The Blame Game - Consumers

In this recent economic downturn, people from all sides are pointing fingers and trying to place the blame on one another. This is the first of a series of posts in which I will try to dispel some of the myths being spread.

The most common theme you hear when it comes to the housing market is "people bought more house than they could afford." While this is true in some cases, more often it only became true three to five years after the home was purchased.

Back around 2003-2004 we were just beginning a recovery from the twin market downturn caused by 9-11 and the tech bubble burst. Jobs were slowly being created, interest rates were at all time lows and many were expecting the economy to really grow. Because of this, more people saw that they were finally able to get into the housing market. This caused house prices to grow which allowed people already in a house to upgrade to a new house. This was the start of the housing market boom.

What people didn't realize was that the economic growth they were seeing in the markets was a shallow gain. While average wages were going up, they weren't matching inflation. What's more is that the average number was skewed by a large increase in income for the top 1% with little to no gains for the other 99% of us (see charts below). At the same time, mortgage brokers and other lenders (who we will discuss more thoroughly later) saw the potential for large profits via new mortgaging schemes now dubbed "sub-prime." This led them to encourage clients that could qualify for standard mortgages to instead apply for adjustable rate or other balloon mortgages.

Courtesy
Courtesy
Courtesy

This is why I say most people trapped in this mess could afford the house they bought at the time. However, when inflation went up (not only food prices, health insurance costs have increased 20-30% annually in many cases; an average of 6%) but their wages didn't, they were put in tighter and tighter circumstances. In the very early days of the current crisis (circa 2005-6) some people were still able to refinance or sell their way out. But some people hit a more severe hardship. Many people got to the point where they were living paycheck to paycheck. If they lost their employment for even a month, they wouldn't be able to pay the mortgage. If they had any sort of medical emergency, they wouldn't be able to pay the mortgage. These people began going into default.

By late 2006 and throughout 2007, the housing boom started really slowing. Job growth had slowed or at times gone negative. Federal interest rates had been raised from their 2003 lows of 1% back up to a more reasonable 3%+. At the same time, personal property taxes were being reset to the new home values. In many cases this caused a doubling of those taxes. People could no longer refinance their homes. Fewer people could buy so housing prices began to slump and selling the house was no longer a way out. Wages that had been stagnant (or negative) for three or four years were no longer able to afford the mortgage and the rapidly increasing cost of getting to work. The people who in 2003 could afford their house were rapidly getting buried under increasing piles of debt. This trap many home owners fell into is what began the popping of the sub-prime bubble.

So I ask you, is it your fault that corporations have enjoyed their multi-million dollar golden parachutes while the employees working 60 hours a week to make ends meet get nothing? Is it their fault that insurance costs grow by double digit percentages while coverage steadily drops?

There were some people who bought beyond their means, don't get me wrong. If you make $30,000 a year, you probably can't afford a $300,000 house. If you are told you can live in a house for three years without paying anything (what some of the balloon mortgage plans promised), it is probably too good to be true and you shouldn't sign up for it. But I can't put the blame on a working family who couldn't see that their earnings would be the same four years down the line but their expenses would have grown by double digits. I don't blame the public school graduate who can't understand the ins and outs of mortgages that even the Harvard educated accountants who invented them barely understand.

Break Down of the Issues - Part 5

Domestic Policy

Domestic policy will be broken up into numerous sections as the candidates go in depth on plans for numerous topics. See also Part 1, Part 2, part 3, part 4, part 6 and part 7. Again, all of these policy statements are taken from the candidates' campaign websites.

Hillary Clinton	John Edwards	Barack Obama
Economy
Link Link	Link Link	Link
Taxes
Expand the child tax credit Provide marriage penalty relief Expand the earned income tax credit Expand the child care tax credit	Create a new "Get Ahead" tax credit to match up to $500 a year in savings for families earning up to $75,000 Expand the child care credit to pay up to 50 percent of child and dependent care expenses up to $5,000 Triple the earned income tax credit for single adults and cut the marriage penalty	Create a tax credit providing up to $500 per person, or $1,000 per working family Create a Universal Mortgage Credit that even tax payers who don't itemize are eligible for Triple the earned income tax credit; increase it six fold for people caring for a child or paying child support Eliminate income taxes for seniors making less than $50,000 Simplify filing tax paperwork by allowing the IRS to supply pre-filled 1040EZ forms to people who request it Increase the child and dependent care tax credit and make it refundable Reduce the self employment tax Eliminate capital gains taxes on start-up companies Clean up the corporate tax code Create an International Tax Evasion Watch List to apply pressure on countries acting as tax havens
Mortgages and other debt
Develop strong licensing standards and require federal registration for mortgage brokers Eliminate prepayment penalties on mortgage products Expand Fannie Mae's and Freddie Mac's foreclosure prevention efforts	Pass a law that will strengthen underwriting standards to ensure that borrowers receive affordable loans suited to their means Create a new Family Savings and Credit Commission to protect consumers Cap interest rates on all payday loans at 36 percent	Push the STOP FRAUD act through Congress, strengthening the ability for the government to fight mortgage fraud Create a fund to help homeowners refinance mortgages Create a credit card rating system enforced by the FTC Establish a credit card bill of rights: CCs have to get consumer assent to change the agreement Interest rate changes only affect future debt Prohibit interest on fees Prohibit a change on interest rate based on failure to pay a third party Require CCs apply payments to highest interest debt first
Jobs
Nothing specific available on her site.	Raise the minimum wage to at least $9.50 an hour by 2012 and then index it to inflation Create a million short-term jobs to help individuals move into permanent work	Increase federal investments into transitional jobs Index minimum wage to inflation
Miscellaneous
Insist on a move back toward a balanced budget and surpluses by funding new expenditures with new revenues or cuts in other areas	Create a million vouchers over five years to help low-income families move to better neighborhoods	N/A

It has good words

This can sum up the credit crisis and the subprime loan craziness far better than I can:

Thanks to BAC for pointing me at these guys

The Mortgage Crisis - Part 3: Fixes and Fallout

If you haven't already, see part 1 and part 2.

Well, this is a fine mess we are all in now, and for most of us, we didn't do much to bring it on us. Housing prices are known to be inflated, credit is much harder to get (is this a bad thing?), and the markets are in a panic (I know, when are they not?). It seems there are two options being talked about a lot - bailout or let them sink. No good options seem to exists (that seems to be a common phrase these past 4-6ish years...). Here is my (probably not very) modest proposal for a good way out, or at least forward.

First, stop this fake rate freeze talk that is actually only going to help a couple thousand people. The people that this would actually help (between the never late for a payment and can't afford next hike restrictions) would be far better served by a true, honest and open, renegotiation with the banks, similar to what FHA is being brought in to do for some.

I believe that each borrower needs to be given a transparent way to ask for a renegotiation. Many of these borrowers were presented with the very false idea that they could afford more house than they really could. These borrowers should be allowed to present this and if fraud (or I expect the lenders might prefer "creative lending strategies") was involved the borrowers should be helped. But I don't think the government should be footing the bill, the lenders or brokers who did the misleading should be forced to face their mistakes.

In all fairness to the lenders, the borrowers should have been more careful in many cases or should have read more of the fine print. My wife and I were very careful with our finances (for those of you running Linux out there, a great finance tool called GNUCash is out there that really helps me keep everything in order - 100% free and open source and it does everything I would use Quicken for). We knew exactly how much house we could afford, and how much renting would cost us, both at the time and a couple of years down the line. We settled for a smaller house that we might have liked, but boy do we understand how tempting that larger kitchen with the brand new appliances can be, especially when the bank is telling you that you can afford it easily... I do think though that the borrowers shouldn't be completely let off the hook. This is why a neutral third party mediator should be brought in. Maybe not a judge, but someone along those lines.

ARMs, and really even fixed mortgage rates need to be more closely examined. Right now, and I didn't realize this until I asked a lender, mortgage rates can be whatever the bank thinks you should pay. It isn't tied to anything at all. Banks pay a discount rate to borrow, then there is the key interest rate, and also the prime lending rate. Mortgages, as I was told, vary day to day and are what the bank is choosing to charge. This means that I can't go bank to bank and compare rates, a rate given on one day could be completely different from what I am told the next. This needs to be changed. Banks can compete on how they treat credit ratings and other features of the loan (closing costs, etc.), but the base rate should be tied to something I can look at, not personal whim.

Finally, we do need to face some fall out. There will still be an increased number of foreclosures. Some banks will lose solvency. Many mortgage brokers will go out of business. The stock market will take a hit. Houses will still drop in price. However, the markets will stabilize quickly if this is handled responsibly. Funds, institutions and banks that are built on the mortgage industry's fraudulent practices will be removed from trading, and while there will be an overall drop in the market, those people who knew better than to listen to the pipe dreams these funds offered won't be as badly hurt (full disclosure, I kept most of my 401k out of mortgage and bond centric plans since I started with my current employer, so while I don't have anything to gain, I have less to lose). These fall outs will happen. I believe it is better to take care of it now and get it over with than to perpetuate the lies and let there be a bigger fall later.

Housing will be cheaper for a while, this will allow some people who may not be able to afford the house they are in to afford a smaller house, that's worth a little bit less than the one they currently can't afford. Not everyone will be able to get a house, but I'm sorry to say, not everyone can afford a house. I know a lot of this is a bit harsh, but there is no good way out other than to have not gotten into this mess in the first place.

Good luck to everyone out there, and if anyone can see a better way of getting through this, feel free to share.

The mortgage crisis, part 2 - Fraud

I already talked about how the Fed is thinking about lowering interest rates Tuesday to help the markets out during this credit crunch brought on by the mortgage lenders. GMB over at I can't believe it's not a democracy! pointed me to this article in the San Fransisco Chronicle about possible reasons for the new "freeze" being proposed. In it the author proposes that the agreement was agreed on to give the mortgage industry time to hide the fraud that is one of the root causes of this problem. I can only speak anecdotally about the subject, but I don't believe the fraud was as rampant as the reporter is claiming.

Don't get me wrong. There was a large amount of fraud happening. Everything from appraisers being paid to give good assessments to websites offering to sell you a paycheck stub (halfway down the page) to inflate your income. There was also the slightly more creative fraud in how these mortgages were presented to the borrowers - "Oh, don't worry about the balloon rate, by the time that kicks in you could sell your house and move in to one twice as big." (never mind the fact that the rate jumps just six months after you sign the paperwork...) However I don't believe, as the article's author said "I assure you it was a minority of borrowers whose loans didn't involve fraud."

Nothing was ever presented to us that would lead me to believe there was any fraud in our house purchase twelve months ago. Our income was just enough to afford this house (although we were told we could technically, according to their math, afford one 10% more expensive, which is shifty salesmanship and probably where a lot of borrowers were mislead), but we never caught wind that there might be a way to "boost" our income. It also just happened that the year after we bought our house it was due for a county re-assessment, and while our lender's assessment was higher than the county assessment (by about 5%) it was not significant and the county assessment was almost exactly what we paid.

Like I said though, this is all anecdotal and just one family's experience in the relatively stable mid-west. Your mileage may vary. I don't think though, that this rate freeze would work as a panacea to escape the fraud issue. There are a few issues that the article brought up, but didn't point out all the implications. First, and this was not brought up, much of the sub-prime lending was done through mortgage brokers and other third party institutions, which is where most of this fraud would have taken place. These people find the borrowers (often through agreements with real-estate agents), sucker them in with promises like what I described above, and then within days of closing on the mortgage sell it to a bank or other large institution, and never worry about it again. These people, currently, are getting off scott free, except for the fact that their business is drying up. Don't get me wrong, not all of them were bad. In fact, the one we finally went through was very helpful and upfront with us, and not pushy about how much to borrow.

The other problem is that these mortgages are only having their rates frozen, and just for five years. I don't know for sure about most of you, but my wages haven't increased significantly (outside of getting a new job) in the last five years, and according to the government, average wages for working class Americans has barely kept pace with inflation. This means that the five year freeze is just a gamble that the same thing won't happen again then, or maybe not a gamble, maybe Bush just doesn't want this to be as easy to stick to him...

Related to that is the fact that house values aren't likely, as of now, to appreciate significantly over this time frame either. Houses still aren't getting sold now, and people are still finding it harder to get financing to buy houses. It's so bad for one seller near me that they are advertising the price on the for sale sign. And like I said before, a drop in rates won't help most buyers because the banks are still more wary about lending.

He also, in the article, mentions that the FHA is being brought in to help some borrowers (the ones that won't get the freeze) to refinance. He says this is so that "[t]hey could say, 'Fraud? What fraud?! You knew the borrower's real income and asset information later when he refinanced!'" The problem though is that these borrowers would need to get approved for this new financing. This just won't happen in most of these cases as their houses clearly aren't worth as much now as when they bought it, even six months previously, and many won't be able to afford a standard FHA rate, which is why they got the ARM in the first place.

No lower, please!

On why lowering the interest rate is probably the worst thing that the Fed can do right now

As I can see it, if the Fed does what Wall Street is asking for it to do, there will be (at least) four major effects, half of which are "good" (depending on who you are...).

1. The trade gap will shrink from a record negative $764 billion last year. This is good for local manufacturers as that means we will sell more stuff and bring more money back here. However, some of the other effects act as a (smaller) counter-weight to this, limiting its impact somewhat.

2. Mortgage brokers and other lenders will see profits increase. This is largely because they can acquire lower risk borrowers with lower interest rates. They will also see profits rise on their currently held fixed rate mortgages. This is the primary reason the Fed would be willing to lower rates.

3. Now we start on the bad effects. First is inflation. Over the past couple months, the dollar has dropped significantly against the Euro and the British Pound (along with most other foreign currencies). This helps the trade gap, like I mentioned above, but it really hurts the consumer. I predict, especially if the Fed does a half point rate cut, that we will see oil prices over $100 within a week. Oil isn't over $90 a barrel just for giggles. It too has gone up in price with every rate cut. That will be the first one you see, but food and other imports are going to jump a bit too. Those have two things going against them, the spike in oil prices and the drop in the dollar value. Oh, and that inflation rate that is reported on monthly doesn't really reflect the inflation working class people face. Just anecdotally, my health insurance costs have gone up about 10% annually, what had been my rent (we got a house last year) had been going up 6%, gas is up, right now, 50% and like I said a moment ago, I don't expect it to come down any time soon. Heating and energy costs are up between 10 and 25% or worse from what I have been hearing. And food, or what I have been paying close attention to at least, is up about 6% too. These are the things working class people spend 70% or more of their paychecks on (most of the rest going to debts...).

4. It won't help fix the one thing that is causing the credit crunch, it will only hide it. This rate drop will not help fix the housing market in the least. Mortgage lenders are still going to be less willing to offer loans without a significant down payment. The group that was supporting the housing boom - college graduates and other first time home buyers - will still be unable to afford a mortgage. The other group supporting the housing market, speculators (i.e. flippers), will continue to lose their target customers and so fewer of them will be buying more houses. Add to this stagnant pool the expected record number of foreclosures expected in the coming months and you will see a continued drop in home prices, which will just add fuel to this fire...

At best I expect any interest rate cut to be a bandaid covering an infected cut. I just hope that the infection is taken care of before we have to cut the whole limb...

So please Federal Reserve, stop listening to crazy investors who can't see financial issues outside of Wall Street and start looking at the bigger picture. Don't lower interest rates; find ways to fix the real problem.