Mortgage Mess: The Blame Game

Not surprisingly, no one has taken any credit for the current mess we find ourselves in. It’s quite apparent that we’re in a recession, as Fed Chief Ben Bernanke implied last week at his congressional testimony. What isn’t apparent, at least in the eyes of those who oversee the economy, is who’s to blame.

Overtly, the heads of the financial firms that are in dire straits, contend that it’s the short sellers of the world who are “bringing down the house.” They believe that short sellers, namely large hedge funds, have colluded to drive the price of a stock down through rumor mongering. While I believe this has some validity, the blame certainly does not end there.

One of the chief culprits of the current economic recession is Alan Greenspan. Yes, the same Alan Greenspan who presided over a large period of economic growth in the ’90s. You see, Mr. Greenspan was a champion of adjustable rate mortgages (ARMs) and believed they were wonderful for the mortgage and housing industries. And they were. Home prices skyrocketed as low and middle class home buyers upgraded their domiciles now that, through ARMs, they could cut their mortgage payments in half and still have a better house. Then reality set in.

ARMs artificially lower the “barriers to entry” for a very nice house that was too expensive in years past. The monthly payments, thanks to the low 2%, 1%, or even 0% “teaser” rates assigned to the ARMs, were very low. Does that mean the house is worth less? Does that mean you’ll have to pay less overall? No and no. But did that stop home buyers from buying more expensive houses? Definitely not.

As mortgage rates went through the floor, everyone was buying. Ever vigilant, the laws of supply and demand took hold and sent the price of homes through the roof. This, in turn, led home buyers to purchase even more spectacular homes and speculators to bet big on the continued housing price appreciation. More loans were taken out, with many using their houses like an ATM, more speculators were goaded into “getting into real estate,” and more mortgage operations sought to capitalize on the mass hysteria with even more exotic mortgages.

Fast forward to today, and we can clearly see that the current crisis we find ourselves in is primarily attributed to the housing boom, which was primarily attributed to the development of ARMs, which was primarily attributed to low interest rates… which… was attributed to Alan Greenspan!

ARMs have reset, individuals find that they can no longer afford the house they are living in both because the payments are enormous, due to the interest rates being reset to absurd levels built into the ARM, and because the value of their homes is deteriorating quickly (read: they cannot use their homes as an ATM anymore).

So, where are we now? There’s a glut of homes on the market today, dropping in price almost hourly, and mortgage originators have finally tightened up lending controls. Again, the laws of supply and demand come back around to exact their revenge. Lots of demand combined with the inability for potential home owners to get a standard run-of-the-mill loan can only equal more price depreciation and foreclosures. Oh and let’s not forget that the ARMs that were most recently written have not reset to a higher level yet. So another wave of foreclosures and increased supply will be coming in the near future.

It really is a downward spiral and will only accelerate as we get closer to the bottom. But again, we ask ourselves, “who is to blame?” I believe there are a few players whose wanton neglect of the future of our economy put us in this mess.

Alan Greenspan & The Federal Reserve – 30% to Blame

I’d say that Alan Greenspan and the Federal Reserve played a significant role in allowing the economy to go into a recession. The current Federal Reserve, under the guidance of Ben Bernanke, didn’t have nearly as much negative impact as many “experts” believe. He inherited a problem that was massive in its scale; not to mention highly profitable for those who pay his salary. I think he’s done a decent job with what he was given.

Mortgage Underwriters – 25% to Blame

Many believe the underwriters themselves – such as Countrywide – are one of the, if not the, largest cause of this mess. I agree, but to think they did it alone is foolish. Most originators never even held the mortgages long enough to care if foreclosure came a year down the road. They sold these mortgages to a willing group of investors who loved them for it. Without these buyers on the market, Countrywide wouldn’t have written over half the stuff they wrote.

Banking Institutions – 25% to Blame

The banking institutions, such as JP Morgan, Goldman Sachs, Lehman Brothers, Bear Stearns, etc. acted as the “getaway” drivers in this mess. They bought these “toxic” mortgages, the ones that were eventually going to go belly up, and provided cash to the underwriters. Had they implemented even a minimal risk management policy, Countrywide and other originators would have had to stop writing these kinds of mortgages. Can you honestly blame this all on originators when there were others more than willing to participate in the raping of our economy? Furthermore, these banks sold the awful mortgages back to – can you guess? – investors like you and me! Many 401ks and retirement plans were sold these mortgages, bundled with other stuff, and now are worth far less than before. Who wants to retire anyway?

Ratings Institutions – 10% to Blame

Ratings institutions such as Moodys, Fitch and Standard & Poors, share some of the blame as well. The whole purpose of these institutions is to measure risk of investment vehicles. They really screwed the pooch on this one.

The United States Education System – 5% to Blame

I bet you didn’t think this would come up as one of the top culprits. Let me explain. When I was going through elementary, middle, and high school, not once did I receive any education on how to manage my personal finances. It wasn’t until college – at Worcester Polytechnic Institute – that I had my first “Personal Finance” course. Even still, it was an elective – I didn’t have to take it at all.

Why does this matter? If individuals are educated about finance, included mortgages, throughout their life, far fewer would have ever signed up for such bad mortgages. I have an idea, how about we take all the proceeds from the lottery and set up an educational program telling people not to gamble and buy houses they can’t afford!

The People – 4% to Blame

Yes, I do believe the individuals who weren’t prudent with their budgets deserve some of the blame. No one was forcing them to upgrade their houses or to “keep up with the Joneses” (or is that the fault of the media?). Unfortunately, those of us who were are now on the hook to bail them out. As well as the companies that took advantage of them. Again, who needs retirement?

Short Sellers – 1% to Blame

Short sellers might have had some effect on the collapse of Bear Stearns. It might have been quite a large effect. That does not mean that Bear Stearns didn’t have it coming to them anyways. Short sellers will ultimately fail if the fundamentals of the stock are strong. Short selling does not affect company cash flow (at least it shouldn’t, but that’s another matter entirely).

So there you have it. To recap, this is the breakdown of the blame, as patented, copyrighted, and trademarked by me:

• 30% Alan Greenspan and the Fed
• 25% mortgage underwriters
• 25% banking institutions
• 10% rating agencies
• 5% United States Education System
• 4% the people
• 1% short sellers
• Honorable mention: the media, the SEC, and the United States Treasury

It’s going to get worse before it gets better, and I hope everyone accepts responsibility for the parts they played in this travesty. I welcome any comments and/or thoughtful responses. I am always open for a discussion.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.