Subprime Mess: No One's Fault But Our Own

The housing bubble that was fueled by multidecade low interest rates priced many people out of their dream homes. But instead of settling for less or renting, people went after their American dream with a vengeance - taking out adjustable-rate, interest-only or, even worse, negative-amortization loans.

Good things end, and great things end with a big bang; the burst of the nationwide housing bubble has left many with shattered homeownership dreams and financial despair.

And now the blame game starts. It must be the builder who charged too much for the house, or the “blood-sucking” mortgage broker who facilitated a loan, or the bank for extending credit we should never have had. Now, there’s a new extreme - the investors who purchased our mortgage with thousands of others from financial institutions.

The blame falls on us and none of the above. Though we want to blame the financial institutions for coming up with these products, as long as loan terms were fully disclosed, it is our responsibility to make the right financial decisions, not theirs. Any product can be dangerous if not used responsibly. Even a hair dryer, if used while taking a shower, could lead to untimely death. The financial products (i.e. mortgages, home-equity loans, credit cards) are electrified by compounding, and if not used appropriately, could lead to financial distress.

Pleading ignorance is disingenuous. With the exception of outright fraud, buyers knew they were biting off more than they could chew. They knew interest rates would reset and mortgage payments could increase, or at least it was their job to find out before they committed to the biggest purchase of their life. But that was in the future, and they lived in the now. The future is today, and there is a price to pay. We need to stop blaming everybody but ourselves and own up to our mistakes.

We hear sad, heartbreaking stories of eviction, broken families and pecuniary anguish resulting from people losing their homes all over the country. Of course, we want to help these folks in trouble. Our first instinct is to look at our almighty government for help. Though government sounds like an ambiguous third party, it is not - it is you and me. Should you and I carry the burden of those who made irresponsible or simply bad decisions? Money is a finite commodity, thus for the government to bail out the victims of this housing debacle, it either will have to raise taxes, cut spending or both. Yes, you and I will be paying higher taxes and/or money will be diverted from cancer research or other social programs because your neighbor elected to live in a larger house, better neighborhood or to have a greener lawn.

But that is just the beginning. The largest cost of a government bailout is the one that is not apparent at first - the moral hazard. In a free economy, incentives are set up in a way so that decisions made in our best interest also benefit society,or the system as a whole. Introduce moral hazard into the equation and individual decisions can benefit participants but hurt the system. The unintended consequence of a government bailout could be catastrophic.

The politician will tell you that only victims will be assisted. They’ll make sure not to call it a bailout. It is close to impossible to identify who the true victims are. Were they the ones with bad credit who took out subprime or Alt-A loans? Or the ones who are facing ARM resets? Maybe the ones whose house value declined because their neighbor foreclosed on his?

Politicians will come up with creative definitions of victim, but the result will be the same - the number of people who fall under the victim umbrella will mushroom exponentially, far exceeding original expectations - the unintended consequences. Homeowners who had all intentions of paying on their mortgages will ask for the government’s (now available) assistance. The ones who could not afford their house in the first place will get a couple years of free rent out of the system, ultimately defaulting on their mortgage a couple of years down the road.

In addition, the bailout will introduce an asymmetric payoff for current and future homeowners: Owning a house will become a risk-free endeavor. If your house price goes up, great. If it goes down, you claim to be a victim and society compensates you for the risk you’ve taken. A risk-free, utopian paradise, isn’t it? This will set the stage for an even greater next housing crisis.

The next couple of years will uncover more fraud committed by some unscrupulous mortgage brokers and banks. Some small elements of fraud are uncovered at the end of each boom: the junk bond boom of the late 1980s, S&L crisis of the early 1990s, the Internet bubble of the late ’90s, and it will happen again. Our economic and legal systems are equipped to deal with these people - they’ll go to prison. And politicians, like vultures, will feed on our misplaced anger. Like superheroes, they stand up to protect the little people (us) against the evil empire by creating “housing reforms.” But you cannot legislate common sense. With freedom comes responsibility. Do we really want to give up freedom and have government bureaucrats decide who should or should not get a loan? Instead, lawmakers should focus on making the lending process simpler and more transparent, where the terms of the loan are clearly spelled out on one page.

Doing nothing is the hardest thing to do when you see people in distress. We are a compassionate people, and we want to help. But there are times when we have to restrain ourselves and do as little as possible because by helping some you’ll hurt many others. This is one of those times. The current crisis will pass, as have many before. Let’s not escalate the magnitude of the next one by irresponsible actions.

This article originally was published in the Rocky Mountain News

Comments

[Devlin]

Excellent article. Finally, someone bringing it right to the point. No sugar-coating. I just bought my first house this summer and I made sure over and over again that I was getting a house that I could afford on 1 salary. A loan that was not shrouded in the mist of legal jargon that I did not understand. I was a.....RESPONSIBLE borrower. I hope that we do not bail these people out. The rolled the dice for a few years and after having all the chips.....lost on a final roll. Not the rest of America's problem!

[omooc]

Well done. omooc

[Lee Carlson]

Let's place the blame where it rightly belongs and it not "all of us ", as you say ! Builders only build what people will buy,..Period ! Same goes for Realtors,..show what the buyers want and will buy !
Remember please, that the "bubble" would not have happened if the Mortgage industry had done it's job, "by the book "!
We had negative amortization mortgages going back to the 80's and it caused a disaster then and is causing another disaster now.
Any bank or financial instution that bought these super high risk mortgages were just plain stupid ! No other word for it. !
Mortgage brokers pushed the appraisers to OK the prices, the bankers wanted to look good by writing a lot of loans, and the institutions that bought these loans, were just as stupid !
As a 25+ year realtor, I could see this coming, long ago, but what do I know,...I'm just a Licensed Realtor and not a banker or Mortgage Broker,..right !
Another factor that people overlook is that investors have a herd mentality and whatever their rich buddies do, must be great, right ? So follow the herd and get slaughtered with the rest !
I have no simpathy for these people who were so totally careless with their money ! LC

[Lee Carlson]

Let's place the blame where it rightly belongs and it not "all of us ", as you say ! Builders only build what people will buy,..Period ! Same goes for Realtors,..show what the buyers want and will buy !
Remember please, that the "bubble" would not have happened if the Mortgage industry had done it's job, "by the book "!
We had negative amortization mortgages going back to the 80's and it caused a disaster then and is causing another disaster now.
Any bank or financial instution that bought these super high risk mortgages were just plain stupid ! No other word for it. !
Mortgage brokers pushed the appraisers to OK the prices, the bankers wanted to look good by writing a lot of loans, and the institutions that bought these loans, were just as stupid !
As a 25+ year realtor, I could see this coming, long ago, but what do I know,...I'm just a Licensed Realtor and not a banker or Mortgage Broker,..right !
Another factor that people overlook is that investors have a herd mentality and whatever their rich buddies do, must be great, right ? So follow the herd and get slaughtered with the rest !
I have no simpathy for these people who were so totally careless with their money ! LC

[Renter]

What really pisses me off still is this phrase that is still being thrown around. Prices are coming down by x%. They always fail to mention how big of a gap their is between the realistic price and the overbloated price which may be 300% difference.

i.e. 12% drop really means that the house is overvalued at 300 - 12 = 288% still.

Excuse my rant - i live in california where these prices were overvalued 300%

[Tesh]

Sure, a large portion of the blame lies with the greedy flipper or idiotic "investor", the status-sensitive socialite or the blind fool. Still, when a company sells something that is proven to be toxic, it needs to be held accountable as well. Drug pushers are just as much trouble as druggies.

I also agree with Renter; prices are so outlandishly stupid right now that "falling" prices are great news. They need to fall much more to get back to anything resembling sanity. I have no sympathy whatsoever for those who whine about house prices falling. It's called "correcting" to those who don't still hope for a greater fool.