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The Mortgage and Banking Mess: Don’t Play The Blame Game

September 22nd, 2008
By PATRICK EDABURN

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With the ongoing problems in the housing, mortgage, banking and investment industries, it has become something of a race for politicians to see how quickly they can blame the other side for the problems in the hopes of making political gains off of the crisis.

Not only is it the wrong thing to do because it distracts them from the more important duty of SOLVING the problem, but it also a very bad and dishonest idea since there is plenty of blame to go around. I am sure some of my half-dozen readers are sitting there thinking that I am wrong, that <insert name or party here> is to blame but the fact of the matter is, this has been developing over the past 20 years and has been the fault of both sides, often through some very well-meaning proposals.

As I have previously discussed, the problems with the home loan process began in the interests of fairness. For many years, there was a fairly-strict policy when it came to home loans. First you had to have a decent amount for a down payment, at least 10% and preferably 20% of the sale price. Then you had to provide detailed proof of your income to show that you could reasonably afford the payments. If you couldn’t do that, then you didn’t get the loan.

I have a friend who has been in the mortgage industry off-and-on for the past forty years. He tells me that in the ‘old days’ they had to put together detailed packages to be sent to Fannie Mae/Freddie Mac for approval and, usually, they got some of them back with the word NO written on them. If you couldn’t satisfy the terms of the loan, then you just didn’t get it and you continued to rent.

<A brief comment here just to put my words in perspective. I am a middle-class professional with an advanced degree and I work very hard but I do not own a home because I simply cannot afford it. I could have tried with one of the fake loans but I didn’t. I don’t mention this to brag in any way but to point out I am not a homeowner denying others the right to join me>.

This policy began to change in the late 80s and early 90s when members of Congress started to complain that they were being told by their constituents that they couldn’t get home loans. This problem tended to concentrate in areas where the people made less money, this tended to concentrate in major urban areas and, as we know, many of these areas were heavily minority. As a result, members of the Congressional Black Caucus began to complain about racism in the process (I’m not sure how they answered the fact that white people in the Ozarks didn’t get loans either) and this was a hard argument for people to fight.

So they started to pass rules saying a certain percentage of loans had to come from urban areas, which then forced Fannie Mae and Freddie Mac to take on loans they would not otherwise have accepted.

While these policies were first started by Democrats, they were strongly-supported by Republicans and by both the Clinton and Bush administrations.

At the same time we saw deregulation enter into the market, which meant that banks and financial institutions were able to take on investments that they probably shouldn’t have. It’s popular to have people blame the Republicans for this (indeed we’ve seen a lot of media hype about the repeal of the Glass-Steagall Act and how it led to the mess on Wall Street).

It is true that the original proposals came from Republicans, but it is also true that the final bill passed the Senate by a margin of  90-8 and the House by a margin of 343-86. It was then signed by President Clinton. Had the Democrats wanted to stop the bill, they had the votes to filibuster; had President Clinton wanted to stop the bill, he had the veto and enough Democrats to sustain it.

But both sides eagerly supported deregulation. Just as with the changes to the loan requirements, I think this was done with the best of intentions but things went too far and had unanticipated results.

Then of course we had the banks and investment firms buying into these loans. I think this may be the place where the most blame can be fixed. It wasn’t done through a desire to get people into homes nor was it done out of belief that it would help business (as with deregulation). It was a fairly-risky step by the boards of directors of these institutions.

On the other hand, we had seen a rise in housing values for decades so it was not like they were putting money into penny stocks. Still, this is one place where things could have been done more responsibly.

Then, of course, we had the collapse in the mortgage industry and the resulting foreclosures. This problem stemmed from several causes and, living in Northern California, I had a front row seat to the whole mess.

The first step was a spike in home prices caused largely by people moving from the high-priced Bay Area over to the cheaper Central Valley region. This meant that most of the people living here could not afford to buy houses with traditional mortgages. Stacking this up against the above-discussed desire to put everyone in a home something had to be changed.

So we saw the advent of 100% financing, teaser rates, sub-prime loans and so on. In many cases, you did have predatory lenders conning buyers by promising them the moon. But at the same time, I don’t care how financially-uneducated you are, if someone offers to sell you a $500,000 house for $ 1,000 a month over 30 years it does not take much math to figure out that something is fishy.

Of course, as long as the housing prices continued to go up, then people would be able to refinance and get out of the bad loans. But nothing lasts forever and, as we saw, a once a housing glut started to develop, it was inevitable that prices would start to drop. But in the Central Valley, we had an additional problem.

Because most people had purchased new homes with no money down, they had no stake in the property. In addition, many of them were urban transplants who felt (and I’ve had people say this to my face) that living in the Central Valley was ‘beneath them’.. So you had huge numbers of people simply give up and not fight to save the house.

Again, I think that this is one area where some blame is to be assigned. People knew they were getting into risky loans and, in the case of the transplants, they didn’t make any effort to save the house. However I understand that money only goes so far and I wouldn’t fight to save a home in a place I didn’t like.

So the result was a collapse in the housing market, which trapped more people in bad loans, which led to more defaults, and so the cycle ran. The bad loans led to economic collapse for those who had invested in the properties and here we are.

But, as you can see, from my admittedly-armchair economist analysis, the road to the current situation was a long one which has stretched through two decades, two administrations, and the efforts of members of both parties. It has also involved bankers, corporate executives and everyone else down to ordinary homeowners who took a risk and lost.

All of these people deserve some blame, but most of them acted with the best of intentions. Despite what a partisan might suggest, no Democrat and no Republican wants to see the economy fail. Neither side wants to let his ‘evil corporate bosses’ get away with robbery. You didn’t have one side pushing for deregulation and one fighting it, both went into it together.

At the same time, while corporate bosses made major mistakes, in many cases they did so with the best of intentions. The gang at Fanny Mae and Freddie Mac did make huge errors but they were also forced to make some bad choices by the well-intended laws.

Homeowners didn’t buy into houses with the desire to abandon them and they have suffered badly with the loss of their investment. However, they also did know there was a risk and sometimes, when you roll the dice, you get double ones.

But most importantly, it’s time to move past blame and on to making a real solution.



This entry was posted on Monday, September 22nd, 2008 at 5:41 am and is filed under At TMV, John McCain, Corporations, Democratic Party, Wall Street, Federal Reserve, Republican Party, Barack Obama, Republicans, 2008 Elections, Politics, Economy, Dick Cheney, George W. Bush, Democrats, Business. You can leave a response, or trackback from your own site.

Viewing 10 Comments

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    This was precisely why the government on both sides tried so hard to get an immigration bill in place last year to allow millions of new immigrants unhindered into the country. More people fast were needed to pay more taxes to avoid this sort of thing. Bush in response to the public outcry started cracking down and the average deportings escalated from 250,000 per year average to over 1 million in the last year. The INS and businesses have been cracking down hard on immigrants and as a result this much needed influx of tax revenue and disposable income has dried up accelerating this meltdown.

    Do not be fooled. The US economy is a house of cards. It is built on debt that is driven by greed and avarice by non caring entity known as corporations. While I do not advocate that corporations or large businesses be disbanded in favor of a communistic society it is clear that when allowed to their own devices that they are incapable of regulating themselves.

    The oil industry is the perfect example. Mindboggling profits and they are spending like 1 percent of their profits on technology and the means to further their companies growth into new energy for the 21st century. Simply because they are driven by greed and the almighty principal of profits at all costs to drive their stock prices up. The Furture be Damned. Full greed ahead.

    America has adopted this same philosophy. We no longer understand fiscal restraint or fiscal responsibility. We simply borrow hoping somehow we can pay it back. BOTH candidates want to spend mindlessly. They promise to spend trillions that we dont have to solve a diverse set of problems that this country could solve simply by balancing the budget and paying off the national debt and using the 330 billion in interest each year to pay for new spending programs till our hearts are content.
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    Lots to chew on here. I think the problem goes back earlier than the CBC's push for loans in urban areas to the Garn-St. Germain S&L Deregulation Act of 1982. That was the act that fundamentally altered the mortgage industry by letting S&Ls offer loans that float at market prices.

    Used to be the 3-6-3 rule: Borrow at 3%, lend at 6%, on the golf course at 3pm.

    State usury laws and Federal limits kept this standard in check. But with interest rates at 21% the S&Ls said they needed to lend at higher rates or they'd go under.

    When interest rates dropped, the S&Ls started getting into riskier investments, leading to the S&L crisis, RTC, and the movement toward mortgage-backed securities, which were necessary to keep the money flowing through the mortgage market (and spread the risk around).

    All of that was before the Community Reinvestment Act had any real effect on loans.
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    It's true there is blame to both parties, since the Clinton administration had a hand in the lead up to this crises as well, but in the interest of accuracy and accountability (a fantasy that last) we need to keep in mind which party has been the loudest, longest and most consistent advocate of deregulation. By all means, let's get on with the cure, but let's not try to dress up history too much either.
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    It's wrong to deliberately avoid trying to determine what went wrong and identify some if not all of the causes. Yes, the Community Reinvestment Act was stupid and so was an excess of federal government intrusion (where it is not essential or imperiative, it is _improper_). Yes, Republicans as well as Democrats wanted to achieve more goals during the 1990s bubble and in "growth forever" days (that being the title of a 1998 or 1999 Wall Street Journal submitted editorial), almost everyone was ready to remove the barrier between banking and investments that was created in the 1930s after the 1929 crash and exposure not only of a bubble but of misbehavior on Wall Street.

    What I don't like, in addition to this disgusting bailout (the Big Three in Detroit are next, likely followed by an airline or two -- and what about things like health care now, or road and bridge repair or new construction?) is that the Democrats are compounding this current idiocy with more idiocy. They want the federal government actually to bail out individual borrowers (i.e., they want to openly buy votes), and they want to impose limits on executive pay, neither of which the federal government has any business doing whatsoever. (Who cares about constitutional federalism any more, I guess, is the only remark that makes sense.) These Democrats, threatening to make the situation much worse, are tremendously irritating this morning. (Where is the sanity such as repeal of the Community Reinvestment Act and and end to being forced to make loans to less creditworthy, more risky borrowers? Oops -- the beneficiaries in question often vote Demoratic. No chance for reform and sanity.)

    There should be _no_ individual bailouts, and the _only_ legitimate circumstance under which executive pay could be limited would be an alternative to the current bailout plan -- which I'm surprised not to hear advocated by some Democrat who is actually creative and intelligent. Rather than just bail out the investment institutions and banks, why doesn't the federal government impose federal receivership, and take over these institutions, all their assets? I.e., "the people" [gag] would now own these failed institutions. Too big to be allowed to fail? OK, now you're a public corporation (or a fake, "quasi" private corporation like Fannie, Freddy, Amtrak...). And because the feds now own you, the feds can impose whatever rules they want, including limits on executive pay as well as on criteria for approval of lending.

    It (federal takeover of large businesses) would be horrible and treat the Constitution more than ever as toilet paper, but at least it would be honest and the public would be no longer simply throwing money at businesses solely to prevent them from failing.
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    I agree with J Spencer, particularly since Clinton left the economy in pretty good shape.There have been many warning signs in the past 8 years that were ignored by both Bush and Congress. The Fed predicted the mess, but merely urged banks and mortage companies to stop making bad loans. Voluntary regulation usually is pretty worthless.

    Also, I remember just a few years ago, that Bush was bragging about the percentage of Americans who owned their own homes as a sign of our prosperity. He had to know that our prosperity was built on the housing bubble, and that real estate is always cyclical. When the boom came to a crashing halt, so would our prosperity. Deregulation works in times of economic expansion but blows up in your face during times of economic hardship.
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    As always, no one is considering the long term effects of clamping down on the mortgage market.

    No money down and stated income loans serve a purpose for our economy. Let’s look at an example.

    Take a mid-50s middle manager at a Fortune 500 company. He has just been downsized and is out on the street. Having worked hard and played by the rules, he has $300,000 equity in a house that, just last year, was appraised at $500,000. Today it appraises for $350,000.

    Let’s say this guy has $40,000 in cash and other investments, so he isn’t exactly destitute. Knowing full well that he is unlikely to find another job similar to what he had, he decides to open a Subway sandwich franchise.

    Previously, he would use a sub-prime stated income loan (since he does not have an income now) to finance the store and his first year operating costs. He would be hiring people, paying taxes and helping the economy.

    Now, politicians who think they are helping people who are too stupid to act in their own self interest are eliminating this option. What will happen to this unemployed middle manager?

    Are people being evicted from homes with bad mortgages? Yes, but not in the numbers you would expect. Even though the default rate is higher than normal, it’s still less than 3% overall. A good deal of these defaults are from investors and flippers who walked away from loans when the home market sank. Mortgage companies have a vested interest in keeping owner-occupied loans going even at a loss, so the images of Michael Moore inspired sheriff evictions is way overplayed.

    When politicians (normally democrats) try to “help” people, they usually end up hurting them.
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    jwest said,
    "A good deal of these defaults are from investors and flippers who walked away from loans when the home market sank."

    Do you have ANY evidence for this?

    A lot of these foreclosures are in exurbs where new houses built in the early 2000s served young (mostly white) families looking to buy their first homes with far less than 20% down.

    I should know because I was one of them (though in an inner suburb). I bought a condo and put only 10% down in 2000; we paid a slightly higher rate instead of mortgage insurance. I refinanced in 2002 and was able to get 20% equity and pay a regular fixed mortgage. It all worked because my condo went up in value from $200k in 2000 to $290k in 2002.

    If I had done the same thing in 2005 I would have been screwed. My ARM would have reset to the higher interest rate in 2007 and I would not have been able to refinance. My monthly payment would have gone from about $1700 to about $2600.

    And you know what? I might not have been able to make it.

    That's what's happened here. Like millions of other young families I wanted to buy a new home and was told by a mortgage broker that I could get a great deal with a 3-year ARM as long as I refinanced in 2 years. Sure enough it worked perfectly.

    But that wouldn't have worked in 2005/07 because the housing bubble burst.
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