Hysterical Lemmings Never Learn

What's Up With the Mortgage Meltdown
I thought I'd wait awhile to really comment on the financial meltdown in the credit markets, because I thought we might actually learn something this time. Alas, we haven't learned much. Quite similar to former housing bubbles, or any investment bubble for that matter, this one appears similar. Amateurs get hooked into the "dream" by snake-oil vendors selling lullabies, who bolster their story based on "expert" opinion. Once the tinder gets near the fire, before you know it, you have a conflagration that's out of control until it burns itself out.

Remember the tech bubble? A lot of money was left on the table there too following highly suspect business models that were worse than most pyramid schemes. It's a strange marketing phenomena though in marketing. It appears you can tag something with another name, add the right amount of exciting "fluff" speak, get some spokespeople, make them presentable, add some "expertise" and sell it. A rose is a rose by any other name as the Bard once said.

What does this have to do with the financial meltdown? Everything. In speculative bubbles the buyer fever is created so that there is too little product being chased by too much demand which drives up price. In the housing world it was cheap interest rates that drove affordable housing prices. A 5% mortgage will buy you 40% more house than an 8% mortgage. Therefore, those used to an 8% mortgage can afford 40% more house, which is the short form of essentially what happened. You've heard ad nauseum no doubt all the finger pointing about whose fault it is/was.

Whose Fault Is It?

It's everybodys fault. Buyers, sellers, bankers, brokers and the Fed. The problem is that everyone keeps wanting to make their money before the bottom falls out. The truth however is that it's like timing the stock market. Everyone has a story about how their "friend" bought Apple stock at $12 and sold it for $70. Further investigation however often dispels that though. Most people who buy at $12 bail out before it doubles. There are infinitesimally few who actually hold out, and those that do in these rare instances usually got lucky by sitting on a long term portfolio invested in certain sectors. Generally money managers don;t do this today. They keep money moving around to minimize risk by "averaging" the investment portfolio. Of course they never discuss the commissions they make by selling and buying, which are usually much more than the mere "maintenance" fees they earn on static portfolios.

So, to get at the root of the problem you need to examine who stands to "make out" on the deal - in any of the commodity chases that cause bubbles.

Financiers
The big cash-stashers - big banks, insurance companies and pension funds are charged with making their clients good returns on their investments. In low yield markets - like when the prime rate was 1%, government bonds are not a very good yield - at least that's the historic perception. In many instances, as in retirement pension funds and insurers, calculations have been made based on average lifetimes and annuity values often predetermined with minimum required yields of say 5% average over a number of years. If the bond market is only yielding 3%, then these investors with large amounts of cash begin to look for riskier and less "liquid" investments with higher returns on investment. These investments are often mortgages, but when mortgages were hovering around 5% the net yield for the investors was often not high enough to meet their investment goals. Therefore, money managers began to "push" riskier and riskier borrowing through "subprime" loans. Then the money managers began bidding against each other to replace the capital they just loaned for even higher yields. So, they mixed more and more subprime (think junk bonds) into the prime mortgage mix to get higher and higher "average" yields. There were bonuses and higher "yield spreads" paid to lenders who could peddle more and more subprime junk.

Sellers
Sellers think they made out the best. Many sold for more than they ever thought they would and faster than they thought. What they didn't realize until they went shopping for their new home is that everything is relative in a rising or ebbing tide. If your house went up, so didn't the one you bought. Today it's the same. What you can get for your property today is relative to what you can buy today - their house has gone down in price too.

Buyers
Buyers were caught in the furor. "Buy now before it's too late!" This was the telegraphed message by every agent and broker in the country every day.

Some bought in 2000, just when prices were rising, sold in 2003 because they could get so much more, then bought and some even sold again. Others just gloated about what their house was "worth" compared to what they paid for it.

Worse, many buyers and some sellers decided to become "real estate investors." When all is unraveled, I believe much of the subprime mess will not only include those buyers who were lying about their "stated income," there Will be a lot of these amateur homeowner investors who bought "investment condos" in Florida and Las Vegas, yet can not afford to make the payments on the huge mortgages that are 40% more than market rents. These properties are falling fast, and the problem is that if you have other equity in a mortgage default - like your personal residence - lenders will go after it to make up for any losses they may take on your "investments." Almost all of these loans for amateur investors were made as "recourse" financing. They can and will come after other assets you might have in most cases.

Brokers
Real estate brokers and their financial brothers - mortgage brokers made out very well too. Where else can you make 3% to 6% on other people's money without any risk of your own? Don't forge the army of appraisers, inspectors and title lawyers either. They all made out quite well thank you. Attorneys and those real estate brokers that remain will still do well. Attorneys will soon be suing the brokers they were so friendly with a few years ago when they were doing all those closings - as money tightens up for indebted sellers looking for alternatives to cashing out their stock funds to pay off their bad mortgage notes. Attorneys often get as much as 40% of other people's settlements with little or no risk to themselves.

Nonetheless, these properties will sell even at 30% less to someone, and the brokers that are left will be involved, and yes, they'll get paid to bring buyers to the table.

The Fed
By the Fed here I don't just mean the Greenspans and Bernankes. I mean the Congress as well to at least the same extent. After 9/11 our government was very concerned we might head into a recession, or even a depression. We might very well have, if we had another large scale attack where fear takes over common sense fundamentals. Americans are not used to that kind of tragedy.

Therefore, to keep from sliding into recession, the government decided to loosen the purse strings on the one asset that most Americans have some equity in. After all, with IRA and 401k portfolios having just taken huge hits in the tech sector, and with the average American not saving as much as their fathers as a percentage of income, what else would help drive the economy?

Real estate! I've been through 4 of these cycles. the real estate boom-bust cycle seems to happen roughly every ten years. Some peak higher than others. Some sink deeper than others.

What to Learn
Here's what I've learned. The promise of the "highs" are never attained. What goes up, does come down. The lows too are never as dreary and bleak as the prognosticators bloviate about. The phoenix always rises from the ashes, and if it should not - remember that everything is relative. People need to live somewhere. Endless vacant houses do no one any good.

The government always steps in when the pendulum swings too far one way or the other. The depression was ended with government work programs. Millions of returning Veterans after World War II received GI benefits for housing and school that added great impetus to our economy.

The real estate boom and bust of the 1970's, 1980's, 1990's and now 2000's were and will be helped along by government policy and in some cases government subsidy. We'll then have a few growing years that will culminate sometime likely in the 2010 decade into yet another up and down cycle.

In each cycle I've been through there were those who claimed I needed to buy now, followed by the gloom and doomers who thought the economy was surely headed into depression. I remember gas lines in the 70's. You couldn't get gas even if you could pay for it. Stations ran out.

In the 80's I bought and sold lots and lots of real estate. There was always a "deal of the century" at least once a week, and most buyers always feel they pay too much in any market.

In the 90's I remember reading a book called "The Next Great Depression," written by some guy with a Doctorate in Economics. He predicted it would happen in 1997. I think he's now with the people waiting in the cave for Armageddon next year.

So, take the gloom and doom claims for what they are, and remember we now have a 14 TRILLION dollar annual economy. We consume about 30% of the worlds goods. There are lots of people worldwide who have a serious stake in our success - especially us. We'll do just fine, as we always have. In the meantime however we'll need to work out the kinks. Some will get hurt as happens with excess, but we'll come out hopefully smarter and more aware next time.

Chris Michaud
Acceptance Group
chris@acceptancegroup.com