Housing Bust Answers – Moon of Alabama

July 15, 2008

Housing Bust Answers

Bellfong asks:

Off topic, but isn’t the crackdown on poor lending practices just cover for defaults based on variable rate mortgages? I recall mortgage rates rising moderately, never going back to record lows even with the fed dropping its rate further in the last couple years. So, was the scam to get people who were happy to qualify for any loan at all into a variable rate mortgage, then take the properties from them down the road? Is this the real scam, with the income-not-verified practice just a cover? Obviously it all fell apart with recession, job losses, cost of living gone up and drying up of liquidity in the mortgage market pushing rates up, but it seems like there’s more to tell, ..

Let me take that in parts:

isn’t the crackdown on poor lending practices just cover for defaults based on variable rate mortgages?

No. The defaults will happen anyway. There is nothing left to cover. Yesterdays the Fed revived regulation that will discontinue some loans types. It is closing the barn door after the horse is out of sight. This is ass covering by a Fed that has not done its regulatory job for more than a decade.

I recall mortgage rates rising moderately, never going back to record lows even with the fed dropping its rate further in the last couple years.

Hmm – that is not really true if one looks at this chart. Mortgage rates pretty much followed the Fed’s fund rate.

So, was the scam to get people who were happy to qualify for any loan at all into a variable rate mortgage, then take the properties from them down the road?

The people who sell the mortgages to the borrowers only care for the money they get when the mortgage is signed. They are not interested in anything else. What drove this bubble was greed at every level and the ability to obfuscate the risk and then push it to investors who lacked the ability or will to see it. I for one don’t see any great conspiracy in that.

Greed is driving markets and unchecked greed leads to bad decision. That is the reason why sane societies decided to regulate markets centuries ago. The U.S. forgot the lesson last learned during the 1930s depression that free markets are indeed bad. Since Reagan the trend was to deregulate. We now see and feel the consequences.

Obviously it all fell apart with recession, job losses, cost of living gone up and drying up of liquidity in the mortgage market pushing rates up, but it seems like there’s more to tell

The current recession is very much the consequence of the bursting of the housing bubble (and higher oil prices) rather than the the other way around. The housing bubble burst because the housing market ran out of customers and housing prices stopped to increase. The homeownership rate reached a historic high (graph) of 69% at the beginning of 2005 and went back down from there. All new houses built after that date added to inventory and depressed prices. Lending to ‘dead’ people and speculation obfuscated the situation for a while, but the bubble burst because it ran out of people who needed houses. (The ‘natural’ historic homeownership rate in the U.S. is some 63%.)

One should note that the expansion after the 2000 dot.com bubble burst was a small and artificial one. It was driven by too low fed rates that led to investment in unproductive real estate and by a classic Keynesian program of debt financed government spending in the unproductive homeland security and defense sectors. This leg of the recession will be very deep because the last 8 years were wasted. They were not used to invest in productive stuff like infrastructure, production equipment and research. I believe that economic historians will see the current recession as a continuation of the 2000 bust.

YY asks:

Can some enlightened soul explain to me how the so called sub-prime crisis isn’t just the end of what is in fact a ponzi scheme. The part I’m suspecting is that when the CDO’s are reconfigured to AAA and junk, wouldn’t there have to be an ever increasing stream of "good" portions of mortgages to come in to offset the junk which may as well be discarded. And since the source is the same collection of dubious debts, wouldn’t the volume need to increase exponentially to even keep the marketing going? Never mind what happens(ed) when the payments started coming due.

Yes, it was a ponzi like scheme.

The reconfiguring of Collateral Debt Obligations (bundles of mortgages) into well rated parts and badly or not rated parts was a critical point. When the originators of the CDOs couldn’t come up with enough good AAA parts, they just declared the AA parts to be AAA. The rating agencies are only payed by the originator when they rate the originators stuff. If they would have denied these AAA ratings of essentially junk they would have lost business. So they took the bribes, agreed to the scheme and investors who trusted their ratings got scammed. The next years will see a lot of litigation against these agencies.

Posted by b on July 15, 2008 at 18:27 UTC | Permalink

Comments

Ok, here’s my conspiracy theory- The Fed and others are afraid of inflation but can’t do much about it because of rising oil prices and the decline of the dollar. The answer is to eliminate some pools of dollars that are sloshing around bidding up commodities and assets. So they gut formerly ‘safe’ investments that foreigners and working stiff pension funds have invested in like Fannie and Freddie and municipals. Billions evaporate, inflationary pressures ease. The rich stay rich. Deflation is only scary when it affects you.
As for the greed thing- I think that most people, seeing the flat wages of the last 30 years and no prospect of things even staying level in the future, just wanted to feel like they were getting ahead for a change. Yes, the greedy who proudly fancied themselves as speculators deserved to get it in the neck, but many bought A house just to live in. Feeling like a chump motivates people to take that roll of the dice.

Posted by: biklett | Jul 15 2008 19:02 utc | 1

Even if the lack of parts caused “false” upgrading of fake bad parts to fake good parts would there still have been enough parts? What ethical, or rather accounting constraints keep the originators from producing more CDO’s than the existing over valued debts? If producing over inflated securities are possible why not securities fashioned out of thin air? What is it that keeps things from turning into complete chaos as opposed to controlled chaos?

Posted by: YY | Jul 15 2008 23:38 utc | 2

“The next years will see a lot of litigation against these agencies.”
The rating agencies are paid by the folks who are rated .. if you rely on those ratings, they have no contract with you. It’s like trying to sue the newspaper horse racing tipster.
Furthermore they rely for their information on the Directors of the company etc.,they assume that the auditors check the books.
It will be a clever lawyer who prises any money from their hands.
This is what Lord King Chairman of the Bank of England said in his annual speech to the great and the good of the City of London at the Mansion House just over one year ago on the 16th June 2007…
“Our central view remains that inflation will fall back this year as the rises in domestic gas and electricity prices last year drop out of the annual comparison, and the recent cuts in prices feed through to household bills.”
He was dead wrong. Can I sue him because I based my financial decisions on his faulty views on the future course of inflation?
If you can’t trust what the Governor of the BOE says, who can you trust ? Well a lot of folks have discovered the answer is… no-one.

Posted by: ziz | Jul 15 2008 23:59 utc | 3

We know already that all productivity gains in the past 30yrs in US got sucked up into capital. So there is this pool sloshing around. And this is happening world over more or less as the fruits of labor, as it were, are being collected into pools that slosh. The capital move around seeking returns but are not discriminating as to how value producing the targets are. So capital go chasing other capital, wrecking havoc by causing huge price increases in commodities which are just inelastic enough in supply to have any opposing effect. This is sort of like having a million bucks in the bank but only having a quarter at the hot dog stand.

Posted by: YY | Jul 16 2008 1:15 utc | 4

I forget where(Harpers?Vanity Fair?) but I remember reading a article that said this scam was first thought up by 6 Hedge Fund managers at lunch in NY City.Or at least they have took credit for it so that it is thought they did.

Posted by: R.L. | Jul 16 2008 1:46 utc | 5

Goodness somebody remind a guy to go check a rate graph before going on the record around here! That post was a half boiled thought from 2 years back brought up again by the current mantra about bad loans, unverified income. Thank you for some economics to soar partly overhead. But on the meme, surely there is something more relevant, that loans of any kind were great because either you got interest and the principle returned or you took the house from the sucker that paid interest until it was time for the boot. Especially pushing the var rate stuff. Rent rates are lower than mortgage – are we to only blame the defaulter with education being what it isn’t? Do high default rates mean penalties or less credit for the bank – oh wait, I’ve waded into deeper waters again – here come the tsunamisans!

Posted by: bellgong | Jul 16 2008 4:06 utc | 6

Ahh, the infinite beauty of third person infinitive as fiduciary layoff.
e.g.
The ‘housing bubble’ caused the ‘economic slump’, it wasn’t us!
The ‘default rate’ caused the ‘credit freeze’, it wasn’t us!
The ‘shorter skirts’ caused the ‘market selloff’, it wasn’t us!
A Martian reading the NY Times in his space ship would conclude (after Rosetta Stone language training, of course), that humans pretty much just screw and make speeches, while the ‘invisible hand’, the ‘iron fist in the velvet glove’, the ‘market incentives’, the ‘economic stimulus plan’ are what really does the work.
[VFX- Roll Jerry Falwell’s tearful “I have sinned” speech in 3… 2… ]
[VFX- Roll Bill Clinton’s quavering “I did not have sex” speech in 3… 2… ]
So how does Wall Street get away with their shifty eyed mewling, “No sey?”
!!There are no third person infinitive economic causations!!
Phil Gramm deregulated the banks, and included the Enron loophole at Ken Lay’s bequest. Alan Greenspan ignored the dot.con neutron bomb until tens of millions
had lost their life savings, then immediately cut rates again after the dot.con sell off, irregardless of 9/11 distraction, and ignored the housing-food-energy bubble which Phil Gramm and Ken Lay’s deregulation was sure to cause.
Ben, ahh, Helicopter Ben. He gets to write the economic collapse epic of our era.
There are many other scurious actors reaching all the way back to Ivan Boeski and Michael Milken, who include everyone from Warren Buffet to George Soros now, and even Goldman Sachs, which mysteriously sidestepped the CDO/SIV contagion right
about the time Hank Paulsen got elevated to Treasury and read the secret stats.
Let’s repeat. ARM’s don’t cause economic recession, Phil Gramm nee Ken Lay-ism does.
Good job, men!! We are now officially fookted. Class action these rat bastards off the planet for destroying your fiscal futures, or they’ll do it again, and again.

Posted by: Scurious McCain | Jul 16 2008 6:24 utc | 7

There will be no prosecutions, nor even any investigations of the financial and political crimes of the two Bush terms. There will be no payback nor recompense to those deceived, robbed, maimed, killed. There will not even be a Truth Commission to simply explore without vengeance an accounting of how our Republic went further afield than even the Third Reich in some ways.
For that would be a high farce. That would be asking half the whores in the bordello to sit in judgment of the shocking escapades and easy virtues of the rest. Such a trial couldn’t stand up long enough for opening statements to be made.
The entire Congress, the full House and Senate, will need to be dragged before honest investigators and prosecutors and their conduct compared to the written laws of the land, to the oaths of office they took, and to the Constitution they have rendered moot if there is to be an accounting of our failure as a Republic.
Because this will ever happen, our nation will slide all the more readily into an impoverished authoritarian hell where the corporatist State is what matters, is all that matters, and every citizen is but fodder for its maw.
From banks and corporations too big to fail it is no step at all to a Federal government too big to fail. The only inalienable right in force in America is for the Federal government to increase its size, budget, strength, reach, power, purse, armaments, and control.
We, the people, are its natural prey, and its only true enemy.

Posted by: Anonymous | Jul 16 2008 6:45 utc | 8

@YY – 2 – If producing over inflated securities are possible why not securities fashioned out of thin air?
That is exactly what the bankers thought of and they immediately implemented it. Ever heard of synthetic CDO’s? These are derivatives created from thin air. Their volume is a multiple of the underlying real asset market.

Synthetic CDOs do not own cash assets like bonds or loans. Instead, synthetic CDOs gain credit exposure to a portfolio of fixed income assets without owning those assets through the use of credit default swaps, a derivatives instrument. (Under such a swap, the credit protection seller, the CDO, receives periodic cash payments, called premiums, in exchange for agreeing to assume the risk of loss on a specific asset in the event that asset experiences a default or other credit event.) Like a cash CDO, the risk of loss on the CDO’s portfolio is divided into tranches. Losses will first affect the equity tranche, next the mezzanine tranches, and finally the senior tranche. Each tranche receives a periodic payment (the swap premium), with the junior tranches offering higher premiums.

Posted by: b | Jul 16 2008 11:29 utc | 9

b:
Is that also called side betting in non-financial circles?

Posted by: YY | Jul 16 2008 12:10 utc | 10

b: Forget that one.
Your example still sounds as if there is an asset that would sustain a loss as opposed to a complete fiction which would be a loss in total from start. This would be very Ponzi. I’m just concerned that the rules to the extent they are followed does allow for cheats. What keeps complete and utter fraudulent dealing from taking place? For example not serial selling of assets but duplicate and triplicate sale of assets. It’s just that a “synthetic” device such as a CDO is much like mystery meat, which can be made without cow.

Posted by: YY | Jul 16 2008 12:17 utc | 11

Above and beyond human factors such as cupidity and stupidity, the single thing most responsible for the mess we’re presently in is monopoly ownership of news and entertainment media. We the people, citizens of the United States, are expected to make rational decisions when we go to the ballot box. But how can anyone expect rational decisions from a gang of people who have been systematically pumped full of shit by paid professional liars?

Posted by: Jimmy Montague | Jul 16 2008 13:12 utc | 12

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