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Credit bubble fraud, American ethics, system instability, government waste/efficiency and more   (week of Feb. 18, 2008)

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Timothy H.

Your blog today really strikes a nerve with me. To give you some background, my degree is in real estate finance from Sacramento State in 1991. During my college years I sold real estate for TRI Realtors in Sacramento, and served for two years on the legislative committee of the Sacramento Board of Realtors.

For each and every sale I made, I was intimately aware of my buyer's financial situation. I insisted that my clients and I go over, on a word for word, line by line, concept by concept basis, each and every form necessary throughout the process. I sat with my clients for hours going over sales contracts and explaining the entire process. I attended and personally reviewed each document presented during the closing process, and occasionally caught an error. In those days (late 80's) the process could take hours. Why did I do this? Because it was my job, and because I took seriously my legal fiduciary relationship with my clients. (By the way, many a real estate collegue, and even my sales manager, took issue with my style - I took way too much time and I talked about things that sometimes soured the deals).

Fast forward to today. I recently had a falling out with a good friend, with whom I've played music with for almost ten years, The reason? I made the statement that behind each foreclosed home is a real estate agent who didn't do their job and failed in their fiduciary relationship with the buyer. In essence, he said, I was telling him his wife was a criminal. I said yes, if she has a trail of foreclosed homes behind her. I wish it didn't happen, but there isn't much I could take back from my statements because I feel in my heart that what I said is absolutely true.

Yes, the loan officer is to blame. So is the appraiser. So is the buyer. All of that is true. But first in line, in my opinion, is the real estate agent. They've spent a lot of money to market themselves as true professionals, so called Realtors. If that is true, if they are professionals, then they should have known they were setting people up to fail, and they should have refused to do the deals. If that had happened, maybe we wouldn't be in the mess we are in today.

Steven R.

You nailed it again. Throughout the mass delusion my wife and I have been aghast as old freinds, neighbors and family bought into the morally bankrupt rational of "its just monopoly money" or "its different this time". We held tight, and did not go for the bloated loans that WERE OFFERED US BY OUR BANK because somehow I guess we are (relatively) dysfunctional and could not go through with the lie. Either the moral compass was demagnetized or the global economic magnetic field shifted. You are right in that masses of otherwise good people were corrupted. And there should be accountability.

If you recall my last email re: Naomi Klein's book and the candidates, I mentioned the Nazi Germany question: how did a nation of otherwise good hardworking people turn into a facist war machine? The answer is too complex for the amount of time I have to spend on this tip of my hat to you, Charles. But, I think you have hit upon the criminal nature of our mass delusion. We have to admit our mistake in order to move on.

I think that in Germany, this was never done overtly en masse. Instead I think that something like mass humiliation served as a surrogate. perhaps that is our choice going forward. Will we collectively (even us 'innocents' must humble down, I am afraid) admit to a lapse in judgement and pay "the fines" or will we allow ourselves to suffer an abiding loss of self esteem for the generations that were involved? What explanation do we owe our children? What context for these events will can be converted into a valuable lesson that need not be repeated?

Cathy C.

I read your essay about ethics vis-a-vis the current crisis, and found your points to be solid and worthwhile. As with everything I read about this topic, though, I want to tear my hair out about the ten-ton elephant in the room that is being ignored. No one ever mentions or tries to seek out what I think would be a very telling statistic: How many of these defaults are Single-Family Owner-Occupied dwellings? (Not merely listed that way for under-writing purposes, but in actuality.)

The Mortgage Bankers Association of America estimates that anywhere between 30 and 70 percent of properties now in default are NOT S-FO-O. That is a crazy point spread which tells two different very different stories. If the low-side estimate is the correct one, then 70% are S-FO-O. That should translate to a lot of families out on the streets. Yet, we are not hearing about the consequences of such scenarios: i.e., shelters filled to overflowing, huge increases in applications for assistance from government programs and private relief charities, news stories about families living in cars and under bridges.

I suspect that the statistic is closer to the high end: "70% are not Single-Family, Owner-Occupied dwellings." Some evidence for my suspicion can be seen, I think, by examining the list of states with the highest default rates: Florida, California, Arizona, and Nevada. These were markets where vacation properties, second homes, and sky-rocketing real-estate values were most prevelant. (Granted, the next two on the list, Ohio and Michigan, probably ARE defaults arising from families unable to pay their primary mortgages due to economic conditions, but I think examining how long such families paid their notes and lived in their homes before defaulting would be a very telling indicator.)

I have seen much evidence to suggest that "flippers" and speculators buying/developing property they expected to turn over for quick profit are really behind this crisis. For such people, the types of "mortgage tools" that are most in default; 3-2-1 buydowns, interest-only, ARM's, balloon scenarios, would be of no concern. They would be the easiest types of loans to get, and the debtor would not be planning on owning the home for long enough for the consequences to be felt. Also, if a property is going to be the "roof over ones own head," one would be unlikely to subject oneself to payments that would/will be unmanageable for ones' economic circumstances. One can live without many things, but shelter is not one of them.

The media narrative of this situation (if/when it is addressed) can be summarized roughly as "irresponsible poor or working class people 'bought into' what they should have known they couldn't afford and have simply stopped paying their mortgages. Now, because of their ignorance and complicity with disreputable brokers and agents et. al., world markets are crashing! The poor/working class have brought/will bring our economic machine to a unprecedented halt. Shame on those poor people." I, however, don't believe this to be the real story. I have no doubt that many of the brokers et. al. ARE disreputable, but I strongly suspect it was real-estate speculation and over-development that drove this crisis. Real-estate speculation is not a poor man's game.

I have also recently seen media stories about re-financing offers and other debt relief programs that are already in place but oddly not being utilized to the extent one would expect if people are in need of saving the roofs over their heads. Again, the media narrative accompanying these stories can be generalized as "stupid poor people don't know how to take advantage of this assistance." However, if one is a "speculator" with a primary residence already, one might be slow to refinance and continue to pay for a property one cannot now unload. The cost-benefit analysis for such a person might suggest that simply defaulting on speculative properties is the better way to go in both the short and long-term. Why keep paying - even a refinanced mortgage - for a property in which you don't live and which won't yeild a return-on-investment anymore, anyway?

I feel these statistics need to be examined by responsible media commentators (supposing such people exist anymore). This is personal for me. My husband and I combined make about 50K a year and had not accumulated a down-payment, so we used the now-vilified AmeriDream program. We were, per the mortgage industry, "high-risk" due to that lack of down-payment, and we were given an FHA loan. The driving factor in our decision to buy, however, is that we were well aware of the maximum payment we could afford. Thus we did not buy a property that was or would become beyond our means. After two years of timely payments we were able to refinance out of the higher-interest loan to a 30-year fixed 5.5%. Our mortgage payment was always comparable to the rent we were paying and rent in general in our area. Now it is somewhat lower.

I resent being lumped into the category of "irresponsible working-class people who took out these unmanageable loans and should have known better." Not one among my friends and family who are in the same general income bracket, but who also bought homes, bought a home beyond their means during these past seven years. None are in default.

When we were looking initially at homes to purchase, I noticed an interesting trend; the houses owned by banks or corporate entities were nearly always priced unrealistically high for the neighborhood. Some of them are STILL empty, even this many years later, and the area is starting to look "blighted." Prices for comparables in our zip-code are dropping and I'm pretty certain that now seven years later, we could not sell our house for more than we paid for it. That's okay. We always planned to stay put. It's bad news for all the owners of those vacant homes, though, as I'm sure you can imagine.

I realize this letter is very long, and thank you for your indulgence. I have a strong feeling, however, that the real story of the role buyers played in this crisis isn't being told because the buyers are being mis-identified as people like myself. Could poor and working-class people really grind the world's largest economy to a halt? It seems unlikely, given the distribution of wealth in this country. The bottom fifty-percent of people, financially speaking, control a disproportionately paltry percentage of assets and resources. Are we really the "Atlas who shrugged?" I'm sure we'll pay the consequences nonetheless. The media narrative seems designed to make the world think we deserve it.

(NOTE: Please see below for my response and Cathy's reply.)

Mikhail S.

You make some good points about the rampant fraud and unethical behavior that has occurred in recent years, in the real-estate finance space and numerous other places. There were the absolute scoundrels who were knowingly selling garbage to investors and giving loans to people they knew couldn’t pay, as well as the many millions of individuals who were more than willing to stretch the truth about income when filling out mortgage applications.

However, there is a broader issue here we must face, which goes beyond the individuals who were actively engaged in some degree of fraud. Namely, the entire credit bubble would never have occurred if society itself wasn’t complicit. How many people were happy to see their money market funds get better than average returns? How many local governments were eager to work closely with builders and the real-estate industry to help keep revenues flowing? How many individuals were happy to enjoy lavish services from their local governments while paying relatively low taxes, because the difference was being made from the real-estate industrial complex?

The insidious thing about corruption is that it slowly infects every single aspect of society, until virtually nothing is untainted. In short: we all bear a responsibility for allowing the credit bubble to become a monster. In a way this is similar to the phenomena of genocide: it cannot occur unless society as a whole is at least willing to turn a blind eye. It rings hollow to hear someone say they had no idea what was going on in a death camp, when they themselves were benefiting from cheap confiscated property or cheap goods produced by the slave labor.

Or in another example, a person who buys artwork masterpieces at ridiculously low prices cannot claim they had no idea the items were stolen. Moreover, such a person who indirectly benefits from ill-gotten gains is (in my view) as morally responsible as the thieves who actually looted the goods in the first place.

We need to think long and hard about what responsibility each of us, and society as a whole, have for the credit bubble and it’s unfolding aftermath. Just blaming a few convenient rotten apples, or investment banks, for causing all the problems is an all too convenient way of willfully ignoring our own complicity and will prevent us from truly understanding how to prevent such catastrophes in the future.

Harun I.

I have been following the posts and indeed things are becoming increasingly unstable. But from our studies in nature, i.e. chemistry, we should understand that all things are seeking equilibrium. In some cases equilibrium is achieved through an exothermic reaction.

The wizards on Wall Street were allowed to concoct things that acted like money (alchemy of junk debt into money) despite the law of our forefathers, which was an admonition as well. And the American people (and human beings in general) for whom hope of something for nothing springs eternal bought the game. So the bomb was built. But to borrow a cliche, the bomb's purpose is to explode. By exploding the bomb goes to its most restful state. Stability leads to instability and vice versa; this is the way of the universe.

But not all explosive are the same. Some, like C4, have a high brissance which means its explosion produces a sharp or high impulse shock. This is good for shattering things. Explosives with a low brissance burn more slowly and produce a powerful, broader shock impulse wave. The Oklahoma City bomber used an ammonium nitrate bomb because of its low brissance and Bahrain bomber also used a bomb with low brissance both of which we can see the devastating effects.

The more we try to mitigate the effects of what has to happen the lower the brissance and the broader and the greater and more the devastating the damage.

The last fundamentally sound bull market ended in 1968, everything since has been the product of attempts to paper over a failing economic model and dwindling resources. Unfortunately we have a Republican front running candidate who believes in using the real threat of religious extremism to not-so-cleverly mask the launch wars of aggression that have the real goal of seizing and controlling resources. Hopefully my fellow countrymen will understand this and cast their vote appropriately.

Ambac and MBIA blaming the market players for their problems comes right out of Reminiscences of a Stock Operator. Evil shorts are to blame. People can waste their time and money on all the books they want but Jesse Livermoore's wisdom is all one ever needs to understand Wall Street.

But its seems its time for more "voodoo economics". Everyone wants the taxpayer, who has already begun to dwindle in numbers, to pony up and save the day. More pay outs with less receipts.

I read an obscure article a couple of weeks ago that the trial of the Georgia courtroom shooter has been suspended indefinitely because Georgia doesn't have the budget to pay the public defender. This is a small sign of the interesting times in which we are living.

As metaphors go I like yours but (this is no criticism whatsoever) when dominoes fall they do so in a neat and predictable manner and can easily be picked up. The lives that will be shattered by this mess will not be easy to pick up and many will never recover. The loss of benefits means that those who can least afford it will not get the medical attention they need and therefore suffer and die needlessly. The fallout from all this will be asymmetrical and it will be predictable only to the extent that we know that those in power will take actions that will make things worse.

And for the grandest fraud in the history of mankind not one of the perpetrators is going to jail and mostly the innocent will be punished. The world is watching, our children are watching; whether there is a much needed revolution at the polls in November, we get what we deserve.

Johnn K.

Your latest article about the government wasting taxpayer treasure struck a chord.

I believe - eventually - the piper will have to be paid, but only when the whole system tumbles into chaos. Then, and only then, will the public wake up and demand something different. Right now, the average Joe & Jane Blow is asleep, oblivious about all the financial pain about to be realized.

There are precious few 'rebels' in this great nation anymore. Most are sheep content to being led just about anywhere, as long as it feels good. Just look at who's running for President and listen to the emptiness of their ideas.

This republic of ours will only function when rights & privileges are balanced by responsibilities. This is revolutionary, but those that don't work or contribute should not have the right to vote.

my 2 cents--

an Active Duty Reader

On the subject of Government waste, I can't even began to tell you the frustration I face everyday on needless waste of our Government. I think there is a fatal flaw in the way system was designed. It forces us to be wasteful rather than thrifty. All departments are awarded for spending the budget not saving it.

Here is an example. A commander is allotted certain amount of money every year to pay for his fuel for the ship. If for some reason, he doesn't spend all the money for his fuel, his fuel budget for the next year may be cut by that much amount. Therefore to ensure that he has enough money for contingencies and operational surprises next year, he is forced to conduct operations that are not really necessary for his missions. Isn't that insane? As a commander, I am forced to be wasteful. The system forces you to spend every penny otherwise you are punished next year. I've been trying to change this ever since I got in the military but I am afraid that I am way too junior in the food chain to make the difference. It would literally take a presidential or a congressional mandate to change the system. Until then, I see no solution.

Mikhail S..

I noticed your article about government waste in the Veteran’s Administration and wanted to make a few observations.

I wonder very much if it is really feasible to “clean up” government, and stop waste? Governments are, by their very nature, wasteful. All the attention that is placed on $100 screwdrivers, $1000 toilets, or any number of other examples of over-spending might be missing the main point: the way to reduce government over-spending and waste is to reduce government itself.

I fear that any re-structuring of the VA will ever have a lasting effect on overspending and waste, no matter how well intended. The simple reality is that governments (and the bureaucracies they employ) are not driven by the profit incentive of the real-world. All the ills flow from that.

Unfortunately, there seems to be a pervasive view that it is possible for society to have its cake, and eat it. If we could just make government more efficient, and clean-up the “waste” then we can continue to get all the services we might possible desire, without the need for a significant tax burden. Whenever I hear a politician go on about how they will make the government efficient or clean up waste, I roll my eyes, knowing that the real issue (i.e. reducing government) is being avoided.

The best way to stop waste at the VA is to eliminate it from the government. I am sure we could come up with some sort of system where the government provides money for private insurance to veterans.

Bill Murath

Looking at life (mine) with the reasonable honesty I do, I learned along time ago that the only true way to really learn things is to immediately admit your mistakes or misconceptions and own up to the mistakes and drop the misconceptions. I have 0 organizing / accounting skills. Plenty of other skills... I can't pay a bill. That is why I have a prepaid cell phone and a prepaid master card etc.

I know back in the day when everyone with a pulse was getting a mortgage I knew in my heart that I am staying away from that whole scene. I am grateful that I grew up when I did with parents and grandparents who lived through the great depression 1. I always and to this day firmly believe that if you don't have 20% down on a house you don't get one.

I don't even know that I would buy a house for less than cash since I am leery. I have no stigma like the general population does about being a renter is being a loser. I don't consider a house an investment (with the caveat being ocean front acreage in Hawai'i) after working on them for so long I know what it takes to maintain it and I would rather spend my time creating other things. We can leave anytime we want at pretty much a moments notice with little consequences.

I see the value in owning a house flat out only because you can live so cheaply but to me I do take what the word mortgage means literally.

I have never bought into the retirement crap. Sit around when I am 65 and watch Oprah and Dr. Phil. I will take the Samurai way out and disembowel myself before I degrade the purpose of existence. Retirement is for the desk jockeys as a carrot I guess but what a miserable existence that must be. My view is when I am no longer useful I am done. For a long time I viewed myself as somewhat a loser ( ingrained stuff from youth from parents who didn't know any better) until I realized the beauty in being a master carpenter. When I am old and decrepit I will still have the knowledge that takes 25 years to acquire to pass on to the few who I see fit to pass it on to.

And how about the ridiculous thought of hanging on to old age to hang out and miss the beauty of just making it for today. Sure there are things to help make it longer maybe, I could quit smoking etc.. But I know some old tough dudes that smoke into their 80's and just keep going yet like the owner of Power Bars who died going to the Post Office at 52 of a heart attack. We all go when our purpose is done. Two things I hold onto from Richard Bach's Illusions.... #1. Remember you are going to die a horrible death and #2. If you are still here your mission is not over. #1 is a tough one to reconcile in one's mind but once you can accept that then you can start truly living.

Jeff C.

I recently discovered your essay site and have become an avid reader ever since. My mother had sent me this link recently and it so reminded me of your recent article on the psychology / pharmaceutical industry. Funny but true. Maybe you would like to share this on your blog site.

Keep up the good work.

Have a headache? (short satirical video with music)


I agree with your moral argument, but you might as well rail against the tide. The "your loss is my gain" ethic is already firmly embedded - witness the growth in popularity of poker and gaming, or trading existing financial assets (as opposed to issuing IPOs of productive new companies). The argument, several years ago, about why being caught in a lie was not enough to remove Bill Clinton from office as President was that the public was benefitting from a good economy or market - moral standards can be trumped by financial incentive.

My appreciation for the hopelessness of expecting this trend to change was planted several years ago when I saw a TV ad campaign announcing reduced prices at a nationwide fast food chain. It featured an excited customer jumping into the passenger seat of a car and breathlessly advising the driver to take off in a hurry because the restaurant had given him too much change - this was compounded a few years later by a local newscaster in Honolulu (where I live) who, upon finishing a report about a gas station with a defective pump that was causing it to underprice gasoline, commented that she wished she had known about it in order to take advantage of it.

Don E.

mish has a take on your latest topic. he is pragmatic about it and tends to make the arguments you despise. so, is it a moral world? does anyone really think so? naw... i recall when once i was a christian being told by other christians that nobody would ever, ever screw you like a christian businessman. they fully understood that the wolf in sheep's clothing was quite dangerous: the carrot was trust and then came the stick, greed. any ethical construct can be bent to any end by the willing mind. i think it really is just what we are like at core, chas. it almost seems an accident of history when we get away from the deceit and corruption on a national level for any length of time. is this view too dour, overly skeptical? i don't think so. i can only fall back here on my main thesis of genes make the man: some of us can walk further and longer than others, not because we were taught, but because we were born with that in us. i don't think ethical concerns are so different. some are simply nicer people than others. don e - don't get too exercised over perfidy; get some chickens.

Cathy C.

NOTE: I wrote this response to Cathy, who then replied with additional comments of great interest:

Hi Cathy:

Thank you for the long letter which raises important points. I would like to reprint your comments in Readers Journal if I may--please let me know how you want to be identified. Initials, full name, Cathy C. or...)

I do not disagree (of course) that speculators are heavily involved/responsible.

However, the whole point of my entry today was to draw a clear distinction between fraud and truth. Subprime applicants who told the truth and subprime lenders who represented the truth bear no responsibility for the catastrophe, nor am I (for one) suggesting they do. As Mr. Bitner noted in my entry from Tuesday on his book, he was proud to identify himself as a subprime lender as he felt the market was a worthwhile service. It was and is--to honest applicants, brokers, lenders, underwriters and investment banks--of which there is clearly all too few.

I applaud you and your husband's fiscal responsibility and again note that you were one of the 1/4 of applicants who did not mis-represent your application. As Mr. Bitner points out, not all lenders were crooks, either. But enough were to bring the entire edifice down. Some blame must go to regulators who were asleep at the wheel, but the 3/4 of people who lied and the 100% of the ratings agencies and investment bankers who lied skirted whatever rules existed. they are all morally bankrupt and need to go bankrupt.

Not everyone "blames" the subprime borrowers, though the media plays on this in order to hide its buddies in the investment community who carry much of the responsibility. My point was moral bankruptcy was widespread--banks must be allowed to fail just like small-time speculators who bought 3 homes with no money down must be allowed to fail.

I hope this clarifies my point and my thinking. CHS

My letter wasn't intended as an indictment of anything you had written! Rather, I'm just trying to bring this issue into play overall. It's the one number I never see -- of these foreclosures and defaults, how many people are actually being put out of homes in which they live? It's kind of like the war we're not sacrificing for... we're not seeing the physical effects of it played out. (i.e. a rise in the number of homeless people, strapped charities, etc.) It's as if there are mortgages in default all around us, but no one is actually homeless as a result. Was it all just empty property or over-development in the first place? That's what it seems to be.

I am grateful that I was able to qualify for a mortgage under the sub-prime system, and am sorry that people like me who benefited from it probably won't be able to in the foreseeable future because of the blame falling on us. I know that a lot of people lied under this system. I wonder how many people might have abused the system by intentionally UNDER-representing their true assets to qualify for these initially-low-payment loans while they waited (what they thought would be a short time) to profit from the property's appreciation? Liars don't lie in only one direction. I suspect some of these loans were issued to people who would have qualified for 30-yr.-fixed, but chose the cheap, easy way. A 3-2-1 buydown is only burdensome to a person who holds on to it. If one expects to turn it around for a profit in three months, it's practically the logical way to go.

Not that I want to discount what may be a huge jump in the number of homeless people going unreported. (?) The apartment complexes in my area still have lots of signs outside the rental offices promising "$99.00 Security Deposit! First Month's Rent Free!" even though my zip-code has the second-highest default rate in the greater-metro area. I wouldn't expect to see those signs if the vacancy rates at those complexes were low or demand for rentals is rising.

btw, your blogs are excellent. I've been reading them for a few hours now. Pertaining to China, I recently read an article about how some activists there are catching on to the reality that the more they use their resources to make and sell us goods on the cheap, the more they're losing their own future ability to have any resources left for themselves. They're selling their country one chunk of iron ore and one gallon of clean water at a time, and cut-rate -- and polluting their own country in the process. It seems a glimmer of "protectionism" is forming in China.

Regarding the health-care crisis, I also proposed the idea that health insurance ought to be exactly like auto insurance. Employers could choose to offer a flat-rate amount of money to each employee, who could then shop for the best rates/coverage for their circumstances. The employer could then direct that money to the chosen company in the same way direct-deposit paychecks work. If employees want more expensive insurance than the what an employers' contribution would cover, they could make up the difference. The employers could be offered tax incentives to offer this benefit (sort of like they already get). We need to pit insurance companies against each other to offer us the most for our money. I believe this would insure they would operate at their most efficient, since their game is to keep as much money as possible. It's almost ironic that I agree with such a solution. I have MS, and my medications alone are over 2000 a month... so who would want to insure me, and/or how much would I have to pay? It's a dilemma for those of us with chronic but treatable illnesses. (Actuaries estimate the lifetime cost per individual to have/treat MS is three million dollars!)

Sorry for another long e-mail. I was just so excited to see someone like yourself putting REAL information about the mortgage crisis out there for consideration, and many of the other issues you address are ones about which I am concerned as well.

Thank you, readers, for such thoughtful contributions.

For more on this subject and a wide array of other topics, please visit my weblog.


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