Wednesday, September 17, 2008

On credit

With the bailout of AIG, and the subsequent tanking of stocks, it appears we are now at the cusp of feeling the tangible effects of the housing bust.

Most analyses of the events transpiring to cause this collapse veer opportunistically toward concrete devils and angels. The consensus among conservatives is that people simply wanted what they couldn't afford. The consensus among liberals is that the government deregulated to the point where collapse was inevitable.

Neither ideology hits the mark here. What's weird is that, even though the housing collapse happened right in front of us, people are confused as to its root causes.

Outside of California (and a couple of other "hot" markets) most houses presently in foreclosure were affordable to the middle class prior to the housing boom. Let's examine a case study. As of 1995, houses in Richfield (a middle-class suburb south of Minneapolis) ran just under $100k. As salaries increased, so did property values, as did the desirability of owning versue renting. This was a good thing.

However, as the market surged, the average Richfield house became unaffordable even to a couple making $50k per year. As such, an average college-age professional could not afford a house. At present, most foreclosures affect those in the middle to lower income brackets.

As for deregulation, few understand what this really means. In the mid-1990s, the desire to increase minority home-ownership became a political issue. As such, lending standards were relaxed under the Clinton administration to accommodate this ideological pursuit.

The result was a market in which people had more control over their risk. Again, this wasn't a bad thing. Some banks were underwriting based on outdated house payment ratios. There is no reason someone making $50,000 per year cannot afford a $1,500 house payment.

During this time, interest rates went down. This was a postive thing, generally, and only the most dishonest partisans pretend otherwise. As such, expensive house became cheaper. Also, banks began leveraging tax incentives that allowed homeowners to write off interest payments on their homes. This led to a massive re-classification of homebuyer risk. Again, not entirely a bad thing. If a $50,000 income can cover a $1,500 house payment, then it can certainly do so with the expectation of a $6,000 tax credit.

So far so good. However:

Recognizing that people were eager to refinance under new rates, a number of former car-salesmen and radio disc jockeys descended on the industry, lured but the high fee/little work ratio of the position. Brokers with no education and no financial background were suddenly pulling the strings of our housing markets.

Worse, mortgage brokers, these folks with no experience and (disturbingly) no fiduciary responsibility to the borrower, were absurdly trusted by banks no deliver homebuyers. Further, there is no requirement that mortgage brokers reveal their commissions, or provide "apples to apples" comparisons of different loan types, or even provide any legitimate paperwork prior to closing.

In a vacuum, this wouldn't be a big problem. Banks could simply blacklist the shadier brokers, and the internet would help shoo customers away from the lowlife. In a normal housing market, with measured growth and stable prices, this would have been the case.

But the bubble didn't happen in a bubble. People who couldn't afford housing loans were snapping up houses, not out of greed, but out of pragmatism. Three years ago, nobody would have told you not to buy a house. For those seeking sound advice, the answer to the question "should I buy house?" was "I have a friend in real estate. Here is his business card."

Banks, whose corporate structures reward compensation for short term results over long-term viability, placed their faith in the former DJs. If you wonder why banks sold so many subprime mortgages, you'll be baffled to know that they actually paid top dollar. Brokers earn enormous kickbacks for the worst of loans, the option-ARM.

In other words, banks were investing heavy dollar amounts to initiate extra expensive loans for poor people with. Worse, they also intitiated them for people who could easily have afforded a nice house, but were persuaded that they could afford a nicer one.

Armed with the extra cash, homebuyers made some startlingly stupid decisions. Condos in the hinterlands (Prior Lake and Savage), planned communities in Rogers, and microscopic "loft-style" apartments in the city centers were commanding upwards of $300,000. $60,000 kitchen and bath remodels, driven by a curious obsession with steel appliances (the olive-green refrigators of our time), forced buyers to refinance their fixed loans into the cockroaches peddled by sleazy brokers.

All of this was built not on greed, per se, but optimism. If the housing market continued to show even nominal gains, the steel appliances and homes in Timbuktoo represent sound financial decisions.

That isn't the way markets work, but property seemed to have a way of bucking normal market trends. Economists explained that houses had tangible value, or that rental prices would serves as a safety net against a downturn. Thank you, economists.

When government DID have the opportunity to leverage legislation to change the course, Countrywide et al... began to line the coffers of legislators. Banks facilitated sweetheart deals for Senators (like, for example, Joe Biden).

At this point "regulation" would consist of condifying what is to become industry standard in response to the crisis. Banks, for example, are ceasing to utilize third-party brokers, who are back to spinning records and selling cars anyway. The housing bill that passed earlier this year was a paean to the special interests who paid for it.

Those citing America's greed would do well to consider that about 95% of mortgages are current. It's not like there was some sort of land grab. In Minneapolis, the hardest area hit is a neighborhood on the cities north side, where houses could be found for under $150,000. It's is hard to ascribe greed to a couple purchasing a two bedroom house that needs new carpet.

We cannot know the extent to which our economy will be compromised. We'll have a clearer picture after the markets respond to Citibank's collapse (I like February 6 as a date for this. We could start an office pool if anyone had jobs), but we would do well to learn all the reasons for our present situation.

The housing crush is sad and fascinating. It is also frustratingly nuanced and complex. If we can understand it, we can learn from it, and be smarter the next time a bubble rolls around.

6 Comments:

Blogger Sarah said...

Thanks Kevin. That was a great post.
I once had the opportunity to but a house and thankfully I didn't get it. I had people trying to convince me to buy on an ARM and reassuring me that 3-5 years down the road the market would be solid. My family's the worst saying that owning a home is an investment.

I scrape by with barely 30K/year and I look at it this way: I could own a home with a $1200 mortgage and have no money to do anything but sit in said home because there are bills on top of that mortgage like gas, electric, water, garbage, etc.... or I can RENT a place for 300-500/month and have little to no utility bills leaving me more money to donate and spend.

I'm a woman. I enjoy spending money. Who doesn't? Renting may not be an investment but I don't need to own a home to have my life fulfilled and it makes me furious anytime someone comes along and tells me that's wrong thinking.

Sure it would be nice to own a home but the world isn't the perfect place full of rainbows and unicorns that credit companies and banks would have you believe. There are limits in life and it's hard to remember that in a society where everything's supposed to be 'limitless'.

12:11 PM  
Blogger Kevin Sawyer said...

Ironically, now everyone will tell you how stupid it is to view a house as an investment.

If you want my house in Phillips, you can pretty much have it. It won't be any $1,200 per month, that's for sure.

12:16 PM  
Blogger Ted said...

If she waits a bit longer she can have her pick of almost any market for next to nothing. In fact if you just moved in I am not sure the banks would have to money to check in on every house they now own by default.

1:28 PM  
Blogger Kevin Sawyer said...

Ted's not kidding. If anyone moved into my house right now, they'd have free rent for at least a year. If the bank comes knocking, offer them $35k for the place.

1:48 PM  
Blogger Sarah said...

Sounds tempting but I don't think I could put up with that neighbor.

9:42 AM  
Blogger Kevin Sawyer said...

He'll be dead soon.

12:31 PM  

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