Who's at Fault for the Mortgage Market Meltdown?
The damage from mortgage foreclosures continues to spread through our economy. One interesting phenomena about this particular issue is how many people see the problem as specifically the fault of individuals and not the system. Yesterday I had lunch with a friend who thought that it was obvious the individuals who took the loans were totally responsible for their situation because they were too stupid to understand the terms of the loans or too greedy as they knew they were speculating and betting that their housing values would go up and up and up. They should have known better.
When I wrote about this issue last week, there were several responses from others who disagreed with my point that this goverment can be blamed for this mess.
To be clear, my argument was that the people who set up this this particular bubble (aka: Ponzi scheme) were explicitly and with premediation actively planning to fleece the gullible. And I felt that we should be able expect more from our government in regulating the rules that lenders follow.
One of the best arguments expressing the counterpoint (individuals are responsible) was from Bill Heffner who writes On My Mind. Because Bill is located in San Diego, he has probably some of the best perspective of how this housing market has played out in one of the most speculative markets in the country. He wrote:
Mortgage loans were attractive for reasons beyond that regulatory change. The change made some people richer, but the country was awash in mortgage money and the subprime market developed because there were not enough prime borrowers to lend it to. Builders were building homes at a frenetic pace, and the subprime mortgage market helped them sustain it.
More importantly, while some of the borrowers are innocent victims, a large majority are not. The terms of the loan were spelled out in documents which the borrowers signed and the increasing payments were not buried in the fine print, they were stipulated in the body of the document. Further, in many cases the borrowers lied about their incomes to obtain the loans. Most all of the buyers knew they were buying homes that they ultimately could not afford, hoping that soaring prices would magically "bail them out." They knew that they were taking a gamble and now they want big brother, that's you and me the taxpayers, to pick up the cost of losing that gamble.
I live in Southern California, land of (among other things) soaring home values. I have been bombarded for years with offers of “fantastic low payments” on my home, mailers telling me of the dream vacations I could go on, the cars and boats I could buy, the easy money that I had in my home. Easy money. I still have my years-old, low-rate, thirty-year fixed.
When a con man takes down his mark there is no truly innocent party, because the con works by appealing to the mark’s greed.
I agree with Bill that in this market many, many people were speculating and ultimately gambling that they would win the bet. And it is clear that during the last two years in California, speculation was the major driver keeping the bubble (and scam) going.
But, I think this argument underestimates how much of this con game was setup and enabled by this administration who relied on the housing market to cover how their policies were hollowing out the economy through tax policies and incentives and regulatory rules affecting corporations -- policies that helped corporations disinvest in the US in favor of other countries. The government's policies were to sell riskier and risker loans to the most vulnerable people as part of their Ownership Society push and belief that government regulation was always bad. And because the overwhelming focus is on the housing market and the individuals, how their policies have mortgaged our country's future away is not discussed.
Here's something I found and wrote about that talked about all the types of scams that were allowed to happen under the current (non-)regulatory scheme.
Today's pop quiz involves some potentially exciting new products that mortgage bankers have come up with to make homeownership a reality for cash-strapped first-time buyers.
Here goes: Which of these products do you think makes sense?
(a) The "balloon mortgage," in which the borrower pays only interest for 10 years before a big lump-sum payment is due.
(b) The "liar loan," in which the borrower is asked merely to state his annual income, without presenting any documentation.
(c) The "option ARM" loan, in which the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan.
(d) The "piggyback loan," in which a combination of a first and second mortgage eliminates the need for any down payment.
(e) The "teaser loan," which qualifies a borrower for a loan based on an artificially low initial interest rate, even though he or she doesn't have sufficient income to make the monthly payments when the interest rate is reset in two years.
(f) The "stretch loan," in which the borrower has to commit more than 50 percent of gross income to make the monthly payments.
(g) All of the above.
If you answered (g), congratulations! Not only do you qualify for a job as a mortgage banker, but you may also have a future as a Wall Street investment banker and a bank regulator.
No, folks, I'm not making this up. Not only has the industry embraced these "innovations," but it has also begun to combine various features into a single loan and offer it to high-risk borrowers. One cheeky lender went so far as to advertise what it dubbed its "NINJA" loan -- NINJA standing for "No Income, No Job and No Assets."
In fact, these innovative products are now so commonplace, they have been the driving force in the boom in the housing industry at least since 2005. They are a big reason why homeownership has increased from 65 percent of households to a record 69 percent. They help explain why outstanding mortgage debt has increased by $9.5 trillion in the past four years. And they are, unquestionably, a big factor behind the incredible run-up in home prices.
Now they are also a major reason the subprime mortgage market is melting down, why 1.5 million Americans may lose their homes to foreclosure and why hundreds of thousands of homes could be dumped on an already glutted market. They also represent a huge cloud hanging over Wall Street investment houses, which packaged and sold these mortgages to investors around the world.
Not too long ago, corporartions believed it was perfectly okay to scam investors because it was part of the stock market game. I worked for a company in the 1990s where the shady accounting practices of the CEO in the early 90s finally destroyed the company. And because those shady accounting practices didn't get dealt with (indeed the bogus accounting practices didn't get any attention until 2003), some of the "accounting innovations" got recycled by Enron. And we know what happened then.
I don't see how these the types of loans were a whole bunch different than the accounting practices that my old company "innovated". And I don't know why the victims of this massive fraud should be blamed more than the people who purposely setup the system that encouraged the fraud and greed that created the bubble.
Just like those innocent employees of PGE in Oregon who lost their pensions through the Enron fraud simply because Enron bough their company, we all will pay for the fraud that was setup and encouraged by policies this government (and Alan Greenspan) put in place.
One more thing, there is a lot of evidence that many, many people were conned into taking these loans who had no idea of the risk they were taking. Many people "fleecing" the sheep were very careful to not let their victims know the extent of the problem. I believe we will see many naive people trapped in this nightmare along with those culpable and guilty speculators.
But since this particular scam couldn't have been set off without the changes in mortgage regulations, it seems to me that this administration gets to carry a good part of the blame for the speculative bubble and the terrible consequences that truly have jeopardized the American economy. We have a long, long ways to go before this mess hits bottom and none of us will escape the consequences of looking aside while this administration let the sharks fleece the gullible because they wanted to say it is up to the individual to manage their own risk.