Is "The American Dream" to blame for the subprime debacle?

There's nothing astonishing about this at all. It's simple economics. Why continue paying for a home that is declining in value, especially when your adjustable rate mortgage is resetting and/or you can no longer afford the high monthly payments? And the recent lowering of interest rates don't help much either since banks and mortgage companies have tightened their lending standards anyways.

https://jessescrossroadscafe.blogspot.co ... uying.html

Why is Bank of America Buying Countrywide Financial?

There is plenty of room to question the decision by Bank of America, "the US's biggest bank by stock market value," to proceed with an acquisition of troubled mortgage lender Countrywide Finanical, since they took a two billion dollar cash position at a considerably higher price, when the company appeared to be healthier, and are now buying the rest of the company at a cheaper price in an all stock transaction.

Herb Greenberg does his usual excellent job of digging into the deal and providing a reasonable range of speculations as to the motivations: The Real Story on Countrywide Cont'd - Herb Greenberg

To summarize:

1. The Fed brokered or facilitated the deal because Countrywide was on the verge of insolvency which would have had a significantly negative impact on the financial markets, a la LTCM. Bank of America had significant skin in the game already because of their two billion cash already in, AND significant counterparty entanglements that might have jeopardized BAC itself should CFC have failed.

a. Moody's had just downgraded thirty tranches of Countrywide's mortgage debt. Similar downgrades preceded the American Home Mortgage bankruptcy. It was well known that Countrywide was in capital and cash flow difficulties.

b. As counterparties go, they do not get much bigger than Countrywide when it comes to holding US mortgage debt. One can only speculate at this point what sort of entangling obligations CFC had with mortgage reinsurers AND the Credit Default Swaps that may have be put on Countrywide (in huge multiples of their book value).

There is little doubt in our minds that the Fed helped to broker the deal. Unlike Hank, we don't think necessarily that the Fed 'promised' anything as part of the deal, any moreso than they had done with LTCM. But we have an open mind on this topic. The Fed seems to be taking quite a bit of opaque assets on, judging by the recent precipitous drop in their Treasuries holdings in the past few weeks, to be supplanted by "other loans and repos." But this begs the question, Why Bank of America, and why now?

We'd like to add two reasons for this acquisition based on our experience in the M&A business, in our own case as both acquisitor throughout the 90's specializing in valuing high tech startups in Boston and Northern California, and as an acquiree, having sold our own company to a tech behemoth in late 1999.

1. Never, ever, discount the impact of egos and momentum in corporate decision-making, especially in a poorly managed company where personalities and not principles rule the day. We do not know enough about Ken Lewis and BAC to make any judgement here, but we can't rule it out either. They are the right size and structure for it.

Some have suggested that the company did the deal to try and salvage their two billion cash initial investment. If this is true chalk one up for egos and poor management. That initial position was a sunk cost. Period.

2. Is Bank of America paying in what they consider to be an overvalued currency? Their first tranche was cash. But the acquisition itself is for stock, as in their own stock. Let's take a look at a chart of Bank of America:

Compare the chart of Bank of America with that of Countrywide Financial. Perhaps BoA received a much closer and better look at CFC as a big investor, and decided not to acquire some of the key pieces of the operation, and avoid any of the pending litigation for various lending infractions, but decided it was strategic to buy the whole thing (with stock). Plausible? Kind of.

Or is BAC looking at its own balance sheet, its own stock price, and thinking, 'there but for a little time and disclosure goes our own stock price, down to pre-bubble levels. At 7 dollars equivalent CFC might have been 'cheap' at least compared to the 40 it was worth before it imploded. But if BAC's stock follows a similar course, then at 3 dollars equivalent and two billion dollars it looks a whole lot cheaper.

As a veteran CEO once told us, "You may think I'm paying too much for this company, based on your valuation. But in order to say that you'd have to know more about what my own stock is worth than I do, since that's what I'm buying it with." By the end of 2000, we could not help but see his point, and agree.

The issue is why is a home that's declining in value a cause for concern? Precisely because it has come to be seen as an investment and not simply a place to live.

What has happened in the low interest rate environment of recent years? Why caused the mortgage boom, and so much so lenders came up with products like "no doc" loans etc. and lenders essentially ignored established underwriting standards to be able to partake in the mania.

In the end, people have fueled this real estate bubble because cheap money is good, and buying homes is good. That's the kind of mentality I am looking to question here. Why is the government subsidizing home ownership by making mortgage interest tax deductible. What makes home ownership so much more benevolent to the country's economy than say higher education? Why make mortgage interest tax-deductible but only offer a few thousand in credits for higher education? I'll tell you why - because lobbying groups like the National Realtors' Association are the biggest Political Action Committees in Washington!

You're right that people are to blame. In my opinion, it's the human behavior of greed that once again got recklessly out of control.

You can't just blame this on the NRA. The citizens and the elected representatives are just totally ignorant of the consequences of their actions. The "get rich quick" and "instant gratification" mentalities of ALL parties concerned to this real estate mania are culpable for the outcome. In the end, you get what you pay for.

now that the USA property bubble has burst..... invest in asian real estate before it crashes

Alternatively, now maybe the time to start going to housing auctions to buy foreclosed property on the cheap

Wow, what a great discussion! I know it is too easy to look back and try to be an expert, but here is my opinion. All of you have already pointed this out in some form or the other, but I think this happened in three stages going back to 2001-02.

(a) It is helpful to go back to 2001-02 to trace the real source of the problem - ridiculously low interest rates - the seed of inflation was sown.

(b) Cheap credit - a direct result of (a). Greedy lenders saw a biz opportunity to make a lot of money by being able to lend cheap money at high interest rates to people with not-so-hot credit.

(c) A third factor , a result of (a) and (b) was speculators buying houses left,right and center - Artificial increase in demand driving prices of everything else.

When prices started dropping because of foreclosures , a small wave was created that resulted in a tsunami.

Just came across this link:

https://useconomy.about.com/od/economici ... Primer.htm

Dear Real Estate Speculators in California, Florida and New York,

Thanks for the good times.

Signed,

The rest of the US economy

Additionally, the apparent willingness of borrowers to ‘walk away’ from mortgage debt has contributed to extraordinarily high levels of early default, which is particularly noticeable in the 2007 vintage mortgages. As Fitch has described in recent research reports, this behavior appears to be largely attributable to the use of high risk mortgage products such as ‘piggy-back’ second liens and stated-income documentation programs, which in many instances were poorly underwritten and susceptible to borrower/broker fraud.

https://www.housingwire.com/2008/02/01/fitch-places-139-billion-of-subprime-rmbs-on-negative-watch-cites-walk-aways/

Great discussion. I agree with solaris that part of the problem is the transformation of housing from a residence to an "investment." We should have known that the end was upon us when shows like "Flip this House" hit the airwaves.

While the details certainly matter, at heart the subprime crisis is junk loans issued to questionable risks on volatile collateral. The alphabet soup of securitization provided some of the smoke and mirrors that made it more difficult to discern what was happening but I do not believe that these vehicles were the root cause. While I do not believe that true fraud had much to do with crisis it does have this in common with the typical Ponzi scheme: the early investors in the housing boom received their payouts and did quite well, while the unlucky souls who came late to the party were left holding the bag.

https://www.bloomberg.com/apps/news?pid= ... refer=home

Bush Subprime Plan Undermined, States Shun Borrowers

Feb. 1 (Bloomberg) -- President George W. Bush's proposal to help 1 million subprime borrowers avoid foreclosure with tax- exempt bonds has an obstacle: states don't want the risk any more than private lenders do.

The state housing agencies that are already offering mortgage refinancing options are turning away so many applicants that they've had no need to raise funds. Since New York said it would commit $100 million in July, three of the 500 loans envisioned have been made. Massachusetts extended four loans under a $250 million program started in August, and Ohio made just 36 of the thousands anticipated by Governor Ted Strickland.

The reluctance to lend threatens to undermine a pivotal part of the president's plan for alleviating the worst housing slump in 26 years. More than 50 percent of subprime borrowers are being rejected by state programs because their homes have lost too much value or they've accumulated excessive debt, estimates Geoffrey Cooper, emerging markets director at a unit of MGIC Investment Co., the country's biggest mortgage insurer.

``These things are basically public relations gimmicks,'' said Bruce Marks, chief executive officer of Neighborhood Assistance Corp. of America. The Boston-based nonprofit organization negotiated an agreement with Countrywide Financial Corp., the biggest U.S. home lender, in October to modify rates and terms on $16 billion of subprime mortgages to prevent foreclosures.

State of Union

Bush proposed the municipal bonds Dec. 6 as part of a larger plan to provide relief to homeowners, and pushed for them again in his State of the Union address on Jan. 28. Housing agencies would get the temporary authority to refinance subprime loans with proceeds from lower-cost tax-exempt bonds, he said.

Right now, the government allows the sale of such debt only when borrowers are buying a new home; if states need money for refinancing, they sell taxable bonds that require them, and ultimately the homeowners, to pay higher interest rates.

Each year the government sets a limit on tax-exempt bonds for the 50 state housing programs, and $10 billion was authorized in 2007, according to the National Council of State Housing Agencies in Washington. They weren't allowed to use the funds for refinancing, and avoided even new borrowers whose credit scores put them in the riskiest subprime category, said Wendy Dolber, a housing analyst at Standard & Poor's in New York.

Didn't Compete

Unlike private companies, the agencies are required by law to document the income of borrowers, she said. They also don't offer the adjustable-interest mortgages that subprime lenders promoted before dozens collapsed last year. The loans were particularly attractive to the riskiest borrowers because they had low introductory rates that reset at higher levels later.

``They couldn't compete with true subprime lenders, and they didn't,'' said Dolber.

Of the 24 state agencies S&P rates, all are investment grade, with 18 ranked AA- or higher. None were downgraded as mortgage foreclosures in the U.S. rose 75 percent last year.

At least 10 states have introduced subprime refinancing programs to help stem foreclosures, and Goldman Sachs Group Inc., the world's biggest securities firm, estimates they planned to raise at least $430 million through taxable bonds. Housing officials in Ohio, Massachusetts, New York, Connecticut, and Maryland say they underestimated the extent of the crisis as well as the number of applicants.

``Often the borrower just has too much debt and the home does not have the value to support the refinancing,'' MGIC's Cooper said at a conference in Washington on Jan. 17.

Stimulus Bill

The Senate Finance Committee approved a $157 billion economic stimulus bill on Jan. 30 that would lift the restriction on refinancing mortgages with tax-exempt bonds and authorize states to raise an extra $10 billion over the next three years. The amendment, not included in parallel legislation passed by the House of Representatives, doesn't mandate that the funds be used for subprime loans.

The full Senate will vote on the stimulus bill next week, Senate Majority Leader Harry Reid said yesterday. The two chambers must reconcile their plans before sending legislation to the president.

The National Council of State Housing Agencies supports the Senate legislation because the void left by private lenders extends beyond subprime loans, said Barbara Thompson, executive director.

Spillover

Mortgage originations fell 14 percent in 2007 and will probably decline 34 percent to $1.55 trillion this year, according to forecasts by the Washington-based Mortgage Bankers Association.

``This is more than a subprime problem,'' Thompson said. ``It has spilled over into the affordable-mortgage product.''

When Ohio rolled out its program in April, Strickland said he anticipated selling more than $100 million in taxable bonds because the state was ``facing a crisis.'' The Democrat told residents to apply to refinance their subprime loans with 30- year fixed-rate mortgages.

The prospects changed once officials saw how many applicants were ineligible because they'd missed a mortgage payment in the last year, said Dawn Larzelere, the legislative affairs director at the Ohio Housing Finance Agency in Columbus.

``I don't think our lending standards are too high,'' said Larzelere. ``I think people have gotten in too far over their head.''

More on this today on dealbreaker.com (quoting the Journal). Makes me even more against any extensive bail outs. It's time people learned to face the consequences of their speculative actions.

In the official version of the subprime mortgage mess, the villians “thousands of mortgage brokers who banked big bucks steering customers into subprime loans and the hundreds of mortgage traders and bankers at investment firms” who recklessly securitized the loans and sold them off to investors. Borrowers are typically portrayed as naïve victims of the mortgage bubble—save for a few actual fraudsters.

But wait for it...

Roughly 20% of mortgage fraud involved "occupancy fraud," or borrowers falsely claiming they intended to live in a property, according to an analysis by BasePoint Analytics, a provider of fraud-detection solutions in Carlsbad, Calif. Another study, by Fitch Ratings, looked at 45 subprime loans that defaulted within the first 12 months even though the borrowers had good credit scores. In two-thirds of the cases, borrowers said they intended to live in the property but never moved in.

https://www.dealbreaker.com/2008/02/was_the_subprime_bubble_built.php