Monday, October 06, 2008

Housing Crisis - Financial Crisis - Sanity Crisis

Right Side of the Rainbow: Who’s responsible for this mess? So is it the Democrats or Republicans who got us to the point of the Subprime Mortgage crisis? Probably a bit of both.

This video is a collection of clips from a 2004 series of hearings on Fannie Mae and Freddie Mac.

Can the government command the tides? Can the government command the rules of the market? Or as one Australian put it. Not Everyone Should Own a Home Because not everyone can afford it. If you hand out a lot of questionable loans, eventually you are going to have a lot of defaults. It isn't rocket science.
Fannie and Freddie dominated the mortgage industry because ultimately government was prepared to fund activities that prudent lenders would not. When their implicit government guarantee became explicit, America's system of government-directed lending on socially desirable, but commercially imprudent, lending stood exposed.
In Australia, there is one other big difference with home loans. You can't "walk away" from a bad mortgage. If the sale of the house doesn't cover the debt in America, the bank eats the difference. (Hence the number of banks failing.) Down under, if the sale of the house doesn't cover the debt, the bank will come after the borrower for the difference.
When Australians borrow money to buy a house, they know that if they default and the mortgaged property doesn't cover the debt, they will be responsible for the shortfall. And the lender will chase them for it. It's a neat way of reminding Australians to borrow responsibly.

In America, where populist post-Depression laws in many states have mandated loans be nonrecourse, the opposite is true. Americans can take out a mortgage more or less as a one-way bet. If you can't afford the repayments and can't refinance, you just send the keys back to the bank. Borrowers wipe their hands of liability.
Prepayment penalties?
Prepayment penalties are either prohibited or severely restricted in the U.S. Thus, an American lender who makes a 30-year fixed rate loan that the borrower can prepay at any time without penalty is simply making a bet about the average life of a loan. And while it's true that there are good quality statistics about how long American loans usually last, these are necessarily averages. Averages don't reflect actual experience and are especially misleading when real outcomes are at the extreme. If market interest rates fall below the fixed interest rates, borrowers will simply refinance at lower rates. Another fine deal for borrowers. If market rates rise above the fixed interest rates, borrowers will stand pat. So loans are terminated by borrowers when they are profitable for lenders and loans last longer when they are unprofitable for the banks. Who would want to be an American lender?
In the long run, when the government intervenes in the market like this, it will destroy the market. Witness the situation we have today.

Do you think the mortgage market will rebound? Why? Because it would be nice if it did? Because you need it to? Because your house is your only investment? The housing market (and real estate in general) of the past 15 or 25 years is a house of cards, and it has crashed. Hoping to rebuild it under exactly the same circumstances seems a bit crazy to me. Expecting government to fix the problem? It created the problem.

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