Conservative's Conscience

Housing Foreclosures-Part One

HOUSING FORECLOSURES
PART ONE OF TWO

The housing market is slow.  Just ask anyone who is trying to sell a house, or any real estate agent.

And this is more than just an inconvenience that touches a few people.  It has caused a flood of foreclosures, that have had a powerful impact on giant financial institutions like Citicorp ($11 billion), Merrill Lynch & Co. ($8.4 billion) and Morgan Stanley ($2.5 billion), and it affects the way that people feel about buying and selling. 

Bloomberg.com, a leading financial news resource, states the global problem succinctly:  “The surge in foreclosures has … led to more than $40 billion of writedowns for U.S. financial institutions.”

Why all the foreclosures?  Recession?  A flawed lending system?  Corruption? 

Recession?

The current unemployment rate is 4.7 percent, the lowest since 2001 and reasonably reflective of that economic indicator for the last few years. 

Given the realities of the mortgage picture now and for months ahead, it is easy to predict a lower GDP growth rate for a time -- but the U.S. is far from a recession in November 2007. 

The lending system?

The 2005 revision of the flawed bankruptcy law, which corrected the easy gateway to bankruptcy that permitted credit card holders to walk away from debt, also brought unintended consequences that contribute to the foreclosure problem.  When the easy retreat to bankruptcy was closed, people living on the edge had to make a choice: Pay the mortgage or pay down on credit card debt. 

And choose they did.  Richard Fairbank, CEO of  Capital One Financial Corp., summed it up nicely:  "What we conclude is that people are saying, 'Honey, let the house go, but keep the cards.'"

This is an example of the price that is ultimately attached to the practice of mixing social goals (more home ownership) with sound business practices (emphasis on ability to repay). 

And in this case, poor loans were the consequence and the piper has predictably returned to be paid.  The system went haywire; people over-borrowed and the cost of finally fixing the flawed bankruptcy law has:

• Spotlighted the bad loans on lender’s balance sheets.
• Weakened the U.S. financial system.
• Punished some low income people (lost homes).
  

Conclusion?  Bankruptcy law appears at the tail end of the lending system.  As written, it invited irresponsible borrowing that has matured in the form of foreclosures; and correcting this flaw in the law indirectly caused an undefined number of additional foreclosures.  

Is the lending system corrupt?

Subprime loans are at the bottom of the foreclosure problem -- they do not qualify for the best interest rates because of the borrower’s deficient credit history.  In short, they are risky.

There are two elements to this corruption issue: Corruption, in the ethical/legal sense; corruption in the business sense.

Corruption - Cheating

Appraisal values have risen sharply for the last two decades.  Lenders are aware that these values in many instances are far greater than the amount of the unpaid balance of the mortgage.  And to some, this represents a pot of gold waiting for the sticky finger.   

The scam goes something like this: A homeowner, often a person with limited education and usually unsophisticated about such things, wants to make a home improvement; he can’t get a loan from his bank; a “friend” directs him to an unscrupulous subprime lender; a $100,000 loan is secured by the owner’s property.  The repair work, performed by contractors recommended by the lender is overcharged and bungled; a new loan is required to fix the property.

By this time monthly payments exceed the owner’s ability to pay.  Foreclosure is the end of the story and if everything works as planned, the lender also owns the property.  The owner is out in the cold.   

Such predatory monsters are part of the foreclosure scene -- a small part, one hopes.

Corruption - Poor Business Practice

Underneath these various contributors to foreclosures is one over-riding aspect of the loan problem -- the sheer number of subprime loans, which by definition represent high risk.  A generation ago, they would not have existed.

What happened to bring them so prominently into being?  See the upcoming Part Two.