Jon Christian Ryter - Mortgage Meltdown

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From The Mailbag

20 years

he upward price spiral in the housing market in the United States hit its peak in the spring of 2006. Buyers all over the United States struggled with financing options as they wondered if they could afford the mortgage payments on their new half million to million dollar home. But, as long as mortgage companies provided mortgage money and Fannie Mae or Freddie Mac guaranteed the loans it made sense to buy homes they could not afford.

Most buyers who wanted into homes they couldn't afford were obligated to take the toxic mortgages offered by giant corporate home builders simply because their incomes couldn't justify a fixed-rate mortgage from a traditional mortgage bank. Buyers with acceptable credit scores seeking overpriced homes easily found exotic adjustable rate mortgages [ARM] from a traditional banks that were guaranteed by Fannie Mae or Freddie Mac. Buyers with exceptionable credit scores found fixed-rate financing with extended terms that stretched their traditional 30-year mortgage out for 50 years.

Most homeowners knew they would not live long enough to pay off their mortgages, but in the 21st century, that didn't matter. They loved their new status symbol homes in the new status symbol subdivisions. When they sold their overpriced dream homes, the mortgage brokers assured them, they would profit immensely since the prices of homes everywhere would continue to skyrocket for at least the next decade. So, even if they paid more than they could afford on the front end, when they sold, they would benefit from the real estate boom windfall on the back end. Buyers were assured that when they sold their status symbol homes, the nest egg from the appreciation alone would provide them with a tidy down payment on their next home.

Mortgage-owners in 2008 discovered that the mortgage hawkers' predictions of immense profits in a perpetual home seller's market were just so much "who-shot-john." US home prices are falling faster than a steel anvil testing gravity—and almost as fast as they fell during the Great Depression when close to 50% of all homes in the United States were in default. Today, only about 4% of US homeowners are delinquent. However, in one California community, Mountain Home, roughly 90% of the homes are "under water," which places those homes in jeopardy. Underwater is a term applied when the outstanding balance on the mortgage exceeds the net worth of the dwelling.

Ninety-five percent of today's delinquencies are from consumers who bought toxic mortgages that let them get into homes they simply couldn't afford. Some of them were low-credit score buyers opting into the housing market through HUD-guaranteed mortgages to those with good credit scores who simply overbought because they were allowed to overbuy. Regardless of the reason, we have a housing disaster in the United States equal to that in the Great Depression when roughly 25% of the American people found themselves homeless.

From sheer numbers alone, the drop in home values today far exceeds the rate of decline in 1932. Home values dropped 10.5% in 1932. The latest Standard & Poor national home-price index shows a price slump of 14.1% during the first quarter, 2008. Adjusted for inflation, its an 18% drop. This is the worst decline in home values in two decades. In raw numbers, more homes went into foreclosure during the first quarter of this year than in the entire decade-long depression between 1929-39.

The Housing Crash of 2008 was the consolidated handiwork of greedy home builders, greedy mortgage lenders, greedy commercial banks, and greedy realtors who made gullible consumers believe the housing boom was in perpetual motion when it was not. And, of course, greedy politicians using the job base of the United States to fuel the growth of the global economy solely to benefit the money barons, the lords of industry and the merchant princes who want to trade the product-saturated consumers in the United States and the other industrialized nations of the world for the human capital of the third world which has nothing and needs everything—especially our jobs.

Cementing the Great American Dream into the marketing package at the community level were greedy county tax appraisers who turned a blind eye to the inflated home valuations since taxes are based not on the price you paid for your home 20 or 30 years ago, but the current value of the dwelling in the housing market—even though you have no intention of selling. It was the legal rape of the taxpayer by local governments who are allowed, by law, to increase your property taxes because some idiot paid too much for a home down the street.

The Housing Boom of 2000 was concocted by greedy national politicians who opened the backdoor of the nation for the exodus of millions of US jobs from 1994 to 2000 under NAFTA. Our elected leaders needed to make the economy look healthy when it was not. Although consumer spending grew at a near 4% rate in 1997-98, Real Gross Private Domestic Investment [GPDI] and Real Gross Domestic Product [GDP] (the goods producing sectors of the economy) were already showing signs of a fracture. The USDA's Economic Research Service forecast a slight downward trend in the GDP in 2000, beginning in 1999 when the Chinese trade deficit erased $100 billion from our GDP.

To keep the economy healthy, and create "mom and pop" jobs to replace corporate industrial jobs lost to the jobs drain as more US manufacturers closed more US plants and moved their factories and jobs offshore, government had to spur job creation in the private sector by loosening credit to spur economic growth. As commercial banks extended more consumer credit and encouraged people to spend rather than save, Congress enacted the Bankruptcy Abuse and Consumer Protection Act [BACPA] which was signed into law by President George W. Bush on April 20, 2005.

BACPA "rectified" nonexistent consumer abuses by protecting America's lenders and merchant princes from potential debt default by the US consumers they were deliberately going to overload with credit in order to keep the economy afloat—and keep the Fed solvent. Congress insisted that BACPA was necessary because US bankruptcy laws had lost their power to shame. Filing bankruptcy, congressional leaders said, was no longer viewed as a stigma. For that reason, they insisted, bankruptcy laws needed to be updated to keep consumers from using bankruptcy as a "debt eraser." Banks and other lending institutions which contribute millions of dollars to the campaign war chests of politicians on both sides of the aisle lobbied Congress for over a decade to toughen bankruptcy laws. They wrote the law they wanted passed, and in 2005, Congress enacted it.

When the bill was debated, liberal economists argued before Congress that if the recommended changes in the bankruptcy laws were implemented interest rates would drop and so would retail prices (since consumers would no longer be able to bankrupt themselves out of debt). The reverse happened. Interest rates on 30-year mortgages that fell steadily from 13.74% in 1980 to 5.34% between January, 1980 to January, 2005 rose to 6.26% by January, 2007. By summer it reached 7%. This act was one of the catalysts that triggered the Housing Crash since escalating interest rates trigger ARM adjustments. Here's how Hybrid Adjustable rate mortgages [HARM] work. Options are set over a period of 2, 5, or 7 years. Hybrids generally offered the homeowner four payment options. At least a few of the buyers of these exotic mortgages would pay off the mortgages early by offering the buyer the option to make their mortgage payments every three weeks instead of every 4.3 weeks. This option allowed the homeowner to pay off a 30-year mortgage in 22 years.

However, most who bought an exotic mortgages signed on to them because they offered a reduced house payment for the first 2, 5 or 7 years. The toxic element in this type of hybrid ARM let the buyer pay only a percentage of the interest for the option period with the unpaid portion of the interest tagged onto the back-end of the note. The homeowner was "income-qualified" based on those partial payments rather than what the mortgage payment would eventually be when the homeowner was obligated to make full payments.

Because of the Bankruptcy Abuse and Consumer Protection Act, interest rates escalated and ARMS adjusted upward, driving up mortgage payments on homeowners whose financial circumstances had not improved, putting them in jeopardy of losing their new dream home.

From 1994 to 2000, personal spending in the United States—fed by a complicit media which constantly assured the American people that the good luck bucket would never run dry—escalated dramatically, creating exciting, new small business ventures for laid-off factory workers. Between 1999 and 2000, as the job exodus continued, employment grew by 2.6 million workers. With a booming home construction industry fueling the economy, another 2.5 million jobs were added in 2000. It seemed there was no end to American ingenuity. Congress and the transnational industrialists were able to export almost 15 million jobs since 1995 and still maintain the world's most robust economy.

During the mid-1990s, community activist and State Senator Barack Hussein Obama and the US Congressional Black Caucus spiked the Great American Dream by using the racist tactics employed by civil rights activist Jesse Jackson to force community banks to finance subprime mortgages for minorities with histories of not paying their bills. Obama, like Jackson, threatened to accuse the banks of racism for excluding minorities from consideration for home mortgages. Newly elected to the Illinois State Senate, Obama—whose US citizenship was never vetted by the Illinois Election Commission to determine if he was actually a US citizen and therefore eligible to serve in the State legislature—appealed to incoming Fannie Mae CEO Franklin Raines to guarantee the loans for working class blacks to buy homes, regardless of their credit scores. Many of the "incomes" guaranteed by Fannie Mae were actually welfare checks.

With the "lending door" open to home buyers with low credit scores because the economy needed the jobs created by the demand for new homes, underwriting subprime mortgages became the new "profit darling" of the investment banking industry, further weakening the financial underpinnings of a nation already fractured by a decade-long job exodus.

The NAFTA jobs drain was largely concealed behind a counterfeit facade of prosperity in the United States. Inevitably, the fractures could no longer be concealed as the trade gap spiraled from 2002 to 2007. US exports fell like a rock in a river, and imports rose like a helium-filled balloon. Economists blamed the economic malady on "...a strong US dollar and slow growth in world markets." The transnational industrialists, bankers, and the merchant princes were profiting so exorbitantly from the transfer of the world's work force from the industrialized nations to the human capital-rich emerging nations that few noticed, or cared, that the collapse of the financial underpinnings of the industrialized economies was just around the corner.

In the minds of the global economists, US labor was resilient-enough to recover. However, adding jobs in the service-sector while continuing to lose jobs in the goods-producing sector was an omen of ill that should have warned the economists that American consumers were no longer investing in the US economy—even when they bought US-branded goods made elsewhere. They were investing in China's economy, in Mexico's economy, in Indonesia's economy, in India's economy and in the economies of those nations where America's jobs were sent from 1995 to 2007, speeding up the erosion of the financial foundation of the United States, and explaining why the $800 billion bailout of the US banking industry did nothing to restore the ability of US consumers to utilize credit to grow the economy of the United States.

As the solvency of the US banking system continued to be threatened by Treasury Secretary Henry Paulson's inept mismanagement of the $800 billion taxpayer-financed bank bailout fund, and the lack of liquidity in the consumer credit market because the banks who received bailout money specifically earmarked to jumpstart the consumer credit markets, used the money to offset their own subprime loan losses, or to buy other banks hard hit by their own subprime losses.

With fewer Fed dollars available for consumer credit, the economy is contracting at a time when consumers should be spending. Retail stores that usually hire more at this time of the year did not hire. Many, in fact, began their after-Christmas layoffs before the holidays. Unemployment is rising. Mom and pop companies that usually pick up the slack, hiring experienced help left jobless by the factory-exodus to the third world couldn't afford to hire since their sales are impacted by the credit-crunch, and many of them are paying their company bills with their personal credit cards because they can't get short term credit from their local banks.

Completing the vicious circle, the newly unemployed have now joined the subprime mortgage defaultees as casualties of the housing crisis. Only, the new foreclosure inductees aren't defaulting on subprime mortgages. Over 50% of all new foreclosures are homes financed with conventional, fixed rate mortgages. Many of them are homes purchased 10, 20 or more years ago. Sadly, homes with no more than 5 or 10 years left on the mortgage that, in the past, could easily have been refinanced with much lower, more manageable mortgage payments, are arbitrarily declined for refinance because the home owner is now unemployed. (When Congress drummed up consumer support for the bailout bill, they promised that the money would be used to keep homeowners in homes threatened with foreclosure and not to fatten the already "fat" fat cats.) The first $350 billion of the Emergency Economic Stabilization Act of 2008 was to fund the Troubled Asset Relief Program. TARP was legislated to buy the toxic subprime mortgage securities from the investment banks which issued them, restoring confidence to the industry and freeing up capital to finance new homes and infuse the credit markets with capital which was to be loaned to consumers, rekindling the failing economy.

Instead, the economy is staggering under increasing joblessness. Escalating layoffs across the broad employment horizon are fueling a troublesome recession that is looking more and more like 1930. Rising unemployment—over 1.9 million lost jobs in the United States in 2008—is pushing large numbers of previously stable mortgage holders to the precipice of personal financial ruin, adding to the economic morass of the nation.

Increasingly, the mortgage holders who are now impacting the foreclosure statistics are middle class homeowners with traditional fixed rate mortgages who are now living paycheck to paycheck as they scramble to stockpile cash reserves in anticipation of joblessness. Many of them, with good credit scores, are now finding their revolving lines of credit canceled or suddenly unavailable as banks tighten credit. Many homeowners with ARMs are finding it hard to refinance even though the $100 billion of the bank bailout funds were supposed to be specifically set aside to help those with toxic mortgages refinance to fixed rate mortgages.

The problem with securing that promised refinancing is the rapidly declining value of homes across the land. Artificially-high home prices peaked in late 2006 and began the slow downward spiral in 2007 with the first reports of inordinate numbers of foreclosures of minority-owned homes in urban and urban-suburban areas. The housing price boom, fed by heavily-leveraged "no-down-payment" loans and non-qualifying HUD loans to credit-unworthy buyers with histories of ignoring their debt obligations created an unrealistic demand for homes that triggered skyrocketing prices.

Peter Schiff, president of Euro Pacific Capital in Darien, Connecticut noted recently that "...[w]e will never see these prices again in our lifetime...These were lifetime peaks." Susan Wachter, a professor of real estate at the University of Pennsylvania noted that, in the 1930s, the loss of home values were the result of economic forces. Today, she said, the housing price collapse is the cause of the nation's economic troubles, not the effect of it. "Homes are different than other goods and services," she said. "The fragility of our banking system is tied to the value of our homes...If we have another 20% decline in prices, we'll need another bailout of banks similar to what we just did."

Wachovia (Wells Fargo) optimistically sees the crisis as half full, not half empty. "The one saving grace," they said, "is the population is growing by 3 million people a year. They need to live somewhere. That means more roofs." In reality, it means more roofs in 2 or 3 decades. Today's homeowners are drowning as value of their homes are shrinking well below the mortgage balances making refinancing toxic mortgages an impossibility.

Ask 57-year old Rick Wallick of Maricopa, Arizona. In Oct., 2005, Wallick made a $70 thousand down payment and purchased his new 3-bedroom home for $200 thousand. Earlier this year the software engineer, who is disabled, put his home on the market in order to move back to Oregon to care for an ailing family member. His home will not sell. Why? Because the mortgage is $200 thousand and his home is now appraised at $80,000. "We're so far underwater it's not funny," Wallick noted. His initial investment in that home, $70,000, is lost. Wallick expected that his home would be foreclosed in a matter of weeks.

Today, roughly 90% of all of the homeowners in Mountain House, California woke up one day last month and realized the value of their homes were in freefall, averaging about $122 thousand less than the balance of their mortgages. According to FirstAmerican CoreLogic, over 7.6 million homes across the nation are now officially "underwater"—the homes are worth far less than the mortgages. Another 1.2 million homes are sitting on the brink if something does not happen quickly to stop the decline in home values. (Most of these 8.8 million homes were sold during the last five or six years.) The asking prices were inflated by realtor-builders, or artificially-stimulated by market demand. In any event, they simply weren't worth the asking prices that eager buyers were willing to pay, and as the housing market continues to weaken throughout the balance of this decade, home values will continue to correct—regardless of the mortgage balances—until they plateau at pre-2000 values, with homeowners owing more to the bank than the home is worth, creating problems for the banks' asset to debt ratios, and making it more difficult for those banks to loan money to consumers. Thus, the problem is going to be felt by every consumer everywhere and not just those with "underwater" mortgages.

What that means is that consumer spending will continue to shrink as the money supply continues to contract. Home prices will continue to drop. Consumer spending will continue to drop proportionate to the shrinking home values causing more bank failures because, on paper, there will be growing gaps in their asset-to-debt ratios because the assets that guaranteed their debt will be diminished by whatever amount the collateral is reduced by home value corrections.

Unless the bailout money is used to physically purchase those underwater mortgages from the banks and assign them to an asset management company like the government-owned Resolution Trust Corporation, any money given to those commercial banks from the bailout fund to jumpstart the economy will be used by those banks to offset their asset-debt ratios.

Looking at the escalation of home prices in ten metropolitan urban/suburban markets that saw home price rise by close to 100% from January, 2000 to the peak of the housing boom in December, 2006, we see that Miami, Florida led the price boom at 178%. Next was Los Angeles, CA at 174%; followed by Washington, DC at 150%; San Diego, CA at 140%; Tampa, Florida at 138%; Las Vegas, NV at 134%; Phoenix, AZ at 127%; San Francisco at 118% and New York at 115%. Nationwide, home prices have fallen an average of 19% from their peaks in Dec. 2006. Statistically, they need to drop another 17% to reach their traditional relationship to household income. From 1950 to 1999 home buyers could qualify for a home priced at up to three times their annual income. In 2006, the average household income in the United States was $66,500. That means the average home buyer in the United States could afford a home priced at $199,500. Instead, they bought homes priced at least a third more than they could afford. The average price of a home sold in America in 2006 was $301,000.

Mortgage companies increasingly sold toxic mortgages from 2002 to 2006 that offered the home buyer "optional payments." Twenty-nine percent of home buyers in 2005 opted to pay interest only, with many of them paying only part of the interest due for one, two or more years, with the balance of the interest tacked on the back-end of the loan. Half of the mortgages sold in 2006 were closed with little or no documentation on the incomes and job stability of the home buyers, virtually qualifying them with no evidence that they could afford the mortgage they were buying Most of those homes were sold with either no down payment, or token down payments. No down payments, or low down payments with Arms gave home buyers tremendously-increased buying power that exceeded their ability to pay for the mortgages they were buying.

America has been notoriously weak on learning from history. Anyone who has studied the Great Depression knows the 1920s was the decade of prosperity. The postwar economy exploded as US factories churned out goods for a world recovering from WWI, with most of the factories of Europe still silent from the bombs of war. There was a housing bubble in 1923-1929 just like the housing bubble from 2000-2006. Banks expanded the money supply and relaxed lending standards to give every American family a shot at the great American dream—home ownership. Typically home buyers in the 1920s put up 50% of the asking price and were able to finance the balance of the mortgage for up to 5 years.

In 1929, the housing bubble burst with the collapse of the stock market. By the spring of 1930 millions of out-of-work factory workers lost their homes as banks scrambled to find enough money to keep their doors open—just as banks, are doing today. National Association of Realtors chief economist Lawrence Yun told the mainstream media in a recent interview that home prices will continue to fall through 2009. Yun, however, predicts that within three years home prices will return to their 2006 level. The return to the bubble may happen, but not in three years. It will take up to five years for the housing industry to stabilize—providing the bank bailout money is actually used to purchase the underwater mortgages and get those "liabilities" off the ledgers of the banks who are struggling to maintain fiscal solvency because of them.