Robert Reich: Problems from Sub-Prime Loans

Is it better to have had a house and lost than to never have had a house at all?:

Home Wreckers, by Robert B. Reich, The American Prospect: Last year, more than a million families lost their homes to bank foreclosures -- a 42 percent jump over 2005... That's still a small percentage of homeowners. But it marks a huge increase in foreclosures -- especially among recipients of what are known as sub-prime loans. These are borrowers with weak credit ratings. They're mostly poor and minority, or young first-time home buyers. All have stretched their budgets to the limits to afford a home. Unfortunately, we're likely to see even more of them lose their homes this year.

A few years ago, banks were awash in money. They were eager to give mortgages to almost anybody who applied. And investors were all too happy to get high yields from mortgage-backed securities. The result was an explosion of sub-prime lending -- along with all sorts of gimmicks making it easy to meet the payments...

Now it's time to pay the piper and the piper's raising rates and calling in the loans. ... The economy is perking up, and adjustable-rates are increasing. ... Some families won't be able to afford the additional payments. ... According to a report issued last month ..., one in five sub-prime loans made in the past two years will end in foreclosure. That's about 2.2 million borrowers who are likely to lose their homes.

Who knows where it will end? Only one thing is clear. Mortgage lenders and investors will come out okay. At worst, they'll have properties they can resell. But meanwhile, millions of families who thought they had found the American dream are ending up in a nightmare.

The anything-goes lending practices of the past few years has made many creditors and investors very rich. But it is taking a large toll on the poor and near-poor. The responsibility of bank regulators isn't just to maintain the solvency of the financial system. It’s also to help Americans buy homes -- and keep them.

I think the Fed could put some thought into whether its regulation of mortgage markets could have performed better, particularly if inevitable swings in the market set inexperienced buyers up for a near certain loss.

Comments

[evagrius]

No one's going to pay attention to this problem as long as it's only the "poor" who are affected.
Let's wait until those ARM's start flexing their muscle and squeezing the middle-class.

[ken melvin]

Gratitude. We should all show proper gratitude to those who, with Greenspan's help, rescued those dormant dollars and used them to save the nation.

[John H. Morrison]

If we had been under a Democratic President, the FED under Greenspan would have taken the view of the importance of carefully monitoring and controlling the irresponsible exuberance.

Okay, they didn't do it with the dot.coms. But the dot.coms were 'Publicans, at least potentially.

[brewster]

"I think the Fed could put some thought into whether its regulation of mortgage markets could have performed better, particularly if inevitable swings in the market set inexperienced buyers up for a near certain loss."

In a very illiquid market, loose credit drives prices high. Fed comes out with study saying market is driven by income, rather than loose lending. Chairman comes out advice that home buyers should take ARMs. All those who point out that speculation based on fraud and loose lending is driving prices up are called nuts and bubble-heads.

If this was all a calculated effort to achieve monetary policy ends, dropping money from helicopters would have been much better. It would have been more equitable.

Now the poor, near poor are going to get screwed, the middle class will get squeezed by ARMs, and the prudent get caught in the crossfire.

The bankers, brokers, investors and creditors would however be fine.

The Fed however has acted. The new lending regulations are being adopted now, since the looting is all over.

[johnchx]

I have a somewhat different take on who is going to be hurt by the unwinding of the real estate / exotic mortgage bubble.

First, the poor and the near-poor are, by and large, immune. Despite everything we've heard about loosening credit criteria, nobody is in the business of lending hundreds of thousands of dollars to families with incomes anywhere near the poverty line. The poor rent, because they have to.

Now, there are undoubtedly some lower-middle class families that have over-extended themselves with the help of exotic mortgages, and rising payments may well squeeze their finances painfully. For reasons which will become apparent below, let's call this group "the hostages."

Finally, the people that face the most significant financial losses are the amateur real estate tycoons of the upper-middle (or lower-upper, if you prefer) class. These are the folks who bought $800,000 McMansions for themselves and one or two "lesser" properties to "flip." These are the folks who laughed at or lectured to those of us too timid to get in on the easy money bonanza. And these are the folks who locked in mortgage deals that blow up in two years, because they didn't expect to be holding the mortgage in two years.

So, if my characterization of the major groups in play is more or less accurate, how would we expect the politics to play out?

I forsee a federally-financed bail-out for over-extended mortgagees. In debating the program, we will hear a great deal about hard-working lower-middle class families who have lost or may lose their homes: the hostages. But it will turn out that the program which actually passes Congress, while rescuing the hostages, will also result in an extremely lucrative bail-out for the amateur real estate tycoons. And nobody will be all that surprised when it turns out that the majority of the dollars spent will wind up in the pockets of those who told us that the real estate bonanza was a no-lose proposition...proving them right.

Or am I just being cynical?

[Ethan]

Johnchx:
You're not being cynical; you're being realistic. Check the comments in the preceeding post on inequality. You won't need to ask your question again.

[piglet]

The anything-goes lending practices of the past few years has made many creditors and investors very rich. But it is taking a large toll on the poor and near-poor.

Why doesn't anybody mention that the near-poor (the poor don't get credit anyway) are charged considerably higher rates than the rich (sorry, the "prime loan recipients"). How surprising is it that they are left struggling?

[unemployed observer]

I think in this case, regulator has a role to prvent those agressive loan program banks offered. But more important, it is the problem of individual investors that did not face the reality. They know how much they make, they know how much they have to pay for the mortgage payment, they how how those aggressive loan program works. They always have the right to NOT buying the house. They always have the right not to take those loan. They still take the risk. they have to pay for thier mistake.

We should remember any trade involves two parties. It is quite inappropriate to blam solely on the sellers. the buyers should be blamed as well if they are true speculators.

The people really suffers are those who can afford the house at the "normal" price (that price follows the historical trend), but not the bubbled price. They have to rent an apartment, or moved to far away places.

[Cassandra]

johnchx

There was a time when I, too, foresaw the same. But now, as a result of the irrepressible optimism of our Anne, the sanguine concern of CBs in respect of leveraged global finance & apparently near zero-cost funding via carry trades, combined with asymmetrically loose and morally hazardous "wait until I see the white's of its eye's" approach to inflation championed by Dr Bernanke (and practically everyone else who lists "politics" as their chief source of income), I believe that there will be little contagion to the speculative American Housing pecadillo, and that nominal house prices will even (along with any and all other assets positively correlated with liquidity from farmland, van Gogh's "Portrait of Gachet" to the rarefied Honus Wagner T204 baseball card), resume their nominal ascent.

That is, at least until the bond market is permitted by enabling CBs & other Official Monetary Authorities to reflect the inflationary potential of their dollar hoards. Until then, red is green, cats love dogs, and debt is wealth, the more the merrier!

[offo]

johnchx:
I forsee a federally-financed bail-out for over-extended mortgagees. In debating the program, we will hear a great deal about hard-working lower-middle class families who have lost or may lose their homes: the hostages. But it will turn out that the program which actually passes Congress, while rescuing the hostages, will also result in an extremely lucrative bail-out for the amateur real estate tycoons.

Like Iraq -we created the mess, so we should fix it? Bush/Iraq and Fed/housing are like evil twins when it comes to dealing with reality.

Who was responsible for letting this frenzy of loose lending continue so far? This was all too predictable, much, much earlier.

The Fed actively aided/abetted the deniers of the mania. They sat in ivory towers, cherry-picked the data and made out what they wanted to see. More charitably, they stopped when they saw what they wanted - asking more would have meant acknowledging reality. I suspect they knew very well what was going on, but as long as there was plausible deniability, they couldn't care less.

If they were really interested to know what was going on, turning on the car radio or looking out the window to read the hand signs would have been enough. "Bankrupt? no income? Cant document income? No pulse? Cant pay your bills? No problem, you can buy a house, and get wealthy"

And if you think that 'hostages' are few, you should read some of the Cali papers. Anyone who could fog a mirror was cajoled into buying a house. (Even today - you are bombarded with sub-prime ads). These are ordinary folks like janitors, yard keepers, waiters and so on. Yeah, 'you could afford it', 'prices always go up', 'renting is for losers' was all they heard. These people are not destitute - more likely one or two paychecks away from it.

But it will turn out that the program which actually passes Congress, while rescuing the hostages, will also result in an extremely lucrative bail-out for the amateur real estate tycoons.

So true. But the time to stop this, was way back, when this mania was getting started. Now it's fait accompli.

Socialize risk, privatize gain. Anyone who claims all this was unpredictable then, should give up the world and enter a monastery.

[fred c. dobbs]

Unemployed observer: "They know how much they make, they know how much they have to pay for the mortgage payment, they [know] how those aggressive loan program[s] works."

You think so? There is no obligation on the part of the lender to disclose "how much they have to pay" once the teaser rate goes away, or when the ARM adjusts. The average homebuyer has no clue as to "how those aggressive loan programs work." They are relying on the professionals in the room: the real estate agent, the mortgage broker, the title agent and the seller's lawyer.

Go to a signing and you've got 400 pieces of paper to sign. You think even 1% of buyers read the fine print?

This is like telling cancer patients that they know how an MRI works.

In the distant past, you might have expected the mortgage banker to be careful not to lend more money than someone could repay, but with the secondary mortgage market of today, it's just not his problem if the loan goes sour. And the investor who buys that mortgage is just betting that 90% or 95% of the loans will be repaid.

And that's the real issue for the Fed and the other regulators: They are looking out for the banker, not for you!!!!!

[Bruce Webb]

What Johncx said. Because this is probably hyperbole:

"Last year, more than a million families lost their homes to bank foreclosures"

Were all of those "million families" actually families? How many of these foreclosures represent owner-occupied and how many are investor owned?

It is not just hostages that use sub-prime lenders, aggressive investors do as well, they allow you to convert credit to equity positions. You can make a lot of money using exotic mortgages, or you can stick with those strategies in markets like Phoenix and Las Vegas and end up under water in a hurry.

I for one am not going to lose any tears because some investor or group of investors lost money because they couldn't flip that empty block of condo units. That is just the other side of the risk/reward ratio.

We already saw this with the S&L bailout. Not only was it a mistake to raise the amount of savings that was insured, it added crime to folly to make everyone whole even more amounts over the cap. In effect S&L depositors were drawing down returns that were based on a certain level of risk, when things went bad risk was simply discounted to zero. For the wealthy anyway.

So I would like to seem some quantification of those million foreclosures to see how many were actually owner-occupied.

There are real victims in the sub-prime market, there are lenders who really, really belong in jail. But this kind of broad brush denunciation of a financing tool that has put lots of people in houses at rates they can afford in markets that will allow them to refinance before reset and whose jobs and credit support it is a little too sweeping.

Target the crooked lenders, not the particular tools professional lenders and investors use.

[fiskhus jim]

In any situation like this, i.e., Publicans and money, we must never discount the Organized Crime factors such as the bust-out, extortion, etc. Many times, when the Publicans design the system, they design it to create default situations where they get to charge the customer for the asset and yet retain the asset.

It's criminal, it's immoral, it's unAmerican - but it's how these folks do business.

[ken melvin]

Blaming the victim is the favorite, hands down.

[offo]

BW,
Were all of those "million families" actually families? How many of these foreclosures represent owner-occupied and how many are investor owned?

At least in Cali, you are going to be surprised. Far too many people are in trouble because they overbought, not because they speculated.

For your edification, I suggest you hang around some broker forums for some clue on what was (and is) really going on. For eg:

http://forum.brokeroutpost.com/loans/forum/2/90346.htm

That should tell you how rare the scrupulous are in the lending business.

this kind of broad brush denunciation of a financing tool that has put lots of people in houses at rates they can afford in markets that will allow them to refinance before reset and whose jobs and credit support it

Don't know where you live-it may be true there, but not at least in Cali. (And probably on the other hot markets too) Here in Cali, these 'tools' have been, for quite some time, pushed onto people who are not the right ones for it. Remarkable, what people will do for commissions.

It would be interesting to hear your estimate of use of these "financial tools" - what fraction was misuse and what was legitimate.

BTW, "markets that will allow them to refinance before reset" is the very definition of an asset bubble.

No tears for investors? I'm with you. No tears for people who overbought either. Put the crooks in jail, let people get their side of the risk/reward ratio.

[unemployed observer]

fred c. dobbs:
I am not sure you are one of those facing higher mortgage rate soon. Buying/investing a house is the biggest investment for most people. but if you are not reading those documents carefully, and if those documents are available to read (not hide by the banker), will this be the investor's problem?

By the end of the day, if reading those documents are too difficult, I think you may be able to find a lawyer, paying a few thousand $ to help you out.

Also, as I mentioned, the job of the regulator should be increasing transparency, not tailor the mortgage schedule of the bank.

btw, I am not in the mortgage industry at all, so, no bias against the investor/speculator.

[theroxylandr]

In the last few weeks subprime lending business is in freefall. The implode-o-meter site http://ml-implode.com/ is counting every busted lender.

The credit protection index ABX is in freefall: http://www.markit.com/information/affiliations/abx

Expect major implosions and fireworks in this business this month, with significant implications to foreclosures and home prices. You saw nothing yet in housing bubble bust.

[Real Person from the Real World]

Brewster - The Fed however has acted. The new lending regulations are being adopted now, since the looting is all over. - Right on! Same with the bankrupcy laws, all the celebs and other high-roll deadbeats got theirs, now the people with medical debt are stuck being penalized.
johnchx - Sorry, but you have a really skewed perception of what "poor" is. In the US, few starve, but living from paycheck to paycheck and at risk with no health care because your job is low paid, doesn't mean you are affluent either. Our middle class is losing more and more ground, and becoming just the upper end of the working poor, not the lower end of the affluent.
Part of the problem is that credit card companies are getting religion, and want something to back debt, since many of us now barely make a decent buck. I just got an offer from Chase, to let me use my credit card against my home equity. I built that up, but am low paid, so the offer is made.... besides, my house is in a good area, and if they get it, the bank can sell it for plenty. Credit card backed banks have sucked people dry and are efficiently going for the last drop of blood, people's homes. Hardly surprising. Even the IRS takes a credit card payment now, for taxes. Amazing, you can get points on an airline, for paying your taxes or paying off your medical bills! Homes are just a quick and easy scam to get even more from hard pressed consumers. Have to maintain that cash flow stream, so that the financial upper crust and get bigger bonuses.

[cm]

There is another element -- when the tide goes out, those in shallower water will be exposed first, and a lot depends on how low the water level goes.

There are regional variations in the distribution of income and "real" assets which have an impact on RE prices and dynamics, and what it means to be "middle-class" or "rich". In any top-skewed distribution, only few can be above average. For example, in the SF Bay Area, I venture that well-paid professionals are a relatively large portion of workers, and they are pretty high up in the national income distribution (and to a much lesser extent net wealth distribution), but locally many of them are at most average when it comes to "competitive" cost-of-living expenses like housing affordability, healthcare, or school/college tuition.

For those who bought here just after 2000, 500K is pretty much the low end of SFH, 700K+ the norm, and 1 million not extravagant. Many people who I know bought with, and/or refinanced into, 5/1 ARMs.

In 2006, in I'd say good, average, but not outstanding "Silicon Valley" neighborhoods, 700-800K for unrenovated and minimally maintained units in need of varying levels of "rehabbing" were not a rarity, and all those places finally sold. Much of the housing stock here is from the 50's.

I don't know how even a well-paid professional household would afford that without committing itself to a high level of long-term risk.