Originally posted in December of 2009… how tragic is that?  Read it and you’ll see why.

HO, HO, HOmeless!

The Real Story Behind the Crisis

We Still Don’t Want to Understand.

A 46 year-old single mother lies awake as night threatens to turn to morning.  She wonders how she’ll make it through even one more day.  She can’t cry… anymore.  Can’t look into the eyes of her two young children, age 7 & 9.  For a fleeting moment she wonders if her sister, 3,000 miles away, should take the kids, for a while anyway.  She pushes that thought from her mind, reaches for her prescription on the nightstand, swallows two without water, and rolls onto her side.  She’s a Registered Nurse; she knows sleep will soon come.

~~~~~

A father of three stands in the shadows made by the tree in the front yard of his home of 14 years.  It’s 2:30 AM.  He’s wearing a tee shirt and boxer shorts. The wind is audible and cold.  His eyes fixate on the flower box he built his first year as a homeowner.  His stare moves to the driveway… his driveway… and remembers pitching underhand to his youngest son.  He had thought they would live in this house forever.  He absent-mindedly scratches his chest with the barrel of the .38 Smith & Wesson Super he’s holding in his hand.  He wonders if insurance policies pay off after suicide.

~~~~~

An older couple, returning from a trip to the grocery store, pulls into their driveway.  They’ve been married for 38 years; bought the house in ‘72.  He opens the back door of the sedan and reaches in for the bags.  She admonishes him not to do so.  The doctor said not to lift anything heavy… might tear his stitches.  They walk inside together, close the door; neither speaks.  There is paperwork taped to the front door.  It says they’ll have to be moving soon.

~~~~~

A young child listens to her father talking on the phone as he makes her breakfast.  His voice doesn’t sound normal to her ear.  He sounds nervous… he’s being very polite. Like when he’s talking to the men at church.  He hangs up and even though she didn’t ask, he tells her everything is fine.  But the child doesn’t think so.  She looks at him.  Thinks he’s crying.  She wants to help.  He wipes his eyes.  He says cutting an onion made them water.

~~~~~

A mother is on the phone first thing one morning.  She reads my column on-line.  She calls to tell me that her son, 41 years old, hung himself in the basement of his home last night.  She found him yesterday morning.  He had been laid off and out of work for nine months. He tried to convince his bank to modify his mortgage since then.  Went through his savings.  Started spending hers. Her voice shakes.  “Now,” she says, “the bank will finally get what they’ve wanted all along… his house.”

~~~~~

Happy Holidays everybody…

This has been a very hard article for me to write.  It’s been hard for me this year during the holidays.  I want to be happy.  I want to make this holiday season even more wonderful than the last, for my daughter, my wife and my family.  But it’s just harder this year.  Harder to forget everything else that’s going on around me.

The foreclosure crisis that began in mid-2006 continues to destroy the wealth of American consumers and the financial strength of our nation’s banking institutions.  And, although it pains me to say it, the end is still nowhere in sight.

It now seems likely that, before the crisis is over, not just millions, but tens of millions of Americans will have lost their homes to foreclosure, and thousands of banks will have shuttered their doors for good.  The scars will be deep and we will be a nation forever changed.

In 2007, the number of foreclosures filed hit 1.3 million, a 79% increase over 2006.  In 2008, that number had risen to 2.3 million, an 81% increase over 2007.  It appears that this year we’ll have something in the neighborhood of 3.9 million foreclosure notices sent out homeowners, if not more.  And next year, absent some unexpectedly competent response from government, is all but certain to be even worse.

As of August 2008, 9.2% of all U.S. mortgages were either seriously delinquent or already in foreclosure.  Today, that number is 14.7%.  Forecasts predict a staggering 14-17 million foreclosures over the next five years, depending on their source.  And, according to Bloomberg, mortgages of $1 million plus are now defaulting at twice the national rate, so there’s no question that the water level is rising.

Meanwhile, unemployment… the real unemployment, known as U6… has reached 17.5%.  In October of this year alone, our country lost another 558,000 jobs, and most of those in manufacturing and other areas that may never return.  In Detroit, according to the city’s Mayor, the actual unemployment rate is fast approaching 50%.

By now it should be abundantly clear that foreclosures breed foreclosures and that the problems are spreading state by state.  And it should be equally clear that our nation’s economy cannot begin to recover until the free fall in the housing market, and the resulting foreclosures, have been brought to an end.

Perhaps you’re among those only interested in blindly optimistic thoughts, and if so, there’s certainly no shortage of those.  Now that our government has run out of things to actually do, and since they’ve run out of money with which to paper over problems, as this year draws to a close it seems they simply would like us to believe the worst is over.  That recovery is right around the proverbial corner.  Few do, though, at least not in earnest.  It’s like Ben Bernanke keeps saying in so many words, the recession is over, damn it… probably… I think… sort of… it’s a jobless recovery… yeah, that’s the ticket… a jobless and homeless recovery.

I’ve come to understand many things about this housing led, increasingly complex economic crisis as I’ve written more than 200 articles on related subject matter over the last year.  I now believe in every fiber of my being that we will remain incapable of finding meaningful solutions until we as a nation come to understand the problems we’re facing and why we’re facing them.  And in this regard we have a very long way to go.

We still don’t know… and maybe some of us don’t want to know.

I have never in my life seen anything like what’s happening in this country today.  I’m not just talking about the severity of the crisis; I’m talking about the amount of misinformation and utter confusion about its proximate cause.  It is truly stunning to behold.  I can barely get through a week without bumping into another armchair economist who’s got lots of opinions on AIG, but has no idea what a Credit Default Swap is, let alone how one works, or why they were sold or purchased in the first place.

It’s uncomfortable to be around, frankly.  When did we become a nation filled with people who feel the need to hold a view on everything?  A few weeks ago I wrote a piece in favor of judicial loan modifications… you know, bankruptcy reform… the “cram down,” if you must.  Quite a few people wrote in to say they disagreed with my position, every one of them based their argument on the identical position: “It will raise borrowing costs in the future for everyone.”

It’s a ridiculous presumption, you should realize.  The “cram down” bill that recently was once again killed by the banking industry has no significant measurable potential to raise borrowing costs in the future.  For one thing, it would only apply to loans on the books at the time of its passage, so no future loans would be affected.  And for another, it only applies to those filing bankruptcy, a statistical probability that investors already price into their models.  And for a third, when a judge writes down a mortgage to the market value, that judge isn’t costing the investor a nickel… which is why it’s called the “market value”.

The funny thing about judicial loan modifications is that we clearly need them badly at the moment, as we watch another 14-17 million homes fall into foreclosure, so some miniscule, incalculable, potential threat hardly seems a good enough reason to kill the amendment within hours.  And many of the people who hold onto views in opposition to changing the bankruptcy code, would all unquestionably benefit from such a common sense approach.  But, regardless… no one changes his or her view on much of anything these days.  I suppose only two factors result in real learning: age and pain.  We don’t have the time to wait for age to do it, but stand by, because the pain will be increasing each month that passes, so maybe there’s still hope as that pain increases.

As it stands, all we’re left with in terms of a plan to stop the free fall in the housing market, is… well… we don’t really have a plan to stop the free fall in the housing market, now do we?  Even if Obama’s loan modification program was working, which it is not, it’s not designed to stop the foreclosure crisis.  Remember, it’s only designed to help “responsible” homeowners, if there’s still such a thing.

My intention is that this article doesn’t beat around the bush, so I want to go directly at the question of why we don’t have a plan to stop the foreclosure crisis.  What is it that prevents our adoption of policies that would lead to our economic recovery?

We don’t have a plan for two reasons, and both are political as opposed to economic.  What I mean by that is that we could fix the problems we’re facing, but a lot of people won’t like what we need to do.  In other words, if we could just get over ourselves, we’d all be much better off.

Okay, so here goes:

1. Stopping the Foreclosure Crisis

In terms of fixing the housing market and stopping the foreclosure crisis, we’re going to have to write down the seriously underwater mortgages to their market value, and we can’t do that because politically it’s potential suicide.

There are still many people that view the homeowners losing their homes to foreclosure today as being “irresponsible,” and who could possibly want to bail irresponsible homeowners out of their underwater mortgages?

What people fail to realize is that the mortgages that are seriously underwater need to be… and will be… written down to their market value.  The only question is the mechanism we use to write them down.  If we continue to use foreclosure as the mechanism, then we’re going to be in for a lot of pain, as we take down everyone else’s home value at the same time.

As a country, however, we don’t want to write down mortgages, in fact we barely want to modify them, because we’ve still got a sizable percentage of our population that blames homeowners for the economic collapse and therefore believes they must be punished.  And by punishing them through foreclosure, we will punish everyone else as well.

The problem with this kind of thinking, besides it being untrue, is that it prevents our elected officials from looking at real solutions to the problem.  Eventually, people will change their views on this issue, but it may take several years for the pain to become intense enough and sufficiently widespread, before people are willing to look at the situation differently.

Until then, we’ll keep foreclosing, and those foreclosures will continue to drive housing prices down… which will in turn create more foreclosures.

2. Fix the Banks and the Credit Markets

In terms of fixing our insolvent financial institutions, the only plan with the potential to succeed, short of nationalization, of course, is to buy the toxic assets off of the bank balance sheets at 100% of their face value… something that’s simply not politically palatable.  We could pay some amount less than full face value but that would only leave giant holes in the balance sheets of banks and we’d have to pony up the difference anyway.

It looks to me like Geithner’s plan is to keep the banks propped up with federal slush money, provided under one wonky acronym or another, and the suspension of all accounting rules that would give away their insolvency… until the banks can earn enough by lending to Treasury and charging us exorbitant fees.  There’s a bit more to it than that, but those are the important points.

I’m not the only one who sees this plan not working.  Geithner isn’t just forecasting economic recovery in 2010… he’s depending on it.  When it doesn’t happen, he’s going to act surprised, I’m sure, but he’ll be acting because he knows now that he’s taking a huge risk.

The “toxic assets” that are still clogging up bank balance sheets aren’t getting any less toxic on their own.  In fact, the more homes that are lost to foreclosure, the more toxic they’ll become.  So far, we’ve papered over the problems, but that only fixes the problems in the short run.  Remember, if the banks believed their balance sheets today… they’d be lending.

Let’s look at today’s conventional wisdom pertaining to the economic meltdown:

1. It’s the fault of sub-prime borrowers…

No, it’s not.  Today’s crisis isn’t a sub-prime crisis, and never was a sub-prime crisis.  From the beginning, sub-prime and prime loans defaulted at the same proportional rate.  That’s not to say that there weren’t more sub-prime foreclosures than there were sub-prime foreclosures… there were.  But proportionate to prime loans, the problem was never a “sub-prime” problem.

2. It’s unemployment that’s causing foreclosures…

No, it’s not.  Unemployment and other life events don’t cause foreclosures.  Look at the spikes in unemployment that followed the dot-com crash that began in April of 2000.  Unemployment in places like Northern California and Massachusetts skyrocketed, as did mortgage delinquencies, but foreclosures remained low.  Why?  Because in flat or slightly appreciating real estate markets, when people get in financial trouble or lose their jobs, they sell their homes, they don’t start losing them to foreclosure en masse.

3. Borrowing too much and not properly qualifying for loans caused the crisis…

I’m sorry, but no.  Roughly 54% of the foreclosures are prime loans for which people did qualify, and as far as borrowing too much, well… it’s just beside the point.   In light of where things are today, it would seem that any borrowing was over-borrowing.  And when you look at the leverage employed by Wall Street firms, which was in some cases up to 100:1, the whole idea that homeowners could have caused the economic meltdown of this country becomes preposterous.

Think about the 40:1 leverage at Lehman Bros.  On one hand, you’ve got a homeowner taking out a 100,000 mortgage, and on the other you’ve got Lehman Bros. borrowing $4 million based on that mortgage.  In terms of de-leveraging, which is the problem… the $100,000 mortgage or the $4,000,000 in leverage.  And, by the way, while we’re talking about it… who was it that thought that housing prices would go up forever?

None of this is to say that lending standards weren’t far too lax, that more sub-prime borrowers didn’t initially lose their homes than others, or that today’s unemployment rate isn’t contributing to the number of loans in default.  All are true, but none are the proximate cause of the crisis we face today.

The Birth of a Crisis… and the Crises that Followed

First of all, we’re not having a crisis; we’re having multiple crises.  The foreclosure crisis is one.  The credit crisis is another.

We could go back many years to begin such a discussion, but I don’t see the point.  Many say that the Glass Steagall Act should not have been repealed.  At the moment, however, I don’t care one way or the other whether it should or shouldn’t.  I’m sure some combination of experts and political types will figure that out soon enough, and resolving the issue today won’t change anything tomorrow morning.

For the moment, I’m only interested in what happened in July of 2006, on a day when housing prices dropped by 30% or more… although we didn’t all realize it at the time.

Declining real estate values are what cause foreclosures, and on a day in July of 2006, a number of pension funds realized that the AAA bonds they were holding were not in fact AAA… and they dumped them in a hurry.  They might have been AA… they might have been junk… no one could be sure.  All investors needed to know is that they were not AAA, as they had been rated by the ratings agencies, Standard & Poors, Moody’s or Fitch, and that was enough for them to know that they didn’t want to hold them in their portfolios any longer than they had to… and the bond market froze solid.  Money stopped moving.  And wherever the mortgages were at that moment, that’s where they would stay.

Banks, like IndyMac, who had $40 billion in mortgages on their books that they had planned to sell to Wall Street, now had real problems.  Banks don’t have any money they can loan out for 30 years.  They originate mortgages, but then they sell them to recoup their cash… or at least that’s what they did prior to the day the bond market froze solid.  Now, unable to sell their mortgages, banks immediately began hoarding cash.  Lending dried up within days.  And all of a sudden, what had been a market plush with mortgage cash, was now dry as a bone.

At the same time, there was another force in play… interest rates had been rising.  In fact, by the summer of 2006, the Fed had increased interest rates 17 times in a row.  Those with adjustable rate mortgages had already started to default, and sales had already started to slow appreciably.

Now, however, since essentially no one could get a mortgage, no one could buy a house… and prices had nowhere to go but down.  As they dropped, refinancing became impossible, and foreclosures were the only option.  The crises had begun.

Treasury Secretary Hank Paulson saw the problem as being limited to the sub-prime market and believed it would be contained there, but he failed to take into account what had really happened.  The credit markets had been broken.  Banks didn’t trust each other.  And as housing prices fell, and more loans defaulted as a result, the bonds were downgraded, and Bear Stearns was the first to go.  Paulson wanted to act at that point, but the now Democrat controlled Congress told him not to come to Congress unless he could assure the legislators that “a crisis was at the door”.

There are always a certain number of homeowners that need to sell their homes each year for a variety of reasons, both personal and career related, and when housing prices are declining rapidly, many of those sales inevitably become foreclosures.  The bubble was deflating fast and the loans that were the worst of the bunch went first.  But as prices fell, people who had over-extended themselves, and everyone else for that matter, stopped spending, and it was only a matter of time before unemployment would start to rise.  It was the beginnings of the downward spiral that continues today, albeit at a slightly slower pace than was experienced at its beginning.

The response by our government has been to pump trillions of dollars into our financial institutions in order to prevent their insolvency and make investors whole, but as long as the flood of foreclosures continues unabated, economic recovery cannot occur and we will all increasingly suffer as a result.  Hank Paulson tried to buy some of the toxic assets off of the bank balance sheets using the now infamous TARP funds, but the banks needed him to pay face value, not some discounted amount, and that would not have been politically palatable.

Even with the evidence of our deepening problems all around us, there is still a significant percentage of our population that is preventing our politicians from taking the steps necessary to stop preventable foreclosures and start the economy back on the road to prosperity.  Those that make up this group, in large part, gained their inadequate understanding of what’s transpired since 2006 from government and banking lobby inspired sound bites.  And even more importantly, their views haven’t changed over the last couple of years, even though almost everything else has.

The bottom-line is that this group continues to blame the borrower… the homeowner… as opposed to the commercial and investment banks, and if you’d like, the government regulatory agencies that stood idly by as Rome burned.

It’s a bleak picture, and sadly it is also one whose duration could be easily be reduced significantly if we as a nation shared a common understanding of how our crisis began and what must be done to stop its continuing spread.  That’s right… I have seen the enemy and it is us.

President Obama, however, now places the blame for the recession on “the irresponsibility of large financial institutions on Wall Street that gambled on risky loans and complex financial products, seeking short-term profits and big bonuses with little regard for long-term consequences.”  He and others are trying to get us to change our view of what happened so he can do something about it, but we continue to resist… we continue to hold onto our desire to punish our neighbors for buying too much.  It appears that we’d rather go down with the ship then reduce the principal on our neighbor’s mortgage.

In Conclusion…

Look… I realize that there’s more to the crisis than I’ve described here.  I realize that the bonds I’m referring to were insured by AIG’s credit default swaps, which were unregulated and resulted in a systemic risk to our financial system.  I know that AIG went under because of collateral calls that came along with the downgrading of the bonds it was insuring.

I realize that the process of securitization played a major role in how banks viewed mortgages, and why they were underwritten so poorly.  I realize that Wall Street’s CDOs, collateralized debt obligations, and other derivatives were, if not instruments of destruction, then something in that neighborhood.  And most recently, I’ve come to realize that the investment banks like Goldman Sachs, that packaged these deceptively risky investments and sold them to investors all over the world, bet against their success without disclosing their positions to investors or anyone else.

Yes, I realize that what I’ve described here is a dramatic oversimplification of a very complex situation, and I plan to write more about each aspect of the crisis in simple terms in the hopes that more people will become comfortable with what is now part of our history, and as a result tell their elected representatives that they are not to do whatever the banking lobby wants them to do.

But for the purpose of this article, none of that matters.  For the purpose of this article, I only wanted to say in no uncertain terms:

A. It wasn’t the borrowers that caused this crisis.  Did some people buy too much house?  Sure, some did.  Did some act irresponsibly?  Sure, to varying degree some did.  But today’s foreclosure crisis won’t abate as long as many cling to the belief that they should somehow sit in judgment as to who was irresponsible and who was just caught up in the worst economic downturn since the Great Depression, a task that will be increasingly difficult as each day passes.

B. Water is wet, the sky is blue, children want candy, and people want houses and money.  Some knew what they were doing and some didn’t.  So what?  No one entrusted individual people to make sure our banking system was safe and well managed.  We trusted the banks and they, of one variety or another, let us down.

C. We would be experiencing a similar meltdown regardless of whether we had a real estate bubble.  As long as some group’s actions were going to destroy the secondary mortgage or credit markets, then house prices were going to fall and fall fast.  And that’s what causes foreclosures: declining home values.

D. Our government mischaracterized its cause in the beginning.  Or, in other words… it was never a “sub-prime” borrower crisis.  We know that now.  If you still think it was a sub-prime crisis, caused by those high-risk loans… well, it’s time to take another look at the data.  Your views are wrong.

And to the homeowners who feel ashamed… who have suffered the indignity of losing a home in silence… this wasn’t your fault.  You didn’t break the bond market and send housing prices into a free fall.  You didn’t fail to address the problem, or fall asleep at the switch as a regulator.  You didn’t securitize every payment stream in the country, or leverage untold billions of investments or create untold trillions in synthetic derivatives.  It wasn’t your belief that real estate would continue to go up that caused the problem, it was Wall Street’s belief that it would continue to do so that brought the financial markets to the brink of destruction.

All you did was buy a house you thought you could afford.  Now it’s worth half of what you paid for it… or it will be worth half soon.  No one saw THAT coming.  No one.

So, don’t be ashamed and afraid to speak about what happened here.  Your neighbor may seem to know what he’s talking about, but he more than likely doesn’t know any more than he heard on television or read in some Newsweek article.  Besides, he’s going to be drowning soon enough anyway.  The economic situation we’re in as this New Year begins doesn’t discriminate… everyone will feel its powerful bite as this year continues to see our economy spiral downward.

Unless you’re a banker, of course.  In which case… stop judging others, you jackass.  You want to have a debate someone about how it was borrowers who caused the meltdown, or pick on someone for being an irresponsible… have the debate with me… pick on me.  Go ahead… it’s easy… I’m at mandelman@mac.com.  And I respond to even the most idiotic of opinions.  Bring it.

In fact, next week I’ll be in Park City, Utah, debating this very issue with a bunch of lawyers that represent bankers at a conference of the American Bar Association.  I’ll let you know how it goes, but I think you have some idea already.

For everyone else reading this… let’s stop the madness and tell our politicians we want solutions for the homeowners in trouble, not punishment.  Because at this point, we’re only punishing ourselves… because it’s the right thing to do… because we smarter now and see the situation more clearly… because there, but for the grace of God, go us all.

~~~

(P.S. If anyone wants sources for any of the data presented, just email me and I’ll send you the links.  It’s the holidays and I didn’t feel like writing a term paper, but I’ve got plenty of sources for everything I’ve written.)

And, as always, the illustration of Santa coming down the chimney into a foreclosed home was brilliantly interpreted and then drawn by Richard Taylor.