How did the housing collapse happen?
As thousands of underwater Sacramento homeowners continue to search for solutions to this seemingly unending problem, most have very little understanding of what really caused it to happened. As you evaluate distasteful options that seem to range from bad to worse, you will find a clear understanding of what happened to you is immensely helpful in making the difficult decisions. If you are in this situation and know very little of the abuses in the mortgage markets, read on… this will be enlightening and may ease some of your internal dilemma in saving your financial future.
I used to feel that borrowers had the legal and ethical responsibility to honor the debt. It was your choice to buy a home and borrow the money, you made the commitment to others, you received the benefit and therefore you have the legal, moral and ethical responsibility to repay. Actually, I still feel this way under normal circumstances. I believe there are moral and ethical implications of a promise to repay a debt.
That said, however, I believe that the circumstances of the current mortgage crisis were not legal, moral or ethical to begin with. After a great deal of research about the causes of the mortgage meltdown, I have come to the conclusion that qualified borrowers that purchased during the boom were victims of massive abuses by investment banks in the mortgage and real estate markets. Trillions of dollars were lent to unqualified borrowers because the debt could be packaged and sold as a triple A security to investors worldwide. The reason lending standards were lowered so drastically was to create more debt. It didn’t have to be repaid, just last long enough so it could be quickly packaged and sold to unsuspecting investors. In fact, some of these same investment banks would then purchase Credit Default Swaps from AIG FP and profit again upon the failure of the security they had just sold as the ultimate in safety. Pension and retirement funds, as well as private investors around the world having faith in the US ratings agencies and stability of the US mortgage and housing markets, purchased trillions of dollars in subprime Mortgage Backed Securities and Collateralized Debt Obligations (CDO’s). They were lead to believe that these were investment grade securities backed by the relatively stable US housing market. With T-Bills paying 1%, investors were desperately searching for investments with higher yields that could outpace inflation.
Wall St. Magic: Turning Subprime Loans into a Triple A Security
Wall St. had discovered a modern alchemy by putting a veil around subprime loans and getting them rated Triple A. Lead could truly be sold as gold. However, they needed more lead, so the bar to qualify for a loan was lowered drastically. As a result of these ‘fog a mirror’ lending standards, genuine, qualified borrowers were forced to compete for homes with borrowers that would never be able to repay loans. With an abundance of money in the mortgage market and a mushrooming population of artificial homebuyers, prices naturally skyrocketed. It was a false and unsustainable housing economy.
The more conservative among us would argue that Federal policies on affordable housing pressured banks into making bad loans as the source of the problem. There were clearly pressures and expectations by bank regulators to promote certain, more speculative categories of loans. In my opinion, while this compounded the problem, it was more of a plausible distraction to the greater abuse by investment banks. The governments involvement made the increased availability of mortgage credit less suspicious and the rapid expansion of the housing market a credible event.
Regardless of whether you prefer to blame Wall St. or Washington for lending to people that could never repay, the housing collapse was not a result of responsible borrowers that simply bought a home at the wrong time. It was deliberate fraud and reckless abuse of a treasured American institution. Our industry, and in fact our entire economy, will take many years to recover from the damage that has been created. Many, homeowners will not recover financially in their lifetimes. The SEC complaint for Fraud against former Fannie Mae and Freddie Mac executives is hopefully just the beginning. I believe there should and will be more civil complaints as well as criminal indictments.
So, what should we expect as legally, morally and ethically appropriate from a homeowner that purchased a home under legally, morally and ethically corrupt circumstances?
Sacramento has thousands of families still trying to do the ‘right thing’ in homes that are $100k to $200k underwater. In my opinion, these owners need to do the math and really understand the financial impact of their decision to stay or leave. It is a decision with serious consequences… a choice between bad and worse.
For instance, an Elk Grove homeowner that bought a home in 2006 for $500,000 that is now worth less than $300,000 and still owes about $450,000 will be financially worse off by about $400k to $500k over a twenty year horizon if they choose to ‘do the right thing’ by traditional standards. This amount of money will change the character of their lives, their children’s education and their retirement. Is it reasonable to expect millions of Americans to sacrifice to this degree when the creation of the debt was under questionable circumstances? I think it’s time to reevaluate what ‘the right thing’ to do is.
It’s Time To Examine What Really Happened
I’m surprised so many in the real estate and financial services industries are so indignant about homeowners walking away. How much remorse and contrition should we expect from a homeowner that has been robbed because they had faith in the American Dream of home ownership and the financial and government institutions that make it possible? We played a role in this fiasco. I think we owe the clients we serve a better understanding of what happened and help them face a bitter financial reality. In my opinion, this wasn’t done by the homeowner; rather this was done TO the homeowner… and the taxpayer, and millions of investors all of whom simply had too much faith in the system.
For anyone unfamiliar with the underlying causes of the mortgage and housing situation, I would recommend “All The Devils Are Here”, “The End of Wall St.”, “The Big Short” and the documentary “Inside Job”.
While I am not trying to release anyone from their role in the housing collapse, including Realtors, Mortgage Brokers and the homeowner, I would say any homeowner that has stuck it out this long, overpaying for housing this many years, has demonstrated a more than reasonable commitment to honor the debt. In the final analysis, it’s time for us all to look deeper into the root cause and hold the real culprits accountable.