In case you have not watched Donny Deutsch over the past few weeks, his new format is in-your-face coverage about the financial crisis using CNBC anchors or contributors as guests each night. His favorites seem to be Gasparino and Jeff Mackey. It is very good. It’s funny to see the CNBC guys say things they would never say during the trading day. The word ‘insolvent’ comes up more times during the Donny hour than during than regular 12-hour CNBC day.
Housing and exotic mortgages comes up a lot. Donny is very vocal about helping out the little guy.Gasparino is all about blaming irresponsible home owners for ‘buying homes they could not afford’. Donny on the other hand says ‘people are not financial experts, they do what their banker, Realtors and mortgage professionals tell them to’.
BINGO Donny – you nailed it! Gasparino is wrong.
But Donny needs to take it one step further – at the time the loans were made, most of the people really could afford it.
This housing and mortgage crisis is not a result of millions borrowers buying beyond their means or some massive consumer driven multi-year mortgage fraud era where everyone lied to buy a home. This crisis was caused by fraud alright – but not by the consumer.
The greatest real estate bubble of all time was only able to occur because of the bank’s allowing home owners to use extraordinary leverage created through exotic loan programs and easy credit that never existed before and never will again.
PEOPLE VIEW THEIR HOME AS AN INVESTMENT – NOT A PLACE TO LIVE
What’s worse is that over the past five years there was a fundamental shift of how people viewed their home – from ‘a place to live’ to their single ‘largest investment’. How could they not when all loan programs from Subprime to Prime allowed 50% of gross income (greater when considering limited income doc loans) to be used towards debt. In the good ‘ol days when housing was viewed as a place to live financing was sound with down payments required and no more than 28% of gross income going towards housing debt. 50% debt-to-income ratios changed the game.
Make no mistake about it – MOST BORROWERS ARE NOT WALKING BECAUSE THE CAN’T AFFORD THE PAYMENTS. They are walking because all of their after-tax income each month is going out in bills and the largest portion is going to a home worth half of what they owe. When they are spending such a large portion of their income on a massively depreciating asset, it makes good financial sense to dump that asset. When you can’t sell, that means walk away.
That being said, there are many who can’t afford their payments because of an ARM adjustment. But at one time they were qualified by the bank and given the way the loan was structured they could in fact afford the home. Banks and Realtors in every city in the nation used high-leverage, exotic loans in order get people to qualify for ever increasing loan amounts. By 2005, interest only was industry standard, so was stated income.
Lenders didn’t worry over what would happen to the loan after a few months because the loan was sold and they lose all liability after six months or so. The 2/28 Subprime ARM was a perfect example of a loan program not designed to hold over the initial teaser period and one that the lender didn’t care about because most were sold and securitized. Therefore, who cares about creating loans that will last – just make loans that will last at least six months.
Even the securities investors never planned on holding these long. Exotic loans with teasers were sold as a ‘way to get into the home more cheaply’ or a ‘way to improve your credit then refi into something better a couple of years from now’. The high churn rate out of these loans was what kept MBS money flowing into this sector. They were short-term, high yield investments. This philosophy was not isolated to Subprime 2/28’s either – Prime 5/1 interest only ARMs and Pay Option ARMs were also sold the same way. ARMs were the majority of mortgages in the bubble states through the bubble years.
EVERYONE EARNED $150K PER YEAR
Due to the way the loans were structured, from 2003 through 2007 everyone made $150k a year for the purposes of buying a home. Teaser rates, interest only, high allowable debt-to-income ratios, zero down, stated income etc made all homes affordable and borrowers rich. Home prices responded by surging higher to meet the new found nationally high affordability level. As home prices surged, new loan programs were rolled out what seemed like daily to keep affordability in check.
Everyone was suckered, as these loan programs became the norm. Folks who really earned $150k a year went out and bought over priced homes based upon flawed and temporary fundamentals not knowing they were being suckered. Now they too are upside down in their home by 50% and have seen their life savings go up in smoke. They overpaid because the janitor was bidding against them using a stated income 100% interest only combo. Hey, the loan officer at the bank and the Realtor told the janitor that ‘based upon his income and credit you qualify for this loan’. Why should he argue with his bank? They know best. They are the experts.
But now it is obvious that the past six years was an illusion and none of those easy credit, high-leverage programs exist any longer. Prices are coming down to the real affordability levels using 15 and 30-year fixed rate loans and a down payment, which has rendered the nations financial institutions and millions of home owners instantly insolvent. The same household that earns $75k per year that two years ago could buy a $650k home with no money down can now buy a $275k home with 10% down. It now takes at least $150k a year and a large down payment to buy a $650k home.
100% stated interest only and Pay option ARMs will not return. Nor will 100% HELOCs. They were doomed to fail from their creation. The banks had modeling systems that they never stress tested. You mean to tell me that it never occurred to the smartest guys in the room to plug into the model that home prices could actually fall? That was a fatal error that the world is paying for.
This is why this crisis was never ‘contained’ to Subprime. This is why those who put down 20% are walking away from their homes – it makes for a sound financial decision. Negative equity is now the leading cause of loan default among higher paper grades. As house prices fall further, more will walk.
Yes, there were people who took advantage of the system. But, that was a small percentage of everyone who bought a home on flawed and temporary market fundamentals induced by easy credit and exotic loan programs that never should have existed in the first place. This five year period of absolute recklessness and blind greed on the bank’s part was the real driver of home prices. Taking that away is ‘going straight’ is the leading driver for the destruction of the housing market and consumer.
If not for the unregulated institutions providing unlimited and irresponsible credit and leverage to every household in America this never would have happened.
First off, I am a fan of letting the market work and the housing/foreclosure crisis clearing itself up on its own. We are already seeing positive signs that the Subprime crisis is on the other side of the hill mostly on its own. The problem is that the Alt-A, Jumbo Prime and Prime mountains lie ahead. However, if the government and banks are hell bent on modifications, I am going to use whatever voice I have to try to convince as many as possible to do it the right way.
This blame does mostly lie with the banks, law makers, and regulators (including Greenspan) who branded and endorsed these loans as mainstream until 80% of all loans in the state of CA in 2006 were exotic by definition. This is very similar to the cigarette makers not telling the American consumer for decades that Cigarettes were highly addictive and cause cancer. They were branded as the ‘cool thing to do’ and then lied about the health effects and addictive qualities in nicotine for two decades until science caught up.
To fix the housing market and greatly aid the economy you must focus on two important segments that made up 80% of all housing activity – the refinancer and move-up buyer. Now they are the minority. This is a major problem. We need to get these people back into the market. Investors, vacation home buyers, renters and first-time home buyers have always been the smallest segments of the market and now they its primary participants. The may be great for low priced homes in foreclosure epicenters, but as the problem jumps tracks into Alt-A, Jumbo Prime and Prime, higher end areas will follow down the same path. Without any reasonable financing available for loans over $417k, it is already a foregone conclusion.
Prices are coming down fast and the market will clear at some point and at some level. But that level could be years away. The banks, regulators and lawmakers with all of their terrible loan modification plans will ensure it takes two decades for this to happen. See ‘The Great Loan Modification Pump- God Save Us All! for the reason why. Recidivism rate after loan mod is 50% because most loan mods keep the borrowers levered up and underwater in their homes. The plans by FDIC, banks and lawmakers do exactly this. My plan will achieve the same within a couple of years. Yes, there will be pain but much less. As with the financial institutions, the quicker the borrowers de-lever and raise cash the better for the housing market and economy in general.
It is time for the very same financial institutions that created all of this to do what’s right and re-underwrite every loan originated between 2003 – 2007 using prudent underwriting guidelines. Then, they must reduce the principal balance to what the borrower really earns using a 28% housing and 36% total debt-to-income ratio at a market rate 30-year fixed loan. When home owners are levered at 28/36 they are able to save money and live a decent lifestyle. If they go upside down in their property who cares – they are still able to save money. At 28/36, their home once again becomes a place to live.
If reducing the principal balance to 28/36 on a market rate 30-year fixed loan is $100k lower than the present value of the home, the bank can take can take the differential through a second mortgage or equity warrant. if the borrower sells or walks away then, the banks gets paid. But the home owner gets all of the upside. If the borrowers can’t prove income, then they need to leave the house and rent. They should have been renters all along. Anything less and the program will fail.
This will not prevent housing prices from coming down substantially over the next few years especially considering the massive multi-year foreclosure overhang, gross amount of negative equity across all paper grades and terrible mortgage modifications that the banks and regulatory agencies are now trying to push. But at least it would be the best way to begin to undo the irresponsibility of the past five years and get back to basics where prices are based primarily on traditional factors such as incomes, interest rates, macroeconomic conditions, sentiment and rental rates. – Best, Mr Mortgage