A Recipe for Unmitigated Disaster

Earlier today, Lenn Harley posted California Subprime Borrowers May Get Relief? - More Questions Than Answers.   It's Lenn's insightful commentary to posts written by Bryant Tutas and Gena Riede concerning the frightful number of looming foreclosures in certain markets.  Specifically, Gena emphasized the concerned efforts of California's governor to offer some relief to borrowers in serious financial distress.  The governor of Massachusetts was the first to offer a plan of sorts earlier this year. 

While the initiative shown by state governments to confront the foreclosure epidemic is laudable, I doubt that localized efforts can pack the punch needed to make an appreciable difference.  Federal intervention is the sole option that makes sense at this very late date.  Some pundits are quick to blame Wall Street for the debacle while others point to lenders and an unmistakable affinity for product design that most assuredly spells disaster for borrowers.  Others want to place all the blame on borrowers for a lack of prudence and a fever-like desire to own palatial residences at any cost.  In reality, the protocol in real estate markets started to deteriorate during the mid-1990's as evidenced by the first sustained spike in foreclosure rates in the history of this country.  Previous eruptions in default numbers were relatively short lived and linked to economic, micro or macro, downturns.  In our current scenario, foreclosure statistics escalated a decade ago and have continued to climb since.  Most disturbing is the apparent lack of corresponding economic factors to explain the phenomena.  Like it or not, foreclosure activity is a solid benchmark of mortgage fraud and predatory lending.  Mortgage fraud and predatory lending are often characterized as distinctly different forms of abuse.  In reality, the disparities between them are academic at best. Coincidently, it was during this same period that sub-prime lending gained traction.  While sub-prime lending is one of many causation factors, it is not the root of the problem.

I feel that a study conducted by October Research in 2006 sheds light on the crux of the matter.  Of 1,200 professional appraisers surveyed nationwide, 90 percent admitted feeling pressured by real estate agents, mortgage brokers and others to inflate values to levels needed to make deals work.  Threats of negative business consequences for lack of cooperation were reported by 75 percent of the appraisers who participated in the study.  It was an inflated appraisal here and falsified verification there - ad infinitum - that laid the groundwork for the nightmare that's about to reveal itself.  Lending practices and Wall Street's malaise, or possibly its unfettered greed, added fuel for the fire.  It's no laughing matter that a generation of mortgages with ridiculously low teaser rates, used to qualify borrowers, are about to adjust ... upwardly of course.   The cost of gasoline is another factor, as is the appearance of inflation, and don't forget the devaluation of the U.S. dollar in foreign markets.  We stand at the brink of a perfect storm that will forever change the nature of homeownership in this country.  We'll talk about it for decades the way our parents, or grandparents, spoke of the great depression.  Real estate will no longer be a path to financial security as it was for past generations.  And, once the feds are forced to regulate real estate markets, the intrusion will have lasting effects and leave permanent scars.

I often joke that I'm the only one in my local circle of friends that doesn't live in a million dollar home.  Of course, their homes aren't worth what they were worth only a year ago while the escalating property taxes are analogous to a noose at a lynching.  Two years ago the average selling price for a starter home in Baltimore was a tad under $300,000.  For anyone that follows average incomes: that dog don't hunt. 

A bill introduced in the house by Rep. Brad Miller and Rep. Linda Sanchez exemplifies a governmental response with positive, short-term possibilities.  H.R. 3609: Emergency Home Ownership and Mortgage Equity Protection Act of 2007 would bestow upon bankruptcy courts the authority to reform defaulted mortgages.  Borrowers filing under Chapter 13 could ask the court to change loan terms ( principal reduction, lowering of interest rate, etc. ) to allow for sustainable payments.  H.R. 3609 is a band aid and nothing more.  But does anyone else have a better idea? Currently, 1 out of every 196 U.S. households is in foreclosure.  Foreclosure is no longer something that happens to those people living in those neighborhoods.  The problem has legitimately reached the status of an epidemic that's poised to attack middle class America on a broad and wide scale.

For an interesting read, I strongly recommend The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else by Hernando De Soto.  Published in 2000, the book effectively predicted current market conditions.   Was the problem precipitated by a credit crunch or was it precipitated by an expectation that home equity would increase forever?   Consider the differences and implications.  Families radically changed their lifestyles and spending habits due to the perceived presence of equity. The perception of wealth that didn't exist created by perceived equity that didn't exist sums up the situation honestly.  Consider the lasting effects on a family when mortgages exceed a property's value.  In a real sense, many have frivolously mortgaged their futures and their hopes for retirement.  Nowhere else on the planet can homeowners access equity as we do in this country.  The devaluation of housing markets has revealed the folly of our ways.

Lenn suggested that we continue the dialog by first posting and then forming a group to aggregate our thoughts and opinions.  I feel that it's a great idea.