It is one thing for the head of a government (or a government’s executive arm) to set a praiseworthy goal that is in the public interest, and quite another thing to rely on the financial sector to implement it. Finance has its own means tied to its own goals, with plenty of greed in the mix. Governmental officials may tend to minimize the potential damage from ego-laden greed to the goals of public policy. Such policy ideally strives for the good of the whole, whereas the goals of a private sector of a part. This could account, at least in part, for the financial crisis of 2008 and the continuing bear market in housing in much of the U.S.
According to The Wall Street Journal, housing prices had fallen for 57
consecutive months by May 2011.[1]
Even though the recession had officially ended in June 2009, the real estate
market still had yet to hit bottom.[2]
Since the housing peak in 2006, home values nationally were down 29.5 percent,
according to Zillow.com. Compared to the same time in 2010, prices were down
8.2 percent in the U.S. markets. In that year, house price depreciation had
slowed or stabilized because of tax credits of up to $8000 that expired during
that summer. Accordingly, negative equity became even more prevalent in the
first quarter of 2011, when 28.4 percent of all single-family homes with
mortgages were "underwater."[3] Monthly declines for February and March were
"really staggering," according to Stan Humphries, Zillow's chef
economist. He
claimed that the declines reflected "the true underlying
demand," which was "being completely overwhelmed by supply."[4]
Fannie and Freddie sold more than 94,000 foreclosed houses in the quarter; this
represents 23% more than in the previous quarter.[5]
The increase in supply from the foreclosures was at relatively low prices,
hence the impact on the market was particularly depressing.
A declining housing price translates into lost wealth for the homeowner.
When home values decline, the values of mortgages often do not go down as well.
Homeowners lose some of their equity, or the stake they have in their home.
When equity becomes negative—that is to say, when the value of a mortgage
exceeds the value of the property—homeowners become especially vulnerable to
default and foreclosure. “Falling home prices can create a vicious cycle.
When a property falls into foreclosure, it tends to depress the values of
properties around it, making those homes more likely to experience a similar
fate. [In 2010], nearly 2.9 million homes
received a foreclosure filing, and more than 2.8 million homes got one in
2009.” based on the data provider RealtyTrac.[6]
More foreclosures further reduced the value of residential mortgage-based
securities, which in turn reduced the asset-values and returns of companies and
individuals investing in the CDOs (collateralized debt obligations) worldwide. This
investment asset essentially has mortgage-borrowers pay the holders of the
respective CDOs, whose value is thus based on the value of the underlying
mortgages.
Problematically, the holders of the CDOs, not the originator of the mortgage, assumed the risk that the
mortgage borrowers might stop their mortgage payments. The mortgage servicers had
sold their mortgages to an investment bank such as Lehman Brothers, which in
turn would pass the then-securitized mortgage-based bonds on to investors such
as Deutsche Bank and the two major banks of Iceland. Neither companies such as
New Century (or Countrywide) nor investment banks like Lehman would face any
risk unless they happened to be holding a significant number of the risky mortgages
(or real estate) when the merry-go-round finally stopped in 2008.
Countrywide was bought up by Bank of America (by Ken Lewis, CEO at the
time) and Lehman Brothers went bankrupt. Both Lewis and Dick Fuld (of Lehman)
could be said to be empire-builders—meaning expansion at virtually any expense
and even as an end itself. Pure ego plus greed. New Century and Lehman both
assumed that they would never get caught with their pants down holding toxic
mortgages. They were both wrong—oh so wrong. To be so wrong and yet blame the
consumers is, at the very least, bad form.
Unfortunately, the housing market was “plagued by scandal” in the first
quarter of 2011.[7]
Homeowners and investors filed “numerous lawsuits alleging that big banks
misplaced or even faked crucial mortgage documents.” After it was “revealed
that companies that processed foreclosures signed thousands of documents daily
without even reading them, potentially violating the law, some of the biggest
banks temporarily halted their foreclosure proceedings” in the fall of 2010.[8]
I suspect, however, that the failure of the underwriters (and compliance folks)
is a red herring; most of the sub-prime residential mortgages required no
documents proving income or even a job, and many of those mortgage applications
contained lies known or even encouraged by the brokers. Not unexpectedly, the
brokers and borrowers have differed on whether the latter should be expected to
have resisted the, “It’s ok, really. Trust me,” from the “professionals.” In
any case, the (in many cases) first-time homeowners were used, and the greed of
the mortgage producers was ultimately behind it.
The claim, for example, made by some mortgage brokers and Wall Street
securitization arrangers that the borrowers should have somehow known better
than to sign low- or no-document subprime mortgages with steep ARM resets of up
to double-digit interest rates is more than just disingenuous; the brokers had
assured the potential homeowners that the inevitable
increase in home equity appreciation from the rising housing market would give
them the 20 percent equity stake that was necessary at the time to refinance
into a fixed mortgages at a decent, constant interest rate. The
brokers did not care whether the borrowers enabling the double commissions
could make the higher ARM (adjustable rate mortgage) payments in case they
might kick in. One might even say that the system was rigged by the
mortgage-producing companies such as Countrywide at the expense of first-time
mortgage-borrowers. Preying on the newbies, in other words, could characterize
the system’s basis. Of course, such preying is unethical, for it puts others in
harm’s way unless the prey should have
known better, which I dispute. In short, it was not a fair fight when the
harm came as even AAA-rated subprime (i.e., risky) mortgage-based CDOs ruptured
in the financial crisis of 2008.
In conclusion, although Clinton’s goal of putting poor people in their own
homes had been laudable, constructing ARM mortgages with resets that low income
people could not afford and relying on a rising market to obviate them was a
recipe for years of a bear housing market. In other words, the system that the
financial world established blocked Clinton’s goal from being sustainable, and
thus achieved. Of course, Wall Street was not in the game to do Clinton’s
bidding; finance had its own goals, which went on through two terms of George
W. Bush in the White House. In retrospect, Clinton should have used government
regulation to establish a viable system in sync with the goal rather than allow
his henchmen—most notable Alan Greenspan at the Federal Reserve, Robert Rubin,
Secretary of the Treasury, and Larry Summers also of the Treasury, to push
Congress to keep the CDOs unregulated. In other words, Clinton, in trying to
position himself in the political middle, followed Carter in adopting a
deregulatory position even as it ultimately rendered his laudable goal
unattainable and even reckless.
