There is an undercurrent of disatisfaction that is surfacing regarding the rescue of homeowners who got themselves into bad mortgage arrangements. Talking heads like the guy on CNBC are going off about how wrong it is that citizens who were more clever about their spending habits should have to pay for the mistakes of those who made bad choices.
As a first order approximation, it is hard to argue that we should line up to provide this payout. If you make bad judgments based on greed, ignorance, or simple miscalculation, the theory is that in an ideal free market you should be free to suffer the consequences as well as the benefits.
That’s fine. Except that we do not have an ideal free market. In this particular bust, the risks of mortgage trading were not accurately communicated to investors or even particularly well understood by anyone. The macro effect of a large number of mortgagees who are suddenly unable to deal with a large interest rate uptick in their adjustable rate mortgages (ARM) was under appreciated by most.
Adjustable rate mortgages and the subsequent investment instruments that followed were dreamed up by somebody- but probably not by hourly workers or anyone outside real estate and finance. There was a kind of wink-of-the-eye understanding between banks, mortgage brokers, builders, and the real estate business. Not only was there the invention of the ARM and the degradation of qualification standards, there was a nationwide marketing campaign aimed at marginal buyers. This real estate boom was financed in part by mortgage instruments designed to capture marginal borrowers.
The previous owner of the home that I presently occupy was a mortagage broker who had hit the big time at the start of this bubble. After the signatures were on paper, he told his wife that she could have the BMW that she had wanted from the equity. Mortgage brokering was practically a cottage industry and many people were making money.
Real estate agents knew this of course. They knew that easy qualification was available and they continued to do what they always do: push buyers into the most home they could afford. It was a sellers market and real estate speculation was rampant. Builders were routinely putting up spec homes and selling them like hotcakes.
This is not just a problem limited to greedy buyers. A whole business phenomenon grew into being around the housing boom. Lending institutions, mortgage brokers, real estate brokers, title companies, builders, and buyers all bought into a dream built upon sand. Buyers may have been guilty of bad judgement, but it was facilitated by entire industry ready and willing to make it happen.
So, are the angry men we see on television justified in their assertion that they should not be forced to help bail out those facing foreclosure? I suppose the position you take depends on your vision of what civilization should look like. I think if you investigate the self-righteous self-made, you’ll find that many of them benefitted in part by the distribution of wealth at some scale. Inheritance money, Pell grants, scholarships, good mentoring, good fortune, talented parenting, and many other forms of benefit that are not necessarily distributed by bank deposit. Simple hard work is rarely enough.
The parties involved in this fiasco should bear the brunt of it themselves to a large extent. That means that lending institutions should not be entitled to the profits they were anticipating and the borrowers should not be entitled to large equity on overvalued homes. There should be suffering on the part of all participants.
Lamentations on Chemistry 
If several homes in the same neighborhood suffer a short-sale or foreclosure, it drags down the value of similar homes to the level of the foreclosed homes.
Hence if you have 100 identical homes and 3 foreclose, then all the remaining 97 are now at the lower price. The good have been punished along with the bad.
Wealth has been vaporized!
So yes, some unwholesome characters will be bailed out, but what is the alternative? Although I’ve heard some say we should raze them to the ground (thus creating work), to avoid the above scenario.
A limited amount of self-righteous justice is merited, because when you sign up to buy a house you ought to understand what it means. People bought in at interest rate lows and wanted the yet lower rates they could get using ARMs. At this point, though, some of the consequences are secondary ones (impinging on people who did not directly take risks but lose their jobs or upside-down because of the mistakes of others), so the self-righteousness makes less sense.
I think the self-righteousness might be more just if it were also given to the banks and financiers who created the mortgage instruments which enabled and drove the failure. Banks which knew much better decided that the profit in the investments was way too good to pass up. The same people complaining of the lack of justice in bailing out stupid homeowners seem to have no problem in bailing out and paying off evil financiers (evil because they knew what they were doing was reckless and predatory, and in the worst interests of nearly all but themselves).
The complaints sound like yet another tired refrain of “Socialism for the rich, capitalism for the poor”.
Thanks for the blog. I was starting to feel a bit isolated. Here in the big south, self-righteousness is still an unrecognized sin.
I think the name of the game here is Risk vs. Reward.
I had an ARM in the late 90’s, and I rode the interest rate downhill until 2004 when I sold… took the equity and put it into a new home with a fixed rate. Good fortune.
I don’t buy into the idea that the buying and selling of debt packages was done in the blind. There are ways to quantify risk in the underlying securities and that is one of the best ways to determine pricing… wiki Capital Asset Pricing Model and you’ll see that you’re comparing the return you can get on the open market vs what you think you might get (and the probabilty of it).
Here’s where I’m going with this. Some folks really liked the upside of high risk investments, and that includes everyone involved- home “owners”, lending institutions, and those who bought and sold the resultant debt. Most of us here are chemists, right? There is an equilibrium between risk and reward… risk is measure of the impact of something going right/wrong times the chance that it will. So high rewards are balanced by significant losses via the probability.
It seems to me that you are messing with something fundamental when you look at an equilbilrium reaction like risk reward and only rub out the downside. I understand the need to keep the credit market liquid but you can’t defeat equilibrium.
Punishing those in the financial institutions now seems too little, too late. Punishing those who have abused our bankruptcy system is again too late. Traditionally the guy who gets caught holding the bag gets nailed… but in this case everyone dropped the bag and ran. Now what?
I’ve got personal experience with one mortgage defaulter (a friend, driving a Lexus) who does not pay federal income tax… thank you (un)earned income tax credit. Who paid for their overextension? And who paid the brokers, bankers and bastards involved in that lending process? Everyone reading this blog, I bet. How many of you are driving a Lexus?
So that’s it, it’s over, the equity got blown on who knows what. Maybe it went to the Lexus Dealer. Maybe it went to China via Wal Mart. It’s gone. The life lesson here is to make responsible choices- and for irresponsible choices to once again have negative consequences. This is the only positive way I can come up with to deal with our situation.
**Rant out**
The concept of irresponsible choices having negative consequences is fine – when applied consistently. I think the problem here is that the wealthy who took risks (many of which with other people’s money) managed to get bailed out (in some cases, profit extravagantly) while the poorer people who took risks…not so much. If irresponsible choices have negative consequences only for the poor (beyond the ability of wealth to mitigate the consequences of bad choices, since in this case the consequences of the bad choices are big enough to wipe out both rich and poor), then it’s not so much the irresponsible choices you’re penalizing as the being poor part.
Wow. Some really great comments and perspectives.
KISS. The cheap, simple, fast, effective solution was to raze all foreclosed properties immediately upon forfeit. The housing market remains in short supply, real estate values of paying mortgages are sustained, builders and their suppliers continue supporting the economy. Amputate gangrenous tissue – including criminal banks.
Dehoused population would be impressed into Federal work camps, House of Reprehensibles HR 645 (Hastings, D-FL).
http://en.wikipedia.org/wiki/Enabling_Act_of_1933
“Law to Remedy the Distress of the People and the Nation”
“National Emergency Centers Establishment Act” …if a national emergency requires large groups of people to be rounded up and detained.
http://www.govtrack.us/congress/billtext.xpd?bill=h111-645
“National Emergency Centers Establishment Act” …if the national emergency requires large groups of people to be rounded up and detained.
Will the URL make it through this time?
“Lending institutions, mortgage brokers, real estate brokers, title companies, builders, and buyers all bought into a dream built upon sand.”
You forgot the media in this list. Garth Tuner is a former Member of Parliament up here who is making his name as a sort of Jim Kunstler-esque figure, though less eloquent and more focussed on real estate. He regularly fingers the media (“real estate pr0n”) as a key player in the housing bubble.
Here in Canada we are lagging behind the USA by about two years, give or take. We didn’t have sub-prime mortgages or bank failures, but we do have a lot of 0%-down, 40-year mortgages where young couples bought way too much house, way out in the suburbs. Now that the recession has hit and job losses are mounting, foreclosures are going up and housing prices in Toronto are down by 5-10% vs. last year, with double or triple the amount of inventory one usually sees at this time of year. Mortgage interest rates are around 3-4%.
Something that doesn’t add to the idea of razing the houses are related to the land itself. another thing is about the cost of making the house in the first place. razing it is not going to fix the problem, because the problem is not the house, is what made the house bought at a very low price or interest
Hi Uncle Al- the URL works. Thanks.
Hi Morris, I’ve been pondering your comments. I guess where I am coming from is that it takes two to tango. Companies who market bad investments should hang with the borrowers in this mass hanging. Yes, borrowers were greedy, ignorant, and … greedy. But there has to be some consequence for the lender as well. Making risky loans with a wink and a nod is a form of dishonesty. It is selling tickets to rubes on a toll road to nowhere. In the end it is unsustainable and leads to ruin. This is why we were supposed to have a banking profession who lends money responsibly. The lender must be connected with the community in some way.
Yes, I am with you on that. I don’t give a free pass to anyone in this mess. What gets me is when I hear it all portrayed as being a shock to anyone that the debt was bad.
A lot of this debt was sold (at least once) after the original issuance of the mortgage. Valuation of most securities includes some sort of “risk factor”- default risk is one kind of risk. There are metrics and parameters to measure default risk, especially with mortgages. Debt as % of income, monthly cash flow, etc, all the crap they look into when you get a mortgage. I’m not a banker so I can’t say what exactly they use as an aggregate measure of risk when selling bundled mortgage packages but I’m fairly sure that it’s somebody’s job to quantify the risk associated with the security.
I would dearly love to see one result of this mess to be that the amount of lending coming from local banks to grow. Purely an emotional call there. In my mind it puts a lot of these shady brokers out of work, too.