Easy money and instant gratification was a social phenomenon that took hold of the average American including the anti-war movement “sex, drugs and rock and roll” culture of pleasure now and deal with the consequences later. And it also took hold of the Banking Industry.
August 2007 was a messy time for the real estate industry. It was even worse for real estate lenders as there were bankruptcies, rumors of bankruptcies, acquisitions to avoid financial implosions and at least one major bank stopped doing new home loans entirely. Financial pundits have, as is usual in these kinds of situations, offered a variety of reasons for what happened. These pundits have continued to do so for all of the intervening months, while the credit markets have not changed significantly. Most of it, in the opinion of this writer consisted primarily of hot air. Watching the Michael Douglas film “Wall Street” gives one a certain insight into how one should treat the news and public information floating around in the financial markets; don't take it seriously unless you can independently verify what you hear.
Meanwhile, the Federal Reserve’s lowering of interest rates did little or nothing, except causing the dollar to lose value in the international currency markets, which, in turn led to higher oil prices. Government stimulus checks likewise haven’t shaken off the credit market’s doldrums. Obviously, someone had the wrong idea as to what was wrong, and how to fix it. At the same time, the idea the prompt government action was needed probably stemmed from what Michael Medved suggested was a desire to do something because doing nothing looked bad. It really didn’t matter what the results were because it was image that was more important. The government had to look concerned and involved. It had to “take action.” That was the only way to show that it cared. In fact, it was wrong headed, and probably did more harm than good.
I have seriously followed investments and financial markets for over 30 years, beginning investing in high school. I have also spent a significant amount of time as a petitioner's bankruptcy and tax attorney and as a real estate broker. With this experience and a graduate degree in business I have come to my own conclusion about what happened. I believe that my analysis is the correct one, largely because it makes sense. Meanwhile, the financial pundits and the politicians are not willing to tell the public the truth because they have their own images to protect and they don’t want to cause a crisis in public confidence in the financial and governmental system.
My own analysis is also quite probably better than the others, because it deals with realities, and human motivations. More importantly, it is not designed to promote any particular interest including faith in the financial markets. In fact, if taken seriously it should shake our faith in those markets considerably. Finally, it is not mired in financial language that is incomprehensible to the uninitiated. It is easy to understand, sensible, and based on facts that every person encounters every day. Because of this, they should take it seriously. They should also take the time to apply the lessons that it teaches to their own financial situation so that they can avoid the problems that the market has created for the majority of Americans.
The story really begins with the rise of the credit card industry, which was a post World War II phenomenon. American prosperity was on the rise, consumerism had taken hold of a society that wanted to forget the Great Depression and wartime rationing. Easily accessible credit helped to make this possible and the more credit that was available in the economy the more consumer goods could be bought now and paid for later. Along with easy money instant gratification was another social phenomenon that took hold of the average American including the anti-war movement “sex, drugs and rock and roll” culture of pleasure now and deal with the consequences later. It went hand in hand with the buy now and pay later mantra of the credit card industry.
It took quite a while for this to truly take hold of the economy. It wasn't until the late 1970's that the credit card industry permeated our society to the extent that people began to want a wallet full of cards that they were all too willing to max out. Visa and Mastercard promoted it, that the merchants went along, knowing that they would profit from the convenience the system offered their customers. They got their money, and if the consumer was left holding the responsibility for making payments at an exorbitant rate of interest, that was not their problem. By the 1980's it was a fixture in the consumer sales markets. The banks and the merchants thought little of the probability that someday the house of cards would come crashing down, as eventually it did. Meanwhile, the credit cards multiplied.
There was a reason for this multiplication; profits. Figures I obtained some years ago from one of California's Chapter 13 Trustees indicated that the average credit card bank was making a fifty percent return each year on each dollar lent through a credit card. This return was calculated after defaults, bankruptcies and other costs. There was no question that the system was a major gold mine. With unregulated interest rates, late payment penalties and the “never never” system that encouraged people not to pay off their accounts it was impossible for it to be otherwise. When ordinary people would be overjoyed to earn twenty-five percent a year the banks were, according to the Trustee’s figures, totally cleaning up. It might have been better than running a casino.
Things first began to hit the fan when the dot com companies imploded in the 1990's. Significant layoffs in the electronics industry had a serious impact on the credit market as people who believed that they were sitting pretty suddenly weren't and the banks were left holding the bag. But the lesson that virtually unlimited easy credit was not a good idea didn't take complete hold. While most banks cut back on their unsecured lending, many took to high risk lending in the real estate market.
High risk real estate lending has been around for a long time and contributed to the demise of some savings and loan companies during the 1980's. These businesses overextended themselves and sometimes issued loans based on falsified appraisals. The weaker businesses folded, but the stronger ones survived, and as the real estate markets in several states, including California took off in the 21st century a buying frenzy fueled by speculation created a another example fit for Charles MacKay's Extraordinary Popular Delusions and the Madness of Crowds.
It was the dot com bubble all over again, with people assuming that no one was going to lose any money. Of course people did, but not immediately, and many actually made money. Those who got in, got a profit and got out did all right. Others who got in too late or stayed too long took the losses.
As the real estate market heated up many banks achieved significant profits. Competition to make real estate loans became more intense. Lenders began to offer increasingly risky loan programs; risky for themselves if the borrowers defaulted, and risky for the borrowers because there were often insufficient examinations of their ability to pay. Some mortgage brokers falsified loan applications and many banks failed to verify the information they contained. Some lenders offered “teaser rate loans” that started at an extremely low payment that increased in 2 -5 years, sometimes depending on the equity growth in the home. When low payment teaser plans expired borrowers either had to sell or go into default. That is precisely what happened when the markets cooled. Borrowers had less opportunity to sell, and properties, which were now overpriced, were next to impossible to dispose of. Because many borrowers bought their homes with one hundred percent financing, and the expectation to sell relatively quickly if they ran into problems, they had no incentive to hold on to the property. They walked away and left the bank to deal with the problem. When this happened enough times the banks had little choice. Risky loan plans were suddenly cut off. One hundred percent financing became impossible, except for the wealthy, and even full documentation loans suddenly required high credit scores and minimum down payments.
Of course this created other problems. The real estate industry including home builders had expected the easy credit to continue when it should not have been instituted in the first place. Real estate lenders suddenly found that they were overstaffed in the sales department and laid off numerous members of their customer service staff. And those middle income people who might have qualified for loans if they had money for down payments didn't because the money that could have helped them begin the “American dream of home ownership” went to pay for credit card based consumption. Thus, the banks sowed the seeds of the real estate slowdown when they fueled excess consumer buying through overextension of easy credit.
The present situation is not a happy one. Real estate professionals are caught in tough situation. Bankers are taking less short term profits and are going back to better business practices, at least for now. What we can expect is that this shake-out will last for some time. It is likely that many banks will have to take losses on many of their loan properties. Others who were more circumspect in their lending practices will have less effect on their bottom lines. Home buyers will have to find ways to achieve less risky financing and sellers will have to wait longer for buyers to qualify. Realtors will have their hands full trying to help both sides cope with the radically changed market and that will be difficult challenge. Many Realtors will probably leave the business because there isn’t enough happening to support them. Mortgage brokers may be some of the hardest hit, and lose their business entirely, if the banks insist that people apply with them directly.
All of this was predictable. Holidays don't last forever. Neither do bull markets. That's the nature of business. The good news is that it happened during a time of general prosperity, and the probability of a true recession or worse is probably quite low. That is, assuming that the oil supply problems are dealt with properly. We should thank our lucky stars for these facts as well as for the absence of massive government intervention which would probably have made the situation worse.
One other thing we need to understand relates to the nature of banking. In the past credit had always been available, but generally it had to be earned. The first half of the 20th century was a time when you did business with a local bank and the employees there knew you, knew your business, and knew your financial capabilities. They had been there for years and would continue to be. They were careful to lend only what they believed you would be able to pay back. They wanted to preserve the bank's financial health and your financial health as well. They knew that the two were linked. But the banking industry changed. Electronics replaced the personal relationship. The local bank officer you did business with for years was replaced by one who might be there for 6 months or a year, only to be replaced by someone else who also didn't know you, and who couldn't work with you from the position of a trusted friend or advisor. And finally, the race to short term profits had replaced the long term view of maintaining a healthy business and a healthy economy.
I believe it was Dennis Prager who said that the banking business was too important to entrust it to bankers. He was right. By the same token, Politics is too important to entrust it to politicians. Both end up looking for their own personal short term benefits and figure that when the future consequences turn up they will either be too wealthy or too powerful for it to matter to THEM, and the rest of us can fend for ourselves. It is a sad testament to the present state of America.
slaib@intellectualconservative.com
http://intellectualconservative.com
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