The foreclosure problem is so large right now that even the mainstream media and Wall Street investors spend their time worrying about the impact in the greater economy. It is worth examining some of the reasons for these record foreclosure rates, though, in order to determine what went wrong and what homeowners can do to stop foreclosure now and avoid being in this kind of situation ever again. Hugely overvalued houses, coupled with teaser rate Adjustable Rate Mortgage loans have caused millions of homeowners to face the possibility of losing trillions of dollars in home values, while banks may lose billions of dollars of loan payments. Why is this happening in the largest economy on the planet?

It is happening because this is exactly the result that Adjustable Rate Mortgages were made for. Homeowners were encouraged to buy homes with low teaser rates and they thought that their income would increase dramatically over the next two years so that they would be able to afford the new payment when it reset. They were willing to bet their house on an uncertain future and hope for a great new job, big pay raise, or lottery win.

Banks, of course, knew otherwise. They knew that nearly every single one of these homeowners would not improve their incomes dramatically, if at all. Some may even lose jobs that the banks were responsible for financing to move overseas, and rising food and gas prices would eat away at the middle class homeowner's ability to pay their current bills, let alone an even higher mortgage payment in a few years. They knew that some of the homeowners would not even be able to afford the low introductory interest rate for much longer than a few months.

But they lent them the money anyway, because banks thought that, even if the house goes into foreclosure, property values will keep rising and rising. Then the banks would just have the easy job of foreclosing on the house and reselling it, making an even greater profit. They overlooked the fact that, with such widespread bad lending decisions industry-wide, the market would go down very quickly if homeowners were unable to refinance or sell their homes, creating a self-sustaining race to the bottom, and they would be left holding a bunch of useless property that they could not sell.

This is why the hedge funds that bought these loans are failing now -- the banks are no longer receiving the income because homeowners are finding that they can not pay the mortgage, refinance, or sell to stop foreclosure, and with the new bankruptcy laws, homeowners can not even file bankruptcy to save their homes without meeting the new, more difficult requirements. The mortgage companies can not sell the foreclosed properties for a profit because property values have fallen so far. They knew they would end up with these houses, but thought they could sell them at higher prices and make even more profits for their hedge fund investors.

Now, though, they are finding that they can not even continue to function without massive injections of inflated money that the Federal Reserve creates out of thin air. Even Bear Stearns, not known as the most ethical mortgage company or servicing company, has seen two hedge funds fail, and the woes in the economy finally caused the Fed to decrease interest rates recently. But these are bailouts for Wall Street, not homeowners desperately trying to avoid foreclosure. A bailout for either, though, will only lead to more inflation and financial problems in the future, as the value of money will continue to decrease as more of it is arbitrarily created to shore up investment firms that made poor financial decisions to begin with. Most homeowners would be in a pretty good financial position if they could spend as much as they wanted, never save, and create money out of thin air when the going got tough.

Without this magical ability to print money that never existed before and bail out financial institutions, why give a loan applicant as much money as they want, without proving income, assets, or even the fact that they have a job? So many homeowners lied on their applications to get more money, as well, which greatly contributed to the problem. Lying about income does not mean that the income will suddenly materialize and the homeowners will be able to afford the higher payment. Inflating income to get that "dream home" now, instead of saving up for another few years, will produce the exact results we are seeing now: foreclosure, falling home values, and the destruction of the wealth of the only large asset that most homeowners ever own.

Once payments reset, or homeowners faced a financial hardship, the foreclosures started. And the quickly growing stream of foreclosures meant that the property values would drop further and further and it would be difficult to sell the properties or otherwise stop foreclosure, further decreasing values, making many homeowners upside-down in the homes and effectively trapped in a house of nightmares, forced to wait for the day that the sheriff shows up to evict them.

Which is exactly what happened.

And is continuing to happen.

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