Sunday, March 22, 2009

Mortgage Lending and Borrower Education

My reaction is to the policy that we suggested in class. I think it would be wise for the lender to require consumer education. Too many people in our country feel that it is their right to own a home. This is not a right, but rather, a privilege. It is a privilege that should come with a wise, informed realization of what financial responsibility comes with owning a home. It is the purchaser’s responsibility to find out what type of mortgage he/she is applying for and what interest rates apply. It is the consumer’s right, however, to have adequate information regarding the reality of owning a home.

I fully believe that if we had a policy implemented to help consumers become aware of how loans work many people now would not be in the foreclosure state. Lenders, too, would be regulated with this policy. It would be interesting to see how many foreclosures could be prevented with regulated loan bail-outs for the banking community. It is the lender’s responsibility to think twice before approving an unrealistic loan to a consumer. I honestly think that in the end, this policy would benefit both consumers and lenders.

The policy you chose to evaluate was one that would mandate consumer education about loans and mortgages for anyone getting a loan. I am unable to see how the federal government can have any justification in the Constitution for mandating such training. If the home mortgage loan is in some way involved with federal home loan guarantees, then yes, requiring consumer education could be part of the strings attached to whatever federal backing is given to mortgage lenders. There could also be a stipulation that the government would only provide certain services for banks when those banks had all mortgage borrowers complete consumer credit education classes.

The Federal Reserve Banks (which aren’t really part of the government, although their governing board is appointed by the government) did in fact try to educate borrowers about home ownership. The Department of Housing and Urban Development also provided good educational materials about home ownership, and supported community development corporations in their efforts to educate low-income credit-worthy potential mortgage borrowers.

What we have here is an essential problem. You are correct that a borrower has a responsibility to become well-informed and self-educated about mortgage debt and how housing loans work (although why this isn’t taught in middle school math classes escapes me). You are also correct that borrowers had a duty to notice how credit-worthy their borrowers were. In the case of our current crisis, lenders were able to quickly sell their home loans to financial wizards who would aggregate the home loans and sell bundles of mortgages as home lending derivatives. Since very few Americans traditionally default on their home loans, these derivatives were considered quite safe. And, since most home loans have borrowers paying 5% to 7% interest, these derivatives could yield investors 4% to 5% annual returns quite safely. Also, there had been no sustained or significant drop in housing prices in recent history (in living memory of the young people who were making, selling, or buying these home-loan-backed derivatives).

In 2005-2006 housing prices stopped rising. In Florida, Arizona, and Nevada the prices started to decline rapidly. In 2006-2008 prices for homes declined all across the Atlantic and Pacific seaboards, as well as in some “hot” real estate markets inland. Many speculators, including common middle-class people, had been buying investment properties or flipping homes, and these people were left with homes that were dropping in value, and no there were no willing buyers. This acted as a sort of trigger, and some of the mortgage-backed securities no longer looked safe, but people in the investment community weren’t sure just how unsafe those derivatives were. Were they worthless, or worth 50%, or 90% of what people had thought they were? No one knew.

A general credit-bubble that had increased consumption and consumer demand began to deflate as housing prices fell, and demand declined, but production was initially high, leading to a glut of products, softer prices, and falling profits. This in turn forced companies out of business. Big companies shrank, closing offices or outlets where sales were especially low. The resulting increase in unemployed persons added to the numbers of the unemployed whose jobs depended upon the housing market. Those in home construction or the financial paper-shuffling associated with home buying-and-selling (bankers, loan officers, mortgage brokers, real estate agents, law offices specializing in home sales, etc.) lost income, and this further eroded demand and hit retail sales. Suppliers of materials for home construction or infrastructure development that had been built to accommodate housing booms in places like Florida, Arizona, and Nevada began to lose business, and lumber mills in Georgia, Oregon, and other places shut down, swelling the ranks of the unemployed.

The very rapidly increasing unemployment rate (unprecedented since the 1970s in the rapidity of its growth) caught many people unprepared. As demand slumped, whole industries began to fall apart, including auto manufacturing and sales, construction equipment manufacturing, luxury goods, furniture, travel, and high-end restaurants. More people lost jobs, and many of these people found that they had been living from paycheck to paycheck, and had not enough reserve savings to pay their mortgages on time. Worse, in many places people found that their debt on their homes was now far more than the homes were worth. In recent recessions a person who had been laid off could quickly sell their home to raise money to help them get through the tough time. Home prices were generally stable or increasing, so people could cash in their homes and move to a cheap apartment until a new job came along. Now, however, with people having no money to gain from selling their homes, that avenue of escape was closed off.

Although the media plays up the idea that there are irresponsible lenders and borrowers, and indeed there certainly are many of those, I suspect that the vast majority of the persons facing foreclosure are merely typical Americans who have lost jobs and are unable to find new ones, and are unable to make payments on their homes, and are unable to sell their homes because housing prices have taken them from having $160,000 debt on a $210,000 home to having that same debt on a home that is now valued at $140,000 (or some variation on this).

When median house prices rise to over four or five times the median household income in an area, how are you going to be able to sell those homes? Mortgage lenders had to adopt new standards and lend people more money in those areas where the housing markets would have priced typical middle-class people out of traditional systems of home lending. So, in California or Florida or Virginia banks might give a family with an income of $70,000 a loan for $240,000 when in the past they would have only wanted to give a loan for $160,000 to such a household. So long as the $280,000 home the family bought with that money was likely to continue growing in value and become worth $300,000 in a year or two, this seemed safe. But, now that the house is worth $210,000 rather than $280,000 or $300,000, and now that one of the two income-earners in the family is unemployed and the household income has dropped from $70,000 to $40,000, the situation has become horrible for everyone concerned.

I like the idea of giving people education about home loans, and I think that such policies might be helpful in reducing the really crazy kind of lending to unqualified people that took place. But, I think the bigger segment of the foreclosure crisis is based on the American tendency to live on credit, and save very little. People were told to buy the largest home they could afford because housing prices always go up and housing is a good investment. And in fact, many people made fortunes on the growing costs of homes, and this fact was widely publicized. Given that situation, how many Americans would save 10% of their income in case of a recession where they would lose their job? Where would they save that money, in a safe investment that gave 5% interest? That would seem like a stupid thing to do when one could use that money to buy a much nicer home and then make 8% or 10% interest on the appreciation of the home while in the mean time enjoying living in it. Or, one could invest in the stock market, which had 10-year average annual return rates of 10%-15% (because of the rapid growth in equity prices in the late 1990s and for a couple years between 2003-2006). Now the stock market has declined by over 40% in a year, and housing prices have dropped nationally by nearly 10% on average across the country, and by over 30% in some areas.

This problem isn’t really reducible to a case of greedy and irresponsible home mortgage borrowers. Yes, such people exist, and it’s fun to think of them getting punished for their greed and ignorance. That is one reason why I showed pictures of people’s belongings scattered on the lawns and sidewalks of their former homes as the law-enforcement people moved them out onto the street. And a policy to help ignorant people become more enlightened will help somewhat. But, you can’t hardly lay the blame for the 30-year credit bubble economy on the backs of the 2%-3% of home mortgage borrowers who bought more than they could afford with the “help” of usurious loans from unscrupulous lenders.

I blame the baby-boomers and my generation X cohorts for generally failing to read enough history to realize that capitalism is prone to cycles of boom and bust. We had parents or grandparents who lived through the Great Depression, and their stories were there for us to hear if we asked. And if we did ask, we might have reflected on what they told us and thought to save 10% or 15% of our incomes instead of spending 102% of our incomes and living well, but building up resulting debts on cars, homes, and credit-card purchases.

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