Re: [MLUG - DISCUSSION] ideas about housing crisis

["Jonathan King" <EMAIL:PROTECTED>]

On Feb 1, 2008 6:57 PM, Mike Miller <EMAIL:PROTECTED> wrote:
> On Fri, 1 Feb 2008, Jonathan King wrote:
>
> > Actually, that's not it at all. You are totally wrong here.
>
> Can you find a third way to say that?  ;-)

Why stop at three?

> > the intent was not to foreclose, because that loan would be held by
> > somebody in Dusseldorf or Chicago by the time that the people mailed the
> > keys back in Florida.
>
> OK, I can believe that.  The intent was not to foreclose, but you are
> saying that foreclosure had no effect on the people who made the loan, and
> I guess that meant they didn't care if the recipients of the loan were
> qualified.

As it turns out, there was some effect on people who made the loans
because, by the end of the bubble, some loan shops were making loans
that were so bad that they would be delinquent *within 90 days*, which
usually meant that they had to buy them back, and, not surprisingly,
find themselves unable to sell them.

> So, to answer my longstanding question of who was making money from this,
> putting together what I wrote and your reply, I'm getting (1) banks, (2)
> people on Wall Street who securitize mortgages into CDOs and such,

as long as they didn't buy what they were creating

> (3) mortgage brokers.  The definite losers were people who bought the CDOS.

*If* they were unhedged. In the olden days (say back in 2002 or so)
you wouldn't buy something like that without hedging your downside
risk in some way.

Ratings agencies also did well, as did monoline insurers. The latter
are in seriously bad shape now, however, because they are having to
pay out.

> Depending on timing, homeowners could be winners or losers.

That's pretty much it. Speculators who got in too late were/are really crushed.

> People
> selling CDOs lost something when they got caught holding them at the end
> of the game.

OK, not to confuse the issue, but there are several products and
layers of products here. The generic financial product is the
mortgage-backed security (MBS), which is essentially a bond whose
interest rate mirrors that of the underlying mortgages. Those are all
over the map. CDOs were designed to hedge risk, but the hedging fails
when the housing market tanks in most places simultaneously.

Home builders also did fabulously well until they got caught with
houses they couldn't sell but were still caught paying construction
loans on.

Overall, growth of GDP was strongly helped by the economic activity
surrounding the housing bubble, and this is why we are having problems
now.

> The big crime seems to have been with Wall Street financiers packaging
> dubious mortgages into AAA securities.  I suppose the banks that gave out
> dubious mortgages pretended they were as solid as ever.  Mortgage brokers
> were negligent, but only because banks let them be negligent and paid them
> to be negligent.
>
> Am I closer now?

You're closer now, but you don't have the parts played by ratings
agencies, who assigned the AAA (or other investment-grade ratings) to
the CDOs, and the bond insurers, who helped prop up the ratings on
some of this stuff. In some cases, the mortgage brokers were downright
corrupt, but in most cases, just greedy and stupid. And that's the
difficulty with all of this: it was mostly greed and stupidity that
caused the current problem. In retrospect, it's pretty easy to see
that housing prices cannot keep on going up 10% a year (or more) when
no combination of income growth and population growth can support
that. As in most bubbles, the thought was that "this time, it's
different". But it really wasn't.

> Another question arises:  What changes allowed all of these events to
> transpire?  Was it merely low interest rates from the Fed?  Or was there
> some change in law that made it possible?

Super-low rates fueled the bubble, as did the honest seeds of real
appreciation in many bubble areas. For example, the DC housing market
had been fairly slow for most of the 90s and housing was arguably
undervalued, because there are places that are clearly worth more
given the difficulties of commuting into or around DC. Montgomery
County (where I live) had healthy population growth in the late 90s
and early 00s, and some of the really desirable locations were all
built out. But the fact that housing prices started to increase *plus*
the fact that mortgage rates were low caused something of a bidding
war, and then the very high rates of appreciation made some people
think that this could go on for quite a long time, which meant that
they could afford to bid housing up further, and...classic bubble.

There were some legal changes that problematic effects. Glass-Seagal
was eliminated during the Clinton administration. The Fed had the
*ability* to regulate mortgage rating, but Alan Greenspan chose not
to. Changes in capital gains tax law made it more profitable to
speculate in real estate. But the big thing was the bubble mentality
fed by super low rates and (usually) some small seed of rational
belief that housing prices should be higher.

> It seems to me that we are perennially in the midst of one
> multi-multi-billion dollar ripoff or another.  Consider the S&L Scandal of
> the late 1980s and early 1990s.  In some ways it was pretty similar to
> what just happened:

The S&L debacle was a pretty clear case of moral hazard. S&Ls
originally were only allowed to make boring loans on housing (that was
boring in those days), but were freed to invest in things like
commercial real estate in the 80s. The problem was that deposits were
insured by the government, so the winning business proposition was to
try and make a ton of money by making high rate loans on (commercial)
real estate. If the loans did well, you won. If they didn't, the Feds
would pay off the depositors. In a situation like this, you are asking
for bad things to happen.

>     ...many S&Ls lent far more money than was prudent, and to risky ventures
>     which many S&Ls were not qualified to assess.  L. William Seidman,
>     former chairman of both the FDIC and the Resolution Trust Corporation,
>     stated, "The banking problems of the '80s and '90s came primarily, but
>     not exclusively, from unsound real estate lending."
>
> Where are the regulations we need to prevent these enormous failures?

Well, there are problems with onerous regulations. They can and do
lead to lost opportunities compared to less regulated markets. But
there was a big change in attitudes towards regulation starting in the
 80s, which painted regulation as inefficient and un-needed. Truth to
be told, some of the regulations were pretty tool-ish, but there was
and is a serious problem of how you will handle downside risks in an
unregulated market. When risks are systematically under-appreciated,
risky behavior is encouraged. What happens next is pretty easily
predicted by an uninterested party.

jking

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