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Sliced and Diced Mortgages

Authored by Carmen and Lloyd Multhauf, Administrators of the Generational Housing Specialist™ Council
and the GHS™ Designation

As we examine the housing market and the problems of the financial system that were largely caused by the mortgage market failures, we frequently hear the word "greed" and are tempted to search for villains. It is widely agreed that there was greed and that there are villains, though we have not seen anyone who would accept that either of those terms applied to them. But the problems that have been revealed are much too large to be explained away so simply. There are numerous systemic issues that have contributed to the problem. Many of those issues have yet to be addressed as we are still in the midst of digging ourselves out from the crisis. But it is relevant at this stage to enumerate at least some of them, and to hope that they will be addressed. Here is our list:

No Skin in the Game

Homeowners with nothing down have no skin in the game. When home values fall, they are quickly underwater, with little incentive to keep paying their mortgages, even if they can. Mortgage brokers who act as pass through agents have no skin in the game. Business can fall, but someone else is left holding the bag. Banks and mortgage companies that package loans into Mortgage Backed Securities have no skin in the game (unless, as often happened, they couldn't resist keeping high yielding risky loans in their own portfolios). For loans they passed through, they had no liability. Is there a lesson here? Have we learned it?

No One to Talk To

Foreclosures are in nobody's interest if they can be reasonably avoided. Short sales may succeed, if there is someone to talk to. But the new system often far separates the homeowner from the lender. The Deed of Trust almost immediately has a substitute trustee, called the MERS (Mortgage Electronic Registration System), which holds the Deed of Trust in place of the lender. The "servicer" who collects the loan payments does not have any authority over the loan terms. In fact, the loan may have been sliced and diced, and sold, perhaps to investors in other countries, separated so far from the homeowner that they cannot make contact to find a common interest, even if there is one. Is there a better way?

Going with the Flow

Many people sensed a problem as home prices rose much faster than buyers' incomes. The financial industry projected that price increases would continue, though it surely could not. Alan Greenspan didn't see the crisis coming, and has said that it could not have been averted in any case. He has said further that it will happen again. There is a pervasive sense that there was no alternative to going with the flow, even if an impending crisis was sensed. Are we doomed to repeat this painful experience? Are we really that helpless, or are we simply deflecting responsibility?

Too Big to Understand

In interviews of key players in the financial crisis, it appears that the system was so complicated that no one understood it. Our Federal Reserve leadership has admitted not understanding the complex programs. Banking houses hired mathematicians who created complex, difficult to understand models with assumptions that were not closely examined. Investors in the system were worldwide. They depended on bond ratings paid for by the very entities that were being rated. Investors made little or no attempt to understand what they were buying, or felt competent to do so. Are we doomed to a system that even our experts can't understand? Or can we change it to make it understandable?

Too Big to Fail

The free market encourages risk taking, with the promise of high rewards for the successful and failure for the unsuccessful. But when failure pulls down the whole US, or indeed, world economy, an entity becomes too big to fail. AIG and other entities became too big to fail. Risk taking without the possibility of failure is not a free market. How do we restore free market principles and protect the public from costly bailouts. Is there a way short of limiting the size of financial entities? Even if size were limited, would competition cause them to use different financial models, or would they simply act in concert, each making the same mistakes so that their failure in concert still threatened the larger financial system?

Is Anyone in Charge?

We have assumed that there were overseers of the housing market and of the financial system. But regulation became a bad word and many still question if significantly increased regulation is possible or desirable. The "insurance policies" against mortgage losses called Credit Default Swaps are unregulated, though they have grown enormously and tie together financial institutions in ways that are not well understood. Is there any agreement on whether and how they should be regulated? With no broad agreement on the need for more stringent regulation, aren't we left with the question, "Is anyone in charge?"

Carmen and Lloyd Multhauf are the founding developers of the Generational Housing Specialist™ Council, a national real estate designation that focuses on the unique impacts made by different generations in establishing housing trends, financial products, negotiating skills and reaching a successful closing.