The Forgotten Bubble

I've heard a lot recently about the economy, as I'm sure you have. Unlike Sarah Palin, I think that it is important to understand the cause of something, in order to understand its solution.

I worked in the mortgage industry for a year after college and I listen to the news an awful lot, so I feel like I know something about what's going on. Let's see if I can put together what happened.

A short history of the current economic debacle is this: Around the year 2000 the economy was faltering, so the Fed slashed interest rates, to try to get people to borrow money, spend it, and thus keep the economy going. In 2003 interest rates dropped about as low as they possibly could go. We're almost talking 0%.

People who never before could have afforded a mortgage were able to get one. Sometimes they got an Adjustable Rate Mortgage (we called them ARMs), where the rate starts low, then jumps up after 3-5 years. I asked my boss, "why would anyone get these?" She replied: "people only get these if they plan on fixing up their house, and will sell it in less than 3 years, when the cheap rate expires."

Some other people applied for a "no-doc" mortage, meaning "no documentation" of their income, assets, etc. I asked my boss, "why would we ever lend money to someone, without verifying that they have a job, or any money whatsoever?" She replied, "Interest rates are so low that we make all our money from closing costs. All we need to do is close the sale, then we'll sell the mortgage to another bank."

This gets to the next big aspect of the crisis: Banks bought the mortgages as a form of long-term investment. Generally speaking, a 20-year mortgage, with interest, means that the owner of the mortgage (the bank) will get a steady stream of cash from the home-owner for 20 years. This is a pretty safe, long-term bet.

To make it even safer, other banks would offer insurance on the mortgages. So, one bank would take out a policy from another bank, insuring that the home owner would keep paying the mortgage. If the home owner defulted, the insuring bank would pay the difference. This made the mortgage owner (the first bank) even more safe. The insurers (the second bank) figured that people would always pay their mortgages.

Three years came up, and "oops." Those "no-doc" loans? Bad idea. With such a crappy economy, even good home owners couldn't afford their mortgages.

Now: understanding the problem. Where to place the blame? The home buyers, or the banks? We've heard this a lot recently. For instance, during the Vice Presidents' debate, Palin and Biden were asked who was to blame: predatory lenders, or over-reaching home-buyers. The answer is always, regardless of the respondant, "both."

Sometimes you'll get people talking about how there was no regulation on the (first) banks, to ensure that they weren't lending to people who couldn't afford a house, nor on the (second) banks to ensure that they weren't insuring bad mortgages. Bush, McCain, and conservatives in general and in toto are to blame for this lack of oversight.

But so in all this talk about deregulation, greedy banks, and over-reaching home owners who were buying houses they couldn't afford, what you don't hear often enough is why these people couldn't afford their houses. And the reason for that is that is the housing bubble.

We used to hear about this bubble all the time. The price of houses was and, largely, still is, astronomical in places like California. Sarah Palin, during the debate, said that people would buy a $300,000 house, when they should have bought a $100,000 house.

The problem is, there were no $100,000 houses.

Which means that the true problem was that, in this market, people were buying houses at all. Unfortunately, home ownership is part of that great thing we call the American Dream, and was encouraged by people like President Bush talking about the "ownership society." The whole time, the price of houses was (and still is) laughably high.

For my part, I want the bubble to burst. More. I want the price of houses to hit rock bottom. I understand that this will mean that a lot of people, who have put a lot into their houses, will lose a tremendous amount of money. But it also means that regular people can own that thing in which they sleep at night. They can achieve the American Dream.

Currently, people throw away 1/3 of their income every month. Rental owners make money simply by holding a piece of paper, the title to the house. Sure, they have certain responsibilities, but for many of them it's still a feudal relationship. And I don't mean this metaphorically. There is a reason why we call them "slum lords."

Tangentially, I've never understood why someone would put money into a house "as an investment." An investment is literally only "worthwhile" if you cash it in. Which means that this investment, to be worth anything to you, requires you to become a renter again.

This might work great for people resigned to spending the rest of their days in a retirement home: they can sell the house and use the cash to pay for room and board. But for the vast majority of us that don't want to end up in a "managed care facility," the equity one's house is off-limits, good only for borrowing against (which will still need to be paid back, at interest and at the risk of losing one's house!). If you use the equity from one house to buy another, you've simply shifted your savings from one investment to another.

On the other hand, if the price of your house falls, you are no worse off than if you had been throwing your money away renting the whole time. Even if your house becomes worth less than what you owe on it, this just means that you have to "throw away" money to a bank, on a house that will take you a little while longer to own outright.