May 21, 2007

Housing Corruption and Greed: The Broken Windows Theory and Fundamental Attribution Error.


Have you ever wondered why many mortgage brokers and real estate agents try to hard sell you on a property or a unique mortgage? Those with dogmatic views usually try to convince themselves as much as they try to convince other people; they have a vested interest in believing that nothing negative can ever happen to real estate. And with this, you create a business culture where anything goes and financial prudence is thrown out the window. And speaking of windows, this brings us to the Broken Window Theory and how it applies to the current housing market.

The Broken Window Theory Applied to Housing

George Kelling and Catherine Coles, both criminologist studying petty crimes in urban areas found that fixing minor public nuances like broken windows and graffiti greatly helped to eliminate larger crimes. They argue that the perception of broken windows and graffiti for example, lead people to believe that the area is unkempt and thus opens the opportunity for criminals to commit even graver crimes. The psychology to this principle is simple yet profound. The environment has an unbelievable influence on how people react. With cleaned up environments they found that the “gateways” for crime were eliminated and thus fighting petty crime such as broken windows is very important in the overall health of the area. It is important because it creates the impression of law and order.

This is absolutely important and has many parallels to the current housing market. The broken window in the housing market is the credit bubble and the direct relationship with mortgages. With the credit bubble, the environment was shaped to support progressively more risky mortgages. Even though the Fed and government would like you to believe that they did not encourage the housing bubble they did. Consider the Fed as the local governance of a community that actively let graffiti and broken windows prevail only to be in shock when they realized crime went up in the progressive years. How can you blame a broken window for more serious crime they ask? And with this, those at the bottom of the pyramid got the implicit message that it was okay to lend money out on risky terms because they had the okay from those at the top. Again, never will you see the Fed openly admit to this blessing but their actions speak louder than words. They essentially let the environment go, like a controlled experiment in a lab, and now are seeing the fruits of their irresponsible actions.


Many want to assign the blame to those at the lower rungs. Make the buyers, sellers, agents, and brokers pay. But what about the government who receives fatter checks from properties that are appraising higher? Or what about the Fed who is still able to claim low inflation and a stable economy? The broken windows of mortgage fraud and credit keep growing with no stop. The L.A. Times has written two articles highlighting that 50% of all stated income loans had incomes overstated by at least 50%. What does this mean? A family making $50,000 a year was all of a sudden making $80,000 to fit into that negative amortization loan. That is fraud fueled by a lax environment.

Fundamental Attribution Error

People tend to underestimate the power of environment. This goes against the grain of the rugged individual so many Americans believe in. It comes off as blasphemy to blame anyone else except yourself. On a recent survey, 90% of all drivers felt they drive better than average. This is the crux of the fundamental attribution error. And how this relates to housing is rather interesting. We are starting to see arguments on many housing blogs and the mainstream media about who is to blame regarding this housing debacle? Is it the lending industry for creating risky loans. Is it the realtor organizations for pushing buyers into homes they could hardly afford? Is it the Fed for flooding the markets with cheap credit? Or is it the buyers for signing on the dotted line? I think blame is never a black and white argument. Usually all parties have something to gain in a bubble. After all, without the signature of the buyer the home would never sell. Yet without the easy credit of the Fed, there would be no discussion of risky mortgages and the mass appeal it currently has.

We are now hearing horror stories coming out from organizations like New Century Financial. The environment seems like a frat party gone bad and scenes from Wall Street come to mind. Some whistleblowers are quoted as saying that they felt “pressured” or “coerced” to join into the herd mentality or else. Again, their rhetoric highlights the power of environment over the individual. Many would like to believe nature has no impact on how we interact with the world. This is false. If the Fed had never injected easy credit into the market the bubble would not be where it is today. The Fed and the Mortgage Backed Securities (MBS) market created an appetite where these vices would be fed. No longer are we grounded on any economic theory or can we use real estate valuation tools because we are in a bubble; and by definition a bubble cannot be defined by rational tools. But don’t be fooled by only blaming unscrupulous agents, brokers, or naive buyers; the blame needs to filter up to those that created the filthy environment where the broken windows of housing were ignored.



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11 Comments:

steven edward streight said...

Good explanation. Am preparing for a Peoria (IL) Journal Star newspaper interview on "Real Estate Agents and Web 2.0": how the web is affecting home buying, selling, listing, etc.

twitter.com/vaspers

socalwatcher said...

Dr. HB, your correlations are spot on. Kudos to another excellent synopsis!!!

The broken window theory is right. For both the economy to actual broken windows from the empty abandoned or REO homes that were shaken by this fallout. This ruins neighborhoods, shatters families, disrupts local economies, etc, etc...

It is more than just bad loans...

Anonymous said...

I personally have no sorrow for the sheeple that will lose everything because most would never have had anything in the first place. Face it they got to have fun for a few years and now get to return to their regular scheduled programming. I guess that is better than never having had the fun in the first place.
I also have no sorrow for the idiots dumb enough to loan them the money in the first place.

Who I do feel sorry for are all the people who did things right. The ones who lived withen their means and bought only what they could afford. I feel sorry for them because not only will their house go down in value, but they also get to pay higher taxes to bail out the sheeple and the wolves.

Moral of the story Rent Rent Rent. I learned this after I put a 30000 dollar sign in my yard once. I have to move every few years because of work so it makes sense to rent thank god. I currently rent an 800000 dollar McMansion with 5000 sqft and a 6 car garage for the low low price of 2400 dollars a month. The payment would be north of 5000 a month.

Lovin every minute of it.

Dr Housing Bubble said...

steven,

There was a great 60 Minutes show highlighting the sacred 6% commission and how online real estate sites like Redfin are cutting into agent's profits. How are conditions in Illinois?

socalwatcher,

You are right about certain areas turning into shanty towns. This is rather prevalent in Arizona and Nevada. In terms of the theory, it applies to the corruption of the industry. Brokers looking the other way with stated income loans. Appraisers pushing up values for fear of losing business. Banks lending money to anyone with a pulse. Once standards fall, the entire industry normally follows. We have a classic case of the slippery slope.

anon,

Renting absolutely makes sense in many high priced areas. And there is a case of schadenfreude going on because prudent folks are finally feeling vindicated after many years. I wouldn't doubt that this will increase with the bubble imploding. Remember all the folks laughing it up during the dotcom bust? The media suddenly shifted focus to certain greedy tycoons and made examples out of them.

I'm not sure I agree with this. If anything, those involved should shoulder the burden of this downfall. That is, buyers will have a foreclosure on their record and restricted access to credit for a very long time. Companies that had horrible lending practices will tank and should tank (i.e., New Century). And the Fed will need to shift its energy to protecting the dollar and moving away from bubble creation.

In the end, bubbles no matter how big they get, will pop.

gzone said...

" Anonymous said...

I personally have no sorrow for the sheeple that will lose everything because most would never have had anything in the first place. Face it they got to have fun for a few years and now get to return to their regular scheduled programming. I guess that is better than never having had the fun in the first place.
I also have no sorrow for the idiots dumb enough to loan them the money in the first place.

Who I do feel sorry for are all the people who did things right. The ones who lived withen their means and bought only what they could afford. I feel sorry for them because not only will their house go down in value, but they also get to pay higher taxes to bail out the sheeple and the wolves.

Moral of the story Rent Rent Rent. I learned this after I put a 30000 dollar sign in my yard once. I have to move every few years because of work so it makes sense to rent thank god. I currently rent an 800000 dollar McMansion with 5000 sqft and a 6 car garage for the low low price of 2400 dollars a month. The payment would be north of 5000 a month.

Lovin every minute of it.

3:24 PM, May 21, 2007 "
Yea baby...loving the money going into real ASSETS bring back REAL RETURNS.

Anonymous said...

We sold our house in 1998 and couldn't give it away (we sold it to our next door neighbor, but the RE crooks still got 6% for nothing. Within months the bubble started. Early on we realized that we were already priced out of the market. We are prudent and didn't want anything to do with unconventional financing. We are also value buyers. If there is no value to the house, we won't buy, no matter what everyone else is doing. If it costs more to buy than it costs to build, I don't want it. The biggest anguish we felt were the snide remarks and the overt smuggness of so many Real estate, builders and mortgage people. Instead of buying we have been renting, and saving and saving and investing in the stock market. Our home sold in 1998 has appreciated 300%, but its still the same old house we "couldn't give away" with all its problems and maybe more. We ran a spreadsheet on our investments, and guess what? Factoring in rent and the inability to deduct interest on a home mortgage we came out ahead! We deducted the amount owed on the mortgage, yearly property taxes and other expenses and realized most of our equity would have been because of the bubble, not because of our accumulation of principal. As prices start to decline and price instability becomes more pronounced we have been looking at buying again. The problem is, the numbers are not there. High California property taxes will always be there as well as greedy Realtors and their 6% "tax". We are rapidly arriving at the conclusion that we may never buy another house, because we are making TOO MUCH money. I know it sounds ironic, but I like having a LOT of money in liquid assets, stocks, bonds and have the freedom to buy anything that we want. Of course you know the rest of the story? We were humiliated and treated rudely so many times about our "inability" to qualify for a normal loan at these high prices, we paid off all of our debt and started saving everything, clipping coupons etc. Its gets addictive living like this. I am so cheap I won't tip unless ITS EXCELLENT SERVICE. So here we are, low rent, debt free, plenty of cash and investments and no worries about housing prices, and ZERO interest rate, and NO PROPERTY TAXES. You may think that they are embedded in our rental payments. No our rent hasn't changed in 9 years. Our house has been sold a few times but the new owners pray for us to stay. AS long as we pay rent on time, we are treated like GODS by the owners. They know, if we want to hang them out by being slow pays, complainers or destroyers like many tenants they will be forced into renting to multiple families which will only kill the value of the house. Bottom, Line: We make $160,000 per year, have over $500,000 in liquid assets plus other retirement accounts, we save 50-60% of our income, have old cars, no credit cards, no loans and no FICO scores. We both know the FICO score is a scam. FICO only measures the creditworthiness of DEBTORS. We have been creditors for 9 years, all the positive stuff like paid off home mortgages never late (3 of them) dropped off our credit reports. These "dropped off" to try to stick us with higher interest rates if we wanted a mortgage. Well Suzy you know where to stick it, NO FICO, NO DEBT and WE DON"T WANT ANY MORTGAGE. The best thing is I won't send you(Suzy O) a dime to learn about a score which can not exist. I pulled our credit reports and they had NOTHING, no mortgage histories no credit cards (we had 14 of them). I guess we are dead beats. Hahaha

We learned that the whole system seems to be a conspiracy of squeezing every drop of money out of consumers. If the banks would only share a little more profit with us from our deposits, we would be well on our road to higher financial goals. Now its my turn to be smug. I used to smile when I saw a young family in a shiny new car that they couldn't afford, Now I smirk when I drive by a large house since I know the pain they are really having. The poor bastards are really taking a beating. We LOVE TO RENT. We live in a nice house, and the owners have the PAIN. If we want to move, we move. I won't even give notice because I want to watch them squirm. Homeowners are the ones who will have the pain. Everyone wants to rent to us with even bigger houses for rent. I can't imagine spending almost $4,000 month house payments on that house we used to own that "wasn't big enough". That is what someone else is paying to live in that same dump. I think we have permanently changed our financial strategies. By the time this real estate housing mess is over, we will have enough money to build a custom house AND pay cash for it. We will never buy a house as an investment. Not after this experience! We hate paying all that interest and taxes to crooks. Our mantra is first baby steps, pay off debt and save save save. I hope all the nasty smug realtors go BK! Shakespeare once said "first, kill all the lawyers". It should read "First, kill all RE brokers". They are truly slime. Oink oink, don't cry on my shoulder.

Dr Housing Bubble said...

gzone,

I think you echo the sentiment of many financially prudent people. Like the seasons, life ebbs and flows, and many things are dynamic. Housing cycles like many business cycles go up and down. We've witnessed potentially one of the largest credit bubbles in history. How far will it go down? Only time will tell. It took seven years to get here. I imagine it will take time to go down as well.

Anon,

You sound very intelligent in terms of your investment savvy. The scary thing is most Americans have their wealth tied up in home equity. Your diversification is key to any wealth management strategy. Housing is good because you are able to use leverage; that is if you buy a $100,000 home with $10,000 down, and the home goes up 10% how much did you make? Since you only came in with $10,000 you've literally doubled your money. It is hard to find 100% returns in the stock market; might as well go to Vegas. However, leverage is a double-edged sword cutting just as deep on the downside.

In any case, you were conservative in your investments and it seems you have a large enough sum that investing in other vehicles will pay you larger sums than real estate. Rent and enjoy life. I'm not sure what all the hype is about if you are caring an albatross of a massively heavy mortgage. Do what makes sense financially. Too bad many people were sucked into paying over priced homes that made absolutely no financial sense; in essence they spun the roulette wheel and lost.

Al Brown said...

The major cause of the housing bubble is the federal government. We have a system that enables monied private interests to sway legislation their way.

So government can subsidize bad economics and doesn't crack down on fraud until after the money stops flowing from that fraud. See Savings and Loan crisis, corporate governance scandals during the boom.

We need to align the interests of our individual elected representatives with the actual interests of those they are supposed to be serving. We'll go from crisis to crisis until we fix that disconnect.

Make Mine A Bubble said...

On a recent survey, 90% of all drivers felt they drive better than average. This is the crux of the fundamental attribution error.

The attribution error principle can be applied to the FBers themselves. Most people believe they deserve a lifestyle that is better than average (because no one likes to think of themselves as settling for average).

I think that's how most people got themselves into this mess. They thought, "If J6P can buy a house...and he's average...I DESERVE a nice house, because my family is a cut above."

Even though our "median income" is too low to really afford housing in SoCal - the problem is, those who earn the median income feel they deserve a better lifestyle than their income and realistically afford.

Throw in shoddy lending standards and low interest rates to help them "afford" the lifestyle they REALLY deserve, and a credit bubble is born.

MMAB

bear cave said...

I tend to think that the broken window of fiduciary duty isn't so much broken from neglect as from intent. In my mind the banking and securities system generally operates to divert funds from the upper middle class and the newly wealthy and into the hands of the established and the very wealthy. Look, e.g., at how eagerly mutual fund managers push those funds with 2% fees--2% off the 8% post-WWII accumulation of the market puts you at 6%, at which point you may as well be using a no-fee internet savings account or hard-money bonds.

With that type of environment going on at the upper echelons, is it any wonder that the home, which is the only investment for so many people (besides the illiquid wealth of the limited-ass 401k plans most employers offer), has taken on the same atmosphere?

In many ways I see the brokers and RE agents as the gatekeepers to the World of Finance--there's a huge fee to pay to play and like the lottery, "you gotta play to win" but when you get in it turns to be less of a "everybody should be rich" casino and more of a abandoned theme park with roaming gangs of robbers.

That said, i think in the past several years America's expectations have gotten totally unrealistic (the casino "everything on black!" meets the "everybody should be rich" mentality) and it will be very, very interesting to see how, when the credit bubble bursts, society reacts when the values it's held for a decade or more get called into question. In particular I'd like to see how young people react--according to recent studies the current youth are the most narcissistic ever, and when dreams of "success" are running headlong into the trainwreck of debt, well, I won't say I didn't say I told you so.

Anonymous said...

I see blame everywhere, but not distributed to all equally as it should be. Even the sassy renting lady with her smartplan is going to be certain to "stick it to the owners" bynot giving notice when she leaves, something I dare say makes her every waking moment very enjoyable.
That's the mindset, everyone is a dirty criminal except me, but deep down I'm going to rip them off with every angle I can comeup with and brag about it as I cackle over my moneypot. LOL
My friend moved to California with a bought out losing company that is still losing money but resting on the shoulders of the new owner's Dad who could be a bigshot on any Soap Opera, with atleast 4 large companies under his belt.
My friend during one of his calls told me, " It's all about image and if you're beating the Joneses out here. Everyone is a snot nosed braggart, the taxes are outrageous, it's 100 bucks for a quarter day fishing at the catch n release hotshot manmade pond, a thousand bucks for a round of golf, and every person you meet has their nose in the air."
Strangely enough over a few years , he began to fit right in, and called me one day to show me the $350.00 old US cent he just exitedly purchased for his personal "coin collection". LOL I laughed my buttinski off with him, as he mentioned what a fine value it was and how it just had to be the most perfect rendition and antiqity of clarity and wholesomeness, otherwise he would dare not even consider it worthy of being in his prescence, let alone his "collection" - something he just took up one day in his waning age. rofl
So, the lesson is, everyone is more than happy to have allof their assets priced sky high, because this gives them " THE CRED " that they are truly a big roller, some hotshot just one fancy skip away from playing tennis with the stars.
Hey, your house was worth one third or one half what it was 5 years ago, that just proves your giganticly massive mental acuity in bright shining star purchasing intelligence, far outshining the not so often spoken of humiliating roots from whence you may or may not have come.( of course you didn't, that's where the true losers still lie)
So, in the final analysis, no matter how much the whiners complain, they all their own little genius bragging points. The ModMaster of the site has his- Mr SMART and INTELLIGENT beyond anyone's years invests in " cash profit turning " "rentals" outside the state, not stupid enough to have doubled his money in 5 years by buying at the beginning and selling now or shortly before.
For all those who have- too bad! Your idiot investment (err former investment) is on the decline, and won't turn that monthly income... hahahaha!!! in 30 years he'll have made what you made in 5 - YOU FOOLS !
Oh, and let's not forget, that sassy lady and her nice hubby you're renting to * ahemm!*( err whoever you sold to is renting to ) are about be screwed with "no notice"of evacuation....
LOLOLOL
Yes,the CHARLATANS ARE THICK, THEY'RE EVERYWHERE, and they're everyone, and not a single one of them is the innocent master investor they all braggingly claim to be. They are all indeed the shotty banker or the dark 6% real estate broker, or the reaping rewards money manager, or the ready to burst bubble crybaby, but rest assured, they are ALL GUILTY, and wether they know it or not, THEY ALL MAKE IT ABUNDANTLY CLEAR.