Blame abounds for housing bust

Blame abounds for housing bust
December 26, 2007 By Patrice Hill - First of three parts This year's housing bust is shaping up to be one of historic proportions. Sales and construction have sunk to levels not seen since the 1990 savings and loan crisis, while foreclosures and price drops are the largest since the Great Depression — and expected to get worse next year. Many parallels can be seen with earlier housing debacles. Each episode had some combination of easy money, loose lending, greed and fraud that turned a housing boom into a speculative bubble. But few housing bubbles have ended so badly as the one today, when the nation is confronting the prospect of mass foreclosures and family dislocations. John Stumpf, president of Wells Fargo & Co., the second-largest U.S. mortgage lender and a survivor of the housing busts of the 20th century, blames today's crisis on unscrupulous lending practices, which joined in a toxic mix with outright greed and extraordinarily low interest rates to send house prices soaring 90 percent between 2000 and 2006. When the bubble burst, house prices collapsed by 5 percent to 20 percent in cities nationwide. "We have not seen a nationwide decline in housing like this since the Great Depression," Mr. Stumpf told investors in New York last month as major banks and securities firms reported an accumulated $80 billion of losses on their portfolios of mortgage investments and widely cut back on lending as a result. Now the country faces a vicious cycle: As house prices fall, homeowners lose equity in their homes, which makes it more difficult or impossible for them to sell or refinance. Many are not able to refinance their adjustable-rate loans when the starter interest rates expire and reset to reflect higher market rates, and so they are faced with sharply higher mortgage payments they cannot afford to pay. The dilemma has sent defaults and foreclosures to historic levels — with potentially millions more in train in the next two years as more than $1 trillion in mortgages reset nationwide. As homes are sold under pressure, prices drop further and cast a pall over entire neighborhoods, driving down the value of homes of even creditworthy Americans and undermining their biggest source of wealth and security. State and local governments also have been hit hard by the declining revenues from property taxes and real-estate transactions, and the housing slump is dragging down the manufacturing and construction sectors. The whole mess threatens to sink the broader economy the longer it wreaks havoc on consumer confidence and spending power. While Americans have grappled with ballooning mortgages and adjustable interest rates in the past, the epidemic of resetting loans today is unprecedented and is the result of a bewildering array of mortgage options for consumers that banks and securities firms developed and mass marketed for the first time this decade. Consumers often were given the option of not paying principal on their loans and even deferring some interest. Many seemed unaware of the consequences of postponing their obligations and chose to make only minimal payments during the first few months or years, backloading their loans so that the payments increased sharply and even doubled after the interest rates reset. The complexity of the loans was exceeded only by the complicated schemes banks developed to package the loans and market them to sophisticated investors, which involved setting up off-balance-sheet investment vehicles and slicing mortgage securities into segments that supposedly allocated the risk of default away from top-rated tiers to junk-rated bottom tiers. Mr. Stumpf, a 30-year industry veteran, said even he was surprised when he read newspaper articles about what some banks were doing. Wells Fargo avoided the riskiest practices and, as a result, is not suffering the major losses that are crippling top lenders such as Countrywide and Citigroup, though it, too, made some unwise investments in home-equity loans, Mr. Stumpf said. "It's interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine," he joked. Easy money While the unprecedented wave of creative and sometimes questionable loans was a key cause of the housing bubble and ensuing bust, lenders were aided greatly by the lenient policies set by the Federal Reserve from 2000 to 2004, economists say. The housing boom started in the wake of the technology-stock bubble that burst in 2000, which ushered in the 2001 recession and prompted the Fed to dramatically cut interest rates. Housing was just beginning to emerge from a long slumber in the 1990s, as it took much of the decade to recover slowly from the preceding housing bust of 1990-91. As the economy slumped and financial markets sank in the wake of the September 11, 2001, terrorist attacks, the Fed accelerated its rate cuts, adding fuel to the budding housing boom. By mid-2003, the Fed had driven interest rates to the lowest in a generation, with rates on 30-year fixed-rate loans falling to a 40-year low, around 5 percent. The even lower short-term rates set by the Fed drastically cut rates on adjustable-rate mortgages as well as borrowing costs for banks and Wall Street firms, enabling them to invent an array of new mortgage products with irresistibly low starter rates, which appealed to home buyers. While the Fed's actions under former Chairman Alan Greenspan were applauded at the time, many economists now blame the central bank for nurturing the housing bubble. "The Fed played an important role" by encouraging people to shift resources to real estate speculation, said Michael D. Larson, analyst with Weiss Research. "The Fed replaced one bubble, mostly confined to the technology sector, with another, far-larger bubble, encompassing most of the housing market." Mr. Greenspan forcefully rejects such accusations. He contends the housing bubble and credit bubble that accompanied it were worldwide phenomena. Moreover, he maintains the only way the Fed could have stopped the bubble was to have raised interest rates sharply, which would have not only deflated the bubble, but brought down the economy with it. Mr. Larson also blames global investors — including many international banks and hedge funds — for misjudging the risks of the securities. And Wall Street firms, by setting minimal standards on the loans and then securitizing them for sale to distant investors, also "removed, minimized and postponed the consequences of poor lending decisions," he said. Global investors were thirsty for the high returns on subprime and exotic mortgages that were packaged as "collateralized debt obligations," and they trusted the high ratings assigned to most of the debt by Wall Street ratings agencies Moody's Investors Service and Standard & Poor's Corp. The global market "stressed quantity over quality" on loans, making it "easier and more profitable" for mortgage brokers and banks to convince consumers to take inappropriate loans, Mr. Larson said. Loose lending With their low introductory monthly payments and easy terms, the loans were easy to sell to the public. In many ways, mortgage brokers followed the playbook of auto dealers, who swamped their showrooms with people on car-buying binges in 2002 and 2003 by advertising zero-interest loans on their cars. As they did with the car loans, many borrowers who acquired subprime and exotic mortgages with low starter rates rarely looked at the loan's overall costs or terms other than the initial monthly payments that were loudly trumpeted in ads and brochures. Loans with introductory rates as low as 1 percent made the obligations of owning expensive houses appear to be easy or manageable and had the effect of driving up home prices as buyers armed with such loans surged into the market and bid up prices. Home sellers found they were able to raise prices by thousands of dollars from one sale to the next with seemingly no resistance. Even the highest-priced homes at the height of the boom in 2005 and 2006 sold quickly, sometimes within minutes with multiple bids. The new-found wealth for homeowners was just as intoxicating as the easy-money loans that transformed millions of former renters, even those with shaky credit ratings, into proud homeowners. Consumers didn't need to sell their homes to cash in on the double-digit gains in their home values; they used home-equity loans and cash-out refinancings instead. Many people used their homes like ATMs, refinancing once or twice a year to take out equity and using the cash to buy cars, go on vacations and make down payments on second homes or investment properties. By 2005, nearly every homeowner in America had refinanced at least once. The cash-outs, which typically extracted $20,000 to $30,000 from home equity, were an elixir for both consumers and the economy, enabling homeowners to supplement stagnant incomes while stimulating consumer spending, the biggest source of economic growth. Loans came not only with minimal payments but often required no down payments or income documentation, enticing millions of people to jump into the market for second homes and investment properties. Coastal resorts and Sun Belt cities like Miami and Las Vegas became lucrative profit centers for "flippers" who weren't interested in owning properties but only wanted to make quick profits buying and selling them. Cable television offered 24-hour housing channels and TV shows demonstrating how anyone could become a "flipper," putting down as little as $5,000 on a condominium and then reselling at a profit before construction was even finished. Greed stokes craze By the height of the housing boom in late 2005 and early 2006, millions of people had been pulled into real-estate speculation, which had become the new "Internet craze," said Stefan Swanepoel, author of the Swanepoel Trends Report on housing. Tales of making quick money in housing became a hot topic at cocktail parties, while cab drivers offered housing tips. "Anything containing the words 'home or real estate' seemed to be as hot as anything with a dot-com during the late 1990s," Mr. Swanepoel said. "The consumers' hunger seemed to have no end," he said, noting that the buying frenzy was nurtured not only by "a plate full of new mortgages," but "bullish customer confidence" and steady employment and income gains. Thomas Martin, president of the National Mortgage Complaint Center, which has heard from hundreds of homeowners stuck with mortgages they can't afford, said the phenomenon of the housing bubble can be summed up in one word: "Greed." "It was a game of musical chairs," he said. "At some point, the music would stop, and someone would get left without a chair," he said, including the banks, homeowners and pension funds experiencing losses today. Besides the "greedy mortgage industry" and the "suicidal" loans they peddled, Mr. Martin blames regulators and legislators in Congress who were "all asleep at the switch with respect to ridiculous mortgage products." Regulators did not seriously clamp down on questionable lending practices until last week, when the Fed approved tough new rules for lenders nationwide, cracking down on dangerous practices like offering loans to subprime borrowers with no income documentation, often called "liar loans." Congress until this year was largely uncritical of the wave of questionable mortgages and sought only to nurture home sales by heaping more subsidies on the industry. One of the last acts of Congress before it adjourned in 2006 was to accede to the wishes of the mortgage industry by enacting a new tax deduction for mortgage insurance. "The housing boom was good politics, " Mr. Martin said, noting the housing and lending industries are among the biggest campaign contributors to legislators. Moreover, Congress since the 1990s has pushed lenders to offer more credit to blacks, Hispanics and other minorities — a drive that led to an explosion of subprime mortgages that went disproportionately to minorities during the housing boom. The "democratization" of mortgage credit appeared to be a shining success until this year, when the subprime crisis emerged and precipitated a much broader credit crunch and retrenchment from loose lending practices. Widespread fraud also fed the crisis, Mr. Martin said, particularly the inflating of house assessments by appraisers under pressure from mortgage brokers, developers and real-estate agents eager to make sales at ever-higher prices. "The combination of blackmailing real-estate appraisers into inflated valuations, combined with insane mortgage products, creates the perfect storm for a real-estate disaster that could be our nation's most costly real-estate meltdown in history," he said. The Fed moved to ban such coerced appraisals as well as the "liar loans" that were the most widespread fraud perpetuated by individual borrowers. The FBI is pursuing 1,000 cases of mortgage fraud and estimates there were close to 36,000 instances of fraud nationwide. States' attorneys general also are pursuing hundreds of cases. In one notable case, New York Attorney General Andrew M. Cuomo is investigating reputed appraisal fraud in deals done by Washington Mutual, the largest savings and loan in the country and an aggressive marketer of subprime and exotic loans. Back to basics As the sordid tales of tainted loans and gigantic losses emerged this year, borrowers and lenders have returned to the basic practices that once made the U.S. mortgage market one of the safest investment havens on earth. Traditional 30-year, fixed-rate mortgages are back in style, with borrowers now shunning exotic mortgages such as "option ARMs" that they snapped up during the housing craze. Lenders require higher credit scores, larger down payments and bigger fees to cover their losses. To securitize the loans, banks are turning again to the federal lending agencies — Fannie Mae, Freddie Mac and Ginnie Mae — which had fallen out of favor and lost market share during the housing boom. While agency-sponsored loans constituted only 45 percent of the mortgage market in 2005 and 2006, they surged to 72 percent of the market this year. Subprime borrowers now are applying for help from the Federal Housing Administration, the federal home insurer created during the Great Depression to address that earlier housing crisis. The housing saga is far from over, many analysts say. With millions more mortgages resetting in the next two years, many more people could lose their homes. Banks, securities firms and investors could foot another $300 billion in losses, by some estimates. If consumers are daunted by bleak housing news and their loss of wealth and spending power, they could capitulate and send the economy into a recession, economists say. Already, consumer borrowing for home purchases and cash-out refinancings has plummeted from a $1.2 trillion annual rate in the first quarter of 2007 to $691 billion in the last quarter, according to Fed figures. David A. Levy of the Levy Forecasting Center said he expects the economy to muddle through, despite the Ponzi finance schemes that led to the housing collapse, and despite further drops in housing prices that could accumulate to 30 percent or more nationwide. "So far, the housing decline has occurred prior to serious weakness elsewhere in the economy," and that has prevented the problems from being even worse, Mr. Levy said.

The Unintended Consequences of the Housing Bubble Bursting

The Unintended Consequences of the Housing Bubble Bursting (December 10, 2007) As the housing bubble pops with a reverberating shockwave heard round the world, we can be sure the players who inflated it did not intend or anticipate the ramifications now unfolding. Just as the teenagers racing down the cliffside highway with bellies full of alcoholic beverages did not intend to lose control of their vehicle and plunge off the cliff to their deaths, the mortgage brokers, investment bankers and their partners-in-fraud, the rating agencies, did not really intend to bring down the entire economy. Yet this is indeed the "unintended consequence" of the housing bust. Let's consider two "unintended consequences" which are emerging as the housing and mortgage-derivative markets break through the safety barrier and descend in a slow-motion cliff-dive. 1. As risk is "re-priced" higher, the cost of borrowing will rise. Frequent contributor Albert T. explains:
The problem with the bailout is that it devalues money by diluting the weighted average of money outstanding through bailing out people/firms whom shouldn't have got it. Ergo, stupid banks who took stupid risks and stupid borrowers. While we won't notice it right away, when the rate freeze is in effect in actuality it will reprice all new risk with a higher implied rate to compensate for the future freeze possibility, hence we will all pay higher rates to subsidize the current "crack addicts". (emphasis added-CHS) Once this happens two things will occur: five years from now instead of losing 30% on the loan, the bank will lose 70% except that 70% will be insured by the gov't as a thank you for the freeze. Hence we will have the doubling of our money supply on loans that weren't supposed to create it. In effect the gov't will allow banks to print money in the future to make up for the loss today. Albert sent in this link Homeowner bailout is a lousy idea (John Markman, MSM Money) and called attention to the following excerpt as evidence of another kind of risk repricing is already underway:
"Indeed, everywhere you look now is evidence that the subprime-debt crisis is morphing and expanding like a creature in a horror movie. Just this week, we learned from hearings in Congress that strapped credit card companies such as Capital One Financial (COF) and Bank of America (BAC) had begun to soak customers by jacking up interest rates on balances for the slightest changes in their credit profiles." "If you so much as apply for a new credit card, according to testimony gathered at the hearing, your current card provider can boost your rates as high as 30% per year." In other words: since lenders now know the government may "freeze" the rates they've charged customers, they'll be re-pricing those rates higher to compensate for that possibility. If the government might step in and freeze the rates I am charging my customers, then it behooves me to raise rates on all customers now, not just the riskiest ones because, well, it's not longer a "risk-free world." The government might freeze all interest rates, or "low-risk customers" might soon become "poor-risk." How does this re-pricing hurt the economy? Since borrowing is the grease which lubricates the entire economy, re-pricing risk means higher borrowing costs for everyone-- regardless of Fed-Speak or the Fed dropping the Fed Funds Rate. This chart reveals how the ratio of mortgage debt to disposable income has risen far above the last housing bubble top in 1990. Simply put: people are spending more on debt service and this has reduced their remaining disposable income. The rubber band of debt service has already been stretched to extremes unseen in 30 years; so the question becomes, how much more can the rubber band be stretched before it snaps? Just to refresh our awareness of how critical debt/borrowing is to our current "prosperity," take a look at this chart: 2. As non-U.S. investors realize they have been handed hundreds of billions in losses, they will be wary of buying more U.S. debt. We are already hearing that the market for SIVs, CDOs and MBS (mortgage backes securities) is dead, over, gone, dried up, history. And just to refresh our awareness of how debt-based derivatives like CDOs and credit swaps have grown, look at this chart: How dependent is the U.S. on foreign/non-U.S. buyers of debt? Very. The standard number tossed around is the U.S. needs to offload $2 billion a day onto non-U.S. investors just to keep the U.S. debt/borrowing/spending machine humming. But now, as this article from the San Francisco Chronicle details, we have ripped off our non-U.S. investor friends and are busily shredding all evidence of fraud --even though we all know every step of the housing bubble, from appraisals to mortgage funding to securitizing of the mortgages to the rating agencies' "AAA stanp of approval" on those securitized loans was riddled with "wink-wink-nudge-nudge" fraud: MORTGAGE MELTDOWN Interest rate 'freeze' - the real story is fraud
But unfortunately, the "freeze" is just another fraud - and like the other bailout proposals, it has nothing to do with U.S. house prices, with "working families," keeping people in their homes or any of that nonsense. The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value - right now almost 10 times their market worth. The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process. And, to be sure, fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies - all the way up to senior management - knew about it. I can hear the hum of shredders working overtime, and maybe that is the new "hot" industry to invest in. There are lots of people who would like to muzzle subpoena-happy New York Attorney General Andrew Cuomo to buy time and make this all go away. Cuomo is just inches from getting what he needs to start putting a lot of people in prison. I bet some people are trying right now to make him an offer "he can't refuse." I can hear it all now--as no doubt you can, too. The non-U.S. pension or township or sovereign fund, realizing its supposedly "safe" U.S.-based investments are now worth 50% or 20% or perhaps 0% of the purchase price, now go to New York and hire a razor-sharp law firm to force the investment bank which sold them the garbage to buy it back, based on the fraud which permeates the entire pool of mortgages and debt. But oh my gosh, we didn't know it was fraudulent. Proving fraud, after all the emails have been deleted and the hard-drives crushed and the paper trails shredded will be very difficult, indeed. The "innocent" bankers will point to the rating agencies like Moodys, who will point to the mortgage underwriters and brokers, who will point to the originators and the appraisers, who will promptly declare bankruptcy or point to the realtors who forced them to support inflated valuations. And after all the attorneys' fees have been deducted from the paltry settlements reached years from now, there will be pennies left for the non-U.S. investors. We all know how this works because we've seen the play before in the aftermath of the dot-com debacle: investors lose $200 million due to fraud, the company settles for $11 million, the attorneys take $5 million for their work and the investors get a whopping 3% compensation. So how does this massive, seamless, trillion-dollar fraud hurt the U.S. economy? Just ask what happens when non-U.S. players tire of getting ripped off or become wary of "AAA low-risk" U.S.-based debt. What happens is this: when non-U.S. buyers of new debt vanish, then the great debt-churn-spending machine that is the U.S. economy grinds to a halt--or at least loses $700 billion a year in non-U.S. funding. Anyone who is an investor (as opposed to a "pusher" who needs to "fund the junkie's habit" so he can afford to buy more "product", i.e. the central banks of China and Japan) will turn away from U.S. debt (other than Treasuries) in complete disgust. Ask yourself this: if a national government might arbitrarily "freeze" or lower the interest rate being paid on a security, thereby lessening its value, how anxious are you to buy more of that nation's debt? If you do, you'll want a hefty risk-premium to compensate you for the unknown risks that the government will gerrymander your return in order to placate their banker buddies and restive domestic voters. Bottom line: as risk rises, so do borrowing costs. As non-U.S. investors shun new U.S. commercial and mortgage debt, those markets dry up. Since debt can no longer be sold to unwary non-U.S. "marks" (suckers), then who's left to fund $5 trillion in new mortgages? Essentially bankrupt U.S. banks? Negative-equity U.S. households? Negative savings rates Americans? If this sounds bleak, please consider this chart: