April 19, 2007

Two Faces of Housing Panic: Schadenfreude and the Lender of Last Resort.

“The notion that a panic should be allowed to pursue its course is perhaps of two strains. One strain takes a certain amount of pleasure, or Schadenfreude, in the trouble visited upon the market, as retribution for excess of the past; this somewhat puritanical or fundamentalist standpoint rather welcomes hellfire as the just deserts of others. The other sees panic as a thunderstorm “in a mephitic and unhealthy tropical atmosphere,” cleaning the air. It purified the commercial and financial elements, and tended to restore vitality and health, alike conducive to regular trade, sound progress and permanent prosperity.” -Charles Kindleberger

It has been said that divided responsibility is no responsibility. We witness this in the moral hazards that permeate our society. For example say an accident will cost you $1,000 and your insurance is $900. Then there is really little incentive to avoid the accident since the difference is marginal. Subsidizing anything makes it more popular, it is a law of economics. In another example unemployment benefits can be seen as a moral hazard as well; in general people are less inclined to find a job if they are paid for not getting one. These are just minor examples of the moral hazard problem. But currently the housing bubble is in one of the largest moral hazard problems. There is this unstated assumption that housing will never go down because of Government Sponsored Entities picking up the flack if a major bust would occur. Sort of like the FDIC insurance you have at your local bank. By instilling this confidence people loaded up their money back into banks because if the bank were to go down, the government would be there with a check to bail them out. This hazard works in some cases but is never black or white. For example, do agents lose any skin if your house tanks 20% right after they get their commission check? Does the broker really worry about foreclosure since the lender now holds the note? Or does the lender really fret about losing declining values on homes if they feel that the government will be there to bail them out on bad loans should foreclosures surge? We are at this stage in the game because a moral hazard, if taken to the extreme will cause a major crisis.

Before, banks actually held in their portfolio large numbers of mortgage notes. So they had a lot of skin in the game and they policed carefully who they loaned money to. If the buyer was unable to make the payment, the immediate lender would be out and would need to foreclose on the home. In addition the bank was local to the area and had a better feel of the job market and other details that someone overseas cannot possibly understand. In the last decade, so many hands are involved in the credit infusion, be it the Fed, brokers, or lenders and the blue ocean of distance is growing from home owner and note holder. No longer is anyone worried about defaults or a crashing market because the omnipresent “government” will bail out the frivolous and imprudent lending that we have witnessed. We have now all heard about the 102 year old man who was able to get a 30 year mortgage and the immigrant farm worker who bought a $700,000 home on a $15,000 a year income. In addition, the data is now out that Q1 foreclosures jumped 800%+ in California from last year. And now that housing is going down and foreclosures are jumping we are doing our normal two-step of the blame game. Fingers being pointed, blame being assigned, and history repeating itself once again.


From reading hundreds of financial and housing blogs, it is the case that some people want to see people fail. The rhetoric is such that I believe many folks are putting out a red carpet for the housing Armageddon to enter this country. Not only do they want to see people fail they feel vindicated that it is a sort of past retribution for sins committed. A housing scarlet letter. Well looking at the massive rise in foreclosures and the collapsing of the mortgage market we are only in our initial stages of the housing crisis. This market psychology is rather interesting because the instant bail out talk came from Senator Dodd most housing bears raised the roof with a collective “hell no we’re not going to bail them out!”

I believe housing will come down and come down hard. No soft landing. This isn’t some wishful thinking but simply the strain on our credit system is hanging on a thin string. The fact that $1 trillion in risky loans are resetting this year. No longer is this supportable and the system needs to flush out excess. In any bubble resources are diverted from prudent enterprises to system wide gambling. The worth assigned to the housing industry in the last few years has depleted resources from more prudent areas of economic growth and created a real estate obsessed society. Want to know how much your home is worth today? Log onto Zillow and find out to the exact penny. Want to know how much your neighbor’s home sold for? Log onto your local county assessor office and get the scoop. We’ll be living in housing purgatory for a few years and the credit orgy we’ve gone through will linger for many years.

Lender of Last Resort

Again the faux pas in believing you will always have a bail out will create risky behavior. Each time Fannie and Freddie accept larger loans it is a de facto statement of insurance protection. Whether this is explicit or not all systems are telling us that credit is available to everyone and if all goes boom we’ll be there to pick up the mess. That at least is the assumption. And for seven years we never had to worry about the intricacies of this because of the booming market. Even if you over leveraged yourself in a home you could always sell the home to break even or make a nice profit. Even banks were losing very little on REOs they were getting back. Remember the moral hazard. So what happens when loans get kicked back and the market is dry? Just look at New Century Financial and you’ll get an interesting synopsis.

Ultimately and sadly, we the American tax payers are the lender of last resort on this mess. We’ll be paying either through inflation and a declining dollar thus hampering our quality of life. Whether you are an owner or renter we will all feel the implications of a massive global credit craze. There will be many lessons to learn from this. History repeats itself. Greed will always be part of society. And suckers are born every minute. Whenever you hear pundits talk about how its different this time and how we’ve learned form our past mistakes just look at the tech bust or world conflicts. Have we really learned from the past? Or do we suffer from historical amnesia now?


lendingmaestro said...

Our government has failed us. I'm not saying it's the governments job to bail us out, but if they are seriously contemplating this, they need to blame themselves.

The regulators on capital hill have known for years that fraud and "shady" business practices infested the mortgage lending industry. There have been voices urging them to implement regulations on brokers for a ,long time. The reason why is that it would cost teh gv't too much money and too much work to regulate brokers.

It's sad when you perform your job ethically at a FDIC insured federal savings bank that records emails and conversations, while there are brokers out there that can say or do anything. The vast disparity in this industry is monumental.

On a different note about Zillow. If you look carefully at the "comps" of the subject property you are searching, you'll see that there is now a notable difference between the "Zestimate" and the sales price. And, surprise, surprise, the sales price is generally lower than the "Zestimate"

Dr Housing Bubble said...


The enforcement branch of our government has failed us. It is amazing how many laws and regulations we already have on the books. When you hear the pundits talk about more regulations I get ill to the stomach.

The last thing we need is more regulations. We have plenty. What we need is better enforcement and policing of the already existing laws. Put what are the use of laws if they are not followed? Not only that, but they are scene as a token gesture.

They're treating this like the tags you aren't suppose to remove from your mattress. Unfortunately this tag is lodged on the side of your home and is connected to your equity.

Ben Franklin said...

Great writing, as usual, Dr. B.

Casey Serin of course is the infamous flipper in Sac who rushed out and bought 8 houses in 8 months, building a real estate empire that is now $2 Mil in debt. He posted today about how one of his properties awaiting foreclosure has a swimming pool that's sat unattended for 6 months, and has been targeted by the city as a public health hazard. All that stagnant water has allowed mosquitoes to proliferate (and West Nile virus is a concern in the Central Valley).

He showed a picture of the pool from last Fall, and it looked rather nasty THEN: it must stink to high heaven by now, as a festering cess-pool.

Of course, in his classic fashion, Casey side-steps his responsibility in creating this problem, even though he still owns the property on paper. He is saying that whomever buys the home as a foreclosure will have to take care of it, or the bank will, or the city will, etc.

Once again, there's a typical lack of personal responsibility we see so commonly nowadays, i.e. "it's not MY problem", even when it clearly IS someone's problem.

Diffusion of responsibility, thinking "someone else" will take care of it. Same thing happens when lenders are dispensing OPM (other people's money).

TO go further, apparently people forget that owning possessions includes an element of increased responsibility, i.e. you need to TAKE CARE of them, if not for your own benefit, but because a lack of stewardship means that others may be harmed by a lack of care! It's why we have laws demanding smog checks for cars, fences around pools, regulations on responsible gun ownership, and even laws pertaining to prudent lending.

I know thinking of the interests of others in a community is a dying, outmoded principle (unless you're forced to, by living in a homeowners association), but if nothing else, all of this mess is indicative of a society that's become vastly focused on a "what's in it for me" philosophy, with an inability to see how our actions effect others.

And while consumerism, the glorious pursuit of more STUFF, is at the cornerstone of our American culture, ownership includes a responsibility to take care of what we have, and that involves budgeting time and funds for ongoing care (and God help the neighbors of the borrowers who didn't factor in the price of a lawnmower, when they got a home loan!).

Anyone who's bought more than they can reasonably maintain soon starts to ask themselves if WE own the possessions, or if the possessions own US!

lendingmaestro said...

We do have many laws, correct. However mortgage brokers that simply have a license in one state are not regulated. They can say whatever they want and get away with it. In california, all I need to do is get my sales agent license and I can broekr deals through Dana Capital, Bridge Capital etcetera, with very little recourse.

IrvineRenter said...

There is certainly a lot of schadenfreude at the bubble blogs. I did a series of analysis posts at Irvine Housing Blog, and the readers complained and wanted more flips. Bring on the schadenfreude. I feel it too. Warning people who were committing financial suicide only got smug quips about being a bitter renter, so the reservoir of schadenfruede was filled one smug FB at a time.

I would note that many of the housing bears were pissed about the talk of a bailout not because they wanted the market to crash, but because a bailout would create more of the foolish risk taking behavior that caused this mess in the first place. Rewarding bad behavior, or simply removing the repercussions, will undoubtedly create more bad behavior. If you thought this bubble was bad, add a bailout, and it will grow twice as large. Eventually the system will break.

CRAZY G said...

I REALLY take exception to the fact that people ""CONTINUALLY"" blame the government, and not themselves....
We, always and ever are passing responsibility to a higher source....""MACHIVALIAN" concepts for sure!!!!


Anonymous said...

The loan officers in OC are getting desperate. LOL!!!!


Anonymous said...

This country is so fucked up I can't believe there isn't more of these shooting massacres going on in our country. Our country does nothing but breed greed, envy, hate and selfishness. And any crazy bastard can go buy a gun anywhere. Our American Empire will collapse.

Ludwig Von Mises said...

How do you like your fiat currency and fractional-reserve banking now? Protect yourself; buy gold.

Kevin said...

Dr. HB,

Could you reciprocal link to my regional Baltimore Housing Bubble site?




Chuck Ponzi said...

Irvine Renter is right.

Noone wants a reasoned analysis, they want a story, and a gory one at that.

Welcome to human nature. Would you rather watch a zoologist on TV explain how a lioness takes down a zebra, or watch it in slo-mo on the Discovery channel as its incisors sink down into soft neck-flesh and blood spurts out?

Bubble blog readers were also pissed, not because a bailout would be moral hazard, but because it's the equivalent of giving the Zebra jet-pack.

They start looking around their apartments and wonder, where's my government-issued jetpack? Hell, I want my damn government issued Jetpack! Those stupid Zebras that got in harm's way because they wanted the tastier grass, so give me a jet pack if you're going to give him one! I'm pissed as hell, and I'm not going to take it any more.

Of course, if the gubmint didn't step in, we would likely just enjoy the show. Of blood spurting.

Human nature, as long as we're not getting eaten.

Anonymous said...

These are some hilarious comments.

"I would note that many of the housing bears were pissed about the talk of a bailout not because they wanted the market to crash, but because a bailout would create more of the foolish risk taking behavior that caused this mess in the first place. Rewarding bad behavior, or simply removing the repercussions, will undoubtedly create more bad behavior."

You don't poke a sleeping bear with a stick. It's a bad idea. And frankly if I get poked with one more stick about how "real estate always goes up" I am going to be sinking some short-selling bear teeth into the next lender to get curbstomped and will relish watching all those 24-year-old real estate petty barons declare bankruptcy. I want to see them crying "I lost everything!" Don't worry, I'm sure if the gov't doesn't, dad will bail you out.

"The enforcement branch of our government has failed us. It is amazing how many laws and regulations we already have on the books."

Absolutely 100% correct. Unfortunately your average financier can't pronounce "fiduciary" even the next five to seven years of his life depends on it, and his boys at the NASD and SEC can't either except to take out the token "rogue trader."

"I REALLY take exception to the fact that people ""CONTINUALLY"" blame the government, and not themselves....
We, always and ever are passing responsibility to a higher source....""MACHIVALIAN" concepts for sure!!!!


Crazy G, your misapprehension of the nature of this discussion about government responsibility borders on hilarious. We're blaming gov't for doing too much, not too little. The government is responsible for directing money into channels that generate tremendous market inefficiencies, in this case, by first advocating mortgages (Alan "ARM" G-Span c. 2003 at 1% interest rates) then offering to bail out the home-"owners" and their lenders--that constitutes a de facto subsidy on housing.. We're not after more government here. We're after less.

vegas crash watcher said...

I have schadenfreud because mortgage holders are almost always supporters of government and collectivism, and thus deserve to suffer.

We need more individualism and freedom (including gun rights) and less taxation, regulation and envy of other people's wealth.

Anonymous said...

The individual who made $15K a yr and bought the $700K house along with the mortgage broker should be arrested pronto...I mean it

Anonymous said...

not arrested, but deported.-I mean it too.

Anonymous said...

I'm writing from Sweden to inform you that you are a finalist for the Nobel Prize in Economics. Sorry it took so long.

(Actually, I'm across the country, but experiencing what you are, and I have to tell you this blog is beyond fantastic.)

repo4sale said...

By 2010-2012 Prices will be "Trash" Values:
50-70% off for Homes
60-80% off for condos+town homes+zero lot line homes
80-95% off for land, lots, acres
30-70% off for commercial buildings (all types)

My Track Record:
Average 1160% Gross profits last 10+ years
Average 2 year hold last 10+ years
Almost 200 buy/sell round trips completed
BBA Finance+Real Estate Ccim Cria Cam Ems Gri xTaxLicense
xParalegal xRealtor xInsurance xStockbroker

Anonymous said...

Here's a candidate for your Real Homes of Genuis:

MLS: 40255029

343 sqft studio condo for 330k!!

The North Coast said...

I understand schadenfreude and I confess to feeling a touch of it.

But I'm a "bitter renter" who watched prices on condos in my Chicago nabe ratchet out of reach and had to listen to all the flippers talk about buying $350K condos on incomes of $65K. Because I didn't want to borrow 4, 5, or 6X my income to support an overpriced junk rehab, I was a "bitter renter"

Can I be forgiven for feeling a bit smug now, and for also feeling that the prudent and honest who sat on the sidelines should not have to pay to bail out the careless and dishonest?

Can I also be glad prices are at last falling to a reasonable range where I just might be able to own my home, UNLESS the feds decide to prop up this overpriced market at keep it out of my reach by bailing out all the idiots who bought at the top?