Five Lessons From the Mortgage Meltdown

The economy has experienced a mortgage and credit market "dislocation" of historic proportion this year.

However, academics use terms like dislocation rather than trader talk like "crash," "bubble bursting" or "meltdown." But regardless of how it's labeled, there are a few timeless lessons. However, let's start by doing a brief review of what led up to the recent "debacle."

Late 1990s to Early 2000s

• Thanks to the effects of high interest rates, the failure of the savings and loans industry, and excessive speculation of the late-1980s, the real estate market languished for many years. As an asset class , real estate took a back seat to the global thirst for technology and Internet stocks.
• A collapse of the technology and Internet bubble led the nation into recession , so the Federal Market Open Committee -- FOMC -- lowered interest rates. Then soon after the attacks of Sept. 11, 2001, the FOMC lowered rates even more.
• Demand for home ownership soared as employment rose and interest rates declined.
• New and innovative mortgage products were developed and marketed in parallel with asset-backed securitizations .
• Mortgage originators and REITs stepped into the void left behind by the S&Ls, keeping the S&Ls' trademark poor risk management and outside of the realm of major regulation.

Mid- to Late 2000s

• Excessive speculation and overbuilding took the housing markets to new highs.
• Underwriting standards by mortgage originators were lowered to accommodate more borrowers who fell into the "subprime" category.
• Interest rates rose as the FOMC removed the "policy accommodation," as it began to tighten interest rates by a quarter of a percent on 17 occasions, up to 5.25%.
• Mortgage defaults rose, liquidity for securitization disappeared, mortgage companies failed and home builders were stuck with too much inventory.

So what can investors learn from this history? Here are five key takeaways to benefit investors in the future -- regardless of asset class.