Wednesday, September 24, 2008

Mortgage Meltdown Revisited

Just as a little perspective on the subject, the odor of decomposition in the housing market was in the air nearly two years ago, perhaps more and there was plenty of past history for anyone to read about, particularly if you had spent any time living in southern California in the eighties and nineties-as I did. Ample time for anyone with a lick of sense to 'know when to fold 'em" as the tune goes. 

In the spring of 1929 Bernard Baruch was on his way to his office and as usual had his shoes shined. He received a hot stock tip from the shoeshine boy. He thought about what it meant to receive the next great tip from a shoeshine boy and quietly proceeded to liquidate his holdings. I'm quite sure the smart money did exactly that.

But the job description of the average citizen of "flip this house" nation does not include watching the instrument panel carefully for signs of overheating. A lot of people who probably thought they were going to cash out big time and live without working got clobbered and are still getting hammered-they're the ones who have had to give up the McMansion for a two bedroom apartment in a seedy part of town along with the section 8 people. 

Ultimately, the entire edifice, from sea to shining sea, was predicated on a very simple bedrock assumption, that property values would continue to increase 8 or 10 per cent or more a year, forever and ever, world without end, Amen. In the end it was a classic bubble and unsustainable. People took on mortgages they never could have supported based on that assumption. Mortgage brokers wrote unverified mortgages and flogged them to the banks who were ready buyers, again based on that assumption. The banks homogenized, chopped, flaked and formed such loans into mortgage backed securities and they found willing buyers the world over, again based on that original flawed assumption of perpetual increase which turned out to be like perpetual motion machines-it was false.

If the past is prologue, there were parallels in the housing market in Southern California in the late seventies and early eighties, the era of what was euphemistically called "creative financing" and "balloon payments" in five years. The idea was, you get in, you build enough paper equity to refinance to a conventional loan in five years and we're all happy people. At one and the same time house flipping and price jacking went on a massive jag.

My buddy Lenny who lives in Santa Monica informs me there were people hosting block parties for the first $2 million sale on the block a couple years ago. One of my friends in the eighties lived in an apartment building that changed hands twelve times in one year. He ended up scraping up enough money for a down payment and proceeded to plow up the back yard and plant a big garden because he actually needed the food for his blended family.  

There were people on late night infomercials back then saying "Get all the credit cards you can get. Take the maximum cash advance on all of them. Put a down payment on a house. Flip it and cash out before the bills come in next month." And people were doing it, too. Some made money with this gambit but by the time it becomes common knowledge the smart money has, of course, moved on.  

About that time (1980) me and the Dragon Lady went out to Corona to look at some new houses in a development. The back yard could house two lawn chairs and a grille, and you could literally stand in between two houses and put your hands on the walls of both houses. They were about $80k at the time and we couldn't swing it so we stayed renting in Long Beach and avoided the long commute too. In 1992 when I was in the process of getting laid off from Douglas and the Southern California residential housing market was in a downturn, I met a guy trying to lose one of those same places and it took him two years to sell it at a loss. He hadn't owned it more than 3-4 years.  

There's also a glaring parallel in the farm crisis of the late seventies and early eighties here in the midwest. 

A speculative bubble in farmland prices collapsed and a lot of people went into foreclosure. Something else happened that I'll talk about in a minute.  

Now....many of today's toxic loans now look as if they'll never make the kind of money they were supposed to are sitting out there on the books of the people who bought them, and they're looking for ways to get rid of them. A lot of people who acquired title to the homes that underpinned the edifice either can't make the payments or never intended to and walked away. There was also fraud on a massive scale because *remember*? no verification of income was in place, because it didn't matter, you see? So the people who have those loans and *securities* on their books are looking for a way to dump them, and they've identified the taxpayer as the only remaining big pot of money that'll let them shed the securities and loans.

A couple of good things and some bad things have happened along the way as byproducts of the meltdown. Home prices are rationalizing themselves, because ultimately a mortgage loan is only as good as the ability of the person making the payments to earn money. That gap is narrowing fast, because there's excess inventory, and it's become a buyers market like no other in recent memory-if you've got front money and a good credit rating. Buyers are being carefully vetted-as they should have been all along. Down payments are required. Dodgy mortgage brokers are being purged from the system, because they're having a lot of trouble flogging loans on suddenly wary banks. The banks, institutions, and pension funds that have a stake in the dodgy loan backed securities are losing a lot of dough-that ultimately gets made up from the holdings of small timers like us. Business credit is a lot harder to get because there's less to go around because of the millstone of toxic loans hanging off the necks of the lending community. 

The insurance companies like AIG are losing a bundle because of their direct investments in the same toxic loans, or because they wrote credit default swaps (insurance policies) on loans that went tits up.  

Ultimately, as someone once observed, "Don't worry about the blame. There's plenty enough to go around."  

In the case of the farm crisis in Iowa we determined that it was in the best interest of bankers and farmers to sort out the loans that could cash flow and that could not, and reorganize them that way. Mandatory mediation prior to foreclosure on a farm operation helped a lot of people out and got the banks more money than foreclosures and short sales would have. There's no reason to think that this could not work today to salvage a lot of home mortgages where the people are willing. Because remember, ultimately people can and do walk away from loans they can't pay-it's called survival. Nobody needs more foreclosures.  

For the same reason, the courts ought to be able to cramdown loan rates to affordable levels if the homeowners are willing and able to make the payments and share the increase with the lender when they sell. A loan that pays is far better than one that doesn't. I think that we will probably see this, or some mechanism to restructure loans for people willing and able to pay. 

In addition there should be vigorous prosecution of mortgage fraud on every level with certain prison sentences.  

As far as the dodgy securities and loans that the banks want to flog on the taxpayers, well, we're going to have to do something about it to free up the flow of capital and satisfy our creditors that we're serious people, but I do not think that "something" requires giving the SecTreas a blank check and the ability to operate unreviewably.  

If ordinary citizens are going to be stuck with the bill, we ought to be able to minimize the cost and share in any profit that accrues and we ought to call senators and congressmen to account who do not act in our interest.


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