In the year of our Lord, 2005, on the Pacific coast of the North American continent, a two-bedroom trailer was offered for $1.4 million. This was hardly a first…or even a most. Other mobile homes have been sold for $1.3 million and $1.8 million. Still another was on the market for $2.7 million.
Why would people pay so much for mobile homes? The $1.4 million trailer, we were told, was in a gated community and on a ‘triple-wide lot.’
“Location, location, location,” a quick-witted reader might think to himself. And he’d be right; the views were said to be spectacular. But in this case, the buyer of the million-dollar trailer did not buy the location. He only rented it.
Unlike most single-family dwellings, trailer owners don’t own the land upon which their houses rest. Instead, they are permitted to park their mobile homes on someone else’s land – for a fee…and for a while. In addition to a mortgage, the typical million-dollar trailer buyer has to pay ‘space rent’ – which, for the $1.4 million mobile home was $2,700 a month. Not a fortune, but still a drain on your money.
And oh yes, we mentioned ‘mortgage.’ But mortgages are hard to get on trailers, because the trailer might be pulled off the land…and then what would it be worth? Almost nothing. In Malibu, in 2005, the average house sold for $4.4 million. A trailer is not an average home; it is more modest. But put it on a lot overlooking the Pacific…and it is worth a fortune; at least it was in the great bull market that lasted from ’96 to ’06.
Meanwhile, in Florida, buyers were taking up condos that hadn’t even been built yet. In Miami, ‘flipping” condos came to be a profitable speculation in the early 21st century. Speculators would buy a group of five or ten condos – even before a single shovelful of dirt had been displaced. The idea was to sell the contracts to other speculators while the place was being built. The second buyer would then sell to yet another buyer when it was completed. Neither the first, nor the second, nor the third buyer had any intention of living in the condo.
The trouble was that the object of their speculation looked rather lonely and forlorn when it was finally put up. Driving by at night, it was noticeable that few of the condos had lights on. Most were empty…waiting for their ultimate buyer; the poor sap who would actually live in the place and, presumably, pay for it.
This eventually became such a problem for developers that they tried to squeeze out the speculators, insisting that buyers take up only one of the condos…and move in within a specified period of time. In some projects, developers announced special offers…which had prospective buyers camping out all weekend in order to get a good place in line to buy when the doors opened on Monday morning.
While buyers were leaping from one absurdity to the next, the lending industry fitted them out with special shoes…with wings!
In the autumn of 2006, the regulators began to wonder. A group of regulatory agencies looked up at the sky and had a fright. They suddenly realized they had allowed too many marginal buyers to take off. The air was full of them…and many were beginning to crash. Even Ben Bernanke, speaking last week, warned that borrowers ought to have some flying lessons; a little more ‘awareness’ of lending practices was what was needed, said he.
Bernanke’s comments followed the release of a new set of standards, in a report entitled “Interagency Guidance on Nontraditional Mortgage Product Risks.”
And then, about the same time, the Comptroller of the Currency, John C. Dugan, spoke about the innovations of the mortgage industry:
“Lenders who originate these types of loans should follow sound underwriting practices that consider the borrower’s repayment capacity.”
Traditionally, the lender judged both his man and his market, we recall pointing out. If both were deemed solid, he would take a chance, lending the man a mortgage and hoping that the market was strong enough to allow him to recover his money if the man failed.
But the new lenders were of a different breed. They didn’t care about the man at all. In fact, they rarely knew him and hardly met him. It was the market that they cared about. And when they judged the market, they found it foolproof.
Longtime sufferers of the Markets and Money know that no market is proof against the ingenuity of fools. Lenders seemed determined to prove this was so – by making outrageous loans to both fools and knaves.
Reading the popular press – not to mention the advertisements in the popular press – we learned about the number and variety of non-traditional mortgages that have flourished in the last six years. Adjustable rates, of course, became common. But so did mortgages with zero down payments, alluringly low starter rates…including interest-only mortgages, flexible payments, and ‘stated income’ applications…in which the borrower is left to use his own imagination in describing his financial circumstances.
When the 21st century first budded out, only 5% of mortgages were of the so-called ‘sub-prime’ variety – that is, mortgages to marginal borrowers. Five years later, one in four were to sub-prime borrowers.
Also in 2000, only 25% of these sub-prime mortgages were of the ‘stated income’ variety. Only 1% consisted of ‘piggyback loans’ – junior mortgages designed to eliminate the need for a real down payment. And none were I.O., or interest only.
By September 2006, 44% of sub-prime loans had ‘limited documentation,’ 31% were piggyback loans, and 22% were interest only. This was the very moment at which regulators were asking the lending industry to be more careful – that is, after they had already let the weasels in the chicken yard.
Do you remember, dear reader, how we laughed? The stated purpose of both the federal government’s housing policy and that of the lenders themselves was to ‘help Americans buy their own homes’ or words to that effect. Easy credit was meant to increase homeownership. (Renting a house was a kind of social failure, like dropping out of high school or driving an old Pinto). They had ‘democratized’ the credit market, they claimed. Yes, now not only rich speculators could lose their shirts. The common man could lose his too!
The obvious effect of all these innovations was to turn Americans into a race of housing speculators, not of homeowners. Instead of actually buying and paying for a house, marginal buyers were enticed into these innovative mortgage products, which were more like options to buy a house rather than an actual purchase of one. An I.O. mortgage gave the speculator the right to buy the house sometime in the future – if things went well. And as the I.O.’s, limited doc, flexible payment ARMs reached farther and farther into the general population of homeowners, fewer and fewer people really owned their homes at all. More and more of them became gamblers, betting that property values would rise fast enough so they could refinance again.
But we felt a little uneasy when we laughed, because the joke was on the people whom could least afford it – the gullible borrowers of the sub-prime market. But how we roared at the gullibility of the sub-prime lenders!
A man can make a fool of himself whenever he wants. Generally, he pays the price himself and the rest of the world goes on with its business. But in order to get a real public spectacle going you need to separate cause from effect. Because it is only when a fellow thinks he can get away with something that he really lets loose.
One of the great innovations of the lending industry during this period was that it broke the link between the person who made the loan and the person who would suffer the loss if the loan went bad. That was what made the housing bubble possible. While the marginal lumpen took out I.O. low-doc ARMs, the hedge fund, pension fund and insurance fund geniuses bought MBSs – mortgage-backed securities. The securities were backed by the mortgages, which were in turn backed by the imaginary incomes of the borrowers and inflated house prices.
The credit agencies rightly judged the quality of the mortgages as less than perfect – BBB – and then with the miraculous powers of modern finance these same mortgages were put into MBSs and turned into triple-A credits! This transformation of bad credits into good ones, in front of the very eyes of Ph.D. mathematicians and hedge fund quants, must be rated along with Christ’s performance at the marriage of Cana, where the Nazarene turned ordinary tap water into wine. Scientists often suggest that the Gospels lie. But as to the veracity of modern finance, they are mute.
When asked to explain, the institutional salesmen resorted to logic little different that of the ordinary homeowner. The component parts may be a little oily, they said, but put together the sliced and diced, processed mortgage packages were less risky than individual mortgages. It was as if you were less likely to get sick from eating a can of Spam than from eating any particular cut of meat. How that could be, was never explained. Presumably, the glop that went in didn’t get any better by mixing it with other glop of similar provenance.
But that insight seems to have never occurred to genius investors at hedge funds and other major investment firms. The sophisticated buyers did not merely buy the packaged mortgage debt; they ate it up. Cheap suits, expensive suits – when you got down to it, they all fell for the same line of guff.
Just how bad some of this glop was became apparent only recently. As reported in Forbes:
“The real estate market has never offered such opportunity for graft. Since the housing market started to soar in 2001, mortgage fraud has become the fastest-growing white-collar crime, according to the FBI. Last year crooks skimmed at least $1 billion from the $3 trillion U.S. mortgage market.
“Now that the market is slowing, fraud is only rising. As business dries up, there’s increasing pressure on lenders, brokers, title companies and appraisers to be profitable. That means loan and title documents aren’t scrutinized as carefully as they might be, and courts – many of them so low-tech they resemble Mayberry – can’t keep up with the volume of paper.
“Then there’s the mad rush to sell, particularly by people who paid high prices for homes and suddenly can’t afford the mortgages.
“It’s like a tasting menu for con artists and grifters, so tempting that in some cities drug dealers have turned to mortgage fraud, plaguing lower-income neighborhoods with crooked mortgages rather than crystal meth.”
The Forbes article told the story – related here last week – of a pair of thieves, known as the Bonnie and Clyde of mortgage fraud. The two did very naughty things – pretending to be who they weren’t, borrowing money to buy houses at inflated prices, forging documents, stealing identities, defrauding sellers and lenders alike – and made off with millions of dollars.
Elsewhere it was reported that lenders made millions in mortgage loans to inmates in the Colorado prison system. A whole group of miscreants issuing out of the Rocky Mountain state pen were able to buy 17 houses for inflated prices and take away $2.1 million in excess loan proceeds.
According to the report, hundreds of houses were sold in what was called ‘price puffs’ – at prices above real market value. The price puffs began modestly – with buyers taking out $5,000 to $10,000 at the time of settlement. But amounts grew until they were walking away with 30% of the purchase price, or amounts over $100,000. By the autumn of 2006 these houses were going into foreclosure at the rate of one out of every thirteen.
Then, the feds got on the case and people started going to jail again. But that is how these stories tend to end – in regret…in court…in workout…in chapters seven and eleven.
Every public spectacle ends in correction of some sort…often in a house of correction. And if the force of the correction is equal and opposite to the deception that preceded it, this one ought to be a doozie.
Markets and Money
Part 1 of this essay can be found here: The Housing Bubble and the Million Dollar Trailer Part I.