. “People were spending their house”.

Rule dodging. “After previous financial disasters caused by excessive bank lending, regulators developed rules to limit how many loans a bank could have on its balance sheet.” Of course, rules were made to be broken–or at least bent and it wasn’t long before banks found creative ways of getting around the regulation. Most often, banks would bundle up the loans and sell them so that they didn’t have to show them on their books. This procedure was called “securitization”.

Financial alchemy. With loans being issued “no questions asked” there was little assurance of them being repaid. Therefore, in order to resell them to investors they would entice potential buyers by making the bundled loans appear to be “super-safe”. Banks found another way to hide these loans from their balance sheets with SIVs. These were Security Investment Vehicles “in which loans could be held…legally off [the] balance sheet”. So the lending went on.
In 2007 when the housing prices started coming down the risky bundled loans were still in the banking system. Additionally, banks found out that they were still responsible for the loans that they didn’t have to list on their balance sheets that were in SIVs. When the loses starting showing up, the loans starting reappearing on banks balance sheets. Although no one knows the extent of the damage yet, the “losses reduce a banks’ shareholder capital”. Banks are now having to reduce their lending capacity by 10 times the losses that are showing up on their books. This could cause a recession in America which could “become global as the contagion spreads through the banking system worldwide”. American politicians don’t like it, but they’d better hope it works to avoid some of the pain in 2008.

The entire article can be found at http://news.bbc.co.uk/2/hi/business/7164898.stm.

Chandra