The Last Time I'm Going to Write About Blame for the Housing Market Mess

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I originally wrote this over 3 years ago. Congress has done precisely nothing to fix the real problems, instead indulging in scapegoating of brokers so that their campaign contributor banks could pretend that they do not bear the largest share of the blame. This scapegoating has cost consumers and taxpayers at least two trillion dollars thus far between TARP and HVCC alone. The demise of Yield Spread means that consumers are no longer going to have access to low and zero cost loans. Basically, as of the end of the just concluded Congressional session, those in the country charged with fixing the problem have ignored the real issues while scapegoating peripheral players and rigging the game in favor of the biggest campaign contributors. I do make a new suggestion at the end for if the incoming Congress wants to actually, you know, have a positive impact on the situation.

Who is responsible for the sub-prime mortgage failures?

There's a lot of blame to go around.

Regulators for failing to police existing Federal Reserve regulations on the lenders. This includes both Clinton and Bush era regulators.

Bond rating agencies for failing to perform due diligence on the investment potential of these loans. This stuff should not have been rated investment grade. Most of it should have been in the speculative junk bond classes (Ds and Fs), not AA or even AAA.

Lenders get a double whammy: Offering unsustainable loans to consumers without adequate disclosure of future consequences, and the games they played with Wall Street investors they were selling the loans to in order to make them seem less risky than they were. Make an unsustainable loan that the consumer cannot really afford, manipulate the paperwork until it looks like the loans are good, and sell them off before they go bad! Great work if you can get it - provided you've had your senses of ethics and self-preservation surgically removed.

Loan originators (that's both brokers and direct lenders, making a third strike for the direct lenders) for failure to make certain their client understood what they were getting into early enough to not get into the situation in the first place, and for cooperating with agents who wanted to sell a more expensive property than the buyers could afford, lest that agent not send them future clients, or talk future clients away from them. In many cases, they did not understand the loan they were recommending for the client. I have yet to see any evidence that direct lenders were superior to brokers on this score.

Listing Agents and Developers who wanted to sell more expensive houses and make more money, and went three states beyond overboard in doing so, and Buyers Agents who failed to advise their client that that huge new beautiful house they had their hearts set upon appeared to be beyond their means.

(Lest anyone thing otherwise, all of these are indictments against INDIVIDUALS who failed to perform their job functions correctly. There were individuals at all levels above who tried to warn everyone they could of what was going on. Pretty much without exception, they suffered for it professionally)

Last and certainly not least, the consumers who fell for the easy, attractive sale because they wanted so badly for it to be true so they could get that huge new beautiful house, that they did no investigation of what was really going on in the largest transactions of their life. Or they wanted the $100,000 cash out for toys without understanding the consequences of the loan paperwork they signed. The information was out there, and available. If you're an adult, you are, in the final analysis, responsible for your own actions. If you're not, what are you doing buying real estate and signing promissory notes for hundreds of thousands of dollars?

Did I miss anyone? Appraisers, yes, but their role was comparatively minor and the result of pressure from without. Furthermore, there were more than enough appraisers participating to render the refusal of any particular one nothing more than an exercise in scapegoating. Agents, loan originators and especially lenders bear a much larger burden of responsibility. Just because I didn't personally participate is no reason to excuse my profession.

So there's more than enough evidence to point fingers at every major player in the real estate business, as well as quite a few minor ones. By far the largest share of blame goes to lenders (and I mean lenders, not brokers), but the idea that any one group bears enough culpability to somehow sacrifice in the name of expiating the sins of all is garbage, nothing more than spin cooked up to distract the Short Attention Span Theater that is American Politics from the fact that it's the system as a whole which failed. Staking out any single group as a scapegoat is setting ourselves up for a repeat on an even larger scale in a decade or two. It's the entire system that needs an overhaul.

From a distance of several years since the start, I have to say that by far the worst casualty of the mess is investor confidence in the mortgage market. The fact that investors got burned (by lenders and rating agencies eager to please those lenders) means they are now imposing requirements upon all of their loans that the vast majority of the borrowing public cannot meet. Because loan market controls the real estate market, this refusal to make new loans means that (in the aggregate) the housing market suffers even worse, which turns even more of their existing loans bad, which means more paranoia on behalf of the investors and we have a vicious cycle feeding upon itself. If I were somebody smart in government who wanted to end the cycle, I'd look at establishing acceptable default ratios for ratings, making ratings agencies legally liable for the difference, and requiring ratings agencies to carry liability insurance (or cash!) that will cover losses over those ratios. This will substantially raise the cost of getting ratings, but make the system much more stable and stop the vicious cycle we're in by giving investors some measure of confidence in the system again.

Caveat Emptor

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This page contains a single entry by Dan Melson published on January 8, 2011 9:00 AM.

The United States is Facing Imminent Financial Failure was the previous entry in this blog.

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