If you’ve read anything about business in the last couple of months, and I’ll work under the assumption that almost all the readers of this blog have to avoid repeating all the sordid details, you know about the subprime mess. The basic story line goes like this:
Irresponsible and unscrupulous bankers offered borrowers loans at high rates, or low rates (in the form of ARMs, or Adjustable Rate Mortgages) that would reset to high rates after a while. Now those borrowers, especially the ones whose ARMs have reset, can’t pay. Many of them are in danger of losing their homes.
All of this is absolutely true. But I’m going to do something dumb here and step on the tracks in front of this fast moving train to pose a question about this story line. I want to ask what kind of responsibility the borrowers bear in all this. And I want to ask what exactly some of these unfortunate borrowers are losing. Some people are going to say that I’m an apologist for the worst brand of mortgage lenders. I don’t think I am. But keep reading.
The thing that has struck me about every story about the subprime mess is that almost without exception the borrowers the stories cite put zero down on their homes. There are some people who might say that putting down no cash and getting a high interest loan to buy a home is irresponsible. I’m not one of them. In fact–oh, and it’s embarrassing for a financial writer to admit I didn’t know this, but it was a long time ago, and it wasn’t nearly as common than–if I’d known that I could buy a house with zero down back in 1999 or 2000, I probably would have done that instead of waiting several more years until I had a down payment.
But a buyer who puts nothing down on a house and gets an adjustable rate mortgage is not really like a buyer who puts down, say, 20 percent with a fixed mortgage. There is a much bigger speculative side to what he is doing. If prices rise, he can gain a lot without having invested any of his own money. But if prices fall and he can’t sell before the rate changes, he is taking a bigger risk. In a few cases–people who put nothing down and got interest only mortgages–the “buyers” are in some ways not really buyers at all, but more like renters who stand to gain a lot of money if the property appreciates.
I don’t expect the average home buyer to understand all the ins and outs of this. One real estate lawyer I spoke with recently points out that many, if not most, buyers these days simply walk into a mortgage brokers’ office and ask “How expensive a house can I get a mortgage for?” and then look for … well, that house. It seems to me that in making a big financial commitment, even ordinary people have some responsibility to exercise the least bit of reasonable care. If you earn $5,000 a month after taxes, and your mortgage broker says that he can get you an ARM, but that when it resets your mortgage payments will be $4,000 a month, you don’t need a degree in advanced math to ask, “Wait a second, can I really afford this?”
In many cases, the borrowers who took out high interest loans didn’t do this. In others, it’s quite clear that they couldn’t afford even the initial payments.
But my interest here is not in beating folks who are in a financial jam over the head and telling them it’s their own fault. The fact that buyers could have thought things through better doesn’t mean we should have no sympathy for their plight. But I’d temper that with this observation: losing your home sucks no matter what, but it sucks a lot less if you didn’t need to put any cash down to buy it.
If you put down nothing on a house, that doesn’t mean you’re willing to lose it. But it’s just not the same as losing both your house and your life’s savings with it. Lose a house on which you’ve put zero down and you’re back where you’ve started. It’s “foreclosure lite.”
I know some people will say, “But your credit record is ruined.” And indeed, for some years it is. But these days having a bad credit record means you’re just in pretty much the same boat as people with good credit records were two decades ago: instead of being able to get a house with 5 percent down or zero percent, you need to actually have a down payment of 20 percent. To put it even more bluntly: the expansion of mortgage options, including even those devilish ARMs, has meant that people with lousy credit records can get a house on the terms as good as (and sometimes better) than those available only to those with good credit in the past.
Are ordinary buyers aware of all this? I think some of them are. Because not every borrower who took out a subprime loan or an ARM is now facing the poorhouse. You can even imagine that there are buyers who took out high interest or adjustable rate loans with zero or just five percent down in states where housing prices went through the roof and did very well. Actually, I don’t need to imagine that: I know a couple of them.
Is that typical? Not necessarily. Maybe not. Without question, many more of these loans were made at the peak of the housing market than early on, as the market was just ramping up. But that doesn’t change the fact that the biggest losers in the subprime mess are often not the borrowers, but the holders of the loans.
You’ll notice I said “holders of the loans” rather than “lenders.” Sometimes these are in fact the original lenders. In other cases, the lenders managed to “securitize” these loans and palm them off on investors like hedge funds. The bottom line is that it’s those lenders and investors, not the borrowers, who are taking the biggest financial hit from these failed loans.
There are two caveats here I should include. One is that it is absolutely a problem when lenders–Countrywide comes immediately to mind–made preposterous loans knowing that other banks and investment funds would take them off their hands and face the consequences when buyers couldn’t pay. If the originator of the loan doesn’t carry the risk, they have little incentive to worry about whether the buyers will be able to pay it back.
Another caveat is that I’m also not talking about the bottom feeder lenders who found struggling, often elderly, people who had houses that they owned free and clear and persuaded them that they could solve their financial problems by taking out high interest mortgages on their fully paid for homes. Now some of those borrowers risk losing everything. The only appropriate policy in dealing with those lenders is one that ensures that they will burn in hell. But con artists who’ve found ways to snooker the elderly out of their homes are not a new thing. They existed before the subprime mess and unfortunately will continue to exist in the future.
I said earlier that my point was not to hammer the folks who are getting kicked out of their houses because they can’t make the payments on their subprime loans. Nor, I’ll add now, is it to garner sympathy for, say, the unfortunate investment funds that bought up these loans; I don’t think anybody should be throwing coins into those cups.
But what I do want to do is ask whether those who would rush to protect future borrowers from subprime loans might not be advocating solutions that will have unintended and unpleasant effects. Remember this: A borrower with no money to make a down payment who takes out a loan at 12 percent and can’t pay it winds up with no house. But the person who can’t get a loan because he has no money for a down payment has no house to lose in the first place.
As I said, I expect that some of you will think my take on this is wrong, or even evil. If yours is different, then please do go ahead and send in your comments.