What sucked up all our money in the mortgage crisis? Policymakers and analysts continue to dispute causes of the 2007-2008 foreclosure crisis, which triggered a much deeper and more serious financial crisis and ultimately an economic recession. Did banks prey on unwitting consumers, or did households overreach and borrow more than they could afford–or was it BOTH? And if the debt on your house in cancelled due to foreclosure, you’ll owe federal taxes on the difference on the amount of debt that’s left when the bank takes control of your house, because they consider it to be INCOME!

A 59-year-old widow who walked away from her $500,000 interest-only mortgage because she makes $34,000 as a home-health nurse and now has a huge tax bill. In the Wall Street Journal, Jeff D. Opdyke quotes Maxine McDaniel as saying, “I had no clue this would happen. I just thought I’d get out from under the house and that would be that.” Opdyke quotes CPA Arthur Auerbach as saying, “People think their house was underwater, so they’re insolvent and can get out of owing taxes. But it doesn’t work that way.”

A new study of the mortgage crisis by economists blames the borrowers. The researchers found that most households in foreclosure were relatively affluent and highly educated people, with few or no children, living in geographical areas that experienced extremely rapid real-estate appreciation (the housing bubble). Although they found some evidence of predatory lending, they conclude that a more accurate explanation of the foreclosure crisis is that consumers overreached and bought more housing than they could afford.

Economist Yeager and four of his colleagues came to this conclusion by analyzing data on demographics and foreclosures to create profiles of households in foreclosure during the third quarter of 2008. They also analyzed geographic patterns of mortgage foreclosures. They found that the group with the highest foreclosure percentage was “Cash & Careers,” the most affluent generation (Generation X) of adults born between the mid-1960s and early 1970s. Members of this group have high household incomes, high education levels, high home values and none to only a few children. Also, members of this group were classified as aggressive investors, most of who lived in areas like California, Nevada, Arizona and Florida, where there was rapid real-estate appreciation.

“Although we did find evidence that low-income households had a higher statistical likelihood of foreclosure, most households in foreclosure were relatively affluent and well educated,” Yeager says. “Also, these household defaults were strongly clustered in southwestern and southeastern states, which is consistent with the overreaching-consumer explanation of the foreclosure crisis.”

Overall, results showed that most foreclosed households were not “duped” into bad loans. Instead, they were caught up in a housing price bubble in which both consumers and lenders were too aggressive. This finding is critical because strong consumer protection laws alone will not prevent future price bubbles or financial crises.

But banks were also part of the problem, because their reckless lending enabled households to become dangerously leveraged. Economist Tim Yeager says, “Our evidence does not disprove or excuse reckless subprime lending by the large Wall Street banks. We argue that there is plenty of blame to go around for the financial crisis. Both banks and consumers overreached. Banks extended too much credit to households, and households purchased more home than they could afford.” And now banks are getting their back from our TAXES.

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