Banks Reap, what they have Sown

The last several months in the home sales and finance industry has been a very tumultuous one. It has been one for me personally as well, but not in the way you are thinking. I currently don't own my home, I rent, and my landlord paid cash for the property as therefore is not leveraged on the home. Where this effects me however is at work, for those not aware my day job is that of a Small Business Financial Specialist for one of the largest banks in the United States. My position is unique in that it allows me to see to the banking needs of small businesses, as well as the personal financial needs (Not just banking) the owners and employees as well. My comments that follow are mine, independent of my employer and are impressions I have based upon 8 years of experience in the Banking industry. This is further supplemented from lessons learned in my college Macro Economics class.


Hopefully the title of this post is providing you with some idea of my angle with the current housing correction. I could quite possibly test the limits of this blog going into the economic details of the Housing industry, with the corresponding Home Finance industry but you and I both don't have the time to read (or type) into such detail so I'll do my best to avoid any tangents. The current financial and home sales situations are a reaping of our own general greed. For the majority of the last few months, I've viewed the primary culprit as the greed of the mortgage industry, but as I've dived deeper into the stories being told, and the things I've personally observed as a lender, I can not leave blameless what has also been a prideful lust of material wealth on the actions of the borrower/home owners. Both of these view points will be addressed.

Everyone has seen those signs at the intersection teasing you with mortgage rates of 1.25%. Well in the itty-bitty print under the big print was that 1.25% was in index payment, not the interest rate. These were Adjustable Rate Mortgages, with rate increases as soon as 12 months, payment re-cast (Re-Amortization's) as soon as 3 or 5 years. Now the ARM mortgages, teasing with low variable rates aren't an evil thing, they have there purposes, but during the housing boom of the mid 2000's, their features were abused by the mortgage industry to get quick easy sells, and to entice buyers into mortgages too large for the average buyer.

A great example of this was a recent tactic used at the start of this year in my development. KB Homes, who was in the process of liquidating their inventory here was advertising new homes with payments as low as $525/mo. Now the cheapest properties available at this time were still high with discounted prices floored at 170k. 525.00 a month is a p&I payment roughly for a 65-75k loan (I'm estimating in my head with that figure, but it's not a gross example.) The problem with this scenario is that ARM's are meant for short term borrowing, often used by home investors and executives who often find themselves moving every 4 to 7 years as they advance with their companies. During the housing boom however, the low monthly payment features (including Pay-Option ARMS with the interest deferring index payment) to put borrowers into homes they otherwise wouldn't be able to afford using a conventional 30, or even a now used 40 year Mortgage. Furthermore the effects were amplified by offering up to 100% financing with the interest deferring Pay-Option versions of the ARM, with the index payment deferring interest, the balance due on the mortgages often at times was racing the market value gains during the market boom.

The final dagger and what had proven the most deadly feature of these products is the rate increases and payment recast. The first, rate increases may not seem that bad when you look at a increase cap of 2% (going from 5% to 7%) However a increase of 200 basis points (2%) on the loan rate equates to a 20% increase in the payment. (i.e. a 1000.00 min payment is now 1200.00.mo) The second dagger in this feature is the payment recast. What this is basically is a reset of your minimum payment for the mortgage. Often times, based on the variables of rate environment and the number of index payments made (deferring interest) a consumer could realistically see a payment increase in excess of 1,000.00. Magnifying this effect here in Florida, most notably in the South Florida is the skyrocketing escrow cost associated with Homeowners Insurance and Property Taxes. I've personally seen a few clients experience increases of more than 150% in their Insurance premiums. That's a discussion for a later time.

It was very irresponsible for the mortgage industry to recklessly lend out money, leveraging the American Dreams of many with fully financed Adjustable Rate products. It was a recipe for disaster, the Market Correction that we are currently experiencing was long fore-told by analyst. Honestly, anyone who had paid attention in their Economics classes in High School and College could had seen this day coming in the Real Estate industry. There comes a point when a products market becomes saturated with both supply and demand. When this pinnacle is reached, a tumble will happen. Unfortunately the rising rate environment fueled by the Fed Board resolve to restrain inflation helped to pull the correction in the R/E Market a little faster.
The American Economy is a resilient one and will survive this. There will be a price. We can lower rates now, but risk a skyrocketing inflation rate, that could potentially mirror that experienced in the 1970's. The option I feel is to allow the market and Economy do what it does best on it's own, Correct and Recover. Any interference on the part of the Federal Government will only magnify these events (and please note that Corrections come BEFORE the recovery....so contemplate if you want the Government magnifying a correction) A government bailout of the housing industry would have much the same effect as a near none existent lending rate, which is essentially free money. This would in turn provide inflationary fuel to the market necessitating further INCREASES in the Federal Funds Rate and soon we'll be thinking that Carter is back in the White House.

The ramifications of the housing and mortgage boom of the early-mid 2000's will be painful, but as we look back to view what went wrong, make the necessary changes needed to protect the market from suck vulnerabilities we will create an even stronger housing market, supported by a more stable lending/borrowing environment for the Home Owners and the Banks. Something said in a training meeting on our "Pick-A-Pay" Pay Option mortgage product (Brought over with the Golden West/World Savings merger) has stuck in my head and applies well to this scenario, "If you protect the customer, you protect the Bank." Lenders such as Countrywide and the Sub-Prime lenders were looking out only for their stock value and wallets. Now, they are reaping what they have Sown.

(Note: Wachovia's Pay Option product, the Pick-A-Pay Mortgage is note a "Pay Option ARM", it has a lower foreclosure rate than the Nationwide average on conventional 30 Year Mortgages. With a maximum 80% LTV, and limits on Index Payment increases, 7.5% versus 20% on Pay Option ARM's, It provides options and protection that help ensure that the borrower is protected from foreclosure as much as possible on the Lender's part. For more information about this solid product, please refer to Wachovia's Website.)