Monday, December 29, 2008

Thoughts on the mortgage mess

There is no doubt that mortgage lending went bad. Banks made mistakes. House buyers made mistakes. So now banks are being bailed out. Ordinary mortgage borrowers are being foreclosed.

Fair or not?

Our (former?) capitalist system thrives (thrived?) on the principle that you benefit from your good decisions and suffer from your bad ones. This creates a kind of economic darwinism: survival of the smartest/best. When economic agents (people, corporations banks etc) are shielded from the bad consequences this sort of mechanism is short-circuited. If people can make mistakes and not suffer the consequences-so the argument goes - then they are not discouraged from making such bad decisions and may even be encouraged to continue making bad decisions of the same sort into the future.

And the same is true of banks that are rescued or bailed out.

But banks are being bailed out because of the public interest bound up in their operation. If large banks failed the repercussion could be severe for the economy. If you default on your mortgage the same is NOT true. 'You' are one person and you do not 'clear transactions for the economy through your home. But if enough people default, then banks may been to be rescued again... and again.

For agents that are bailed out the risk is for the future and it is called moral hazard. If you get bailed out you might not mend your ways knowing you could be bailed out again if you did the same thing again. And since most bailed out banks/firms have not been forced to have management changes, and losses have not been inflicted on shareholders, and bond holders, there is little to dissuade them or to force change in their actions... in the future.

On another point, comparing banks and individuals it is reasonable to assume that banks knew better of the risk in housing. There are some exceptions to this, such as if a borrower mis-declared income to get a mortgage. But even there, any bank that did not require proof of income must have suspected that something was not entirely kosher with any number of the income declarations they were getting. Banks have a long history or forcing compliance to lending rules; when you lend with a wink and a nod you know you are accepting extra risk. Banks bet too heavily on house prices going up forever. They bet on refi dollars always being there regardless of the economic fundamentals of the home and its owner. They bet on securitization to protect them along with it mortgage security ratings that there were pure fantasy.

Punishment does not fit the crime
Banking and house financing is a world that the bankers know and know it much better than home owners (or prospective home owners). Despite the fact that bankers 'knew the risks better' than the run of the mill home buyer, it is banks that are being helped more than the homeowners whose lot has been worsened by these banking practices that were roads to perdition.

By eroding the standards for lending, bankers put the value of every house at risk. But this did not happen until they ran all those those home values up by qualifying many more people for house purchases than had ever been able to be qualified before. That created a boom in home building and of homes in fancy price brackets since bankers would lend for amounts heretofore unallowed. The man in the street is less likely to understand anything except that house prices are rising and wanting to get in on it. That was the boom phase. But once you get homeownership up over 66% it is hard to find new buyers. Moreover, homebuilders built homes to the new financing standards and once the boom unwound and price backsliding set in the stock of homes for sale was no longer suitable for the income distribution at hand. Homebuilders had 'bought' the 'new model' of home lending hook line and sinker and set their polices to profit the most from it, by building more expensive homes that people were then being approved to buy.

So now banks are in trouble and getting bailed out. Home builders are under a lot of pressure. People - a lot of them- are being foreclosed on, or are delinquent or simply have mortgages that cost more than the house is worth. There are few programs to help these people out but banks they are getting assitance.

The road map out of this mess is not a clear. So far the path has been to put banks first. This is despite the fact that as lending professionals they are the entities that should have known better. No one (few in fact) want to help homeowners. There is a lot of lip serves here about helping YOU with your MORTGAGE. But little in the way of helpful initiatives. In fact rules are much more concerned with making sure that someone who lied about income and got an expensive house for the wrong reason is not helped while bankers that did exactly the same sort of thing thing are being 'saved.'

Some would have the government do nothing. But with the full dimension of this recession showing itself it should be clear that the intercession was necessary to avoid something much worse. Even that does not make the decision any easier or the choice for the road ahead..

But more effort to help homeowners is needed and warranted.

1 comment:


Yes the housing market is a mess.