For those of you who have been away from the blog recently, you missed some new developments regarding the Federal Reserve's plan to use $500bn in government money to purchase MBS in the open market. This program is aimed at supporting and fostering the mortgage market and should help mortgage rates reach a stable 4.00% (+/- 0.50%) in the next two months. After reading some of the excited reactions to the press release a reader posted some controversial comments which we felt deserved further discussion. So to further explore the topic we posted our response to this readers comments.

Here is the blog post with the original comment.

Here is my response to the comments posted.

To remain fair we encourage this reader to offer a rebuttal to my commentary address this controversial posting.

Mr.Lane's response:

Adam,

For good or bad, here's my response. 

First and foremost let me apologize if my comment was perceived as a slight towards those in the mortgage industry.  I have the pleasure of knowing many very knowledgeable and honest mortgage brokers out there.  The unfortunate thing is I also know personally many who are (or at least were) not... Quite a few of my high school and college friends jumped on the cash cow bandwagon of the early 2000's, did not understand what they were doing, took home hundreds of thousands of dollars a year in commissions and then complained when the bottom dropped out of the hugely inflated market that they helped to create.  They did not understand the industry.  They did not understand responsibility.  They understood $$$$.  The fortunate thing is that most of the dishonest or unknowledgeable brokers have been washed out of the industry by this bloodbath that has occurred.  It was neither my intent nor my desire to claim that those honest mortgage brokers/bankers are at fault

I am going to attempt to flush out my argument and show why I have a problem with a lot of the actions of the government.  Since I have not taken an economics class since my freshman year of college about a decade ago, I am going to lay off of the technical terms/schools of thought and simply write a narrative of my thoughts on the subject.  I leave the labeling and interpretation as to what school of thought my opinions belong to the experts. 

Let me begin by giving a little insight to my background.  I work in a branch office of a large independent brokerage firm (I cannot elaborate... compliance... sigh).  As you can imagine, business is difficult in this industry as well.  That being said, we are not your typical investment firm and believe in active management and technical analysis.  We've spent much of the year in cash and have made a handful of strategic short term moves into the market (some good, some bad admittedly) but all in all, we've had a great year and in most accounts are only down in the single digit percentages.  We are getting more client referrals than ever before due to our conservative actions this year.  I spend the majority of my days meeting and talking with new and existing clients.  We've had new clients come in who used to have $5 million that is now $3 mil.  $300k that is now $100k.  Etc.  We have several clients who are mortgage or real estate professionals.  I am keenly aware of the pain of the average investor and very much informed about how bad things were for mortgage and real estate professionals in 2008.  I am also keenly aware of how good things were for several years prior (and as a financial planner I say shame on you for not saving!! Please take that as the joke it was intended to be)

Let me begin my explanation by saying that my original comment was purely aimed at the fallacy of the statement that the Fed has no risk in these transactions.  While I suppose the general public might believe this, I feel it is a classic example of robbing Peter to pay Paul or cutting off your nose to spite your face or [insert cliché here]... Freddie, Fannie and Ginnie are all now (Ginnie always was, FRE and FNM since they went into conservatorship) officially backed by the full faith and credit of the US government.  While I will admit that lending standards have tightened immensely, if these MBS that the Fed is buying go sour, then FRE, FNM and GNM have to pick up the tab.  Yes the Federal Reserve doesn't have to show a loss, but let's be serious.... The US government is picking up the tab one way or another. 

Now, a lot of you (or Adam at least) seemed to feel that I am anti-bailout.  And, honestly, I am not a fan of it.  I am a firm believer in personal responsibility (whether it is a person or a business).  If you make the decisions that sink the company or yourself, then I feel like you should lie in the bed you make for yourself.  However, I grudgingly admit that the bailout is a necessary evil.  Lets look back to late September/October specifically (apologies if I miss anything but there was A LOT going on in the credit markets at that time).... Money market funds broke the buck, major banks were on the verge of collapse, rates on newly issued paper (corporate or muni specifically) were astronomical!  The TED spread was at or around 5%... basically there was a @^$@ storm going on the credit markets.  Everyone was hoarding cash and no one was willing to lend for ANYTHING!  It took massive intervention by the US government to avert a financial panic and things would have gotten A LOT worse had the gov't not taken the steps necessary.  They have already had some stabilizing effect on the markets in general (both stock and bond).  I also typically do not believe in deficit spending and am absolutely sickened by the debt level as of now; however, I also realize that worrying about deficit spending when we are potentially facing a depression is like worrying about whether or not your bed is made when your house is on fire. 

Lets take a quick look at how we arrived in the mess we are in today.  If I get something glaringly wrong then fair enough, but this is an oversimplification so please don't nitpick on details.  Borrowing costs were pretty artificially low from the early 2000's through 2005.  This caused a frenzy of buying and a artificial appreciation of real estate prices.  People who couldn't afford to buy, rush to buy because they thought if they didn't buy now, they would never be able to.  Historically, mortgage to income ratios have resided in the 3:1 or 4:1 area.  An example, Adam and I both live in the greater Washington DC area.  While real estate has always been inflated in this area, a small 25 year old townhouse was selling for $450k.  This means that by historical standards someone would have to make $100 -$150k to reasonably afford that payment.  How many people do you know who make that kind of coin and are willing to live in a 25 year old townhouse?  I don't know any. 

 So what happened?  People stretched to buy more than they could afford.  They brought their mortgage to income ratio to 10:1, 8:1, 20:1 etc.  They were sold on "creative financing" options, ARMs (which I admit are not by definition bad), pick a pay, etc to buy more than they could afford.  They were "sold" on the idea that real estate ALWAYS appreciates in value.  No down payment, no problem!  Loan officers did little to nothing to verify income to make sure that they could actually afford the homes.  I'm not completely blaming you guys.  It was present everywhere: word of mouth, commission hungry real estate agents, financial planners who wanted more assets under management who suggested cash out refi's, unscrupulous mortgage brokers, kids who wanted to suckle at the tit of their parents for a little longer.... Whatever.  Everyone was screaming buy buy buy!!!  And the public listened... simple supply/demand relationship.  Throw a ton of buyers into a market the prices will appreciate.  Rapidly.

 Then the bottom dropped.  Rates reset.  People who didn't bother to look into how their loans really worked suddenly faced hugely escalating payments that they couldn't afford.  Reality set in and jingle mail went on the rise.  I don't need to tell you this.  A lot of people have lost their homes.  And a lot more people should lose their homes.  I don't say this without sympathy, but I do say it with very little sympathy.  IMHO if you are going to execute a major financial transaction, you damn well better know all the details of the payments and if you can afford them or not.  The excuse of "no one ever told me that my payments could go up" holds very little merit in my book.

Anyway, I've gotten a bit off topic.  All in all, I don't think it will, but the plan could work out beautifully.  Mortgage standards might remain high.  The MBS that the Fed purchases could perform as expected.  It could wind up being profitable for the taxpayer.  Here's why I have a philosophical problem with the gov't buying $500 billion in MBS:  I see this action as a green light for people to write loans at a high rate(as in speed, not interest rate) again.  This is not a bad thing in itself.  The real estate market is a huge drag on our economy and we need to start selling some of the unsold home inventory!!! However, I view this action with a lot of concern.  This could be another slippery slope of falling back into irresponsible lending.  Americans are poor students of history.  We rarely learn from our mistakes.  I see the potential of a repeat of the problem.  I see the potential for standards to drop again as people say "the government will buy anything" or "I'll just see if I can sneak one by"... the phrase "good enough for government work" is rooted in some amount of truth after all!!!   I also fear the return of the housing bubble that only recently popped.  We're still in the process of housing prices reverting to the mean and I think unhealthy and inflated prices still exist in some areas and we still have room to fall.  A return to cheap money could succeed in Re-inflating the bubble. 

 In addition, you can't fix a problem caused by overly cheap money with even cheaper money.  Its counter intuitive and will only succeed in prolonging the problem (see re-inflating the bubble comment).  Also, many people forget that a lot of the unsold home inventory is unsold because people refuse to accept that their homes have depreciated.  They operate on the assumption that it's happened to everyone else, but "my home is different."  "Its special."  "Those custom blinds I spent $2k on add at least $20k to the house value."  They expect to get what they paid for the house in 2005 now.  I can only laugh when I hear these words actually come out of people's mouths.

 Anyway, I've rambled on for long enough; however, I'll leave you with my prediction of how the Fed is going to get us out of this:  They are going to inflate the currency on purpose.  They are going to inflate it until home prices catch up to 2005 levels so people can feel good.  Forget the fact that they're going to inflate it until it's worthless on the international level so we're screwed and can't afford to buy goods.   What do we do then?  No one cares because it's a problem for future generations (like myself) and I'm pissed. 

 In closing Ron Anaya hit my point on the head.  I am asking for a modicum of conscience when you're writing your loans.  I don't deny you your right to make money.  I'm not bitter that mortgage professionals should experience a nice boom to make up for the prior year's bust.  In fact, I'm happy for you!  All I ask is that you "Do right by your borrowers. Leave them walking away with a huge smile on their face." (again, thanks for the wording Mr. Anaya)  And make sure that the smile remains on their faces for the 30 year lifetime of the loan, not just for the initial couple of months or years. 

-Brian Lane

Ok people...comments for Mr.Lane?