Wednesday, 19 September 2007

The Dukes of Moral Hazard

When I was younger, I always looked forward to the day when I could play the crusty old coot with complete alacrity. Who’da thought that the day would come so soon? The project is in a stage now where I am spending all day reading plans and specs, listening to the news and brewing over what I’m hearing. Soon enough I will be up to my eyeballs and have no time for any of this so enjoy it while it’s here, right?

For kind of a long while, I’ve had two stock rants: the mortgage/housing price rant, and the oil rant. Well, I heard on the way in this morning that oil capped out over $82/barrel in Asian trading overnight, but the credit deal is really what’s on my mind today. If you’d like, you can call me the swami and say I predicted this crap a while ago, but this fiasco has been inevitable for a long time.

At this point, if you have an inclination to know why this thing got so fouled up, you’ve listened to and read the news and you pretty much know what’s up. You know about collateralized debt obligations (which are becoming more and more of a misnomer by the day), mortgage underwriting practices, adjustable rate mortgage resets, and you certainly know about the Fed and interest rates. So you definitely know that the Fed lowered rates by .5% yesterday.

Two days ago, I ended my post with a note promising some thoughts on the election and why people who don’t deserve it are going to get bailed out of risky decisions and bad behavior. Well, I’m no economist, but I play one on this ridiculous blog, and I think it absolutely sucks that the Fed a) cut rates and b) cut them as much as they did. The rest of this post will be about why they shouldn’t have cut at all, but to the point of why so much: hey guys, if it turns out that this doesn’t accomplish your goals, then what?

If you bought a house thinking that there’s no way prices could do anything but go up the way they had been when you bought it, that was dumb but not fatally so. If you arranged your debt obligations such that you depended on the market to rise in order for the whole deal to work out, that was really stupid and borderline fatally dumb. If you bought a bigger or more expensive house than you might have otherwise because, hey, when you’re on the right side of leverage it’s a great thing, that was fatally stupid and you are a system criminal. System criminals are those whose actions, when replicated by a critical mass, cause a negative system shift.

To illustrate my point about system criminals, think about the people who drive in the left lane on the Beltway, yakking on the cell phone while going 50 mph. It’s not right to pass people on the right, it’s not the way the system works, but if anybody wants to pass Mr. or Mrs. Cellphoneyakker, they have to pass on the right. I HATE to pass on the right. It’s dangerous. But anyway, now the dam is open and passing on the right is common practice. This makes it okay for Mr. Tokyo Drift to weave in and out of lanes going a million miles an hour because, hey, everyone passes on the right. So you take a system that has one little gateway in it that causes the system to work well, then you remove the gateway and mayhem ensues.

In this case, system criminals, motivated by greed, turned the housing market into a Ponzi scheme. Certainly the credit markets were incredibly willing enablers, as without all of these people awash in a sea of cheap cash this wouldn’t have happened. And without the cheap interest rates brought to you by Greenspan and friends (and continued now by Bernanke), the credit market couldn’t have acted as it did. People had more money than they should have had available to them, and spent it on housing. These actions, repeated ad nauseum by countless others, drove the market up. To a certain degree, housing is a finite resource, and the simple laws of supply and demand are in play here. If you are willing to pay more for a house than I am, you get it. That’s the way it’s supposed to work, and all is well. But, when you, armed with debt that you will at best be able to repay if the market goes your way, are willing to pay a price that you otherwise could not afford to offer, we have a system breakdown. In that case, prices will rise constrained only by the willingness of the credit system to pump money out into the market, and the willingness of naïve consumers to take on that debt.

Whether it’s greed for flipping the house for a quick profit or greed for a bigger backyard, better school system, shorter commute, fancier cabinets and countertops than you can afford, or whatever, it’s still greed. But now when you get into trouble, you are someone to whom the politicians can make a promise. And they’ll make those promises and you will listen to them because you need those promised delivered. So all of the politicians will be looking for any way that they can help the faultless “American homeowner” over the next year, and that will frame a huge part of the debate. Even though I, and many others who either did not “have to” or did not choose to get embroiled in this whole shitshow, did the right thing, I will wind up paying for it.

The lesson for everybody who nearly got their noses burned off in this whole thing, from the traders who lit up the CDO markets to the homebuyers who didn’t know any better but should have, is that the government will pick up the pieces and all transgressions will be forgiven.

1 comment:

fabsroman said...

The federal government isn't really picking up the pieces. Bush isn't providing a bailout to these people, he is just allowing them to find financing. I read a pretty good article about that, and I agree whole heartedly with him. His position is that if he bails everybody out of this mess, then nobody will learn from it. Also, the cutting of the interest rate might not actually result in a substantial decrease in the 30 year fixed mortgage, but I guess it might actually help out those with ARMS in the short term. Again, just another patch for the idiots.

When my wife, then fiance, and I were in the market for a new home 3 years ago, which ended up being a townhouse, we were approved for $450,000. However, we knew we couldn't afford that loan at that time, so we only opted to borrow $300,000 and I went for a fixed 30 year term at 5.75% versus these stupid ARMS. When it came time to put a contract on our house, our real estate agent was insane. The house had been on the market at $375,000 for 3 months, then $350,000 for 3 months, and finally it was listed at $325,000. There was all of one other bid on the house and the bids would be opened on Monday, with that day being Saturday. Our real estate agent wanted us to start at the asking price of $325,000, use a $5,000 escalation clause, and go all the way to $375,000. I had to ask her to leave the room so I could talk to my wife in private. We ended up going with the $325,000 starting point, an escalation clause of $3,000, and an ending point of $345,000. We ended up getting the house at $333,000. What really bothers me is all this stuff about escalation clauses, max bids, etc. Why don't we just use something like "What is the max you are willing to pay?" I know why, because too many people would be able to understand that and the realtors wouldn't be able to get house prices high enough.

At the end of the day, I blame the realtors, home builders, mortgage brokers, and mortgage companies for the housing mess we currently have. I hope they saved all the money they made over the past 5 years, because they are going to need it now.

I have a drywall contractor and a granite countertop contractor as clients, and they made so much money 2 years ago that they didn't know what to do with it. Now, things are different. I tried to tell them that things would eventually cool down, and the drywall contractor paid attention, but not the granite contractor. Oh well. Now, I am working on collection accounts for the drywall contractor and a couple other clients. I also have a couple clients that are trying to get out of home purchase contracts.

I also have a couple that makes about $180,000 combined and their mortgage interest last year was $55,000.