02 February 2008


Subprime mortgages were always insane

I've never run a business any larger than my own solo writer-editor endeavour, and didn't enjoy the paperwork of that very much. I don't like reading business magazines, I don't play the stock market at all, and most financial analysts on TV, radio, the Web, and newspapers give me the heebie-jeebies. So I'm no financial expert.

Still, in the past few years, I couldn't understand why anyone in the U.S. could think a subprime mortgage (better called a "high-risk mortgage" or a "poorly qualified mortgage") would be a good idea for anybody. I heard some stories about them, but it wasn't really an issue in Canada, so I thought these mortgages were a silly, fringe thing and pretty much forgot about them.

People borrowing from banks and mortgage brokers and other finance companies who offered these mortgages were betting that house prices would keep going up indefinitely and interest rates would stay low, no matter what. The firms and financial analysts were, insanely, betting the same. Sometimes the companies loaned people more money than their houses were worth at the time on that assumption—and didn't check on their customers' ability to pay either!

I'm only 38 years old, but I've seen several economic booms, busts, and recessions in my lifetime. I remember when interest rates were 17% and higher in the early '80s, and my junior high school classmates and I—barely comprehending teenagers at the time—laughed out loud when our teachers said loan interest used to be 4% and lower. We never thought that would happen again. And if it did, we knew that could change. The dot-com boom and bust are less than a decade old too.

So I agree completely with Daniel Gross when he writes at Slate that bankers and financiers, now getting pounded in the markets because the subprime mortgage situation (which is vaster than I could have imagined anyone letting it get) is now shooting holes in the U.S. economy, are acting like a bunch of spoiled toddlers:

Children typically display an unwillingness to reckon with the consequences of their own actions. They look to parents to pick them up when they fall, and spare them from responsibility for their misbehavior. And parents will go to great lengths to insulate their offspring from the jolts the world can deliver.

The same might be said about Washington's current economic ministrations. The nation is now nursing a seriously skinned knee because of reckless housing and credit practices. But rather than force consumers, borrowers, and bankers to face the consequences of their own actions, Washington is functioning as a helicopter parent.

As we face another recessionary slump (maybe insulated a bit here in Canada), we're all going to pay for that childishness, because governments don't have enough money to do anything but cushion the blow a little. Steven Pearlstein put it even more simply in the Wall Street Journal almost a year ago:

Bankers shouldn't make—or be allowed to make—mortgage loans that require no money down and no documentation of income to people who won't be able to afford the monthly payments if interest rates rise, house prices fall or the roof springs a leak. It's not a whole lot more complicated than that.

What I do wonder is, when people are losing or walking away from homes they shouldn't have been able to buy in the first place, and also losing jobs as the economy weakens, why do the well-paid supposed mavens of Wall Street, and other finance types around the world who bought into this scheme, still have jobs?

And why do investors continue believe them when they're wrong more often than weather forecasters used to be before we had satellites?

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many of them don't have jobs anymore. give this a read, it's pretty enlightening:
I'd put a lot of the blame on the liberal US government. In the interests of "fairness" and political correctness, they encouraged lenders to make loans in bad neighborhoods, to unqualified buyers. When these loans naturally went bad, everyone blames the greed of the lenders, and once again, looks to Government to fix it, when they were the cause of this (and most) problems in the first place.

The lenders, on their behalf, are getting their appropriate reward now. The free market has a way of correcting things.
Julien, that Hedge Fund Manager interview is indeed fascinating.

As for the role of government, I've always found it funny how people such as the chairman of the U.S. Federal Reserve are considered (and style themselves as) free-market capitalists, when they're the world's biggest price fixers, because they set the price of money.
Good post, Derek.

Australian banks have been impacted by the US sub-prime fiasco also. All the big-4 banks here have increased lending interest rates independantly of the Reserve Bank of Australia official rate, effectively making current loan holders pay for someone else's lack of financial prudence. In my mind, the bank executive (via their exhorbitant salary packages) and the shareholders need to shoulder more of the burden, and not those who have followed proper prudential process.

It should be the Government's role to ensure that the right people are held accountable. The RBA is at least independant of Government, as is APRA (Australian Prudential Regulatory Authority), but I doubt they will do much about this, since there is no direct sub-prime exposure - all the exposure is in the local banks investments in US sub-prime lenders. Still, same logic should apply, and the shareholders need to carry the risk, not the customers.

Melbourne, Australia
I live in Colorado. Three years ago we got a regular mortgage. Nothing fancy. Nothing extreme. Not beyond our means. Now we want to be able to move due to job opportunities in another state but we are stuck because there are so many houses for sale in our area. We just saw an ad for a house just like ours a few blocks away, but with more square footage (finished basement) and a larger lot. The owners must be trying to dump it, because we know approximately what it cost them. Unfortunately, by giving their home a "clearance" price, they have screwed us. So to sell ours in this market, we'd have to take a loss, lose all the money we put down on it, and walk away with nothing to use to buy a future house. So, now we have to decide how badly we want to move, or if we can stand to stay put for maybe years--changing the plan of our lives, just to see if we can eventually break even.
(By the way, the reason US residents buy houses instead of renting is, not only that you aren't throwing rent money down the drain, but because you pay less income tax--you get to deduct your mortgage interest from your income on the Federal tax return.)