The standard plotline for market bubbles is an ever-widening buying frenzy. Our most recent example—but by no means a unique one—was the tech bubble of five years ago. As the prices on tech stocks climbed, people who had never gambled on the stock market were begging for tips and learning how to place an order with a broker. Apparently, if the descriptions are accurate, thousands of people forsook their jobs to stay at home, hunch over the monitors of their computers and get rich as day traders.
Respected business figures and academic economists—not to mention the swarm of stock-market analysts who turned out to be crooked—were all crooning that this was a new economy, one in which the price of securities only goes up and everybody gets a free ride to finance’s big rock-candy mountain. As with past bubbles, there were a few Cassandras, party-pooping spoil sports who prophesied the coming bust, but the doomsayers were ignored until it was too late, and the only sound to be heard was the popping of balloons and the inaudible snap that soap bubbles make when they collapse.
Now there’s a housing bubble, and there are no lack of bandmasters conducting the “We All Get Rich Waltz.” Buy, borrow, buy again, borrow some more is the song being sung by David Lereah, chief economist of the National Association of Realtors. The enthusiastic Mr. Lereah is the author of an opus entitled Are You Missing the Real Estate Boom? He tells inquiring reporters from the Los Angeles Times, “If you paid your mortgage off, it means you probably did not manage your funds efficiently over the years. It’s as if you had 500,000 dollar bills stuffed in your mattress.”
But despite Mr. Lereah and his confederates from Lending Tree and Ditech.com, the Internet lending operations whose odious ads run nonstop on TV, the housing bubble is deviating from the usual blueprint. This time, the woods are loaded with Cassandras. Everybody in banking, finance and economics with a beard to pull or a thumb to suck has written and speechified warnings against the real-estate bubble. Those whose finances implode by excessive borrowing on housing or overpaying in happy confidence that what is too high a price today is laughably low tomorrow cannot say that they weren’t warned. Even Alan Greenspan—not one to stir markets up—has been heard uttering what appear to be cautionary words. Of course, with Mr. Greenspan’s involuted syntax, one can never be positive about the message, but decryption by people skilled in the art leaves no doubt that the Federal Reserve chairman is warning people that prices which go up can come down.
Bubble or not, it would be a mistake to believe that millions of silly-willies have gone out to buy and borrow over their heads against all the banking, finance and securities industries could do to prevent it. Just as financial institutions have made it progressively easier for dubious, poor and bad credit risks to get credit cards, they have done the same with mortgages. Mortgages are routinely issued to people who would not, in all past American banking history, have qualified for them, and the mortgages themselves are like none seen before. Almost 40 percent of houses sold these days are issued with down payments of under 5 percent.
Many residential properties which were originally bought with 10 or even—oh, shades of bygone times!—20 percent down have been converted into no-money-down mortgages through serial refinancings which may, depending on the state of the real-estate market, have wiped out any equity the home owner may have had. In effect, these homeowners, after having put a certain amount into their property purchase as a down payment, have borrowed it back.
Borrowed it back and then some. There has come into existence an instrument called a negative-amortization mortgage. (There is no end of cute language in the world of not-so-high finance.) This is a mortgage on which the home “owner’s” monthly payment is insufficient to cover the interest charge, much less anything on the principal. Unlike home owners of the past, a person buying a home on these terms doesn’t scrimp pennies and deprive himself of small treats as he looks forward to the day he invites family and neighbors over for a burn-the-mortgage party. The modern homebuyer may have the means but certainly doesn’t have the intention of ever paying for his house. The Los Angeles Times quotes one such homeowner asserting: “There is no longer an incentive to paying off your mortgage. The only way I’ll ever pay mine off is if I win the lottery.” For this man, his house and mortgage constitute an A.T.M. machine. “It’s like I’m sleeping in my piggy bank,” he told a reporter. “In this market, real estate is a liquid asset.”
Financial advisors with a conventional cast of mind are prone to think that such a path of economic behavior leads to personal disaster. It may in the long run, if the speaker is one of the 100 million who have made no provision for their retirement and will tell you that first they will shop till they drop. Then they’ll resurrect themselves and work till they drop—and, to use the idiom of the day, they’re comfortable with that.
This happy-go-lucky homeowner is of a time and generation to whom bad things have not and do not happen. The closest they’ve come to a generation-wide painful experience was the 2000 market crash, and in the end everybody got through it well enough to try to get rich again in real estate. That old dame who dogged their grandparents, the hag named security, does not haunt them. Tomorrow will take care of itself.
They may be right. If interest rates go up, hundreds of thousands of houses will only clear the market at a lower price than their owners paid for them. Higher interest rates may put people with adjustable-rate mortgages and home-equity loans with floating interest rates in a nasty fix, but the countless people who have no real equity in their homes won’t take a hit. Their piggies may be broken, but there were no coins in them in the first place.
If they have been serial refinancers, for instance, taking out a new loan every time the putative value to their property increased and spending the money on cars and vacations, they have gotten their profit out of the property. So what if the rates go up or they lose their jobs and can’t pay the mortgage? They can walk out. They only owned the house in a legal sense; in an economic sense, they are renting.
A bursting bubble isn’t a prerequisite for some such series of events. If the rise in real-estate prices merely arrives at a plateau—if rates rise a point and a half to, say, the non-outlandish level of 7 percent—we may see hoards ceasing to pay on their mortgages while, like apartment-house tenants, they wait to see if the landlord is going to evict them.
But who is the landlord under these circumstances? Who holds what may be a trillion dollars worth of property?
It probably isn’t the banks and savings-and-loan institutions. They nearly destroyed themselves—and us with them—in the 1980’s by making mortgages on absurdly overpriced properties. The government saved them from the worthless I.O.U.’s in the form of rotten mortgages they had amassed in their vaults.
This time, the mortgages have been put together in batches selected according to various formulae, dropped into a mixing machine and extruded as asset-backed securities—yet another beguiling name cooked up by the sales department. That is, they are bonds that derive the money to pay the bond purchasers interest and principal from the underlying mortgages. If the mortgagees can’t or, for whatever reason, won’t send in their monthly payments, the bondholders take the hit.
The names of the owners of these bonds are not known. Maybe some of the banks and mortgage companies bought some themselves. It is believed that retirement funds, mutual funds and foreign investors like the Chinese have been buying them. Doubtless, individuals have been buying them too.
We’ll find out who owns them if home owners or renters stop paying. Then what happens? It is inconceivable that all of the homeowners (or even most) will stop paying. If enough do, however, the value of the bonds will go down the toilet, with repercussions that can’t be predicted because the bondholders are not known. Therefore, their power and importance in the grand scheme of things isn’t known either. If most of the bonds are owned by individuals, it’s one thing; if by the Bank of China, it’s a very different thing.
Of this, you may be sure: If the defaults are widespread, with many threatened with eviction from their homes and the Bank of China furious for being sold crap bonds, the Republicans in Congress will come up with a bailout scheme. It will be very expensive, and you don’t have to be told who will pay. What is yet to be worked out is how.
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