by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
Most loan originators are grateful for the “government option” in the mortgage markets because of the liquidity crunch. I submit that the reason for the mortgage liquidity crunch was TOO much government involvement in housing and its increased involvement has ruined mortgage banking. That’s going to be a hard concept to grasp because all of us have relied on the government, at one time or another, to insure the mortgage loans we make. Lend me your mind for a few minutes and consider what might have been had we weaned ourselves off of the milky government teat for a free market approach to residential real estate loans.
Government lending didn’t really start until the 1920s with farm and home loans. FDR’s New Deal supercharged the idea of US government-backed home loans as a “band-aid” to the Depression-era liquidity crisis. Poorly-trained, high school social studies teachers taught us that the New Deal policies are what saved the American economy. In fact, evidence suggests Federal intervention ultimately prolonged the Depression, curbed creativity and innovation in lending, and turned the residential lending industry into a ward of the Government.
Twice, in recent history, did residential lending attempt to divorce itself from this dependent relationship…twice, we failed. Current legislators use these failures as evidence for why free market capitalism is “dangerous” when left unchecked. In reality, the de-regulatory efforts towards banking in the 1980s, and securitized real estate lending in the earlier part of this decade, were constrained by a government-provided safety net (FSLIC insurance and expansion of the GSE mortgage conduits) akin to bad parenting.
Consider the teenager. Adolescence is the awkward period between a child’s dependence on his parents and the independence from those parents that comes with adulthood. Responsible parenting dictates that greater responsibilities be given, as the adolescent ages. Responsible parenting rewards the adolescent for good choices and levies punitive restrictions as consequences for poor choices. It is when parents indulge the adolescent in freedom without responsibility that adolescence continues to the child’s middle-age years. In short, if Biff kills his girlfriend in a drunken driving accident, in Dad’s Porsche, and Dad’s lawyer gets him off, Biff is going to continue to drink and drive. Dad removed the moral consequences that comes with the responsibility of adulthood.
The government is guilty of bad parenting and mortgage lenders will be perpetual adolescents because of that. The 80’s banking deregulation permitted savings and loans to expand its loan customer base without removing the “safety net” of FSLIC insurance. Was it any wonder that the adolescent loan officers engaged in “drunken driving”-type loans? The result was insolvency of the FSLIC. Savings and loans were folded into the FDIC insurance system and we all went on our merry way. What regulators should have done was rip a page from the Barron Hilton playbook and disinherit those wards.
More insidious was the social engineering that was associated with our most recent demise. The Community Reinvestment Act, among other wealth redistribution efforts, blurred the lines between government and industry and created a moral hazard unseen in human history. Government “social engineers” provided a huge safety net for mortgage lenders with a quid pro quo provision that certain wealth redistribution tactics would be incorporated into the lending guidelines. Is it any wonder that (a) the system collapsed? and (b) the lenders engaged in REALLY risky behavior? This “bad parenting” was akin to the cougar mother who trolls bars with her teenage daughter, for casual sexual encounters. Why would we be surprised if the young lady contracted a communicable disease?
Today, mortgage lenders make few, true “free market” loans. One look at the jumbo mortgage market will show that the real cost of mortgage capital is in the 6’s, for borrowers with pristine credit, lots of income, and at least 25% in equity. Ask any Californian looking for a $1,000,000 loan about the costs and hassles associated with a jumbo loan approval. Where did all the creative financing options go? Why won’t an ambitious bank should step up and dominate a profitable niche ?
The private mortgage market just isn’t as profitable as the “government option” right now. Government-subsidized banks have access to really cheap capital (around .5% carrying cost) and can lend it out with a loan guaranty, at 5.5%. This is less than what the free market is telling us is the “real” retail cost. If a foreign competitor engaged in this type of behavior, in another industry, it would be gulity of “dumping“. The government option is creating a “single-payer” system for real estate finance which curbs creativity and innovation.
It’s gonna bite us in the ass….again.
FHA will be “technically insolvent” in two weeks. The FHA Commissioner is complaining that there a bunch of “bad teenagers” in his home. He’s wrong; the FHA is a bad parent. Instead of addressing the problems with its lending guidelines, the FHA Commissioner’s solution is to find richer “bad teenagers”. If we learned anything from the most recent attempt to divorce ourself from government lending, it is that wealthy teenagers just create bigger losses.
What’s the solution? Kick governments out of lending…for good. If Governments want to offer home loans as an employee benefit, like teachers and veterans get, they need to originate and fund those loans themselves rather than to offer them as a loan guaranty through the mortgage industry. We need to kill the “government option” and let healthy lenders develop profitable loan products . It’s going to be ugly in the short-term. A larger liquidity crisis will develop which will accelerate the housing price decline to a ridiculously low level. Properties will be so cheap that only a fool wouldn’t lend against them-
-that will be the beginning of the profitable private mortgage market.
PS: You might accuse me of hypocrisy because I originate a lot of government-guaranteed home loans. As a mortgage originator, my responsibility to my borrowers is to arrange financing at the least costly terms . As a private citizen, my responsibility is to point out why this system will ultimately fail. As you can see, I love my job so much that I’m thinking about a solution for the inevitable problem.
William J archambault Jr says:
Brian,
I think a lot of the short sighted supporters of the tax credit mistake criticism of the program as criticism the users. Personally, I’m against the program, but I believe it would be foolish not to collect the money if you’re qualified.
In fact the only thing I disagree with is: “Poorly-trained, high school social studies teachers taught us that the New Deal policies are what saved the American economy.”
Actually, they’re highly trained social indoctrinators!
Bill
September 19, 2009 — 7:07 am
Joe Strummer says:
Mortgage lending is simply become another way to buy votes. For many years it was just the middle class, but as the American dream became co-extensive with owning a home, government “needed” to extend homeownership into ever risky population groups. There’s nothing wrong with a little social justice. But, you know, when these risky mortgages become part of a highly leveraged investment strategy, also government induced through cheap borrowing, it is an awful sight to behold. Welcome to 2008.
There’s too much money at stake that the government will never divorce itself from lending. We’re too late in the game for that.
Incidentally, there is nothing hypocritical about envisioning a better world, and also advising clients how to play by the rules in this world.
September 19, 2009 — 4:22 pm
Brian Brady says:
“There’s too much money at stake that the government will never divorce itself from lending. We’re too late in the game for that.”
I’m thinking of what’s going to happen when game ends. I don’t know how FHA is going to make it without a subsidy and the political climate for bailouts is starting to turn.
It may take ten years for this divorce to happen but I really think demand will present an opportunity for a private mortgage banking market
September 19, 2009 — 6:52 pm
Randy Hooker says:
Too far, too deep, too long. The machine is in control, and the machine will ultimately destroy itself in the name of “higher self’.
September 19, 2009 — 7:50 pm
Robert Worthington says:
Brian, your theory of the parent/teenager scenario is spot on. I am a capitalist personally and feel no need for any government restriction minus legal ethic lending parameters. Government in my opinion needs to service citizens, not compete against private entities.
September 19, 2009 — 8:36 pm
David Losh says:
AntiAmerican sentiments run very deep here. It always amazes me when I read comments in support of banking. Banking pushed property prices up so they could write bigger loans.
Banks need to be heavily regulated. Debt has enslaved more people since the beginning of time than any government. Bankruptcy is specifically mentioned in the Constitution, but banking, or the rights of banking, to excessive profits is no where to be found.
In Real Estate the bank is the enemy. That’s where we get the phrase to beat the bank. Owning property free and clear is the only Real Estate. We leverage to get property paid off. We never, ever, want the bank to make a dime. Every nickle you give to a bank is another problem for all of us.
September 20, 2009 — 8:06 am
Al Lorenz says:
“I’m against the program, but I believe it would be foolish not to collect the money if you’re qualified.”
Would it? Would you be better off just signing up for medicare when you are able, even if you are against the program? Try explaining an issue to somebody at the medicare office. When you try it you’ll realize, nothing can be explained to the medicare bureaucrats.
Frankly, I don’t want it. Any of it. I don’t want social security. I don’t want a home buyer’s tax credit. I don’t want medicare. I’ll handle it myself, thank you very much. Having control over my destiny is far more important to me that slopping down a few dollars at the public trough and losing my freedom.
What do you think would happen if more people thought that way? What if all the people at tea parties and demonstrating in Washington never cashed their social security checks? What if we keep demanding smaller government AND quit feeding on government as well.
David, as far as anti-American sentiments running deep here, I have to disagree. Getting government out may be anti-socialist, but it is hardly anti-American. The whole idea of the republic was to have a small, limited government. The perversity of it is something that calls for the principles that made us successful is now called anti-American, not just by David, but widely by educated, supposedly thinking citizens and the media.
September 20, 2009 — 10:44 am
Brian Brady says:
“The perversity of it is something that calls for the principles that made us successful is now called anti-American, not just by David, but widely by educated, supposedly thinking citizens and the media.”
This is the only way for the authoritarians to sway public opinion, Al. It’s an attempt to marginalize you (and me) so that we are considered insane.
Upton Sinclair once said “Americans will take Socialism but they won’t take the label”. I suggest that Americans won’t defend capitalism because we have “labeled” capitalist thought as “anti-American”.
September 20, 2009 — 11:31 am
David Thompson says:
Brian- would love to see you pass along the statistics that prove the CRA lead to our current demise. Just how many CRA loans defaulted? I’ve never been able to get that question answered;if you could I certainly would appreciate. I have yet to form an opinion on this particular aspect of the problem because I’ve never seen conclusive evidence. Having spent time on numerous MBS trading desks on Wall St in my day, IMHO the issue that created the meltdown also had a great deal to do with what happened to the risk once the mortgages were originated. The secondary side of the market, where the seed money for originations was sown and watered, needs to take their share of the responsibility for the mess as well. The tranching and re-engineering of these risks, as well as the false assurances given these derivatives, had a great deal to do with the collapse. Would WAMU/Wachovia/Golden West have ever sold as many option arms if their credit rating were less than investment grade instead of AAA? Would Alt-A/No Doc products even have existed with accurate ratings? While I’m not saying the fault lies 100% at the feet of the ratings agencies, they also contributed. In my tenure, I knew many a corporate controller who was looking to invest funds, who had internal limitations placed on the credit quality of their holdings. Many of those purchases NEVER would have happened if the ratings were accurate. So,in a backwards look, if the money wasn’t there to finance, would originations have happened or would the money have flowed elsewhere, where risk /reward were more transparent? Or, would the money still have been there, but at much higher premiums to adjust for the risk/demand?
Brian, theres no doubt that mortgages were originated to people who had no business getting them. And the Government was fanning the flames of this unsustainability with both hands, no doubt. But thats not all that did us in. We still need a 360 degree panoramic understanding of what caused the meltdown. While I think you have a great start towards that end, I believe we still need to dig deeper.
Respectfully,
DT
September 20, 2009 — 2:55 pm
Brian Brady says:
Howdy Dave,
I’m glad you showed up. Your experience on the MBS desks is invaluable.
I’m not looking to assess blame anymore because I know what will work; unfettered capitalism. I know a bunch of private money looking to lend but they just can’t compete against the gov’t-subsidized (and failing) options.
Critics of these participants is that their money is expensive. Critics suggest that the residential real estate market would collapse if left to the private mortgage market. I submit that if the prices are low enough, even 18% mortgages can be offered.
We’re all so scared of deflation but money actually becomes more valuable when deflation hits (and less valuable when inflation hits). The money’s here, looking for a home but it wants to be rewarded for this risk it’s taking.
September 20, 2009 — 3:11 pm
Sean Purcell says:
Brian,
Beautiful post. Your analogy is, as Mr. Worthington said, “spot on.” While you may not have listed the many contributing causes in a “360 degree panoramic” view, as Mr. Thompson suggested, you have certainly laid down the philosophical ground work that forms the very basis of our current problems. More importantly, you simply but specifically present the solution to the problem.
You also elicited some interesting comments:
I agree with both Mr. Archambault and Mr. Strummer in substance and ideal, yet their comments reflect the insidious nature of Rotarian Socialism: “I’m against the program, but I believe it would be foolish not to collect the money if you’re qualified.” and “…”envision a better world, (but) also advise clients how to play by the rules in this world.” How is it foolish to do the right thing? When the rules are morally wrong, do you play by them anyway?
We appear to have reached a point in our society wherein right and wrong are mistakenly defined as legal and illegal. Just because a bribe has been “legalized” doesn’t make it right. We see this same mistake made over and over: prostitution, capital punishment, abortion and so on. Most interesting right now is the confusion over the legality of “enhanced interrogation techniques” and the morality of the same. Bottom line is: the legalization of an action has little bearing on its morality or, in the case of government intervention and bribes, its congruity with a free and prosperous state. If we are to be anything of value in this world, let us begin by being consistent in our beliefs.
As for Mr. Losh, he deserves a rebuttal post all his own.
AntiAmerican sentiments run very deep here Good Lord, what an intellectually lazy comment. Thank goodness Mr. Lorenz already addressed it.
Banking pushed property prices up so they could write bigger loans This is the same canard often applied to real estate agents, implying they don’t look out for their clients’ best interest because they make more commission when the price is higher. Please, do the math! The increase in profits is incidental in every way and certainly does not balance the increased risk assumed by manipulating prices or abdicating one’s fiduciary obligation.
Debt has enslaved more people since the beginning of time than any government Seriously? Are we including all the people literally enslaved by governments over the millennia or do you limit your hyperbole to a figurative abstraction? Are you including all the people becoming intellectually enslaved by current governments (whether communist, socialist or even whatever it is we are right now)?
Bankruptcy is specifically mentioned in the Constitution, but banking, or the rights of banking, to excessive profits is no where to be found I know this concept is slowly being stripped from the intellect of the populace, but please try to remember that the Constitution is a document limiting the powers of the federal government, not enumerating them. One might argue there is no justification for a federal banking system (which would be received warmly by many here at BHB) but this has no bearing on a company’s profits or right to profits or right to excessive profits – whatever that means.
In Real Estate the bank is the enemy. That’s where we get the phrase to beat the bank. Owning property free and clear is the only Real Estate I don’t have any enemies in a free market. I will agree that one’s personal residence would probably be best served if free and clear so we do agree on one thing.
We leverage to get property paid off What? We leverage to purchase property we could not otherwise afford. This would be the definition of leverage.
We never, ever, want the bank to make a dime. Every nickle you give to a bank is another problem for all of us Not sure how you get there from here, although if you substitute the word “government” for “bank” in that last statement you’d really be on to something.
Thanks again Brian. Great post and stimulating comments.
September 21, 2009 — 12:33 pm
Brian Brady says:
“Brian- would love to see you pass along the statistics that prove the CRA lead to our current demise. Just how many CRA loans defaulted?”
I had to think really long and hard about that. Here’s my answer; every default, for a loan originated after 2002, is due to the “philosophy” of the CRA. My reasoning:
During the Clinton era, we supercharged CRA to include sub-prime loans. That was duly embraced by GWB. He made a token overture, in 2005, but he wasn’t THAT worried about it.
The Federal Reserve’s actions, post ’99 tech bubble and spurred on by the Y2K scare and 9-11 disaster, were designed to obfuscate the American public from the fact that its management of our currency, through monetary policy, was failing. The housing boom and easy money was a shell game, advanced by Greenspan, to disguise that failure.
Greenspan believed he could manage monetary policy as if there were underlying reserves; I believe he pursued that path from 1987-1999. It was the collapse of the Russian currency that made Greenspan realize that he could promote himself t0 Chief Economic Planner and play with people’s lives. He knew the system was failing but pursued a “driveway for every family” much like FDR wanted a “chicken in every pot”, in order to make the little people (that’s us) feel prosperous. That’s the “National Reinvestment Act” and it’s loonier than the CRA.
The Republicans wanted to play GI Joe (we nabbed Saddam Hussein in 2003) and the Democrats wanted to play Monopoly. Greenspan just played Isaac Newton (the alchemist), and accomodated them all.
Let’s examine the past ten years; tell me when we’re supposed to feel the economic shoe pinch:
1- People treated 401-k accounts like bank accounts that earned 13.67% annually through tech stock fund investment. That crashed and should have hurt.
2- Our heavy reliance on data processing, at the turn of the millenium, caused a psuedo-panic that cost business a small fortune to develop redundancy in the data. That didn’t hurt.
3- Our economic center was crippled by a terrorist attack. We responded by pursuing a war on two fronts- no rationing, cut-backs, or sacrifice (that would have killed the war support). The economic policy was to get everyone a home, an investment property, a Wii, and a plasma TV. Let’s just call that the “National Reinvestment Act” just to give it a name.
Guns and butter is unsustainable. Guns, butter, and consumer electronics, financed by counterfeit money is a recipe for…well…2008.
They were ALL CRA loans, Dave; all of them after 2002.
September 21, 2009 — 4:18 pm
Brian Brady says:
Hat tip to Joe Strummer for the comment above. This is what got me thinking:
“Mortgage lending is simply become another way to buy votes”
September 21, 2009 — 4:28 pm
William j Archamault Jr says:
Hi Sean,
“How is it foolish to do the right thing? When the rules are morally wrong, do you play by them anyway?”
Among many other things I’m pragmatic with regards to my students and clients! My responsibilities are to improve are to one person or couple at a time. Politically I carry the right side of the convective banner our mutual friend carries the other end of the same banner. Or maybe the center, I’m sure you’re in the parade.
There is nothing to be gained by encouraging a individual not to take the money, in fact it would be “insidious” to leave the client $8,000 poorer.
Insidious is suggesting “the bank is the enemy.” The banks interfacing between the savers and the borrowers have allow the incredible highs we’ve known. The government inserting itself into those relanships have pirciptated our lows.
We can’t hope for reconvey without returning to a free market relationship!
For a bit of pandering check my blog: http://activerain.com/blogsview/1236187/maggiebrady-com-offers-discounted-magazine-subscriptions
For the record I charted an Optimist club, but I’ve never been a Rotarian! >:)
Bill
September 21, 2009 — 7:03 pm
Teri Lussier says:
>Frankly, I don’t want it. Any of it. I don’t want social security. I don’t want a home buyer’s tax credit. I don’t want medicare. I’ll handle it myself, thank you very much. Having control over my destiny is far more important to me that slopping down a few dollars at the public trough and losing my freedom.
Right on, Al. My husband and I live this way. It’s glorious to be free, and there is nothing anti-American about it.
Really great post, Brian.
September 22, 2009 — 8:32 am
Tony Gallegos aka The Mortgage Cicerone says:
Brian – Enjoyed much of your post, however wanted to provide further insight regarding the following statement:
“FHA will be “technically insolvent” in two weeks.”
I believe a bit further investigation into this issue is warranted. Yesterday I spoke to FHA Commisioner David Stevens face-to-face and he provided insight regarding his speech last Friday concerning the FHA Reserve Fund and IS NOT being reported by the media. He had this to say about the FHA Reserve Funds or should I say FHA Reserve FUND(S) (as in plural).
As you are well aware, when Commissioner Stevens’ announcement concerning the FHA Capital Reserve Fund was made, it caused quite an uproar. As is widely reported, the Commissioner affirmed the agency insurer will most likely see its 2% capital reserve requirement fall below the minimum level set by Congress. However, what media neglected to disclose is that the FHA actually maintains two reserve accounts to address and pay expected losses.
While we have been hearing about the Capital Reserve account, nothing has been articulated about the FHA Financing account. The FHA Financing account was established to reserve funds to cover expected FHA losses over the next thirty years and the Capital Reserve account is a residual account over and beyond the Financing account. In addition, these two accounts hold in excess of $30 billion. To put this into perspective, Commissioner Stevens recently ordered a large portion of the Capital Reserve fund transferred to the Financing account, thus causing the level of the Capital Reserve fund to approach the 2% level. However, to provide further clarification, the two funds collectively account for a 5% reserve fund.
Another point that must be made; while the FHA reserves enough funds for projected losses over the next thirty years, FANNIE and FREDDIE only reserve their expected losses for the next twelve months. Since most industry individuals reference the two latter agencies as the industry standard, they failed to discern or communicate this very important distinction.
Subsequently, contrary to what is widely being publishstressed, HUD does not expect the FHA to have the Congress appropriate additional funds to cover additional losses.
September 22, 2009 — 8:27 pm
Brian Brady says:
“To put this into perspective, Commissioner Stevens recently ordered a large portion of the Capital Reserve fund transferred to the Financing account, thus causing the level of the Capital Reserve fund to approach the 2% level”
Valuable info, Tony. Commish Stevens would do well to explain that in more detail. I doubt the papers would print that detail though because it wouldn’t sell newspapers.
That’s bad news for private mortgage bankers (but better news for taxpayers).
PS: So, YOU are The Mortgage Cicerone?
September 22, 2009 — 10:49 pm
Tony Gallegos aka The Mortgage Cicerone says:
Hey Brian – Yes…ha ha!
September 23, 2009 — 11:15 pm