The United States is in a financial
crisis that has so many causes it is very difficult to figure out who
to blame or what to do. Or is it? This letter will reveal
many of the root causes of this meltdown, however, I am certain as each
ox gets gored (no pun intended) there will be those out there who disagree.
So let them write a letter.
I am going to start at the
beginning, with the building of a home. This is a very straight
forward process. A developer buys a 100 acre piece of property
and goes to their local jurisdiction (city or county) to obtain a permit
to build 500 single family units (5 units per acre). During the
1960’s this was a common practice. The jurisdiction affirms
the concept of the project in a year or two or three but notes that
conforming to “Smart Growth” ideals, 30% of the land must be dedicated
to Open Space and there must be neighborhood parks, 200 foot setbacks
for streams (riparian right-or-ways) and other “Green Considerations”.
The developer realizes they can only build 230 units and the units cannot
be 1,600 square foot homes, rather they must be larger than 3,300 square
foot homes to create the income needed to make a profit.
The problem here is that the
new buyers cannot afford the units so the building industry sees FNMA
& FHLMC as the rescue agent. FNMA & FHLMC design a program
that is interest only at the start of the loan or negatively amortizing
but requires that the borrower has adequate credit and income (NY Times
9/30/1999). There will be little or No Down Payment required.
Also, there will be mortgage insurance companies who insure the lender
against loss of the top 20% of the loan, or the loan will be made as
an 80/20 giving the holder of the 20% second most of the risk.
It didn’t stop there, the
Chicago Board of Trade and its dealers started buying Sub Prime loans
for their Collateralized Mortgage Obligation (CMO) debt instruments
and sub-prime lenders were on their way. After all, this would
help “everyone” achieve that holy grail of home ownership.
The investment bankers could also create derivatives, which is to say
they could break the loans into pieces. A 7.5% subprime loan for
$300,000 could have the first $100,000 give up a 4 % return ($477.42/mo),
the second $100,000 a 5% return ($536.82/mo), and the last $100,000
a 12.71% return ($1,083.40/mo). Now we are supposed to use the
taxpayers’ funds to bailout the high risk investors.
Let’s change the subject
somewhat to the actual mortgage brokers and lenders. Harry and
Helen Homebuyer come to them to buy a home using one of these subprime
mortgages. They wish to use a stated income loan that has a 2%
start rate that lasts for one year. They wish to borrow $500,000
for their purchase. There new principal & Interest payment
is $1,848.10 plus taxes of $520.83, plus insurance of $85.07 per month.
The total is $2,454.00 and should have a qualifying income of about
$6,500. Our borrower states that they do make $6,500.00 per month
and the loan gets funded. Everyone gets paid and Harry and Helen
live happily ever after or at least for one year when their mortgage
payment goes to 5% and $2684.11 and totals $3290.01. Harry and
Helen are starting to feel the pinch as they may have overstated their
income on the application. Year 3 rolls around and now we get
to the 7.5% rate and the new payment of $3,456.47 or a total of $4,062.37.
Hopefully, Harry and Helen are making a lot more money however, they
are not. Also the value of their home has dropped to $380,000.00.
Their first words are that someone took advantage of them and they are
the victim. But they are the ones who overstated their
income, although encouraged by their lender, and, after all, they were
taught in public school that truth is relative and that their
needs come first. So who is to blame?
Of course the government got
into this to help the downtrodden obtain home ownership with the Community
Reinvestment Act started in 1977 but was given a new improved version
in 1995 and really took off in 1998 when all lenders found out that
they could make destructive loans and sell them to FNMA & FHLMC
(Franklin Raines would like to thank Barney Frank, Chris Dodd, Charles
Schumer and Barak Obama for keeping the Feds out of his business).
These loans are for people with marginal credit, lack income verification,
and have little or no assets and who did not qualify for any loan prior
to this intervention. Of course these loans have No Down Payment
requirement. These loans get securitized, of course, and that
is where Wall Street came in. After all, we have a perfect storm.
The street can buy these CMO’s and then break them into financial
parts and sell them to everyone because American real estate has always
appreciated and there can be no losers. This gives “the street”
the motivation to keep the highest return portions and leads to the
failure of Lehman, Merrill, and so many others. It is like magic.
Keep the investors looking at the parts and the return and they will
never see or understand the underwriting. By the way, America
is not the only country that tried this program. Bummer!!
Here is another issue.
If a sub-prime loan is funded at a higher interest rate than a prime
loan, how do we justify the larger payment to a less qualified borrower?
How do we justify a distinctly poor loan to people who could not afford
a lower payment on a quality loan? This type of thinking will
never meet the stink test. The only ones who win here are the
Realtors, the mortgage brokers, and the lenders who sell these loans
and are not held accountable because they have met the underwriting
requirements of FNMA, FHLMC, and other institutional investors.
So, why does the 100%, no down
payment VA loan program work? It is because the borrower has a
stake in the program. The borrower had to serve in the military;
they are only able to use their VA entitlement once without meeting
lengthy criteria and time requirements, and they have to have verifiable
income and assets. There is pride that does not flow to the sub-prime
market where borrowers already have marginal credit, indefinable income,
and no source of down payment. Sub-prime encourages straw-buyers
who deed over their property to investor/speculators for flipping.
After all, no one had any cash in the transaction anyway.
Has the government ever come
up with a program that helps the less fortunate and has accountability
factors tied to it? Yes!! About 1980 the government developed
the Mortgage Credit Certificate Program and it worked quite well.
Let me explain. First, the borrower had to have documentation
for income and assets to close. The program was not administered
by the lender; it was administered by an agency. Therefore, the
borrower had a tremendous choice of the kind of loans they would be
able to obtain. This loan allowed the borrower to apply for the credit
through the MCC program office and the benefit was a credit that paid
20% of the interest accrued to the loan for a period of 10 years.
The loan credit was delivered through the IRS when the tax return was
filed, showing that the property was owner occupied, and that the borrower
fit in the qualifying income bracket required for assistance.
The moment an MCC recipient sold their home it would show on the tax
return and no more MCC benefits would accrue to the homebuyer and the
homebuyer would have to pay back some or all of the MCC benefits at
the time of sale for a period up to ten years.
The major mistake in the MCC
is that it is funded using municipal bonds. This leads to lobbying
groups moving the tax free money to pet projects and severely limiting
the amount of dollars that can be used for the MCC. It is not
unusual to wait long periods in escrow just to have the money available
for one transaction. If the American people can afford $700,000,000,000
for a bailout they certainly could have afforded $5,000,000,000 to assist
folks obtain the goal of home ownership.
Why does the government value
homeownership so highly? First it is the major source of wealth
development for the great majority of Americans. Second, good
neighborhoods have a majority of owner occupied homes (not so many first
responder calls). Using the MCC the homebuyer got a benefit, home
ownership, with 15-20% of the payment paid for by the government for
the first ten years of the loan. After the ten years was up, no
more benefits accrued to the borrower but the borrower who was still
in the home did not owe anyone for the benefit they received during
the ten year period. Buyers were not willing to give up the MCC
benefit and hung onto their homes jealously.
Where do we go from here?
We have a new $700,000,000,000 Bailout Bill that does not appear to
try to regulate the lenders, FNMA, FHLMC, or investment houses.
Good luck on that. The underwriting guidelines must return to
a more sane time when it was expected that people should be able to
save five or ten percent down payments plus their closing costs.
Mom and Dad should not be their kid’s banker but rather their mother
and father that taught the kids when to spend and when to save.
Lastly, I would like to direct
the reader to a national philosophy which I will call the “Theory
of Everyone” philosophy. This line of thinking goes something
like this;
Everyone should be able
to own a home. What kind of stupidity is that? Not everyone
knows how to push a lawnmower, much less fix one. Not everyone
is motivated to paint their home, fix a faucet, or change the filters
in the heating unit. Those who will not do these things should
be called tenants. Not everyone makes enough money to pay for
a home.
Everyone should go to
college. That’s rich!! Some people don’t go to college
because they don’t qualify. Others because they chose to do
other things such as military service, or other public service or attend
an apprentice school. Others should not go because they just cannot
compete. Because the college is able to get paid by these students
does not mean that the employer will be pleased with the product.
Some people are just not qualified for college and should do other things.
Everyone should have
health care. The people of Great Britain thought so too.
They really got sucked in to the “Theory of Everyone”.
Everyone who is hungry
should be able to eat well. Then why are we the most obese country
in history?
Everyone should have
cheap fuel. Sounds good but the politicians are in the bag with
Middle Eastern Oil. The Greens impede America from drilling for
oil or using nuclear solutions.
The common thread that runs
through the “Theory of Everyone” is the lack of personal
responsibility.
Everyone should own
a home, so save some money or buy in a cheaper neighborhood.
Everyone should go to
college. Study hard and you can but how about trade schools or
the military, after all graduates you may actually want to earn a living
someday.
Everyone wants free
health care. Maybe they should walk around the block and limit
their caloric intake. Take a look at Great Britain!!
Everyone should be able
to eat well. Same answer as previous statement.
Everyone wants cheap
fuel. Drill, Drill, Drill. Attendant to that, if nuclear fuel
is good enough for France, then it’s good enough for America.
The only reason I continue to see for delay is that some folks want
the United States of America to become weak.
This isn’t just about housing,
it is about all these leftist ideas that have crippled America for the
last many years. Those ideas are based in the ”Theory
of Everyone” just ask Karl Marx.
America’s role should be
that it provides all the opportunity to succeed that anyone could possibly
use. America should understand that not all of her citizens will take
advantage of these opportunities and some will even fail. We are
especially taught these truths in sports where the athlete must lift
weights, memorize the plays, practice to get the timing down.
The more he or she does of each one the more likely the athlete is to
win.
Now we are back at the beginning,
trying to build some homes and the great circle of non- responsibility
continues, or does it? Will the Greens/socialists back off
the housing issue? No. Will the investment bankers start
taking their client’s interests to heart? No. Will your
political representative start to represent the average Joe? No.
Will America start using creative and accountable programs (such as
the MCC) to help less fortunate Americans buy homes? No.
Will Congress be able to resist the Middle Eastern OPEC money until
we have drilled on American soil? No. But we are the United
States of America, the North Star for all countries. If we are
out of place then what?
Stephen J. Ferry
Copywrite 2008
