"Home equity, which consumers had been using like cash"
Can you explain this sentence please? What is the mechanism behind that?
Home equity only means the difference between what you currently owe on your house and what it could sell for currently on the market.
Simplistically speaking, let's say you paid $300K for a home in 2000. That is what you owe the bank, and what your house would still sell for after taking out the loan. By 2005, within five short years, the market price for similar homes trading in that area shoots up to $500K. You don't know why, and you don't care. It's your windfall, so happy days! You now have a home that is "worth" $500K, because you could sell it to someone else for that amount. That also means you have $200K in additional "home equity", meaning that if you sold your home (at that time), you could pay off the loan for $300K and pocket $200K for yourself.
Banks during the housing boom saw this equity as a way of making more loans. Believing that your equity was indeed real (i.e., your house really would continue to be worth that much and more to others), banks would offer to loan you cash based on that equity. So home equity loan offers from banks were splashed out all over the place, as enticements to take out second mortgages. You could now borrow against your equity, and use that cash for anything you wanted; home improvements, a down payment on yet another overvalued home, a new car, send your kid to college, vacations, or anything else. You would now owe the bank(s) $500K total, but that's OK, because everyone knew that your house would be worth yet even more down the road, which meant that you would have even more equity! You could sell the house for that increased amount, pay off the first and second mortgages, and pocket that difference as well.
Many homeowners were so euphoric about what was happening in the real estate market, and all that "wealth" being "created", that they were literally using their homes as ATM machines. The mechanism for using home equity as cash was simply going further into debt. This was on the belief (shared by banks and homeowners alike), on the
full expectation that there would always be another sucker down the road who is willing to pay even more than you did for it -- that real estate prices could only increase - exponentially even.
When the housing bubble finally did burst in 2008 (lots of triggering mechanisms for that inevitability), housing prices fell dramatically. Banks finally woke up to the fact that the free home equity ride was over. Now your house is back to being worth only the $300K you originally paid for it. But you took out a $200K second mortgage. That extra $200K was spent and is now long gone, but you are now "upside down", as you now owe $500K total for something that is currently only worth $300K. Much of the
illusion of wealth was wiped out (the nominal market value of the home). Not the nominal price of the debts. You still owe that amount, regardless what the home is worth.
The entire housing boom was a phase in the business cycle where rampant speculation was fueled by low interest rates, easy credit, government guaranteed loans, etc., all of which combined to cause the general prices of real estate to skyrocket. But real estate was not the only market that was affected. That extra $200K that you and others had spent from taking out second mortgages on overvalued real estate -- that created yet other market distortions -- other market bubbles as artificial expectations spilled over into other markets. These other markets, many unrelated to housing, saw only increased demand for their goods and services. And there was a full expectation that this demand would continue as well. There was no reason to believe that demand would dry up, so everyone geared up accordingly. Nobody was paying attention to the fact that much of that extra spending was coming from banks in the form of a massive amount of debts that were about to go sour.
