Mortgage Bait for the Two-Legged Rat

I have often said that humans are like rats in that they are extremely ingenious when it comes to looking after their personal interests. Lock a rat in a metal box and it will almost be able to figure a way out. Almost. A human would actually have a shot at it.

In the debate about what went wrong with the economy and how to fix things, the topic of loose credit standards usually arises early in the discussion. And correctly so. Due to loose credit standards, people without the financial resources to own a home were practically carried across the threshold by predatory lenders.

Well, at least that’s how the outraged political class and their adoring punditry see things.

According to that section of the jeering crowd, these lenders were so avaricious, greedy, and downright dastardly that they would actually hand the keys to a $500,000 house to an individual with not just poor but pitiful credit and with little or no money down. Bastards!

Of course, as a former banker (shudder), I have a somewhat different perspective.

Because no matter how devious or dastardly a lending institution might be, it wouldn’t even contemplate making such loans if it didn’t have a fairly well-reasoned plan in mind to actually get paid back… with interest.

Enter the government in the form of the Federal Housing Administration (FHA) and the quasi-state-owned (and now absolutely state-owned) Fannie Mae and Freddie Mac. Absent their guarantees, the private sector would never, but never, have made the loans just described. That’s because…

(a) Loan officers actually take professional pride and go to great lengths in assuring that the money they loan out comes back. In fact, failing to get loans paid back with even a sniff of regularity is quick cause for a pink slip followed by a solemn escort to the front door for the approving loan officer.

(b) Foreclosing and all the attendant activities are difficult, time consuming, and costly. To wit, trying to get juice out of a rock gets you little more than dust.

As a result, within the acceptable tolerance range for any human endeavor, banks are historically careful in setting lending standards.

But add into the equation a rate-slashing Fed looking to stimulate things a bit, side by side with a bloated Uncle Sam looking to engage in some social engineering by putting people without the credit or means into a house, and the picture quickly changes. The FHA, the world’s largest government insurer of mortgages, whose “loans require small down payments” and provide “more flexibility . . . than conventional loans,” as its website states, has currently 4.8 million insured single-family mortgages.

For the record, there are about 55 million single-family mortgages in the U.S., so the FHA has about 10% covered.

But the FHA is just one of Uncle Sam’s kissing cousins. Others, including the aforementioned Fannie and Freddie, guarantee another 31 million mortgages between them. So, in total, U.S. taxpayers now stand behind about 65% of all home mortgages in the U.S. But it is worse than that, because ever since the credit crisis began, over 80% of all new mortgages generated have been “conforming” in order to go onto the books of a government agency.

Thanks to Uncle Sam’s largess and no-risk lending guarantees – warmly applauded by the nation’s banks and sundry money shoppes, to be sure – since 1992 there has been about a 50% increase in U.S. homeownership.

Is it any wonder, therefore, that until recently you could spot loan officers by the wide smiles on their faces, as well as their ink-stained fingers, the result of producing prodigious quantities of freshly printed loan contracts?

The way it all worked was very simple. Uncle Sam shouts for all lenders to hear, “Bring me your poor, your unqualified, your liars, and your wannabe speculators, and I will buy up their loans, allowing you to make a quick profit for generating them, and then passing them like a hot potato into my portfolio.”

Given the opportunity to make money by giving money away – not a real hard sale – the lenders rose to the occasion. A rat, sniffing out a crust of bread down an unguarded alleyway, would do much the same.

Likewise the masses, equally quick to discern the opportunity, can hardly be faulted for scrabbling to take the house, oftentimes along with a loan that put extra money in their pockets in the process.

No one was much concerned about paying for the homes; the lender’s risk was assumed by the government and the unqualified buyer didn’t have much of any money in the game, and besides, everyone was certain that house prices could only go in one direction, up. As for the government, well, the government doesn’t really pay much if any attention to the money it spends, because it’s not their money. It’s yours – if you are a U.S. taxpayer, that is.

Of course, as the smell of free cheese and wealth without end spread throughout the ether, more and more two-legged rats acted on what they perceived to be their self-interest, causing a steady influx of new buyers to stream into the alley of homeownership. And the next thing you know, you have a housing bubble of historic proportions.

But you know all this, so why am I repeating history? Well, because this week, I stopped in at a local sandwich shop and, to occupy myself with something other than looking out the window, took hold of a regional real estate guide that, as part of its editorial features, includes a table showing all of the lenders who do business in the area – 16 in all.

Among other information, the lenders’ table displayed whether or not the various lending institutions offer “Mortgages to Buyers with Less Than 20% Down?”... and whether they “Offer Mortgages with Credit Scores Under 600?”

Even today, after all the news and global angst, 9 out of 16 still advertise that they offer loans to individuals with credit scores below 600, and four of them actively promote the fact that they’ll go down to 580 – which is roughly the credit rating of an escaped felon on the run for credit card fraud. But such a loan, each of the listing institutions further qualifies, is available “Only w/FHA.”

And 12 out of 16 will still give you a loan with less than 20% down… in fact, “w/FHA,” the solid majority will still provide a loan with less than 5% down, and one touted the availability of a 103% loan.

Alas, despite the understandable desire of lenders to earn yet more cheese by generating poor-quality mortgages for Uncle Sam, borrowers now believe real estate can only go down. Given the oversupply, they are largely right for the foreseeable future. On that basis, they whiff the downside, spot the trap that waits behind the front door of Home Sweet Home, and scamper away.

The lesson in all of this, other than that once I get pounding away on the keyboard, I seem to have no off-switch, is that the real cause of the housing-led crisis was a failure to appreciate the similarities between humans and rats. Every government interference in the market, no matter how well intentioned, carries the seeds of dangerous unintended consequences. Just ask the twenty-something welfare mothers of the 1980s who, when offered monthly pay for each new offspring, quickly converted their wombs into baby factories.

I wish I could say that this lesson – that humans, like rats, will always figure out a way to pursue their self-interest, even if it requires chewing through a real or proverbial wall – has been understood, thanks to the crash. Chances are it hasn’t.

Fortunately, there is consolation to be had from the current trend towards more and bigger government. Namely, if you can fully understand what’s going on and what’s coming next, you have a rare opportunity to – in the words of a stock promoter who used to speak at conferences some years ago – get “stinky, filthy, sloppy rich.”

Comments

[kelm:]

Thank you for reminding everyone that there was a great push by the government on banks to lower or "interpret" lending standards downwards to broaden home ownership as a way of growing wealth. It is interesting to see that the practices are still occurring. It will keep occurring as the government pushes on bans to make loans with the TARP money with no discussion as to what quality of loan they are making.

Feb 05 09:41 AM

[notsosmart:]

blah,blah,blah. we all know the story by now. nobody could have stopped it. as long as the tide raises all boats all the crew are happy.all that can be hoped for is that regs are put in place so it cant happen again.(yea,sure).anybo... remember the s&l crisis of just a few years ago(sen. mccain was one of the keating 5).trust & ethics are gone for now or ever.who knows?

Feb 05 10:54 AM

[OldLimey:]

Great article. Much the same happened in the UK, but without banks here having any government cover for their lending.

Feb 05 01:33 PM

[km in atl:]

HAH, more finger pointing.... let's see I am signing documents today with a monthly payment of 2700, PLUS taxes and insurance of 500, for a total of $3200 monthly, but WAIT, I only make 35k per year, PLEASE MR LAWYER take the GUN off me, I will sign the documents, OH WAIT that was just your FINGER in your POCKET pointing at the REALTOR who does have the gun pointed at ME, about to pocket a cool 6% vig for showing me a home they knew i CANNOT afford, and somehow they found an appraiser that JACKED the value of the house to make it look like i was putting more down, BUT in reality they had to jack the value and sales price so that the SELLER could give me 3% as my "DOWN PAYMENT", and SOMEHOW found a LENDER that believed that I make 60K per year as a stock clerk for some national department store but did not actually verify that i only made 35k. MAYBE I WON'T SIGN THE DOCS AND HOPE THE REALTORS AIM IS OFF.....

Feb 05 02:22 PM

[henarl:]

Yeah, so the entire real estate industry is greedy, self serving, and dishonest, including the buyers and sellers, the RE brokers and salesmen, the colluding appraisors, the mortgage brokers, the primary lenders, the securitizers, the rateing companies, the stupid purchasers of those bogusly rated securities, the writers and buyers of CDSs, the blind regulatory agencies, and the voter pandering U.S. Congress. I guess that just about covers it. Did I forget anybody?

Feb 05 02:54 PM

[Gedankonomist:]

"...they would actually hand the keys to a $500,000 house to an individual with not just poor but pitiful credit and with little or no money down."

Actually, they do that in many cases because the Fed Gov requires a bank to lend to a certain percentage of "minority homeowners."

So who's fault is it, the bankers, or you, who keep electing these goofy politicians who keep coming with goofy laws which are screwing up our country?

Feb 05 03:38 PM

[skopros:]

true, government set the stage and provided the scenery (all those wonderful dream house McMansions), loaded the guns and pointed them at the targets....but the shooters, those clever rats on both sides of the desk, picked up and fired away w great gusto, celebrating their good fortune.

free cheese will always attract and motivate hungry rats.

the problem is closing the cheese factory in Washington DC, where folks who know their own kind are mixing up new product.

Feb 05 05:00 PM

[derryl:]

Your article was an amusing read! (and completely accurate)

Feb 05 05:52 PM

[Leftfield:]

Good article. But, the 40/1 leverage, the slicing into financial products with AAA ratings by Wall St. sent this into stratospheric levels of financial catastrophe.

Feb 05 11:40 PM

[Geldpress:]

The bottom line is that human psychology and greed feeds on itself. When the trend was up, consumers and bankers were clamoring at each others throats to get into the next deal - regardless of underlying fundamentals. And that accelerated the price increases. Now the tide has turned and consumers want nothing to do with housing, and rightfully so. Take a look at this house very close to Microsoft, which is off 18% in a single year.
www.geldpress.com/2009.../

Feb 06 02:31 PM

[john1:]

Just more unpatriotic negativity from liberals who hate America, and the troops.

Feb 06 03:02 PM

[Mavo:]

The gist of your article blaming the whole of the housing bubble on the government dictating making bad loans to poor people with bad credit.. is RUBBISH! You conveniently forget to mention the push for financial DEREGULATION where the idiots in Washington like Greenspan and Gramm pushed this mantra for years! It was not government regulations that caused this meltdown.. it was LACK of sensible government oversight all in the name of the mythical "free market"! Had we kept the sensible financial regulations that were put in place during economic hard times in the 1930's... this would not have happened. But too many libertarian and Republicans believed their own hype about a self-regulating "free-market"! Your claim that big bad Freddie and Fannie caused this is tantamont to claiming that a nasty hangnail caused the death of the elephant in the room ... ignorning the idiots with the smoking elephant gun in their hands!

Feb 06 07:34 PM

[blackdog:]

An old man once told me, "boy, you can't borrow yourself out of debt". Unfortunately that old man is now dead, because Obama could sure use his simple common sense advice today.

Feb 07 07:19 AM

[Mr. Ed, Jr.:]

Remember when....all the politicians of both parties were pointing with pride at what they had accomplished ? How a record number of Americans were becoming homeowners ? How that was great for America and great for the economy ?

Now, it is all fingerpointing and denying involvement.

And the home buyers... Housing prices were rising so fast, they were all afraid they would miss out on the "sure thing". They would surely have hundreds of thousands in equity in just a few years. They practically stampeded the mortgage lenders' offices to get in on it.

And they are now claiming they were duped, tricked, and bamboozled into buying a home they really couldn't afford-- with terms that buried them (and the rest of us).

I believe the saying is "Success has many fathers, but failure is an orphan".

Feb 23 03:05 AM

[jksisco:]

In order for the whole Government involvement in this to blow over, you have to keep the rats occupied with quasi-class warfare, keep them fighting each other or designate a scapegoat, i.e., bankers, capitalism, greed, or throw them a little more cheese ($13 a week). Works everytime, just like an FHA loan, guaranteed. Thanks for the reality based article.

Feb 23 03:37 PM