Did this mess start with Main Street ?

[Nick at Noon]

We've all been reading a lot about how this crises began. Some blame it on Wall Street and some blame it on poor minorities. Ther's plenty of blame e to go around, but I'd like to make one illustration that I think will fit almost all -- except for changing the numbers.

The problem did not start on Wall Street. They simply exacerbated it when they thought they saw a quick profit with little risk.

It started on Main Street USA when banks were asked to bend the rules a little to help minorities own houses. Bankers did that with a few mortgages, sold them to out of towners and realized something: There is a lot on money in sub-prime mortgages if you don't have to hold them to maturity.

A few local bankers blew this idea by a few fellow profiteers in the local real estate business and they all decided -- "we can make a killing". The big problem was that -- in 2002 -- median houses were not that expensive so the size of the payoff would not be as large as they would like. They did not want to waste their time with $80 and $90,000 mortgages. What to do ? Call in a few real estate appraisers and explain to them that a $125,000 house was now worth $200,000.

That was do-able.

So in 2003, Joe Schmedley has a family income of $50,000. He is looking for a house in the $125,000 neighborhood if he can get it for $5,000 down -- which is all he has. He talked to a real estate agent the previous year and found it discouraging to buy with so little down. So he is surprised when that agent calls him and offers to show him a house he can afford.

Joe and wife ride out to look at a house that the agent -- Al Capone Jones -- shows them that is listed for $225,000. Al's brother-in-law and real estate appraiser -- Jim Leach -- gave them the figure. Mrs Schmedley thinks the house looks familiar. She ought to. It's the one Al showed them last year when it was appraised at $125,000. But Al convinces them that house prices are rising rapidly and no matter how much they pay -- they will be able to sell it for a good profit in three years.

They are taken by the mortgage banking firm of Holdem, Cheathem and Howe and introduced to loan officer John Gotti Smith who takes their application.

It is explained that the only way to afford this lovely home is to accept a variable rate mortgage with payments for the first three years of only $500 a month. Hell, they can afford that. The bankers lawyer assures them that -- odds are -- interest rates will never rise, so all should be fine. Joe gives them his $5,000 down and moves in. His mortgage is $220,000. Al collects his fat commission -- almost twice what it should have been -- and John sells the mortgage to some dandies on Wall Street.

So everything is lovely with the Schmedleys until 2006 when the "teaser rate" expires and his payments rise to $1450 a month. He can't afford that. So they decide to sell. Problem is nobody wants to give them more than $125,000 for the house.

Multiply the Schmedleys experience by about 6 million -- and you see why Wall Street is in a dither. You will also see why nobody at the local Country Club wishes to discuss it -- except with their Congressman -- who they are begging to bail out Wall Street.

Let's examine the figures. Schmedley -- with an income of $50,000 should have never been given a loan for more than a little over twice his income. Or a little over $100,000. Let's say $120,000 to be generous. Twenty years ago, no responsible banker would have allowed him to have more. A 30 year mortgage for $120,000 at 6% would have given Schmedley a monthly payment of $760. He could have afforded that.

Was there complicity between local brokers and bankers in the run up of house prices and the lax mortgage criteria over the past 7 years ? I don't know. I leave that for the reader to decide.

Just a personal opinion from a regular poster.

[Jackpine Radical]

1. Real estate also got driven up in value because the market was wobbly

and money had nowhere else to go. Real estate looked like a safe harbor, so all kinds of lower-echelon investors started putting their money in houses. Rental units, investment houses that they were planning to flip in a couple years, etc., and the banks were happy to finance these little ventures.

[ThoughtCriminal]

2. The mess started with how much...

Wall Street was willing to pay Main Street in wages. Shrinking buying power lead to more debt.

[stray cat]

3. It started I think with a lack of responsible lending practices and then unethical lenders

[TwilightGardener]

4. I think there's some truth in that. I don't know when it became common

practice for local banks to be able to sell risky mortgage loans to bigger firms, but once that started happening in mass quantities, especially with the housing-value bubble going on, it sounds like that became an overvalued gravy train that was too hard to resist, both on Main Street AND on Wall Street. As long as the risk was absorbed far from the site of the loan origination, there was no real brakes to the subprime lending practice.

[TexasObserver]

5. You do not understand the markets at all.

It can't start on Main Street.

It started with The Fed keeping the economy going on cheap money and high liquidity long before it hit Main Street. The policies by the Bush administration, the lack of regulation, the lack of oversight, the ridiculous acceptance of every risky, high leverage financial security Wall Street dreamed up - these are the things that drove the boom and bust.

Your attempt to blame the consumers is distinctly right leaning.

[tekisui]

7. It's always "the People's" fault, don't you know?

:banghead:

[TexasObserver]

9. Yes. Remember all the Di-tech commercials begging you to buy a house?

The Bush administration wanted the economy rolling in 2004, for the election, and they got it. They were pushing homes for everyone.

[Nick at Noon]

10. Since when are a few crooked realtors and bankers called consumers ?

Your attempt to blame the consumers is distinctly right leaning

Actually I am on the side of the local people ... but not the speculators and profiteers at the local country club who benefited most.

[TexasObserver]

11. No, you blamed MINORITY loans.

"It started on Main Street USA when banks were asked to bend the rules a little to help minorities own houses," is what you said.

No, it didn't start there at all. It never starts THERE. It starts in some GOP enclave, where they scheme to use government to help them steal more money.

You're not fooling anyone here.

[Nick at Noon]

13. It's possible you misunderstood me

Making a few loans to minorities was good. Taking that same lax criteria and extending it to most of their loans was bad.

[jobycom]

15. Excellent post. nt

[TexasObserver]

17. I am really upset about the "blame the consumers" theme.

Yes, many gullible Americans bit off more than they could chew, probably without much thought, but we're talking about consumers with zero business acumen. They don't know what the hell they're doing when it comes to buying that first house. They are totally dependent upon the professionals who lead them by the hand from real estate office to banker to mortgage lender.

It all fits together in a way consumers never understand. All they know is they have to pay X dollars a month for their home, for Y years. They understand their interest rate may change, but they don't realize what that means until it happens.

We can't save all their homes, but we can avoid treating them like greedy bastards who schemed to upset the Treasury. They're people who bought into a lie. Their investment in a home went South.

I have a solution that would put an end to the problem of lenders making stupid home loans: Require that all home loans are guaranteed ONLY by the title to the property. That would be NONRECOURSE notes by the consumer. If they walk the deal, all the mortgage holder gets is the home back. This would force lenders to avoid making home loans that are too risky.

[RC]

6. Explain to me again why no one is talking L-O-N-G prison sentences for the

criminals profiting from their housing fraud schemes? WHY?!!

[Nick at Noon]

14. I don't know -- but they all need some hard time n/t

[liberal N proud]

8. Let's see...

If the government hadn't relaxed regulations that allowed the lenders to offer the loans that those who couldn't afford but took anyway. We would not be in this mess.

It is the borrowers fault that Congress allowed the lenders to offer loans to those who should not have been allowed to borrow money?

15 years ago, the people they are trying to blame would not have been allowed to borrow that amount of money!

[jobycom]

12. No, didn't happen like that.

There were a lot of factors involved in the mortgage industry crisis, ranging from changes in home equity loans to fraud to loose investors to overly-aggressive lenders, but none of it happened the way you spell it out. As always, "minorities" (and by that I mean historically discriminated against groups, however you define the traits that make them discriminated against) got the least favorable terms, the least access to loans, and the least leeway when they encountered troubles.

My spouse was in the mortgage industry when it exploded over the last ten to fifteen years. It started with the deregulation of banks, which allowed mass conglomerate banks to make money by taking a few risky loans. They didn't target minority investors with their new products, they targeted investors and wealthier home-owners with equity locked into their homes. In Texas, where home equity loans were illegal, they campaigned to legalize them (under Bush, of course, who screwed up Texas before sticking it to the rest of the world), and once they did, lenders targeted borrowers with a barrage of new loans and loan formats and schemes. There were 5/15/80 plans, where you could borrow 80% on the first mortgage, 15% on a second mortgage, pay 5% down, and avoid PMI. There were home equity loans, and aggressive appraisal systems that assumed a house would increase in value in a short time, so that the 80% cap on equity loans could be maximized.

As these loans created new mortgage companies, from small broker offices to larger banks, the investors had so much growth and wealth tide up in the loans that the only way to justify their existence was to loan more and more, and sell the loans to get money to sell more loans. Brokers and lenders no longer made money by carrying loans, but by originating them and selling them to a secondary market who managed and collected on the loans.

As these companies strove for more and more loans to maintain their business income, and as the equity market in Texas (an overlooked source of much of the problem) began to reach the down side of the Bell Curve, lenders came up with more and more creative ways to entice people into borrowing. Use an aggressive ARM to buy a house outside your income bracket (thus driving housing prices higher). Refinance a two year old loan to take advantage of a lower interest rate. Refi from a fixed 8% loan to a five year 5% ARM with a 1% yearly cap, so that you can hold the house 8 years before the interest rate increased above your original loan. Lenders got to where the connection between the actual loans and the lender's income was irrelevant--the only income from the loans came from origination fees, discount points, and the selling price to a seconday lender (the lenders who buy the original mortgages from the lender who originated the loan).

Eventually everything got out of hand. It turned from a mortgage industry into a Ponzi scheme for many companies. At about that time, BushCo took over, deregulated even more, refused to enforce the regulations that already existed, and fraud exploded into the scene, exactly as it had in the 80s with the S&L crisis. Scam artists would found a cheap piece of property, and get a straw buyer to put his or her credit rating on the loan documents. They would fake an income statement for the straw buyer, get an appraiser to value a 100K property at 500K, get the money from the lender, make three payments (just enough to make the loan look viable), then skate with what was left of the 400K overage. The lender would sell the loan as top rated paper, and the new holder of the mortgage would think they had an A+ loan, only to have it collapse in the end.

A more legal version of this was for a loan originator to get an honest appraisal and credit check on the borrower, then sell the loan when the market fell below the loan value. The loan still seemed perfect, but the new loan holder was stuck with an upside down mortgage.

As the other side of the Bell Curve became a downhill ski slope, lenders got desperate. They made riskier loans, they made more aggressive incentives, they got more aggressive and less honest with borrowers on the terms of new loans they were offering. And they stretched their loans out into the historically underrepresented markets--the "minorities" you are talking about. They then used agressive and deceptive sales and marketing pitches to rake in these loans, hoping only that they could get a loan, sell it on the secondary market, and reap the profits while the secondary holder got stuck with the bad paper, and the borrower got stuck with a time-bomb ARM they had no chance of paying off.

As always, minorities were the victims in these schemes--they were the last to benefit, and the first to get the shaft.

Eventually nothing could continue the illusion. The Bell Curve bottomed, the mortgages began to collapse as the ARM increases were triggered beyond what the borrowers could bear, and the credit dried up at the exact same time that borrowers needed the loans to escape their ARMs, and at the exact time that the values of the mortgaged properties collapsed below the loan value, so that no one could refinance these loans.

Don't blame minorities. Don't blame Main Street, either. Sure, individuals should be expected to monitor and manage their own finances and credit ratings. But the problem here wasn't the individuals. The problem was that the protection system built up since the last Great Depression was dismantled, destroying the protection of the entire system that kept individual mistakes from collectively creating an entire systemic collapse.

In short, if an individual trips on a sidewalk because he's not watching his feet, it's the individual's fault. But if dozens of individuals trip in exactly the same spot, you know there is a problem with that spot. At that point, the bigger blame for the problem goes to the people hired to maintain the sidewalk for their failure to do so. That's where we are now. This is Wall Street's problem, and their fault. More than that, this is Washington's fault, and Pennsylvania Avenue's fault, for ignoring a problem everyone saw coming.

[Irish Girl]

16. No, it started with neither Main Street or Wall Street

The problem started with the Federal Reserve Central Bank. Alan Greenspan, during the Clinton Administration, flooded our market with cheap credit, which created an artificial bubble on Main Street. When this bubble burst, it brought the subprime mess. Wall Street had a separate bubble forming off bets they were using to get rich, called Derivatives. When the subprime mortgage bubble burst, it triggered TRILLIONS of dollars of Derivatives to burst. But make no mistake. Many on Wall Street betted that the subprime mess would happen and unfortunately some got very, very rich off people defaulting on their homes.