Wednesday, June 8, 2011

The subprime culprit

Currently, home ownership is under assault. Mind you its under assault from those who probably already own their homes and are not renters (unless they are New York media types). First, the right blame the government’s encouraging home ownership and pressuring lenders to lend to the unqualified thereby causing the great recession by fostering the subprime crisis. Second, the left is also critical of subprime because they assert it is predatory. Of course they are both wrong. As I have pointed out before, subprime is just a convenient whipping boy for those who have agendas. It was not large enough to cause the entire real estate market to crash. It was part of the overall mortgage bubble created by the Fed’s low interest rate policy which was a result of their supporting increased government spending. The right by attributing this to subprime think that they are attacking government social policies – when they just look like racists. The left attack subprime because it ultimately means financial independence for poor people – especially poor minorities. Americans traditionally build wealth through the growth in home equity. Now that we have entered a period in which equity is eroding everyone is piling on home ownership as being bad. In doing so they remind me of the commentators of the NBA finals. When Miami won the first game, they all said that Dallas was dead and the series was over. The Dallas won game two and they all foresaw the demise of Miami. The Miami won game three and they all flip flopped again. Now with Dallas winning game four, they are all piling on one Miami star and saying that Miami is in serious trouble. The conclusion is that they don’t have as clue. The same is true about the critics of home ownership. They are only critical when home values fall. We all know that home prices will eventually recover and wealth will again be built through home ownership. It is a shame that the Fed has written rules that essentially kill subprime. Sure, subprime’s risk assessment did not work in the face of an overall collapse in the market – but which one did? Still, 80 percent of all subprime loans are current and giving home ownership to a group that has been ill-served by traditional mortgage lenders. As the market recovers, they will build wealth much to the chagrin of the critics on the right and on the left. A pox on both of their houses.


John in KY said...

I have always thought that it was a combination of the government - through Fannie/Freddie underwriting and CRA - along with a few greedy mortgage loan officers , taking advantage of the Fannie underwriting, making predatory ARM loans that they knew would default at the end of the low rate. That is why we are still bailing out Fannie to this day .
Also I think that the accounting procedures - forgive my ignorance of the name - that make a bank show a real-time loss for a property they haven't sold at a loss... and the law that allows short selling without even having a stock , are both factors also .
I guess I am a right winger who mostly blames the CRA and Fannie -mostly Fannie - but there is plenty of blame to go around . It seems to me though that they got the snowball barreling down hill and the thrill seeking greedy loan officers couldn't pass up the opportunity for a fun ride- with their Fannie safety net on .

H.A. Black said...

John, Don't forget the greedy consumers. There were many people who would buy a house using a hybrid ARM, keep it for two years, sell it at a 15-20% gain and then buy another one. There were also the developers who would finance this way hoping for sales before the rates went up. Again no lender lends if they know a default will occur. Fannie and Freddie would either put those loans back to the lender or stop buying their loans. HB

John in KY said...

Flippers had their part for sure , but I believe it is not so big of a part. I disagree with your assertion that fannie wouldn't lend if they believed a default would occur , because of two reasons: 1- under Franklin Raines (99-almost 05), Fannie had a program that lowered credit requirements for them to buy up loans. This padded the pockets of the execs at fannie because their bonuses were based on their holdings, and also got higher risk people into loans.
2- The bonuses, and I believe a tacit understanding that the gov would take care of fannie, and lenders feeling that fannie would buy up almost anything , created a snowball until we had low/no-doc loans and 100% loans were common. When the early loans started failing - probably at the end of the ARM- we had McCain in late 05 having hearings about the scandal at fannie and the impending trouble from bad loans. with nothing done then... the snowball/avalanche kept growing till the crash in 08- and we have been bailing out fannie ever since. fairly sure fannie is by far the largest bailout amount of any company. I believe that there may even be a connection between illegals getting sub-prime loans and the foreclosure crisis because I saw two different lists at different times- one showing the states with the highest illegal population , and the other showing the highest rates of foreclosure by state . 4 of the top 5 from both lists matched . Coincidence? Maybe.
The really scary part is I don't think the policies have really been changed .

H.A. Black said...

John, Love your comments but Fannie Mae would not buy low doc or no doc loans from originators starting in 1990. They did however buy pools of these loans from Wall Street just prior to the crash. Fannie has made noises about putting those loans back to the investment banks but I honestly don't know of the resolution.

John in TN said...

It looks to me like the whole mess started with a routine price correction. Prices were inflated and inventory was high, so values fell when inventory couldn't be sold. There were still a lot of folks (TV talking heads, columnists, realtors, and financial advisors) advocating taking the ARM at a rate lower than the fixed, then re-fi to the fixed at the end of the ARM term. This let consumers buy more than they could afford, since the cost was shifted to the out-years.

The problem came in when the re-fi fell through b/c the value of the house couldn't cover the note. I think the re-fis would have been dicey anyhow, but when you're stuck in a note you can't pay, you default and foreclose.

H.A. Black said...

John (TN), You are correct. The lenders were supposed to qualify borrowers of ARMs given the worse case scenario. Remember that those mortgages have caps on interest rate adjustments over the life of the mortgage and yearly. Also remember that at its worse defaults and foreclosures were 20 percent of subprime and 10 percent of prime. Most of the population would be shocked at these rates are so low. However they are twice what the market anticipated which put the value of the mortgage backed securities under water. Having to mark to market, this caused the write downs and collapse of markets and institutions.