Tuesday, April 10, 2007

Sub-prime and home ownership redux (aka, Why Barney Frank is a Moron)

Earlier today, my younger brother, who we'll call LB (little brother), sent me and a few other guys this article. He prefaced it with this statement, "Apparently Barney Frank not only thinks he's smarter than the markets, but wants to determine where you allocate your capital. If people want to lose by purchasing subprime mortgages why should that be his concern?"

This led to a series of responses between me, LB, and our friend CK. CK respoonded first, saying this:

It's not only Barney Frank, Spencer Bachus is featured prominently in the article, too.

I think their overriding concern is for the poor, over-leveraged homebuyer who is cajoled into buying an overpriced house using an exotic mortgage they don't understand. Assuming that Congress wants to prevent homeowners from getting "screwed" they have a couple of levers they can use.

1. They could directly limit subprime borrowers from borrowing - not politically feasible.

2. They could put in tougher standards for subprime originators - probably the most sensible place for regulation. However, given the collapse of many originators, Congress feels originators won't be around long enough to help "make whole" the subprime borrowers who fell victim to predatory lending.

3. They could place the liability on the source of capital - see article below. While this affects how the market works for subprimes, this is the area where there are deep pockets that won't go "poof" like the originators when the market gets tough (e.g. the originators get going).

This seems like a least worst attempt to address the whoas of subprime borrowers and the wave of defaults...these are disgruntled voters that will affect whether Congressmen get reelected.

-Ck

My younger brother (LB) responded with this:
CK, I think you're leaving out choice 4.

4. Let the markets work. As defaults increase, purchasers of the loan will require a higher rate of return due to the increase in the perceived riskiness of the asset. This will force borrowers to pay a higher interest rate, which will increase the cost of the loans to homebuyers, and which should decrease the amount of capital attracted to the sector. For those who are less laissez faire, you could also combine this strategy with actually prosecuting the people who lied on their loan applications (a Federal offense, mind you), but that might be hurting the poor over-leveraged homebuyer, which we clearly can't do.


Suspecting that CK was being a bit sarcastic, but frightened by his attempt to deflect any blame from Barney Frank (one of the biggest morons in the political arena), I responded with this rant:

Good God, CK, I hope your second sentence was intended to be dripping with sarcasm. Please, please, please. [note: it turns out CK was being sarcastic, thank goodness]

My main problem with this whole line of thinking is that it totally, totally bypasses personal accountability. It’s the lenders’ fault, not the borrowers’. The borrowers were just poor, abused souls who were given enormous amounts of money to buy houses they knew they couldn’t afford.

Here’s my favorite sentence from the entire article, “’More money was being lent than should have been lent,’ Committee Chairman Barney Frank, 67-year-old Democrat from Massachusetts, said in an interview from Washington. Frank, who last month predicted that the House would approve such a bill this year, said growth in the market for mortgage bonds ‘provided liquidity without responsibility.’”

Here’s how I might reword it if I were so inclined (though I’m not), “more money was borrowed than should have been borrowed.”

The lenders have a responsibility to their company and their shareholders, which they failed on. Bankruptcies abound and, guess what, the guys who own these toxic bonds are already being punished. And how on Earth do you fine someone for buying a bond? Which guy do you fine? The primary purchaser, or one of the innumerable secondary purchasers? Is it based on how long I owned the bond for? What if I lost money on it, do I still get fined? What if the bond ultimately lost money but I made money on it? Are you going to fine the originators of the bonds? Well, most of them are out of business. What a dumb idea.

Frank is such an enormous moron. I mean, a huge, huge, unprecedentedly huge moron. Let’s think who’s about going to get screwed if someone actually enacted this socialist law: it’s the f’ing homeowners that aren’t in default! That is who. If you change the standards of the lending market artificially in a negative fashion, you will eliminate the ability of the marginal borrower (or, perhaps, several layers into marginal borrowers) to access loans on what otherwise would have been prevailing market terms. If the marginal borrowers (e.g., prospective home buyers/refinancers) cannot access loans on market terms even though the current owner paid a price that reflected market terms, then the marginal home seller is totally, totally fucked. Frank is trying to dry up the home-buyer market, which obviously means drying up the home selling market. Further, for sub-prime homeowners that actually managed to not default yet but need to re-fi because they are about to reset on their 2 year option ARM, well, sucks to be that guy. Frank just decimated your ability to re-fi. I hope you like renting because you’ll be mailing your keys back soon! I give Bachus some minimal credit for at least recognizing that risk and saying, “It's very important to preserve the liquidity in the subprime lending market. If you get too aggressive with assignee liability, you dry up the ability of low and middle income families to own homes.'' Indeed. Including the fact you totally F those that already own homes! Frank goes on to say, “Our job is to continue to have money available for people to continue to buy homes with minimal chance of these kind of disasters. The effect this has on the ability of people in the bond market to make money is simply not a factor.” That shows such a lack of understanding, that it is hard to know where to begin. I suppose I’ll just summarize by saying that if “people in the bond market” can’t make money on homebuyers, there won’t be any “people in the bond market.” And if there are no “people in the bond market”, the odds of continuing to “have money available for people to continue to buy homes” is remote. Borrowers will only ever be able to access money if “people in the bond market” believe they are being rewarded for the risks they are taking.

This is the beauty of capitalism! It is imperfect in that it is not always in balance, rather, it is like a snaking curve that goes above and below a line, but keeps reverting to the line over time. It often requires pain to cause the reversion, both at bottoms and tops. But it is self correcting. This legislation and dumbass legislation like Sarbanes-Oxley, they are both trying to prevent problems that already happened and have already been addressed by the market. Instead, they add to the problem and cause pain to those who were the good people, those left standing.

I put the whole sub-prime disaster in my “who gives an F” category. It is typical of capitalism and necessary for society. And guess what, it helped a lot of people.

The good news is no bill like this would ever get out of the Senate, much less the White House, so it is just a bunch of saber rattling by people trying to win brownie points back in their district. In some sense, I almost wish it would become law because it would crush home prices and I’d be a happy purchaser. But I like benefiting from unnecessary regulation just a tiny bit more than being hurt by stupid regulation, which is to say I hate them both.

-TTB

PS: Barney Frank is an idiot. The fact that he is head of the House Financial Services Committee literally makes me ill. Bachus seems only marginally better.



After writing that, I went back and re-read CK's email and got upset all over again, thus sending this diatribe out to the group:

CK, I just re-read your email and got angry all over again. LB’s point could not be more spot on! How do you leave out the option of “don’t do anything since there’s nothing that needs to be done”?

I always laugh about things like this (see tech market 99, portfolio insurance in the 80s, buying fixed rate bonds in the 70s, the Nifty Fifty in the 60s, etc., ad nauseum). During the emotional ride up, everyone knows this BS is happening. It is being highlighted in real time by intelligent skeptics everywhere, but Frank and Bacchus look the other way and don’t feel the need to stop the gravy train from derailing even as it is obvious that the mountain is becoming too steep to climb and the tracks can’t possibly hold the increasing burden as more and more passengers (many of whom effectively stole their ticket) jump on board. It isn’t until after the train crash that fools like Frank pile onto the damage and, as they walk over the bodies of the fallen, accidentally break the necks of some of the survivors in order to find those that financed the building of the train (not even the builder of the train himself or the conductor (see Alan Greenspan or “the mirror”, since mortgage interest is deductible, it basically encourages borrowers to avoid building equity and to debt finance as much as possible and massively discourages renting!)). But the financiers are in ruins too – the assets backing their loans have collapsed in value and the prospect of putting new capital out is dim. Future financiers have learned a lesson and have already made adjustments. Capitalism has worked. This is the point in time when Frank, standing on the bodies of those already dead or injured, steps in and metes out his “punishment”, even as the market has already punished the offenders on all sides (the lenders, the brokers, the borrowers). But his punishment is redundant, ill focused, and full of unintended consequences. At least it was “a least worst attempt to address the whoas [sic] of borrowers…[the] disgruntled voters.” Sickening.

Personal accountability is important. Our government’s nannying just causes more of this crap and inherently reduces innovation.

-TTB


CK responded, probably fearing that I was about to stalk and kill him (which, given the tone of my rants wasn't an irrational worry), with this:


TTB, your prior email was correct, the second sentence was dripping with sarcasm. Unfortunately, you couldn't see my sarcastic visage as I typed the email in class. Alas, we'll have to wait until Web 3.0 for that feature.

LB, as for leaving out option 4...I was trying to finish the email quickly at the end of class and realize that I didn't put the obvious choice in the list. Mea culpa.

As I am again facing the clock - as I have to get to class - I will leave my email at that and face the wrath of the Brothers Linebacker for any omissions I may have made.

-Ck


I felt much assuaged knowing that CK was being sarcastic. I presumed he was until I saw him try to deflect some blame from Barney Frank. That behavior calls all assumptions into question and I told him so. He responded with this:

Yes, I guess that providing an observation that both senior members of the House committee were making comments on this subject could make you think that I was "defending" Frank, whereas I was only being bipartisan.

One more thought on the subject of regulation. While I agree with the non-regulation viewpoint, I offer the paternalistic view for the sake of flushing out the discussion fully. An argument for regulation in this context is the information assymetry between "naive" borrowers and "sophisticated" originators. Obviously, no one is in a better position to know their financial well being than the borrower themselves. Likewise, originators are in a much better position to understand the dynamics of the loans they are offering, including the benefits and costs of the loan. So, it comes down to which side has the best information. If you believe that borrowers are being led astray by transaction hungry originators, then you would believe that some sort of regulation is necessary. This is essentially the viewpoint that is offered by Congressmen Frank and Bachus (and, I assume, many others in Congress).

Why? Because we're talking about people's homes. The American Dream.

That is the crux of the problem for Congress. Their office seeking incentives align them with their constituents who are crying over losing their homes. This isn't the stuff of which great policy is made. However, it is the reality we have to live with in a democracy.

Anyway, I'm against lender liability in this case...especially since I am going to work in the leveraged lending business!

-Ck

PS. CNBC had an interview with Barney Frank where he sounded quite concerned with the proper functioning of the capital markets. This isn't entirely surprising as his district does include the financial center of Boston (Fidelity, State Street, etc.).


Noting that I never accused CK of "defending" Frank, given his indefensibility I don't presume to think CK would even try. Instead, I noted CK tried to "deflect" blame from Frank and, as noted above, Frank deserves all the blame he gets in my email below:

For the record, I didn’t accuse you of “defending” Frank. I know not even you would stoop that low (backhanded compliments abound!). I said you tried to “deflect some blame” from Barney Frank, which is true. You and I both know that in life, Barney Frank deserves any blame that comes his way, even if he doesn’t “deserve” it, he deserves it.

The fact that we’ve been brainwashed into thinking owning a home equates to The American Dream is part of what is wrong with America. I love that we have legislated that as part of The Dream and that legislation perverts prices without making The Dream more attainable, since it merely makes houses more expensive. Good times. Not only do laws that allow mortgage interest as a deduction make houses more expensive, it encourages owners to avoid building equity and to stay nice and levered. The fact few people in government actually think beyond first order outcomes does not surprise me, given we live in a sound bite world. But it certainly disappoints me.

I totally agree with the flaws of Office Seeking Incentives (good phrase, by the way). It’s why I’m a proponent of changing the House to four year terms and the presidency to six year terms. Three Senate terms, two presidential terms, and four house terms would be my limit. I think the House would serve as a natural farm team for the Senate, though I wish it wouldn’t. I don’t like resigning myself to bad outcomes for big issues just because it is the reality we have to live with. That’s what rants are for!

-TTB


This interchange led to another IM'ing session between CK and me (TTB). Again, anything in brackets was added to clarify, I cleaned up a few typos and reordered some parts of the conversation so they make sense, but nothing of substance was added or removed after the fact:

CK: That was a fun interchange of thoughts today. I knew after I sent the email that I would catch some hell for leaving off the best solution (e.g. doing nothing) from my list.
CK: Your analogy of the train crash killing most onboard, followed by the well-meaning samaritans breaking the necks of the survivors was very entertaining.
TTB: thanks. you deserve hell for even pretending to deflect blame from Barney Frank.
CK: I just wanted to give a "fair and balanced" disclosure that both Rep. & Dem. were involved in this plan.
CK: Disparage Frank all you want, but don't forget Bachus.
TTB: i didn't forget Bachus, I just note that Frank is a moron. [i don't know enough about Bachus to give him moron status yet]
CK: While reading Rubin's "An Uncertain World" today, I stumbled upon an appropo quotation from the Asian crisis: "Both borrowers and lenders are at fault."
TTB: Rubin is fantastic. Probabalistic thinking is massively underutilized.
CK: Agreed.
CK: Its a pretty good book and interesting to see what was going on in government during the various crises.
TTB: he's absolutely right that both borrowers and lenders are at fault. and they both were punished by the market.
TTB: really, they were punished for their on choices, which is how it should be.
CK: true
CK: This is such a good topic for this audience [basically CK, me and my brothers], specifically because of your passionate views on mortgage interest deduction.
TTB: indeed
TTB: [mortgage interest deduction is] just a total perversion of what should be
CK: True
CK: I'm surprised [your older brother] hasn't weighed in [given his passion on the subject of housing as well]
CK: I'm all for getting rid of the mortgage interest deduction.
TTB: [speaking of getting rid of things] I'm all for getting rid of the cap on social security tax...and then getting rid of social security!
TTB: okay, the latter's not totally true
TTB: but the former is. it is ridiculous that SS tax is capped on high income
CK: The Tax Reform Panel suggested that we have a credit instead of a deduction. Credits being more equitable. [I don't know much about this, but I'm assuming that it is a uniform housing credit that can be spent toward rent or ownership]
TTB: why anything?
CK: The cap on social security will have to be raised in order to save the system.
TTB: again, it just flows threw to pricing
TTB: "through"
CK: Sure. But they have a transition problem with "pulling the rug out".
TTB: then phase it out
TTB: 10 year phase
CK: Seems equitable to me.
CK: Frankly, they wanted to remove the whole deduction, but it is too much of a political football to do...politics doesn't make good policy.
CK: Which, ultimately, is sad, as the country is hurt by not getting the best policy.
TTB: regarding "saving" the social security system, i'm not a huge fan of really trying to do that too prematurely, because I suspect the actuarial assumptions leave a margin of error a mile wide.
TTB: but I am a fan of treating people equitably and for now the rich are getting let off the hook
CK: Agreed.
CK: There are a couple of things that could shore it up, too. No borrowing against the trust fund [by the government]...which would make the gov't a better steward of your tax dollar (as I paid minimal taxes this year).
CK: ;)
CK: We ought to increase the age limit as people are living (and working) longer.
TTB: absolutely.
TTB: and probably phase [social security] out to people with net assets above some inflation indexed baseline
TTB: [phasing out above a net asset value] will create bizarre problems as well, such as the gov't wanting the inflation measure to be as low as possible [or certain sorts of assets being tough to value or somewhat punitive to include, like a large family farm, but life's tough]
CK: You should be Secretary of the Treasury
TTB: probably ;)
TTB: i finally updated my blog with a rant we had on IM a long time ago. I forgot until about five minutes ago that I had saved it in my "edit posts" area.
TTB: it's from August 06. Seems fairly precient right now!
CK: I've lost your blog address, can you send it to me again?
TTB: http://investmentlinebacker.blogspot.com/
CK: thx
CK: gotta run
TTB: later
TTB: i'm in the zone today. going to update my blog some more
CK: good
CK: i look forward to it

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