HP Special Post

An HP'er in the know wrote this letter to a friend who was thinking of buying a house, trying to recap for her the Great United States Housing Bubble and Crash, while warning her NOT to buy until this little crash thing is over.

The letter was so good, I post it here, in its entirety. He asked to remain anon, as he's in a position to see how bad it is, and how bad it's gonna get.


XXXXXX, I am delighted to explain. Some of this is theory and some is fact, but I feel very confident I am painting a very accurate portrait.

The early part of this decade was marked by the bursting of the tech bubble and 9-11, and resulting subsequent economic disruption. The many free trade agreements signed during the 1990's led to bleeding of middle-class manufacturing jobs that used to be the backbone of our economy. Since Bush took office, nearly 4 million manufacturing jobs have been lost. But it goes beyond that. American companies, looking for increased profits, have outsourced millions of white collar jobs so that careers that were supposed to be "the wave of the 21st century", such as computer programminng, engineering, and other high-tech areas, have continued to see negative growth.

In order to keep the economy going, the government did a series of unwise things. Our leaders were happy to have our economy heavily dependent on consumer spending (nearly 75% of total GDP) and debt (consumers have had a negative savings rate the past several years: only time since the Depression!). Moreover, the government greatly expanded legal immigration through H1B and L1 Visas. Much of this was done at the behest of the business community, which has continuously sought cheaper labor costs.

Part of the reason for this increased immigration was that the government wished to stimulate economic activity by expanding the population. Consistent with this, the government wished to greatly expand homeownership, in order to boost the land development and homebuilding industries, along with other related industires such as landscaping, real estate brokerage, and home improvement (Home Depot, etc.). Bush (also known as the Worst President in History: rest easy James Buchanan) regularly boasted about the "ownership society".

Of course, as has always been the case, these millions of first-generation immigrants (along with American renters) had little to no savings and work in service jobs with generally low household income. Notwithstanding that fact, the government and the private sector did a number of things to enable this homebuying orgy. All of these actions were unwise in the long run and are coming home to roost now.

First, Fed Chairman Allan Greenspan, the most overrated public official in American history, lowered rates more than 15 times and kept them extremely low far beyond what was dictated by circumstances. The rate cuts allowed the mortgage industry to offer unprecedented levels of adjustable-rate mortgages to unqualified borrowers, many using "teaser rates" that have huge built-in increases. The rate cuts also encouraged increased consumer borrowing for an already debt-laden society. This allowed Bush to brag about economic growth and "the ownership society" but the consequences of the rate cuts have been enormous. Consumer debt has led to unprecented levels of foreclosures and bankruptcy. The rate decreases have destroyed the value of the dollar. Now the impact of the rate cuts is being felt in terms of inflation. They have been a factor in the huge spikes in oil prices, as more people invest in commodities when dollar-denominat ed investments fall in value and inflation expectations rise.



Of course, the biggest factor in the increased oil prices has been demand from China and India. This was an unintended consequence of the aforementioned globalization, as American companies have been all too happy to outsource their production to the cheaper labor markets. Needless to say, retailers like Wal-Mart have been happy about these developments, and they have pushed hard for expanded so-called free trade. But the rapid growth of these overpopulated (both over 1 billion) third-world backwaters has hugely impacted global oil supply.

Another factor has been the greedy developers and greedy financial industry. These greedy developers, with state and local officials in their pockets, have managed to get subdivision after subdivision approved, many over the objections of the local communities. Because these developers control the politicians, they have not been forced to pay any impact fees. Consequently, taxpayers have been forced to pick up the tab for roads, schools, hospitals, and other infrastructure needs that have exploded due to unprecedented levels of hombuilding activity. Of course, this unprecedented growth has impacted traffic, the environment, schools, hospitals, and every other aspect of quality of life. Now states across the country, led by California, are going bankrupt as they try to keep up with all these costs. An unspoken factor in all of this is the fact that the homes have been built by an enormous wave of illegal immigrants from Mexico, who have been illegally hired by the greedy builders and developers. Needless to say, these low-wage, low-skill (Mexican immigrants average a 7th grade education) immigrants have been an enormous burden on social services, not to mention traffic and other factors.

As noted above, the government sought ways to put millions of people in these homes. The private sector contributed to this effort by disregarding the most basic banking fundamentals. Whereas lenders would hold mortgages in portfolio years ago, they almost never do today. Consequently, they have no concern whatsoever about the repayment capacity of the person to whom they are lending: they make their income from the origniation fees. The aforemenntioned Greenspan rate cuts allowed these lenders to offer adjustable-rate mortgages with very low rates. The lenders could then sell the loans to private investors, who would chop the pools of loans up into thousands of pieces and sell them as CMO (Collateralized Mortgage Obligations) or CDO (Collateralized Debt Obligations) tranches. Since worldwide rates have been very low, investors seeking higher yield have been all too happy to buy these, as they general ly did offer higher yields. Those investors were usually hedge funds and foreign governments, as American consumers with their negative savings have no money to invest.

Needless to say, since these CMO's and CDO's were so esoteric and chopped up, it is doubtful that anyone knew what they were holding. But no one worried because the investments were secured by American homes and, as we all know, residential real estate always increases in value (sarcasm font). What the investors didn't count on was artificial home price inflation caused by compromised lending standards (no down payment, no verification of employment and income, low credit scores, minimal job history, and high debt-to-income ratios) and "flippers", those investors that came in and drove prices up in hopes of selling the home they don't live in and making a quick buck. The CMO's and CDO's were given the AAA stamp of approval from all the rating agencies, including Moody's, Standard and Poor's, and Fitch. Of course, what people did not know (and the lazy American media failed to report) was that these agencies were getting huge fees directly from the bond issuers, a nd they were therefore interest-conflicted and incentivized to give good ratings.

The run-up in home prices, and the unsustainability thereof, were demonstrated by price-rent ratios. These ratios have historically moved in tandem but became hugely out of whack in recent years, a true red flag that the homes were overvalued. If one wasn't inclined to look at these ratios, they could simply apply common sense. Here in Atlanta, the median household income is less than $60,000 per year. Yet you can't touch a new home for less than $250,000. It doesn't add up. And, in terms of home price compared to household income, Atlanta is way better off than places like LA, Phoenix, Washington DC, Las Vegas, and Miami. But, once again, our lazy media was asleep at the switch.

The growth in homebuilding and homeownership was greatly fueled by government-sponsored agencies FNMA and FHLMC. Historically, subprime and more marginal mortgages have been sold to private investors. The primo stuff has historically been sold to "Fannie" and "Freddie", who have securitized the mortgages into CMO's and CDO's as described above. But, during the current decade, Fannie and Freddie bent their standards and they purchased and securitized billions (maybe trillions) of mortgages they would not have done previously. Consequently, a number of economists are predicting that an enormous taxpayer-funded bailout of these agencies will be necessary.

Upon taking office, President Bush appointed a Texas banking buddy, Donald Powell, to be FDIC Chairman. Mr. Powell ran a small national bank in Texas that came within an eyelash of failure in the early 1990's. Powell had a severe disdain for regulation and regulators and immediately proceeded to gut the staff. He publicly stated that "all of these small community banks could fail and it would make no difference." He implemented the MERIT program, which equated to drive-by examinations. Banks throughout the nation (particularly here in Atlanta) proceeded to go crazy making nothing but Acquisition, Development and Construction loans to developers and builders. These local bankers lent millions to developers without regard to the fact that those borrowers were overleveraged and they continued to lend like crazy even when it became evident that the market was oversupplied. Underwriting was poor, to say the least. In other words, bankers did exactly what the banking industry did in the 1980's only on a bigger scale.
We as regulators stood by and let it happen. Now, development loans are defaulting at an incredibly rapid rate and the financial industry is likely to see massive bank failures.


So there it is. Incompetent government leadership, excessive desire by government leaders to make GDP and job growth numbers look good, corporate greed and short-sightedness, have led to an implosion of unprecedented magnitude. And the sad thing is that all of it could have been prevented by applying the most simple and basic fundamentals. But greed, politics, and stupidity took over.


As I have stated before, when the dust settles, this largely government-induced financial and economic implosion, which I think will rival the Depression, will be an even greater black mark on the nightmare that is the Bush legacy than even Iraq.