Tuesday, October 28, 2008

Housing And The Candidates

"Homeowners are the innocent bystanders in a drive-by shooting by Wall Street and Washington." John McCain

"What we need is a floor in the housing market, a, a stop to the decline in housing values."
Barack Obama

One of these two men will be our next President. Neither of these two men have shown any understanding of basic economic principles or economic reality. There seems to be a collective re-writing of history underway that passes nearly all of the blame for the mortgage debacle on to Wall Street and Washington and absolves the home buyer from any guilt. That may make it easier for Congress to pass its ill-conceived bailouts, but it doesn't square with the facts.

Let's start with McCain's quote. Homeowners are the innocent bystanders? I can only hope that this comment is driven more by political expediency and pandering than actual belief. This type of comment makes me wish he'd focus less on the economy and more on Palin's wardrobe and make-up.

The fact, however, is that many homeowners over the last few years knowingly took a gamble on housing. Some gambled that interest rates would always remain low. Some gambled that they'd always be able to refinance their mortgage at a low teaser rate. Some gambled that they would be able to sell their home to a greater fool at the time of their choosing. Some gambled that their eccentric rich old Aunt Eunice would kick off and leave them a mint. Some gambled that they would get a raise that would offset any mortgage payment increase. Some gambled that they would be able to flip their negative cash flow investment properties for a nice profit to another investor who was even less concerned with cash flow.

Yes, there was some fraud that occurred. Those folks/firms should be prosecuted to the full extent of the law. However, when financial institutions agree to lend money to a homeowner with some combination of low credit score, low earnings, low down payment, and little savings, that's not fraud. It's just bad business. The bank was foolish for making such a loan, but that doesn't mean that the homeowner who willingly accepted that loan should bear no responsibility. Do you think these same homeowners would be complaining about their mortgages today if the real estate market and economy hadn't soured? Of course not. It seems to only be a problem for them because their gamble didn't pay off.

If you sign a document, you're acknowledging that you understand and agree to its terms. If you don't understand the terms, you have no business signing the document. Any homeowner could have hired their own lawyer for a few hundred dollars to explain the terms. Anyone could have Googled "mortgage" to help get up to speed. Instead, people were willing to spend more time researching the purchase of a new plasma TV than the details of their mortgage terms.

What about Obama's quote about needing a floor in the housing market? This ridiculous statement shows Obama's complete lack of awareness of the disastrous history of price fixing. This reminds me of
Pakistan's stock exchange. The Pakistanis grew tired of falling stock prices in their country this summer so they instituted a floor under stocks on August 28th. Until further notice, stock prices would be allowed to fluctuate within a 5% range, but they wouldn't be allowed to fall any further.

What has happened since? Volume has dried up and the market has barely budged. Who in their right mind would want to step in and buy with such a lack of transparency in this environment? If price fixing and floors really worked why don't we put a floor under incomes at $1 million? We could all be rich! In addition, let's pass some legislation mandating that everyone is entitled to a minimum level of attractiveness. We'll just have the "government" pay for all of the "necessary" implants, botox, and liposuctions.

Trying to put a floor under housing will lead to buyers stepping away from the market, which is the last thing we need. There is only one real ultimate solution to the housing crisis and that's for new supply to fall and for home prices to decrease to levels at which buyers (new homeowners and investors) will be able and willing to absorb the existing excess inventory. Artificially inflating prices by putting a floor under them would have the adverse effect of decreasing price transparency and discouraging buyers from making offers.

There is also the issue of fairness. Most U.S. taxpayers either rent a home or can still comfortably handle their mortgage. Why should this majority of Americans bear the cost of bailing out those who gambled and lost? It's truly absurd from the perspective of renters (future homeowners) as any government intervention that serves to artificially support home prices doubly bites this group. They incur their share of the cost of the bailout while artificially inflated home prices keep them from fully benefiting from the housing price correction.

Talk is now building for another round of bailouts, this time focused on directly helping homeowners who are under water. McCain has proposed buying mortgages from banks at face value and then replacing it with a new 30-year fixed government mortgage at an interest rate of just over 5%. He basically wants to reward the financial institutions who made these ridiculous mortgages by paying them full value. Then he'll give the homeowner a new smaller mortgage that's in-line with the current value of the house. What happens to the difference between the size of the old and new mortgage? Well, that loss will be borne by you and I, the U.S. taxpayer. You have to love the absurdity of the plan. Reward the banks for making bad loans and then turn around and reward the homeowner (who likely gambled) with a lower mortgage at an interest rate better than a new borrower with an 800 FICO score and 40% down would receive!

We don't need the government to get involved with loan negotiations. Banks will negotiate with homeowners when it makes economic sense to them. If the present value of a new mortgage at new terms exceeds the amount the bank projects that it would receive from foreclosing, a bank is going to take a hard look at negotiating with the homeowner. Otherwise, the property should be foreclosed upon. The homeowner will get out from under the mortgage and become a renter again with a rental expense that is likely much below their previous house payment. The homeowner may have to endure the stigma of foreclosure for some time, but with so many people facing foreclosure, I'm not sure much of a stigma will be attached. The bank will take the hit it deserves for making a loan it should have rejected. The property will be put back on the market and will eventually be sold to a new homeowner who will be able to meet the more stringent mortgage qualification requirements demanded by banks. No government (taxpayer) money needs to be wasted in this process.

Neither Obama nor McCain nor Congress will or can solve the mortgage "problem." The problem was the bubble. The correction is the solution, not the problem. I recently read that 6% of the U.S. workforce are lawyers but 45% of the members of Congress are lawyers (another 45% couldn't get into law school). The real problem is that it's impossible for a room full of lawyers not to meddle.

Congress, along with either Obama or McCain, will continue to pass ever-larger bailouts and stimulus packages in an effort to encourage increased lending in an economy that is imploding because of too much debt. Somehow, they (and many economists) don't see the irony of trying to fix the problem of too much debt by encouraging increased lending.

Disclosure: The Rubbernecker is short bailouts, pandering, and botox, and he's longing for the end to this election season.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.