United States Economy posts are designed to help you cut through the positive and the negative spin out there to get at the truth.
This hilarious video is a metaphor for what is happening to the United States Economy at the moment. It reflects how our policy makers are dealing with the crisis.
The new legislation on banking reform does not address the “mayday” call of the increasing number and scale of housing defaults, growing unemployment and monetary inflation. In this post, we’ll address the housing defaults. Take one minute to watch this.
The financial reform bill is supposedly designed to address those greedy banks and Wall Streeters and to protect the consumer. Do we have problems in the financial services sector? Yes we do.
But it’s not the banks and Wall Street that’s the primary problem. They’re doing what the government is telling them they must do; that is to loan money to people who can’t afford to pay it back.
Bad policy is at the bottom of the crisis. Bad policy no matter how well meaning, is still bad policy.
As a fifteen year veteran of financial services as a senior banking executive and a hedge fund partner, I can tell you up close, there are problems in the United States Economy with regard to the financial sector.
This new legislation will not solve the problems because it doesn’t address one of the root causes; the degrading of lending standards.
From 1990 through 2005, I had invested in real estate both in New York City and in Portland, Maine. These were small properties I intended to rent for my retirement. In 2004 I received notice that my property taxes were doubling so I decided to sell everything. The risk of keeping the properties was higher than the risk of selling and taking my profits “off the table”.
What happened next shocked me.
The first buyers, a husband and wife, both employed, were given a mortgage that did not require anything from them. Nothing. Nada. Zip.
It didn’t require them to have a job (ability to pay the loan).
It didn’t require them to have good credit rating (willingness to pay back loans).
It didn’t require them to put any money down (to assume some risk if the value of the property fell).
It didn’t require them to even pay the closing fees!
I was really confused.
Then my real estate agent told me “80% of loans we’re sourcing are just like this”.
That’s when I got scared.
Congress demanded that Fannie Mae and Freddie Mac and the banks, degrade lending standards so more people could buy homes.
This isn’t just a bad idea. It’s financial suicide. The first law of physics says, “for every action there is an equal and opposite reaction”.
And so there is.
Mortgage lending standards were in place for generations to protect the banks as well as the borrowers.
These traditional lending standards required the buyers to prove their income and required the buyers to put at least 20% of the purchase price of the property as a down payment.
You could always make a larger down payment, but 20% was the minimum standard. And the standards kept the banks and the borrowers honest.
The buyers had something at risk that no doubt, they wouldn’t want to lose. The buyers had a reason to pay back the loan.
The banks also had some downside protection. If the property value fell as much as 20%, they were still whole on the mortgage.
Is it an act of mercy to give someone a house they can’t afford to upkeep?
What about the trauma of the inevitable loan default and repossession of the home?
Is the bank evil? No, the bank has no choice.
The rate at which banks are repossessing homes is accelerating according to Realty Trac.
I’m shocked, how about you? And this is news?
When you hold an apple and release it, what happens? It falls to earth. If you do this once or a million times, the same result will occur.
Why? Because the law of gravity is operating. You may not like it. You may be ignorant of it. But it operates and you ignore it at your peril.
It is no different with financial markets. If you loan money to people to buy houses they can’t afford, they will default. It’s just a matter of time.
It’s not “if”, it’s “when”.
This financial bill will not change that. The cause of this financial crisis which surfaced big time in 2008 was the suicidal lending standards at the source.
Sometimes “no” is the right answer. Sometimes “no” is the best answer.
The cost of property is never just the initial purchase price either. Property taxes have gone through the stratosphere in this country as property values have climbed. That’s the open secret no one is talking about.
What about cost of ownership and maintenance? One property I bought had roofing, plumbing, ventilation and drainage problems.
If you can’t afford to pay the mortgage on a house, how in the world can you expect to pay the taxes and the maintenance?
I rent my apartment right now. I am happy as a clam renting.
That’s right, RENTING.
When something breaks, my super takes care of it.
Somehow “renting” became a dirty word.
I’m going on record to say, renting is an honorable alternative to owning.
Sometimes owning a home can turn the American Dream into the American nightmare.
Not everyone should own a home. Not everyone should want to own a home.
Owning a home is a tremendous responsibility.
Not everyone has the capability of dealing with the headaches of owning.
That’s OK. We need to get real here.
The ongoing problem is we have not learned our lesson. Half the mortgages sourced in the last two years are to people who can’t afford them.
It’s like the gusher in the Gulf. The defaults have not even been capped.
Bad lending policy is still in place leading to more defaults in the future. Therefore, not only do we have a mortgage default problem that originated a few years back, but we’re perpetuating the problem going forward.
The problem continues to grow. The crisis continues.
Why do the banks continue to loan to these people? They have been strong-armed into doing so. They have been told if they do not lend the money for mortgages to these high-risk buyers, they will suffer extremely heavy financial penalties.
Don’t forget, the Feds also have the power to revoke banking licenses.
This piece of financial legislation, no matter how well-meaning, is ill conceived if it doesn’t tighten lending standards.
The banks are doing what they are told to do. Tightening the noose around their necks with additional regulation will not solve the problem.
Bad lending policy is the root of the problem. It’s not addressed anywhere in this legislation, so far as I can tell.
The United States Economy will continue to sink.
And the US Congress’ response?
“What are you sinking about?”
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Dawn Fotopulos
{ 2 comments… read them below or add one }
Excellent article, and your comments on renting are spot on. I’ve owned six properties in my lifetime, and if I ever get out from under this last one – I’ll be a happy renter for years to come.
As a Southerner – “It’s the LAND, Katie Scarlett!” – home ownership is ground right into my DNA – my new husband straight out of college and I bought a house right before we married, and on and on. It still makes me a bit nuts, when I’m renting, to think some other party has a key to my house.
However, the tradeoff of being able to make adjustments QUICKLY if my income changes, I desire to live in a different city, etc. – there’s no more trapped feeling than paying a mortgage on a place you know you couldn’t sell within 90 days if you wanted/needed to. This is my first time experiencing that, and I’m DONE.
A little clarification on the video which may not be obvious to people not familiar with the language. It is difficult for Germans to pronounce the “th” sound. It is substituted with the ‘s’ sound. Therefore the answer of the radio operator translated to English is “What are you thinking about?”. That’s because he is hearing “We are thinking! We are thinking!