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.

Schadenfreude

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?