Foreclosure Crisis

One of the common phrases of the day is "the housing bubble". Perhaps if this is read in just a few years, some of this will have faded from the common memory, so for our future readers, here is a short summary.

A bubble is, obviously, anything that increases in value at an unsustainable rate, and then experiences a reduction in value, which feels like a collapse. The image of the bubble could be considered somewhat of a bad metaphor, because when a bubble collapses, it ceases to exist. During many collapses like this, the values eventually recover, but it tends to financially destroy some people in the process.

We had the so-called "dot com bubble" in the late 90s when several people were making new internet based businesses whose value was wildly overestimated and eventually collapsed. In that case, these new entities, internet based businesses were in some cases never worth anything. They were not what they now call fully monetizable. Sure, there were some great ideas and many of them were fun to use, but they were free to the users and didn't generate any revenue, while the cost of staffing them and having servers to support them could quickly outstrip their operating revenues. The search engine Google is a prime example of a company that dodged this dot com collapse and learned to become a huge money-maker.

The real estate market became a refuge for money when the stock market had a severe reversal. You had to have somewhere to put your money that was safe, and the conventional wisdom was that Real Estate Values Will Never Go Down. That prompted the financial markets geniuses to migrate over to the real estate domain and turn it into a crappy thing. Revisionist history is now reworking the story, saying that big bad government was forcing these traditional, conservative, careful banks and mortgage companies to loan money to risky, often minority people that normally would not qualify for these loans. I have yet to find any reasonable proof that this was the case. What I have heard about that makes sense to me was that the financial geniuses came up with risky investment portfolios called mortgage backed derivatives. Investors were hungry for these and the pressure to come up with them was enormous. Loan companies like Countrywide and Wells Fargo were busy looking for any warm body to sign mortgages which they could then bundle and sell off to investors. Regulatory agencies were asleep at the wheel, and no one was questioning why shortcuts in approving loans were so widespread, and certainly no one was telling any mortgage company that they could not make these risky loans (in my version of recent history, no one had to tell them or force them to make the loans, they had plenty of profit incentive to keep doing this, as well as no one stopping them). Finally, the market started waking up to the fact that there was a much higher than normal default rate on the loans, and there were less and less buyers standing in line willing to pay whatever crazy "market rate" (meaning huge increase in home value from just a couple of years before - vastly outpacing the rate of inflation) was asked for.

Oops. We had stopped treating homes as investments that you primarily bought to live in, and started treating them as vehicles for fast profits. These investments only paid off when they changed hands, so you had to buy and sell constantly. If (when) the market hit a point of overvaluation where no one wanted to pay the ridiculous price you were asking, suddenly your sure thing investment is a loss.

You could have seen it coming and many people did. I remember watching the house next door turn into a house flipper's plaything. It went from $250,000 in the mid 90's to $500,000 and hard to sell in 2003, to $1.2 million and impossible to sell in 2008. Not only did this house next door lose value because of the market reversal, it lost money because no one was living in it and taking care of it. The basement flooded twice, and flippers infatuated with shows like This Old House and other home makeover themes kept tearing it apart and rebuilding it according to their latest fad or dream. This diluted the turnover profit in any case, but really went haywire when they sunk a lot of money into the house and then it dropped in value.

Meanwhile, some people were buying and reselling homes to themselves fraudulently. These people have not been caught or prosecuted in very large numbers yet, but he scheme was to resell the house to themselves at successively larger numbers, pocketing the profit each time, and eventually defaulting on the loan, sticking the bank with the house, which was not worth anything near the value of the loan out on the house. This is a complex web of deception, but simple at its root. It relied on people willing to dummy up home value assessments and mortgage companies willing to sell to anybody and everybody. It was like the accelerator was stuck on the market and the driver, rather than being horrified at the prospect of being flung off the road, was sticking his head out the window and screaming in delight.

Now we have reached a phase, after a sufficient pause where there was not much new loan activity where banks started rushing to foreclose on homes. In many cases, the houses were purchased at inflated prices and the owners were walking away from the investments, but there were also many people that were recently unemployed homeowners that simply could not make the payments.

When the houses were being flipped and people were walking away with profits from the inflated sales, you could be sympathetic to the banks, as they would be the ones stuck with the overvalued houses. You realized that these homes would have to be sold at a greatly reduced price and the banks would have to take a loss on the house. If only someone would agree to live in the house and make payments, it wouldn't be so bad on the banks. Now they have those people already in place and they want to kick them out. It seems like the banks should be able to allow an unemployed person to continue to live in the house, and work the mortgage like a reverse mortgage for a few years. I'm not suggesting that the bank pay the people to live in the house, but they could charge them interest and maybe some slight penalties for skipping payments, and when they got their jobs back and resume payments, they owe a little bit more on the house. The bank, rather than losing the difference in what is owed on the house, gets to resume a healthy loan. However, the best home to repossess is one that was purchased back before the market raced upward. In other words, a house that is actually worth more than what is left on the loan. This is sort of like recouping losses on their crazy loans with the exact kind of people you want buying homes, namely people that will stay in the house, take care of it, and make their payments over the long haul. It is also possible that the banks have finally determined that the market has bottomed out and it has nowhere to go but up from here. That was the assumption that got us into this mess in the first place, wasn't it?

In an unrelated story, there was a serviceman in Iraq who had his home sold out from under him on the courthouse steps because his wife, depressed at her husband's long absence, was failing to pay the bills. The home was already paid for, and the bill that was overdue was the homeowner's association fees. Texas has some laws that were written favorably for Homeowner's Associations. This gives them the ability to foreclosure for overdue fees. The homeowner has to pay the lawyer's fees in this case, so it doesn't even cost homeowner's associations anything to go after the homes. Groups of lawyers figured out that this was a ripe opportunity to make some serious money. Not just the fees that they were charging to foreclose, but also in arranging buyers to snag the houses for a fraction of their true value, resell them quickly, and make some serious money off of them. The serviceman's house was returned to him when national attention was brought to bear on the case, but who knows how many other people have lost their homes in this legally sanctioned scam. Just another reason to avoid Texas. I've always felt that the deck is stacked in favor of the wealthy and powerful in that state.

The theme is the same here. Rich, intelligent people with no moral or ethics are looking at life as a game of winners and losers and trying to game the system for their own benefit. They do not care who gets hurt or whether it is fair, and in some cases, they don't care if it's legal. Anyone suggesting that the rules be strengthened or the enforcement be (applied!) increased is labelled as someone in love with big government and an enemy of the free market.

Democracy and capitalism in action? More like a system out of control and ready to run over anyone that gets in its way. Do I admire the people at the top of the heap that make more and more money? Not if it comes from the misery of the people at the bottom. We need to find a way to put the heart back in capitalism, or it will not survive.