The true party responsible for the housing mess and bailout response

As Americans wait in anticipation of the vote on the bail out bill, it might be a good time to reflect on the numerous factors that contributed to this mess.

This week, we have seen harsh and outright nasty attacks from every direction and from all sides. We have seen a record response from Americans to their representatives. We have seen mainstream news, at long last, reporting on issues by our lawmakers instead of what Britney is wearing (or not wearing). The one thing we have not seen or heard is anyone taking responsibility in this mess. Lets see who should take responsibility:

The Democrats: They are not exempt. Sure, they can point their fingers to Republicans claiming that their policies and trickle down economics did not work. Or they can even point to the numerous speeches by Bush himself in early 2002 regarding the need to help Freddie and Fannie approve more loans. These are all true, but what they can not deny is their responsibility for pushing policies and public opinion that housing loans were not fair for minorities and poor individuals.

In the late nineties and even up to the point where accounting irregularities were found in Freddie Mac in 2004, they claimed and preached that we must loosen lending standards. They did not care about the ability to pay back the loan, the income of the individual or family applying for the loan, or the credit score of the individual or family applying for the loan. In fact, if you argued that these measures were necessary you were flagged a racist or part of the rich white elite. This is not rocket science, there are very accurate statistical measures about the probability of ones credit worthiness based on income, credit score, and debt. The formula is not racist, it is not skewed, it is simply saying given these factors, there is x% the loan will go into default.

Ok, so you argue what about the lower income folks that do have a low credit score because they do not have the opportunity to establish the necessary factors to create credit. Valid argument and an easy one to solve. If the only reason a person has a low credit score is from lack of history, you simply make an exemption for this lending profile. This way you can give an opportunity to lower income individuals that are responsible, but just have not had the chance to establish a credit history. Someone with no income, or late payments, defaults, etc. should fall under normal risk lending practices.

The second thing missed by democrats. You are not helping someone if you only give them a perceived benefit that really is no better than what they had before. Before the housing bust, we were in the mist of the highest run up in real estate this country has ever seen. Magically, with the highest home prices ever, you all of a sudden had the highest ownership of houses from low and middle income individuals. How does that work? How does a person who could not afford a house 5 or 7-years ago all of a sudden buy a house that has doubled its price from 5 or 7-years ago with no change in that persons income?

Here is how: You change the lending rules, create products that give a perceived feeling of affordability, and you don’t ask questions. Now more people than ever can “afford” a house. But wait a minute, no matter how creative you get, someday, sometime, the loan has to be paid back. That is where they failed. Simple math tells you within reason what the maximum house affordability is to an individual or family. You can’t change that, you can’t make creative payment programs, it is a simple fact. There is no way to get low income individuals into expensive houses without a) increasing their income, b) subsidizing the house cost, c) subsidizing the monthly income of that family. That’s it, if you don’t do a,b, or c, you doom the family to failure. How is that helping the lower class?

The republicans: They don’t get off this mess either. What it comes down to is a simple fact: They lacked the balls (to be perfectly honest), to stand up to poor lending practices and bad policies. Why? Well, you have a housing market that is on fire, home ownership is at record levels, and the market seems to be doing great. Do you want to stand up and say tighten lending practices? This would decrease demand, lower home prices, and keep families from achieving the American dream of owning a home. They would get trampled by the press and democrats.

You also have to look at the big business side of this. If the republicans stand up and fight these policies, they are in a sense standing against the home builders, the home lending institutions, and Wall Street. Many of the companies that contribute campaign dollars to both democrats and republicans would push back and apply pressure. As we all know, pressure from firms with large coffers goes a long way.

And lastly for the Republicans, you have an environment where they can push through their agendas because everyone is benefiting from growth in the housing sector. It is a lot easier to push through tax cuts when their is a large sense that incomes, revenue, and homeownership are up.

The lending institutions: It is pretty clear their roll in this mess, however, it may not be understood why the problem grew so large. One place it begins is with market performance and the pressure to prove double digit earnings to investors. Fueled by low interest rates, a demand in home buying started to produce better than expected earnings. Normally this would be fine and investors would be happy, however, with no end in sight to the housing boom the pressure to continue these same earnings only increased resulting in firms taking on more risk.

At some point, investors should have stepped away because everyone knew that a vast majority of the loans being sold back a forth had very little chance of being paid back. The problem, however, was that these investments were making great returns mixed with policy that said the government would step in if the market crashed. What we saw was a money grab. CEO’s were making huge bonuses, investors were making double digit returns, and many dividends were beyond 10%. Logic really went on vacation.

The Buyers: They are also at fault. To call the buyers who are in over their heads victims is simply not true. There were absolutely predatory lenders that roped individuals into bad loans who really are victims, but the vast majority of individuals should and probably did understand the basic principle of paying back the loan they were taking out.

I had the opportunity to speak with a few firms individuals from Countrywide and other lending institutions. For most of the variable rate interest loans, the reason individuals took them out were so that they could “afford” the house in the short term while it increased in value. If they needed more time they would just re-finance.

You can not exclude the individual in the money grab race. To do so is naive. If the individual is a victim, then so are the wall street fat cats. Say you have a family that makes $50K a year that is doing just fine renting a home. You present to the family a way for them to own a home that is bigger and better than their rental, has the opportunity to earn 50-200% in appreciation based on the market at the time, and no end in sight to interest rates rising. What do you think happens? They get a bigger house and more money in two years than both members working 4-years make. Sign me up.

There were probably thousands of families that said no, it is to risky, they could never pay back the loan, etc. But wait, our neighbor did it three years ago and they just re-financed and they are now 200K richer, our friend did it last year and now has 30% equity, and our work colleague just bought two houses because he is doing so well. One by one more people took advantage of the virtually no lending restrictions on the hopes of a bigger home and greater wealth.

This is fine, but if you enter into a strategy that is based only on profit and upside you will eventually lose. Very few wanted to know the downside, those that did and planned are not in situation to lose their home. Or if they are losing their home, they knew they would if things changed and have planned accordingly.

The key point here is to know that the vast majority of individuals probably knew they were entering a risky proposition vs. those who were really victims. The true victims should be helped and the offending parties prosecuted, but to group all buyers as victims is ridicules. Bad credit stinks as a result of foreclosure, but many of these families can afford a place to rent, they just can’t afford the doubling of the mortgage from a crappy loan. They obviously moved to upgrade so why is it so bad when they have to transition back to a rental they can afford?

As you can see, everyone had a roll in this mess. Any one of the groups above could have substantially mitigated our problems by doing the right thing when the signs were flashing. But money and success has a way of throwing reality out the window.

We have a long way to go to fix the problems and unfortunately now is when you can call everybody a victim.