People are losing their homes and many more will lose their jobs before the mortgage meltdown works its way through the system.
To paraphrase Alan Greenspan's remarks on March 17th, 2008, “The
current financial crisis in the US is likely to be judged in retrospect
as the most wrenching since the end of the Second World War. The crisis
will leave many casualties.”
How many casualties? Experts are predicting that in the next few
years, between 15 and 20 million homeowners could have homes worth less
than what they owe. Walking away from a bad situation may actually make
sense for people who mortgages that are 'upside down' considering the
fact that refinancing is out of the question and home equity is
nonexistent.
It seems quite easy to point fingers at greedy Wall Street titans for
causing the sub-prime mortgage crises. They after all, put together the
deals that allowed banks to underwrite mortgages and then offload these
liabilities to investors. What many fail to realize is that there is no
shortage of blame to go around from homeowners buying more home than
they could afford to real estate agents looking for more commission
dollars. Mortgage brokers and bankers, the banks themselves, ratings
agencies such as Moody's and Standard & Poor's, Wall Street, the
Fed and last but certainly not least, the Federal Government.
Let's start with the homeowners--the people who are now in the
process or soon to enter the process, of losing their homes. Some of
these people had never before owned a home and as such, may not have
been prepared for the costs associated with homeownership. Basic
financial literacy is sorely lacking in this country despite there
being no shortage of budgeting and tracking programs readily available
such as Quicken and Microsoft Money. The lack of financial literacy
does not absolve these buyers of their responsibility. Every borrower
receives a truth in lending disclosure statement. Here is a portion of
what the act covers:
The purpose of TILA (Truth In Lending Act) is to promote the
informed use of consumer credit by requiring disclosures about its
terms and cost. TILA also gives consumers the right to cancel certain
credit transactions that involve a lien on a consumer's principal
dwelling, regulates certain credit card practices, and provides a means
for fair and timely resolution of credit billing disputes. With the
exception of certain high-cost mortgage loans, TILA does not regulate
the charges that may be imposed for consumer credit. Rather, it
requires a maximum interest rate to be stated in variable-rate
contracts secured by the consumer's dwelling. It also imposes
limitations on home equity plans that are subject to the requirements
of Sec. 226.5b and mortgages that are subject to the requirements of
Sec. 226.32. The regulation prohibits certain acts or practices in
connection with credit secured by a consumer's principal dwelling.
Much of the subprime mortgage crisis can be traced directly back to
variable-rate mortgages. As is clearly stated above, “TILA does not
regulate the charge that may be imposed for consumer credit. Rather, it
requires a maximum interest rate to be stated in variable-rate
contracts secured by the consumers dwelling.” It also clearly states
that TILA also gives consumers the right to cancel certain credit
transactions that involve a lien on a consumer's principal dwelling.
One has to wonder whether or not these homeowners:
1. Bothered to read the truth in lending act disclosure at all.
2. Understood what the truth in lending act disclosure meant.
3. Chose to ignore the information printed clearly the truth in lending act disclosure.
A number of months ago, just as the subprime mortgage crisis was
beginning to unfold, The New York Daily News ran an article about a
family in New York City, who had bought a home and were now faced with
the prospect of foreclosure. The article was sympathetic to this
family, highlighting the fact that they're living the American dream
and that this dream was about to come to an end. What I found to be
distressing was the fact that clearly visible in the photo that
accompanied this sympathetic article was a very expensive flat screen
television hanging on the wall. Perhaps I'm naďve, but I can assure you
that if I were faced with the prospect of losing my home and having my
family put out on the street, there is absolutely no way that I would
still have that expensive television hanging on my wall. It would have
been one of the first things to be sold and some financial relief would
be found by jettisoning what I'm sure was the expensive cable bill.
Clearly the public needs easy access to financial literacy courses.
Too bad we don't see the need to make this a mandatory course of study
in our educational system.
Mortgage bankers and brokers have in the last four or five years
been raking in cash by the bucket load in the form of commissions paid
when mortgages they've originated, close. Many of these people have not
needed to do much in the way of prospecting. Instead, their phones have
run off the hook as people have jumped on the homeownership and
refinancing and take out extra cash bandwagon, despite their ability to
pay for their home. No-document loans were readily available without
the borrower having to produce documentation that backed up their
income. Clearly this practice can and indeed has, lead to substandard
loan underwriting processes. Were some of these mortgage bankers and
brokers dishonest? Sure. Were all of them dishonest? I think not. To
have a massive nationwide conspiracy, where thousands and thousands of
people involved in the mortgage banking and mortgage brokering
profession got together to create this situation is simply not
feasible. Yes, some of the blame does belong with those in the mortgage
industry, but they were simply a small cog in the huge machine that
created this mess.
Let's discuss real estate agents. In 2007, we bought a home, and
also sold a home. The agent we used to purchase our home was absolutely
fantastic. In our opinion, she went above and beyond to make our deal
happen. She answered every phone call, followed up on every concern and
was the epitome of professionalism. We consider this individual to be a
friend, and we have sent referrals her way that have resulted in her
earning additional commissions. We will continue to recommend her to
all who ask or mention that they'd like to buy or sell a home in our
area.
The real estate agent, we used to sell our home, could not have
been more different. We got our old home ready to sell prior to closing
on our new home. We decided to list it as “For Sale by Owner.” In the
event that we didn't sell this home on our own, it was our intention to
list it with an agent as soon as we had closed on the purchase our new
home. Literally, from the day we put the sign in front of our home and
listed it on a “For Sale by Owner” website we were inundated with phone
calls from real estate agents. We were told many lies and were
constantly harassed; although we had already made it quite clear to
every agent who called, and there were more to 60 who did; that we were
willing to pay half the commission-the same as they would have received
had they sold another agent's listing. We also told every agent that
called that we had already lined up an agent to sell our home in the
event that we chose to no longer sell it ourselves. Our deadline was
the closing date of our new home purchase. We did have an interested
buyer who shortly after our closing date decided to keep looking so we
listed our home with a local agent so that we could concentrate on
getting our new home ready for our moving date at the end of the school
year. This agent showed our home a maximum of two times and got an
offer which we accepted. We ended up getting $1,000 less than we had
wanted in a declining Real Estate market. The agents who had called
many times to harass us called our listing agent on a number of
occasions and he lied telling them that the house was under contract
when in fact it wasn't at that time-clearly a breach of our agent's
fiduciary duty. Quite frankly an ethical agent would have continued to
show our home until closing in the event that the deal fell through.
But wait, there's more. Our agent also acted as the buyer's
mortgage broker. At the closing table, we learned that he had signed
documents from the buyer stating that he (our agent) represented them
and we had signed documents stating that he represented us. We also
learned that the buyer had effectively put down approximately 2-3% of
the purchase price when financed closing costs were factored into the
equation. Their first mortgage had what we thought was a high fixed
rate and their second mortgage came with a rate in excess of 8.5%.
Because the closing happened in August, literally in the midst of the
first wave of the meltdown, if they didn't close on the day they did
(August 31st, 2007), Citibank wasn't going to extend their rate. When
my wife & I have bought houses in the past, it had always been a
very happy day. These people looked absolutely shell-shocked at the
closing table. I'm not convinced that they knew just how much their
monthly payment was going to be until closing day. We knew down to the
penny well in advance having budgeted and planned everything on a
spreadsheet. Were these people stupid or just inexperienced and mislead
by a greedy combination of real estate agent & mortgage broker? I'm
extremely confident that they are intelligent people but inexperienced
and taken advantage of by an unscrupulous agent.
The banks are also culpable. Prior to bank deregulation, Savings
and Loans provided mortgages to home buyers and kept these loans on
their books. Non-performing loans had a negative effect on the
S&L's profitability which of course caused tighter lending
guidelines such as job stability and decent down payments in order for
prospective home buyers to be approved for a mortgage. Way back then, a
home buyer had to actually save up enough money for a down payment 10
or even 20% before a bank would ever consider underwriting a mortgage.
The checks & balances kept banks solvent and borrowers responsible.
Although this approach worked, some cried foul stating that the
regulated system was racist and discriminatory-and there certainly was
some truth to this. Skipping forward to the present, banks made a
bundle on mortgages over the past five or six years. For the most part,
they allowed their underwriting criteria to be stretched so far out of
alignment that almost anyone could and indeed did, qualify for a
mortgage despite their ability to pay. Some folks even applied for and
received mortgages for more than the property was worth. Sometimes for
as much as 25% more than their property was worth!
Under the prior system, 125% mortgages would not have been possible
because of course these loans were held on the banks' books and could
have led to losses that would have had to have been absorbed directly
by the bank.
So what went wrong? Under the current system, these loans were sold to
the big Wall Street investment firms who repackaged them as
collateralized mortgage obligations (CMO's), Mortgage Backed Securities
(MBS's) and other similar acronyms. These instruments were then sent to
the ratings agencies for their blessing and more importantly a letter
rating. Many of these structured finance deals receive AAA ratings-the
highest ratings available meaning that in theory, these instruments
were least likely to default. How does one create a 'triple A' or AAA
rated financial instrument out of sub-prime mortgages? Herein lies the
magic. These Asset Backed Securities (ABS) are made up of different
tranches or slices, each carrying a different risk and reward level.
The first dollar of principle and interest is applied to the securities
with the highest rating, and the first dollar of loss is applied to the
tranche with the lowest ratings. The lower slices are designed to
provide a security blanket that in theory protects the higher-rated
securities. The investment banks that package or 'structure' these
securities in order to earn fat fees when they sell them to investors
are the same entities that pay the ratings agencies to rate these
instruments. Clearly the possibility for conflict of interest is
present. If investors and not the investment banks that stand to rake
in millions in fees were to pay for the rating, the potential for this
conflict of interest would be negated. Furthermore, the investment
banks have a vested interest in convincing the ratings agencies of the
credit worthiness of these securities.
So we've already pointed fingers at homeowners, some greedy, many
more I suspect, naďve or uninformed, real estate agents-one out of more
than 60 in my experience was a gem, mortgage brokers & bankers,
banks, Wall Street and ratings agencies so who's left? The Federal
Reserve and the Government of course.
The Fed as its known is responsible of the country's monetary
policy and for supervision and regulation of banks. This is the
definition of the Fed's roles in their own words:
Monetary Policy
The Fed is best known for its role in making and carrying out the
country's monetary policy-that is, for influencing money and credit
conditions in the economy in order to promote the goals of high
employment, sustainable growth, and stable prices.
The long-term goal of the Fed's monetary policy is to ensure that
money and credit grow sufficiently to encourage non-inflationary
economic expansion.
The Fed cannot guarantee that our economy will grow at a healthy
pace, or that everyone will have a job. The attainment of these goals
depends on the decisions of millions of people around the country.
Decisions regarding how much to spend and how much to save, how much to
invest in acquiring skills and education, how much to spend on new
plant and equipment, or how many hours a week to work may be some of
them.
What the Fed can do, is create an environment that is conducive to
healthy economic growth. It does so by pursuing a goal of price
stability-that is, by trying to prevent inflation from becoming a
problem.
Inflation is defined as a sustained increase in prices over a period of time.
A stable level of prices is most conducive to maximum sustained
output and employment. Also, stable prices encourage saving and,
indirectly, capital formation because it prevents the erosion of asset
values by unanticipated inflation.
Inflation causes many distortions in the market. Inflation:
· hurts people with fixed income-when prices rise consumers cannot buy as much as they could previously
· discourages savings
· reduces economic growth because the economy needs a certain level
of savings to finance investments that boost economic growth
· makes it harder for businesses to plan-it is difficult to decide how
much to produce, because businesses can't predict the demand for their
product at the higher prices they will have to charge in order to cover
their costs
Bank Regulation & Supervision
The Fed is one of the several Government agencies that share
responsibility for ensuring the safety and soundness of our banking
system. The Fed has primary responsibility for supervising bank holding
companies, financial holding companies, state-chartered banks that are
members of the Federal Reserve System, and the Edge Act and agreement
corporations, through which U.S. banking organizations operate abroad.
The Fed and other agencies share the responsibility of overseeing
the operation of foreign banking organizations in the United States. To
insure that the banking system remains competitive and operates in the
public interest, the Fed considers applications by banks for mergers or
to open new branches.
The passage of the Gramm-Leach-Bliley (GLB) Act in November 1999,
was the culmination of a multi-decade effort to eliminate many of the
restrictions on the activities of banking organizations.
Some of the main provisions of the GLB are:
· Repeals the existing limitations on the ability of banks to affiliate with securities and insurance firms
· Creates a new organizational form that allows banking organizations
to carry new powers. This new entity called a "financial holding
company," (FHC) and its non-banking subsidiaries are allowed to engage
in financial activities such as insurance and securities underwriting
The Fed's enlarged role as an umbrella supervisor of FHCs is similar to
its role in supervising bank holding companies. The Federal Reserve
Banks will supervise and regulate the FHCs while each affiliate is
still overseen by its traditional functional regulator.
The Fed has to delineate the financial relationship between a bank
and other FHC affiliates. Its primary goal is to establish barriers
protecting depository institutions from the problems of a failing
affiliate. To do this efficiently the Fed has to ensure increased
communication, cooperation, and coordination with the many supervisors
of the more diversified FHCs.
The Fed has access to data on risks across the entire organization,
as well as information on the firm's management of those risks.
Regulators will be in a position to evaluate and presumably act on
risks that threaten the safety and soundness of the insured banks.
It would appear that the Fed has failed to curb housing inflation which
played a role in this entire debacle then made matters worse and in
their efforts or lack there of, to properly supervise banking
institutions.
Finally the government, a.k.a. Uncle Sam, the big Kahuna 10,000
pound elephant etc. Where do we begin? How about with: 'Where were
they?'
It now appears that after millions of horses are out of the barn
(some horses ran, others were foreclosed upon) the government wants to
step in with a bailout to save the rest. While nobody wants to see
people lose their homes, the question that must be raised is this: What
about all those of us who were responsible? Those of us, who scrimped
and saved up a decent down payment, bought less-house than we could
afford and who live below our means? Many of us drive older cars and
keep them longer. We don't run out and buy the latest and greatest at
inflated prices, we watch, wait and budget.
When the World Trade Center was attacked, families who decided not to
sue received government payouts and we certainly don't begrudge them as
I'm sure that given the choice, they'd prefer to still have their
loved-ones over the money. The problem, in typical government fashion
is that those who were responsible and had insurance policies in place
received less than those who were irresponsible and didn't plan ahead.
I'm not talking about dishwashers at Windows on the World and blue
collar workers; I'm talking about executives, traders and people who
should have known better.
Now our government, the same government that sat by idly watching
as this bubble got bigger and bigger despite many warnings, wants to
step in and bailout people who are in danger of losing their homes.
There has been no talk about educating people, let's not teach people
to fish, rather, let's give them a fish and bail them out once again at
the expense of those who are responsible.
Clearly, by keeping the majority of the population financially
ignorant, there is a lot of money to be made by the poverty industry.
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