The Perfect Storm

Ah, the credit crunch and the mortgage crisis. How did it happen & who is responsible? There's a different answer from just about each person you ask. Often it depends on their position relative to the issues at hand. Are they a homeowner at risk of, or in the middle of, foreclosure? Are they a Realtor? A mortgage broker? An investor? Or maybe someone unrelated to the industry, seemingly untouched by the events of this past July. Every person involved in each "bad loan" is responsible. It's everyone's fault. Everyone got a bit greedy.

Well, it begins at the tippity top. The tippity top of the mortgage world is not necessarily the bank that you got your loan from in the first place. It's the investor who buys that loan from the bank that gave it to you initially. When you agree to the terms of your loan and sign the stack of paperwork confirming your agreement, that package may stay with that bank (like Countrywide, they're the largest holder of mortgages in the country) or it may get sold to a bank like Countrywide, or a company like Merrill Lynch. Since these investors are the ones ultimately left holding the mortgages, they decide what they're willing to buy and how much they'll buy it for. The answer to that is based on levels of risk. In fact the decision to give someone a loan or not is purely a measure of risk.

For a while there (think 2002-2007 or so) the measures of risk got virtually thrown out the window. If you could breathe & sign your name you could get a loan (okay, maybe it wasn't quite that easy, but almost!). The investors at the top basically said, "Okay, you get the loan and we'll buy it." Loan originators (all the mortgage brokers & bankers, loan officers, and retail representatives of the bank on the corner) were basically guaranteed easy money since just about anyone could get a loan. Their greed was obvious. Get more people to sign on the dotted line, make more money. But what incentive did the tippity top investors have to buy loans that were given to people who had no money to begin with?

Well let's go back to 2000-2001 at the dot com bubble burst and the onset of the real estate boom. Now, keep in mind my experience in real estate practice is limited to California's Bay Area -- one of the priciest places to live in the country. When I sold real estate during the boom I saw one house receive 63 offers and another with an asking price of $949,000 sell for $1,500,000 (that's 50% over the seller's asking price, not to mention the cost of another house altogether!). Year after year, each January we saw approximately $100,000 of value tacked on to the previous year's price of homes. Around twenty percent equity each year for just about 5 years. From the perspective of the investor, they couldn't lose! And so the big banks, the investors, bought up just about any mortgage they could get their hands on -- including subprime mortgages (those loans to borrowers with low credit scores and often little to no money of their own brought into the transaction). Why? Because even if they ended up foreclosing on the borrowers with 20% equity each year the investor could still come out ahead. The investor is not in it because they care about fuelling the American Dream of home ownership, they're in it for the American Dream of capitalism. There's the investors' greed.

Moving on to Realtors. On one hand, it's the Realtor's job to help their client buy or sell a piece of property. On the other hand, we were the ones advising our sellers to price their homes $100,000 under market value to inspire multiple offers and we were the ones advising our buyers to offer $100,000, $200,000, $500,000 (as in the example above) over the asking price -- often with no contingencies! A few times during the boom I heard, "Well if Realtors stop telling their buyers to offer such high prices the market wouldn't be so crazy." Maybe. There are a combination of factors, but ultimately the money was flowing on into the Realtor's pockets as well. Homes rarely sat on the market longer than a week or two then closed escrow within 14-30 days, that means fast money (at least for those representing the sellers). Higher sales prices meant more money since most Realtors work on commission based on the sales price of the property. Everything worked together hand in hand to create this perfect real estate storm.

Think about it, with the easily accessible money from the investors there was an influx of buyers. More buyers than homes on the market for them to buy (that would be the definition of a seller's market, by the way) means they had to compete to buy a house at all. Not only were there more buyers, but most found that all of a sudden they could qualify for and receive a loan that was larger than they thought they could get. So instead of looking at 2 bedroom, 1 bath starter homes for $650,000, they could jump right on into the 3 bedroom, 2.5 bath family home for $850,000. Yes, they may have had to get an interest only loan, or worse, a negative amortization loan to afford the monthly payments and yes, their interest rate may only stay at 4.75% for 3 years and yes, they may have padded the seller's retirement account with an extra $125,000 over their asking price but hey, they got their dream house. And there's the borrowers' greed.

With regard to the borrowers getting into bad loans and not understanding the terms of the loan they agreed to, if you don't understand what you're signing DON'T SIGN IT. I don't care if everyone tells you you're going to lose the house, trust me that you'll find another one. Stop everything, call your loan officer, mortgage broker, whoever helped you get your loan, and ask any and all questions. This is likely the biggest purchase you will make. When you sign the paperwork you are saying that you've read it, you understand it, and you agree to it. I know few, if any, people actually read all of their closing papers, but if you don't know what you're agreeing to and what it really means and you sign it anyway you have no one to blame but yourself.

Ultimately, this mortgage crisis is just a readjustment back to where we've been in the past; back to giving money to people who demonstrate that they have the ability to repay it. Doesn't that make the most sense anyway?

How have things changed? What does it take to qualify for a loan these days? I'll let you know in another post, this one's long enough.