What happened to personal accountability?

The $700 billion bailout package has raised a lot of eyebrows on Main Street. After all, isn't it Wall Street's fault for making all these risky investments that went bad? If so, why on earth would the government want to use taxpayer money to bail them out? Well, I've listened to a lot of radio commentary and read a whole host of opinons and articles on the topic and I am disheartened by one key thing that is missing in all of these pieces; where is the personal accountability in all of this?

Let me make this a bit more clear for you if you are having trouble following me. If you were walking down the street and a drug dealer popped out and offered you some drugs for free, would you take them? You know it's bad for you even if it is free. You know this decision is not likely to have a good outcome for you, but you decide to give it a shot anyway because everyone else is doing it and the dealer tells you it's good for you and you can handle it.

Is it the dealer's fault that you decided to take something you knew was bad for you? Now we all know that the dealer is a bad guy and should be punished for breaking the law and dealing drugs. But, aren't you also somehwat responsible for your bad choice? Shouldn't you shoulder some of the blame?

By now, you know where I am going with this. Sketchy mortgage brokers and slick Wall Street types told you that you could afford that $500,000 house even though you had not saved for your down payment and you only made $50,000 per year. After all, all your friends and neighbors were doing it, right? Even though it was available to you, you knew it did not make sense that you could get such a loan. But, you took it anyway. Then, when your house rose to $700,000 in value, another slick mortgage broker told you take take a second mortgage for $200,000 so you could put in a pool, go on that nice vacation and buy that expensive car. Or maybe you could just refinance your first mortgage and "Pick Your Payment" so that you could cover the new GIGANTIC mortgage (at least for 12-24 months until the payment adjusted). Hey, you deserve it and everyone else is doing it. Never mind that you couldn't affored the first mortgage payment much less the second mortgage payment.

Now that all of these loans are going bad (not really a shocker, by the way), banks and mortgage companies are going under and the securities issued to allow these silly loans are defaulting, people are trying to blame everyone but themselves. Greedy CEOs, lying mortgage brokers, etc. are the only ones to blame. It's not my fault that my payments are TWICE AS MUCH as my income!!

Why don't people start to take a little responsibility for their decisions and actions. Sure, there are plenty of cases of legitimate fraud, lying, cheating and stealing and the corporations that profited from all of this mess should also be severely punished. But, if that were the only problem, we would not be in this mess. The bottom line is that Americans have spent more than we make for over a decade now (think negative savings rate) and it is catching up to us. So, here is who I blame (in my opinion):

1) Individuals: if you are not diligent enough to read your own loan documents and understand them, then you probably shouldn't be taking on the debt required to buy a house, car, etc. While the small print is mind numbing for sure, the Truth in Lending Disclosure is actually pretty easy to read (shows the costs of the loan and your payments over time). If your paycheck was only $2,000 per month, you can't afford a $4,000 per month payment (now or 24 months from now)! It really is that simple! Spend less than you make (that's called saving, by the way) and don't get duped into believing it's OK to do otherwise.

2) Congress/Federal Reserve: The knuckleheads in Congress and the Fed have promoted easy money for so long now that we all believe we are entitled to it. When a number of Congressmen raised the issue that Fannie and Freddie might be a disaster in the making (in 2004 and 2005), most folks in Congress buried their heads in the sand. "We are meeting our housing objectives" (this is code for people that can't afford homes are getting loans for them - this is also known as "subprime" and the initial shoe to drop in this mess). Even Alan Greenspan (who shoulders a good chunk of the blame for his easy money and 1% interest rates) noted that Fannie and Freddie were a potential ticking time bomb. No one in DC listened and now they want to spend $700+ billion to try to fix the problem (I'm skeptical this will work, by the way).

3) Wall Street/Ratings Agencies: We were all convinced that the smart guys on Wall Street had invented a way to make risky borrowers less risky. Somehow, through financial alchemy, Lehman Brothers, Bear Stearns, UBS, etc. all convinced us that you could take a bunch of risky loans, wrap them up into a nice little bow, slap some insurance on them and call them AAA quality. Then, the ratings agencies, who were being paid to provide ratings on these securities (no conflict there), called them "Investment Grade" which allowed pension funds, retail investors and others to buy them up. As if that weren't bad enough, the investment banks et al decided to borrow 30 TIMES their equity capital to buy these toxic securities (for every $1 of capital they had, they would borrow $30 and buy these bad securities). When it came time to borrow more money as loans came do, the investment banks imploded.

So, what can we learn from all of this? First of all, people need to take responsibility for their own decisions and the consequences for those decisions. If you bought more house than you could afford, you have to live with the consequences of that decision. If you are spending more than you make on your credit cards, that too has a consequence for you. Just because you got a great 0% APR offer (think free drugs - see above) that doesn't mean it's a good decision to load that card up. I fear that the government bailout only reaffirms the dangerous and increasingly pervasive cultural phenomenon that individuals are not responsible for their own decisions. If there is always someone to bail you out when you make a bad choice, then is it really all that bad a choice to make in the future? The corollary to this is that good decisions are not rewarded, but rather penalized (think higher taxes). Until we return to the basic economic principals of freedom, individualism and true capitalism, I fear there is going to be a lot of economic pain in our great country.

Housing Crisis Over? Mixed Data Suggests....

P2P-Loans.com has recently noticed a number of smart folks writing about the end of the housing crisis. In two separate articles in the WSJ ("Opinion: The Housing Crisis is Over" and "Is Housing Slump at a Bottom?"). These articles make very valid points with regard to housing starts, low interest rates, etc. What these articles fail to debate in any material fashion is that housing prices relative to disposable income are still extremely high!

This chart from Ned Davis Research (the line graph at the bottom of this page is most relevant) demonstrates that we remain at very high price levels relative to historical data. Ultimately, the value of housing is a function of affordability. When it's all said and done, this is the single most important factor that drives demand for new housing and the price of such housing. For example, the data in the chart suggest that in 2001 (yes, interest rates were in the sub 7% range for 30-year fixed mortgages then as well) the Median New Home Price / Disposable Income ratio was near its 30-year average, which is where it had been for the better part of 15 years. In fact, the ratio had been even lower before that, however this is likely due to the artificially high interest rates of the 1970's and early 1980's.

This dynamic has served to dramatically reduce demand for housing in conjunction with tougher lending standards (fewer buyer approved for new mortgages) and skitish buyers (when will prices stop falling). As a result, housing inventories have spiked to record highs. Accross the US, housing inventories are more than double typical levels, and are as high as 4-5 years worth of inventory (versus a long-term average of 5-6 months) in formerly hot markets such as Florida and California.
According to a recent post at Seeking Alpha, housing inventories are beginning to come down, but remain well above historical averages. Seeking Alpha points out that, at the current sales pace, inventories of new homes will be "back to normal" by the end of 2009. Simply put, we will be in a supply/demand imbalance for the next two years (and this is assuming that the market doesn't overshoot to the downside, which it's been known to do in prior busts - think about when many tech stocks were trading at less than cash value in 2003). The data is similar on the inventories of resales as well. In my estimation, this means we still have a ways to go before calling the end of the housing crisis. I hope I am wrong.

On a side note, the government is trying to push through a MASSIVE bailout program. Generally, when the government makes a move like this, they are too late to the party. Thus, this single fact alone could lead one to believe we are at the end of the housing crisis.

Tax Payer ALERT! The Gov't Wants To Bail Out Troubled Homeowners

Is there a tax-payer funded (err... "government sponsored") bailout coming for honeowners? Momentum appears to be building for a broad-based program to bail out folks that bought homes in the boom times and can no longer afford to make their payments (e.g. are approaching or are already in foreclosure proceedings). This has been a topic of much debate. For those that made smart, sound financial decisions (e.g. didn't borrow more than they could afford to pay back, and read the fine print on their mortgage documents, etc.), this seems like it might be unfair since the taxpayers will potentially be bailing out these folks. But, as the outline below reflects, the current debate in Congress revolves around structuring a compromise that enables any eventual program to pay for itself. P2P-Loans.com is encouraged by some of the provisions being discussed (especially the payment of insurance premiums to the FHA and a sharing in any equity gains to homeowners upon a sale). We would hope that the equity gain sharing is substantial and not a pittance given any gain will be made entirely on the backs of tax payers (errr...the "government-sponsored" program). Generally speaking, the government has a terrible track record on projects like this (they underestimate the total costs, botch the execution and mess up a market-based system that works pretty well in the long run).

Here is a summary (from an article at Money.com) of what's being debated (P2P-Loans.com will report back on this issue once a program is passed):

While critics worry that an FHA rescue plan could amount to a bailout, supporters say it's not since everyone involved - lenders, borrowers and mortgage investors - would make a sacrifice.

Lenders get 100% backing from the FHA if a loan goes south. In exchange, the lender takes a "haircut" - reducing the principal owed and converting adjustable-rate loans to fixed-rate mortgages.

Borrowers get to keep their homes, but they would pay a premium to the FHA for the mortgage insurance and they would have to give a small portion of their equity to the FHA when the house is sold. They would also have to show they can afford the newly refinanced loan.

Mortgage investors - while they would sacrifice some future income from loans that have been reduced - would have more confidence investing in the new loans since the refinanced loans will be affordable and the borrower therefore will be more likely to pay them back.

President Bush Reveals Sub-prime Relief Plan: What do you think?

The Bush Administration today released the much-anticipated sub-prime loan plan that provides for lenders, investors and loan servicers alike to voluntarily freeze “teaser” interest rates on a select number of sub-prime loans made from January 1, 2005 to July 31, 2007 for up to five years. This agreement does not include any funding or bailout from the government (e.g. tax payers), but some fear that this may be the first step toward deeper government involvement in the credit meltdown. While the agreement will provide relief to some borrowers, the qualifications for relief are somewhat unclear (I'll keep this post updated as more details emerge). For example, to qualify, a borrower must have a loan that was originated during the above timeframe, must still live in the home, must be able to afford the current payments (while proving they won't be able to afford the payments once their rate adjusts upward), and must have less than 3% equity in their home.

P2P-Loans.com View
As a general rule, P2P-Loans.com has mixed feelings about the government getting involved via increased regulation in just about anything that the free market can sort out due to the laws of unintended consequences (for example, the Alternative Minimum Tax). P2P-Loans.com does believe there were some unscrupulous mortgage brokers that gave bad advice to borrowers, but P2P-Loans.com strongly believes that individuals need to take responsibility for their own actions. If you signed the mortgage documentation, you should have read it to be sure it said what your broker told you it said! If you didn’t, shame on you and we hope you learned a valuable lesson for the next time.

This deal, however, is not a bailout as it is being willingly agreed to amongst private parties (lenders, loan servicers and others) at the “urging” of the US treasury department and the White House, and not as a result of new legislation, regulation or subsidy. Additionally, the net result of this agreement is simply to accelerate what the banks were likely going to have to do for many borrowers anyway (cut them a break and offer a new deal). As the number of foreclosures continues to climb, lenders/servicers were going to have to eventually face the music and begin to cut borrowers a break through adjustments to their loans. After all, it is a far superior outcome for the lenders to keep a loan performing (even if it is at a lower rate) versus foreclosing on a property.

So Why Are the Banks Willing to Agree to This?
As stated above, P2P-Loans.com thinks they were going to have to end up doing something like this at some point anyway (and, by many accounts, they are already renegotiating a number of loans with late payers). But, the real reason, we think, lies in the fact that the financial services companies are being increasingly attacked by Congress (principally Democrats) as the banks/mortgage companies and Wall Street make the most convenient scapegoat for this whole mess (the story goes something like this, “greedy, self-serving, wealthy financial types lied to millions of innocent borrowers, stole their money and now want to take their house and kick them out on the street,” etc.). By agreeing to this type of deal, the lenders buy themselves some political cover (and time) to stall or eternally defer some nasty legislation working its way through the Democrat-controlled Congress. In addition, the banks do get to slow the pace of foreclosures and, hopefully, the rapidly declining value of their collateral. This is just one idea, keep in mind, but it makes some sense.

So, what do you think? Please submit your comments on this difficult issue.

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