Tuesday, September 23, 2008

Congress Mortgaged our Markets

The financial markets in this country are weathering a severe storm. My strategy in life, modeled for me by some great people, has always been to face rough times with humor. Right now, though, is no time for a belly laugh, not with a lot of very good people watching their net worth slip through the netting and down the drain. But a chuckle is still appropriate, even if it comes with a grim echo.

The funniest gag of all comes from Nancy Pelosi, blaming the Bush administration for the collapse of the nation’s mortgage base. This occurred, she says, because of a lack of regulation and oversight. For people living out here in the real world, that is a real thigh-slapping screamer. What brought so many mortgage banks down was a surfeit of regulation and oversight, but regulation designed for goals other than fiscal security.

Look, anyone who has bought or sold a house in the last twenty years is well aware of the situation. The real estate agent or mortgage broker whom you work with will certainly clue you in to the existence of FHA mortgages, Fannie Mae and Freddie Mac. You, as a middle-class person, will be told that you must put up 20 percent of the cost of the home you purchase. It is possible also to pay 10 percent in advance and borrow 90 percent, but then you will have to pay a monthly charge above the mortgage payment. That charge is to pay for mortgage insurance, where the bank gets some additional degree of protection from loss in case they foreclose and the house only sells for 80 percent of value.

But if you are poor, the agent or broker adds, then you are in good shape. Between Fannie and Freddie they can lend you up to 95, 97 and 100 percent of the price.

Now, I have been both buyer and seller of real estate over these two decades, and I have been shaking my head quietly over this situation. It was clear to me, as it should have been to any responsible person, that this system was a disaster waiting to happen. There is a reason why banks do not agree to lend more than 80 percent of the value of the property, more than one reason in fact. Values often go down twenty percent on their own, and the value of a home in foreclosure is also hurt by the process. There is also a reason to demand that a buyer put up some money, more than one reason here too. It is important that a person has some ability to manage funds well enough to accumulate some; it also bodes well for repayment when the purchaser has put some of his own capital on the line.

The idea of helping a poor person get a house is wonderful, but it flies against some of the harder edges of reality. It could work in many cases, or even in most cases, but it puts the lender in the position of having no margin for error. As long as the borrower can keep his job, with a salary increasing in proportion to inflation, without radical new expenditures caused by illness, and as long as the house keeps its value, the result will be a win-win. But if any one of those elements takes a hit, the whole house of cards will come tumbling down.

Clearly, then, the only way this system works is by eventually pushing the bad debt back to the government. Yet the government bureaucrats do not have their own money at stake. What they do have at risk is their job if they cannot show Congress that enough poor people are getting into homes. An unhealthy paradox evolves, where the government worries more about pushing loans than about collecting loans. Lenders and brokers get the message, so they run around recruiting new buyers among the barely-employed. How could this fail to fail?

Fail it has. After years of scratching my head, trying to figure out how this works, I have achieved perfect clarity. No mystery here after all. The answer is simple: it does not work! Never did, never could have.

As with any crisis, the only hope is if the villains are correctly identified and blame is reasonably apportioned. What are the chances that Congress will suddenly hit themselves in the collective forehead and yell, “Eureka, two plus two equals four”? Now there is a thought that has to make you chuckle.