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I keep hearing about the banks and their predatory lending. Who did they lend to? People. And why did those people choose to be taken advantage of by the banks? Because they were not educated in finance.
The HIGH SCHOOL my husband and I attended educated the students in business arithmetic, economics, etc. so we would never have taken on a loan that could not be paid off any time we choose and that had an interest rate that changed. Why didn't the people that took out these predatory loans know any better? Why is the United States not educating its students? Why isn't a basic general business class in the schools mandatory for graduation?
No. The economic disaster was caused by the wholesale government intervention in the housing market. In the mid-90s, the government embarked on a policy to put more people into homes as a way to grow household wealth. So when lending restrictions were relaxed in programs such as FHA, Fannie Mae, etc. etc., there was an immediate effect.
Whereas home prices had, for decades, tracked pretty closely with the inflation rate, home prices began to outpace inflation by a few percentage points at first and into the mid-teens by 2004-5. What's more, as someone who works closely with small banks, there was pressure applied to ensure applicants were approved for mortgages, despite being a marginal credit risk. I remember sitting in quite a few meetings of underwriters when the new regulations came down. I remember quite a few old hands shaking their heads and predicting disaster and, boy, were they right.
In fact, two different clients of mine totally bailed from the mortgage business in the late 90s, chiefly because they felt their portfolios were becoming heavy in nonconforming loans and felt helpless to stop it. So they sold out. Others took to selling their paper upstream because they simply didn't want iffy loans on their books. In turn, this led to the government having to find a way to sell these loans to investors, which is why they approved securitization, beginning with Bear Stearns in 1998. Before then, Mortgage Backed Securities were about the safest investment one could hope for outside of U.S. Treasuries. So the investors, assuming the continued safety of MBSs, bought into products that had drastically changed in nature.
In short, the problem had much more to do with the Law Of Unintended Consequences rather than lack of education. It was the people at the top who were the idiots, not the borrowers.
Well, what is the excuse for the higher educated lenders (among others) who loaned money they could not afford to lose? Seems the business education the employees had did not work well for a few companies.
A person not affording their payments just gets their house foreclosed on; a business that takes out too many risky loans in pursuit of short term profit ends up with a failed business that either goes under, or gets a bail out.
No. The economic disaster was caused by the wholesale government intervention in the housing market. In the mid-90s, the government embarked on a policy to put more people into homes as a way to grow household wealth. So when lending restrictions were relaxed in programs such as FHA, Fannie Mae, etc. etc., there was an immediate effect.
Whereas home prices had, for decades, tracked pretty closely with the inflation rate, home prices began to outpace inflation by a few percentage points at first and into the mid-teens by 2004-5. What's more, as someone who works closely with small banks, there was pressure applied to ensure applicants were approved for mortgages, despite being a marginal credit risk. I remember sitting in quite a few meetings of underwriters when the new regulations came down. I remember quite a few old hands shaking their heads and predicting disaster and, boy, were they right.
In fact, two different clients of mine totally bailed from the mortgage business in the late 90s, chiefly because they felt their portfolios were becoming heavy in nonconforming loans and felt helpless to stop it. So they sold out. Others took to selling their paper upstream because they simply didn't want iffy loans on their books. In turn, this led to the government having to find a way to sell these loans to investors, which is why they approved securitization, beginning with Bear Stearns in 1998. Before then, Mortgage Backed Securities were about the safest investment one could hope for outside of U.S. Treasuries. So the investors, assuming the continued safety of MBSs, bought into products that had drastically changed in nature.
In short, the problem had much more to do with the Law Of Unintended Consequences rather than lack of education. It was the people at the top who were the idiots, not the borrowers.
Excellent points! The study of "The Law Of Unintended Consequences," should be a required course in all high schools and universities.
No. The economic disaster was caused by the wholesale government intervention in the housing market. In the mid-90s, the government embarked on a policy to put more people into homes as a way to grow household wealth. So when lending restrictions were relaxed in programs such as FHA, Fannie Mae, etc. etc., there was an immediate effect.
Whereas home prices had, for decades, tracked pretty closely with the inflation rate, home prices began to outpace inflation by a few percentage points at first and into the mid-teens by 2004-5. What's more, as someone who works closely with small banks, there was pressure applied to ensure applicants were approved for mortgages, despite being a marginal credit risk. I remember sitting in quite a few meetings of underwriters when the new regulations came down. I remember quite a few old hands shaking their heads and predicting disaster and, boy, were they right.
In fact, two different clients of mine totally bailed from the mortgage business in the late 90s, chiefly because they felt their portfolios were becoming heavy in nonconforming loans and felt helpless to stop it. So they sold out. Others took to selling their paper upstream because they simply didn't want iffy loans on their books. In turn, this led to the government having to find a way to sell these loans to investors, which is why they approved securitization, beginning with Bear Stearns in 1998. Before then, Mortgage Backed Securities were about the safest investment one could hope for outside of U.S. Treasuries. So the investors, assuming the continued safety of MBSs, bought into products that had drastically changed in nature.
In short, the problem had much more to do with the Law Of Unintended Consequences rather than lack of education. It was the people at the top who were the idiots, not the borrowers.
I understand this part of the problem and Bill Clinton said he was responsible for it. But I don't understand people borrowing money for a home that has an interest rate that can change. We were talking to our son and realized he had one of these loans. Our advice to him was to refinance immediately and he did. Otherwise he would have lost his home too. This is a young man who went through four years of college in agribusiness and graduated third in his class. It amazes me what schools are not teaching these days. My mother said the same about the education I received. We seem to be going backwards in this country when it comes to educating our children.
Oh, I forgot to thank you for your very informative post. You verified many things I had been told before but without the inside knowledge.
I understand this part of the problem and Bill Clinton said he was responsible for it. But I don't understand people borrowing money for a home that has an interest rate that can change. We were talking to our son and realized he had one of these loans. Our advice to him was to refinance immediately and he did. Otherwise he would have lost his home too. This is a young man who went through four years of college in agribusiness and graduated third in his class. It amazes me what schools are not teaching these days. My mother said the same about the education I received. We seem to be going backwards in this country when it comes to educating our children.
Oh, I forgot to thank you for your very informative post. You verified many things I had been told before but without the inside knowledge.
Yeah, totally understand your question. And I see your point.
I think the thing that really came into play was the bevy of new lending that sprung up in the mid-90s and beyond to accommodate a more credit challenged market. One of the reasons that mortgage-backed securities used to be such a safe investment bet was because you traditionally had to put 20% equity on your house. What's more, that restriction ensured that a fiscally-prudent person would be borrowing the money.
Then the Federal government led the way in lowering that barrier to entry, and a few banks abetted matters. Suddenly, non-conforming loans were all over the place. Interest-only, Zero-Down, ARMs, you name it. Basically it was a gigantic case of the Bigger Fool theory, one where you think you'll get out of the game before it falls apart, leaving the Bigger Fool to pick up the pieces. Several incidents stick out in my mind.
First, I remember my wife and I driving through the northern suburbs of Atlanta almost ten years ago. We just couldn't believe the pace of construction and the strange deals popping up. Mind you, this was 2002 and we already knew there was going to be a reckoning. My wife, a VP of Finance, and I started mentally toting up the borrowing costs and realized it was a house of cards right then.
Second, I remember sitting down and talking to a veteran underwriter for a mortgage-driven bank and discussing nonconforming loans. "Used to be, people asked me what the rate was going to be," he offered. "Now they just want to know the monthly payment, like they're buying a car or something. It doesn't matter what the price of the house is. Just the monthly payment. It won't end well." And, because these guys did a lot of nonconforming lending, they really had no choice. Underwriting was essentially pointless by that point because the loans were just sold upriver within two-three weeks. No one cared. And people who raised concerns were punished.
Third, the developers, spurred on by this were just doing crazy things. I was asked to consult on a new home development out in the exurbs of my city with 5,000 homes. This guy had done reasonably well in another market, and had been given a blank check for literally tens of millions by the bank. So he bought property out in the boonies around a lake and just started turning dirt without any kind of research. No absorption study. No environmental impact statement on the lake (Which, by the way, was owned by the metropolitan water works board). No nothing. My gut feel was that this was a disaster in the making and I said so. I finally convinced the guy to spend $20,000 on an absorption study which found that he might, if lucky, sell 250 homes. But he was already millions in the hole. I mean, the Feds had already begun nixing Jumbo loans, but this idiot kept right on building.
Fourth, I remember being called into a meeting with the same bank in Spring, 2006. It was a presentation by a Latino marketing specialist. Given the cultural differences in marketing to Latinos, larger organizations routinely reach out to hire guys like this, so I didn't think much about the meeting. But when I sat down, I found out the presentation was about how illegal aliens were going to be the next great mortgage market. You read right. Illegal aliens. The guy had a nice, thirty-minute powerpoint presentation. In the conference room, I distinctly remember looking around the conference room and watching all these bankers nod their heads in agreement. Bankers. You know, the guys who are supposed to manage risk.
The lights came up, the presenter asked if anyone had questions and I raised my hand. "You mean, you'd lend $250,000 to someone who could get deported the next day?" My God, you would have thought I had spit on the cross in that meeting. One banker said, "Oh, CG, who cares? We'll just sell the paper in a few weeks anyway."
Joseph Kennedy knew when to get out of the stock market when he heard shoeshine boys giving stock tips. I knew it was time to get out after that meeting. I left the building, went home, hired a painter to do some touch-up work, and we put the house on the market a couple of weeks later. We sold on June 30th, 2006, at the tip-top of the housing bubble and bought a modest house for a steal from a motivated seller. Our banker literally asked me, "Why are you buying such a cheap house? You could borrow four times this amount."
Hey, I'm not the sharpest knife in the drawer. But I also don't like wishful thinking. The whole casino-like atmosphere was created by the Federal government in the mid-90s. The more conservative banks resisted for a long time, but finally many succumbed to the belief that this was going to go on forever. I couldn't wrap my head around how a market could absorb yearly double-digit increases in home prices without a reckoning. I couldn't figure out how we'd permanently see Case Schiller indexes north of 200. And whenever I voiced my concern to builders, bankers, and even a couple of Federal guys, I was considered to be the chicken little of the bunch. I remember a client of mine in Las Vegas kept calling me up and bragging about the 17% and 20% increases in home prices out there, with the added bonus of talking about how many properties he was in the process of flipping. He was one of the first to fold when the bad times hit. Holy crap, I think he's living in a trailer somewhere now. And, the last time I was in Las Vegas, there were relatively new homes on the market for $20,000.
But getting back to the consumer. If you're a first-time homebuyer and the Feds are saying it's okay, the developers are saying it's okay, the lenders are saying it's okay, and the shills and whores on cable channels such as Jim Creamer are saying it's okay then consumers will believe it. Because there were relatively few people in 2005 who were saying, "Wait! Wait! Don't do it!" The only people who I remember actually ringing the alarm bell was a writer for Money Magazine in 2005 and a writer for the Atlantic Magazine somewhere around the same time. The rest were just egging the country on, chiefly because journalists have totally defaulted on their responsibilities to their readers and spend more of their time reprinting press releases. So borrowers like your son listened to the prevailing wisdom and likely thought you were the one out of touch, when actually it was you who understood the fundamentals of borrowing.
I can't give cpg35223 anymore rep, but he deserves it.
I have been thinking alot about it lately, and, to be sure there is enough to go around, but the preponderance of the blame squarely lies with the politicians and wholesale government intervention in the housing market in pursuit of some cockamamie social engineering.
Yes, bankers could have shown more backbone, but, to a significant extent, they really had no choice but to follow the lead, even on pain of discrimination lawsuits if they refused. As mentioned, the easier path of resistance was to push these toxic loans upstream where top investment bankers run a revolving door with some of the top government treasury and housing finance posts.
In between you have the home builders, local politicians, and real estate agents.
And, yes, economics and finance should be a regular part of high school education, but how many, among the common people, would refuse what seemed like free money and a house? Not many have that kind of backbone either.
The other thing to realize that the average banker is probably the most unimaginative businessman you've ever met. No, I'll go one further. Most bankers are put-one-foot-in-front-of-the-other clods who never really look up from the pre-ordained paths created for them. Oh, there are a few mavericks in the business but, for the most part, these are guys who get excited by a 1.25% return on assets and are so hamstrung by lending regulations that they can't hardly wiggle their ears. They fill out forms and toss applications out of loan committee if there's so much as a hair out of place because of bank policy, but they never look up and think to themselves, "Does this make a bit of sense?"
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