Monday, July 30, 2012

Deja Vu All Over Again

You may have slept through it, but there was a financing debacle a year or two ago that brought the economy to its knees. There are a lot of explanations for what the causes were, but the one we don't want to use is "greedy mortgage lenders."

Businesses that loan money are in it to succeed, not to prop up social causes. If I have investors in my mortgage company then I will be able to take the money under my stewardship and finance home buying. I loan the money to Joe Bagadonutz for his house. He pays me back over time with an addition called interest. To succeed, my interest rate has to be competitive with other sources of financing.

To be sure that I will get that stream of payments there are routine requirements for the borrower to meet. My check on those items is referred to as exercise of "due diligence."

No rocket science here, folks. Before I slip you a Benjamin to get you through the weekend, I'll consider your previous pay-back history. I'll also want to know how you expect to get the money to pay me next week; do you have a source of regular income.

Seems simple enough to me. But then enter the glowing face of Barney Frank and the Community Reinvestment Act.

It starts with one of those standard assertions about the "rights" of every know the song very well, I'm sure. Every American has a right to healthcare. Every American has a right to home ownership. Every American has a right to a college education, a Corvette and a two week spring break in Aruba. Of course those aren't "rights" at all. They are hand-outs. They are supposed to be the product of grasping opportunity and then working hard. You don't have a right to those things. You have a right to seek them through your own dedication and responsibility.

CRA, however, started with your "right" to home ownership. Then it linked denial of mortgage applications to discrimination. Due diligence was not to be allowed. The home-seeker didn't need to have a good credit rating. No flaws in the pay-back record could deny someone their "right". The home buyer didn't need employment history or income stream. As Scarlet said, "I'll worry about that tomorrow."

Those buyers are now identified as the "sub-prime" market. A mortgage lender with common sense would see those loans as very risky and subject to default. He would be out the money and forced to seek foreclosure, which that very same government would vilify.

The solution of a creative marketplace was creation of bundled sub-prime loans into risk-sharing pools. Take one bad loan that fails and you lose everything. Take a thousand bad loans and you may be able to keep the financial ship afloat when 30% of them fail. If an investor only holds 5% of the bad-loan pool and 30% fail then you don't get too big a hickey. Finish the souffle with a big gob of government guarantees, known as the Gold-Dust Twins, Fannie Mae and Freddie Mac. Risk is controlled. We know have a silk purse plus a pair of brocaded slippers emerge from a sow's ear.

That's it in a nut-shell. Sure there are niggling little details, but the bottom line is that loaning money to people with bad credit histories and unreliable income is a short-cut to failure.

Here's the deja vu part:

GM Targeting the Sub-Prime Market

The government jumps in and effectively nationalizes a pair of the  major car-builders. The debt is restructured, the union becomes a major bond-holder, the private market investors take a bath and the Messiah walks on water through the flooded streets of Detroit.

There you are with your bad credit, your minimum wage occasionally show up job, and a luke-warm reception from all of those other car dealers. The Bamster wants to put you in a Volt. You really don't like the Volt because even with some chrome twenties and 20-series profile rubber it still won't get you any street cred. But you're in the dealership, you aren't getting hassled about your ability to pay, and that 3/4 GMC pick-em-up looks cool. Or maybe that rumble-bug Camero with the Belch-Fire Eight and 500 ponies under the hood?

Keep doing the same thing expecting a different result...the definition of insanity.


bongobear said...

That's as clear an explanation of the sub prime mess as I've ever read. I ran a flight department for a large regional bank for 30 years until I retired a couple years ago and I can attest to the fact the government did not play soft ball when it came to forcing banks to go along with this crap. My chairman was able to avoid the exposure somehow but many were not so fortunate. A lot of good people lost a lot of money because of people like that disgusting Barney Frank.

FlyingBarrister said...

Your analysis on the housing mess doesn't really touch on just on how insidious the Dim involvement was in pulling strings on the marionettes at Fannie and Freddie. Fannie and Freddie have gotten so big that they set market terms in the secondary market. In other words, if Fannie and Freddie start offering to do X, they private entities have to follow. If govt officials can push Fannie and Freddie to do X on political considerations and without regards to common sense, prudence, and basic economics, then the market participants have to go along. The real death blow was when Dims got their way and Fannie and Freddie agreed to buy liar loans with crazy terms, like interest only and reverse negative amortization.

Then came the money dump after Sept. 2001, and stupid money followed the herd in real estate after the equities bubble burst in spring 2000 and money needed to go somewhere.