A mortgage broker responds

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Our post last week quoting Lou Barnes’ assessment of the mortgage crisis drew a number of angry comments along the lines of: how dare we use Barnes -- a mortgage broker! -- as an objective source! Lou, who writes at Inman.com, read your comments and sent me this email:

‘I read all of the posts, and the range of replies is an accurate indication of breadth and depth of concern in the nation, and the equally deep confusion about what’s going on.

‘For those suspicious of the messenger... you are wise. I’m an old guy, 58, and a lack of discipline has led to a checkered career: five years as proprietor of a 45-broker real estate firm (difficult years for mortgage supply, ‘78-’83); five years as a bond and mortgage-market investment banker, including two years of regulatory work in the S&L disaster; and the last 20 years a co-owner of a modest mortgage bank. As far as I know, no client of our firm has ever gone into foreclosure, and my life-total closings of sub-prime loans: one.

‘I think it’s very hard for anyone without experience in all three fields -- real estate, investment banking, and mortgage lending -- to understand the current problem and how we got into it.

(Read more Barnes below)

‘Too many people want to find villains in the play. They are always with us, but luck is a far bigger actor. Circa 2000, four elements combined to produce this hazardous moment: the invention of ‘credit derivatives’ on the Street; the overwhelming demand for financial investments by the ‘global savings glut’ (the Asian Trade Dollar Recycling Machine later joined by Petro recyclers); the Fed’s deflation-fighting cut in the cost of money to 1% (yes, it was necessary); and a natural home-price boom in land-scarce coastal markets, at first fueled by the immense gain in household financial wealth in the 1990s.

‘All four elements then reinforced each other, the most important spiral the rapid home-price rise camouflaging credit risk. Those who want to blame fraud, or greed may if they wish, but be careful about magnifying the effects of the few, and envious gloating at the misfortune of others. Those who want to blame the re-sale of loans need to study banking.

‘Your return commentators are right that booms like this one should come to their own painful ends, ‘moral hazard’ lessons learned. Nobody should be bailed out, with taxpayer money or otherwise. However, those who think that solution lies in a deep-enough cut in sellers’ prices should reconsider: 15% of American households have less than 10% equity, and cannot cut their prices. If prices fall farther, more sellers will be upside down versus their loans, and we run the risk of a negative spiral. Historically, the solution to prior housing escapades has been a long, long, long flat-price interval, as markets wait for incomes and scarcity to support over-shot prices.

‘The exception, of course, was that unpleasantness 1929-1939. Extreme fans of market discipline should always consider that time -- the Fed sitting on its hands; early on, the government trying to balance the budget; and the great stabilizing benefit of the FHA and Fannie Mae, government credit guarantees for good loans that restored faith in credit.

‘The problem today is a loss of confidence in the credit-derivative structures in which sit the $4 trillion mortgages that I wrote about, and probably a like amount of corporate devices. Investors bought vast quantities of these in reliance on ratings by the three private agencies, and elegant models of future behavior. These structures -- ‘tranches’ -- are completely opaque as to the underlying credit, and today no one knows what they’re worth. The market loss at the moment, confidence destroyed, is vastly greater than the actual credit loss!

‘Until confidence in actual credit quality is restored, the owners of these things are not buying any more. And, because they are leveraged, they and their lenders are at bankruptcy risk as well. That means further: an extreme contraction in credit available for new borrowers.

‘The classic moment for government to intervene: when markets appear to enter a self-reinforcing downward spiral. This is it. To figure out what really stands behind those tranches, and certify the finding -- that’s the job of government. Right now.’

Thanks, Lou.
Thoughts? Comments?