A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.

About Me

Age: 26 Occupation: Private Equity

Wednesday, March 14, 2007

No Bailout for Irresponsible Borrowers

First, I'd like to introduce myself as this is my initial blog.

My name is Ryan, and I am a 25-year old financial analyst living in Philadelphia. My professional background includes Investment Banking (formerly) and Private Equity (currently). Prior, I graduated from Swarthmore College in 2004 with a Degree in Economics. Many of my posts will be directed, for now, toward what I believe to be an enormous and growing problem in the U.S. - Housing and it's lack of affordability.

I'm writing in staunch opposition to any legislation that offers a bailout to irresponsible borrowers who over-levered themselves in order to purchase a home. All borrowers have a choice before signing on the dotted line. If a bailout occurs, it seems that once again congress will penalize the financially prudent with higher taxes (or a greater budget deficit) in order to reward the profligate few.

If money isn't involved in a bailout, legislation that makes foreclosure more difficult will penalize the lenders, who followed through on their contractual agreement in the first place and provide a valuable service to the economy. Much like onerous European labor laws that discourage hiring, I believe that such an action will discourage lending to a greater extent than any of us would like.


I believe we all have a right to the American Dream, but we have a duty to follow through on our obligations as well.


"Predatory Lending" is merely a symptom of a larger problem, that being a lack of affordable housing. The median income, in many areas of the country, cannot begin to afford a median house. Does anyone not see a problem here? This is what drives borrowers to take on more debt than they can afford. Housing must be allowed to correct in an orderly manner so home ownership is a reasonable proposition for all Americans.

Please keep in mind that there is a large and growing class of losers from the housing bubble that has nothing to do with mortgages and delinquency. It is the youth of this nation, ages 27 and younger, who never had the chance to buy a house during more affordable times (A "starter" house in many parts of this nation costs $1500 per month (more in others) , or more than half of the average person's take home pay. Keep in mind that much of this demographic is already saddled with debt from ever higher education costs. Just to add insult to injury, these are the lucky few who will bear the brunt of our burgeoning social security "time bomb." It is truly a great time to be alive.

It's not quite the Grapes of Wrath at this point, but frustration and discontent is growing among this group, myself included.

12 comments:

Harold said...

Wow,
Great point! Hope you post early and often.

__k said...

I totally agree. I'm not a youth, but I also never had a chance to buy a house during the affordable times. I came out of school with $50k in school loans debt. Several years later, when I got to the point of being able to potentially buy a house, it was too late. Sure, I could have taken out a liar loan or something, thinking that if I end up unable to pay off the mortgage debt, oh well. But I consider that to be highly unethical, and find such things appalling.

As a single non-homeowner with no kids, I already have to pay for the tax breaks for married couples, families with children, and homeowners. I'm also in staunch opposition to any legislation that makes me also pay for people who bought homes that they couldn't afford, to keep them.

Lance said...

Eternitus said:
"(A "starter" house in many parts of this nation costs $1500 per month (more in others) , or more than half of the average person's take home pay. Keep in mind that much of this demographic is already saddled with debt from ever higher education costs. Just to add insult to injury, these are the lucky few who will bear the brunt of our burgeoning social security "time bomb."

I felt like I was going back in time reading this. Everything you say about the situation now was just as true back in the early 80s down to the fear of the burgeoning social security "time bomb." You're a financial analyst, as an exercise you should go back and using data from then, calculate what it cost to buy a home back then. Take into account the fact that interest rates were in the double-digits (hovering just under 20%) and the fact that starting salaries just coming out of college were high teens to low 20Ks. Also take into account that house prices themselves had more than doubled in a period of something like 5 years. Further take into account the fact that jobs were not plentiful as they are now ... i.e., factor in the very high unemployment numbers. I think you'll find that the situation was not better ... and perhaps worse. Nothing ever changes. It just always looks better from another perspective ... because the bad tends to be forgotten and only the good remembered. Oh yeah, one other thing, don't forget to factor in that more-affordable lending practices such as "10% down" (or less) didn't exist back then. Try to calculate in what that meant for the average person to have to put down 20% down on a house when that 20% came to 3 to 5 years of their salary ... and how that served as a "barrier of entry" for most youth ... and why back then, like now, people didn't even consider buying the first 5 to 10 years out of school.

eternitus said...

Lance - The early 80's was the worst economic climate since the great depression... so if today draws comparison to then in any way, we are in trouble. (Saying something isn't so bad because it was worse before, in another way, is like saying loosing your hand isn't so bad because you lost a whole leg 20 years ago).

(By the way, the explosion for Social Security was scheduled for the same time then as it is now, so it didn't go away).

If I had my choice between then and now, I'd definitely take now. But being better than the worst just means being second worst, so its not the best basis for comparison...

I'll do the math, because that's what I love to do.. Just throwing out some numbers.

1981 (The lowest housing affordability year ever)

Med. Income - $22,400
House Pr. - $66,400
Int. Rt. - 15.12%
Tax, Ins. Maint - 3%
Income Taxes - 30%

After Tax Income - $1,307
PITI - House - $1,012
House / Disp. Inc. - 77.4%

OUCH!

2007

Med. Income - $48,000
House Pr. - $210,000
Int. Rt. - 6.5%
Tax, Ins. Maint - 3%
Income Taxes - 30%

After Tax Income - $2,800
PITI - House - $1,827
House / Disp. Inc. - 65.3%

So yes, today, houses are more affordable than the WORST YEAR EVER.

However, housing is considered affordable only if you spend less than 40%-45% of your POST-TAX INCOME on housing (30% of your PRE).

Asside from very recently, and 5-years or so in the 80's, housing has met those criteria.

So yes, while today's environment is not the worst, it still bites.

If people spend too much on their homes, they aren't spending money on goods and services that keep the economy humming, and probably aren't saving very much.

Lance said...

Eternitus,

First, thank you for acknowledging that is WAS worse back then. Secondly, check your Social Security data ... at the time it was due to become insolvant by the turn of the century (20th -> 21st) ... but Congress made some changes to extend it an additional 20 yrs ... including scheduling my full retirement pay for something like 67 yrs of age (vs the 65 that had traditionally been the norm.) As of the last statement I received, I now need to wait till age 70 for full benefits ... so, some additional changes have been made. Thirdly, the point I was trying to make in discussing the 80s is that just about everyone I know (myself included) ended up being okay in the end (in the housing dept.) I.e., the "easy" years that came later allowed for purchase and the high appreciation of last several years leveled the table for those who had initially been delayed from purchasing because of the bad conditions earlier (myself included.) I guess what I was also trying to say is that this ebb and flow and cylcical nature is normal, has happened before, and in the end means that what seems like the impossible dream for those faced with exhorbitant costs (such as now or in early 80s) eventually works itself out ... And complaining about it isn't going to change anything ... or make things any better for you or others ... Other than perhaps it feels good to "whine" ... Personally, I would have felt a lot better at your age just knowing that what was happening was a normal cycle and that in the end it would all work itself out 'cause just like I had once been dealt the "unfair" situation of having an impossible market to buy into ... I would also down the road benefit from seemingly "unearned" shortterm high appreciation. And lastly, an additional lesson to be learned was that in the end one ALWAYS wins by owning real estate. It may not be fair, it may not be right, but that is how "the system" works ... You can either fight the system (and hope on the odd chance that you'll make it better for everyone in the end) or just accept it and learn to use it for your benefit. Of course, if the purpose of a blog such as this one is to whine, then I guess I see its value.

eternitus said...

Lance,

Come on, no slinging mud... I'm not whining... I can do that to my wife... I'm trying to get people to wake up and smell the roses... Too many people walk blindly into the biggest financial decision that they will make in their lives without taking the time to do the math, fully buying into the 10% annual price appreciation for eternity best investment you can ever make garbage (which is mathematically impossible without similar income growth)... Many in the real-estate industry (like stock-brokers in the 90's) know that most of us are sheep for the slaughter... It makes me sick, frankly. What makes me sicker, though, is the web that reinforces this junk - a mix of a naive public looking for their next quick buck, powerful lobbying interests, and the wolves (brokers, builders, etc.) who profit off of the above mentioned naivete. At best, the young and working-class screw themselves into paying a huge mortgage that seriously cramps their happiness to fund someone's capital gains (and happiness). At worse, it ruins their lives.

I'm trying to help turn the sheep into wolves in sheep's clothing, and to do a small part (I believe it to be my duty as an honest human being) to end this madness before more people (see: all the press on foreclosures) get hurt so others may profit.

People don't always win in real-estate... in fact, they rarely make more than they spend on insurance, interest, maintenance and taxes over the life of their "investment" - See "Why your home isn't the investment that you think it is" at the Wall Street Journal.

No investment is good regardless of price. In fact, the price you pay is the primary determinant in how good the investment turns out to be.

About Social Security...

I didn't elaborate (or my 10-page response would have turned into 30), but I was speaking in general terms about social security. And my statement depends on which projections (the SSA makes several) one uses. The main point, without knit-picking at the details, is that the problem hasn't gone away... (Social Security is one of my favorite topics, but the discussion is very detailed and I will revisit in later posts)...

Suffice it to say that the 1983 reforms only delayed the inevitable, and we'll have to go through another round of tax increases and delayed or reduced benefits to keep solvent... the real problem is medicare, which may run out of money as soon as 2018. (I speak of medicare as part of social security, by convention).

I can't wait to pay more taxes than by dad did and wait longer than my dad will to get the "benefits."

eternitus said...

To your Credit, lance, you are right about cyclical markets... It will eventually work itself out, but I want to see that happen soon, before more get hurt.

Lance said...

eternitus said...
"To your Credit, lance, you are right about cyclical markets... It will eventually work itself out, but I want to see that happen soon, before more get hurt."

Some people have to touch a hot stove to learn a lesson that will last a lifetime.

Eternitus, you know more about markets then most people ... Do you really think just because something happens quicker that there is less pain involved?

eternitus said...

Lance, you're getting to a much deeper point. Asset appreciation without growth in fundamentals is a zero-sum game. So is the "fall to Earth."

The holders of the asset gain at the expense those who pay more and more of their income to buy in when prices rise. When prices fall, the "pain" shifts to the holders, but not too much to those who held all along, but more acutely toward those who bought "high."

If the fundamentals rise (primarily income and interest rate environment), then everyone is better off... incomes rise, values rise and everyone has a party.

In response to which pain is more severe... I think most people have enough equity to weather a 10% or even a 20% loss in "value" (As their homes almost certainly appreciated (in paper terms) twice that amount over the last five years). That won't really hurt too many because, as above, the gains are paper in nature (unless they re-mortgaged everything)... They'll just "feel" a little less wealthy, but they still may have a house that's appreciated a good amount (they were the "smart" money, that got in at a point where their gains were sustainable.)

For those who bought at the top, there will some pain, no doubt, but if the correction is short-lived, and sharp, I think that might be preferable to a decade of slow erosion of value (and many more people will be able to buy houses that are "good" investments, sooner, I believe, which is important to the long-term growth of the economy, than there will be who suffer because of a quick drop.

Anonymous said...

Being born in the 1980s is tough. I'm born in '83 and am -incredibly- lucky to have talked my way into a six figure job. I can't touch any real estate inside the beltway. I have a serious problem with: paying over $500/sq ft.; buying a place < 1000 sq feet; or needing to earn 8% return on the house just to break even on a 10 year horizon. Add in private school loans and a modest car loan, and it's going to take me until nearly 30 just to register a positive net worth.

I'm at the top of my game and I'm screwed. Every man for himself. This thing is coming down...hard.

Anonymous said...

O.k., Let's cut the B.S.. The general public is neither stupid or irresponsible. That's twisted real estate spin. They do not lie on their loan applications. Brokers do. The public does not overvalue it's homes. Brokers and appraisers do.

The general public has been caught off guard by an utterly lawless industry that thrives on lack of oversight, minimal barriers to entry and a pervasive Anything is o.k. mentality.

The lack of affordable housing is directly attributable to appraisers inflating home values for brokers. They wouldn't get any work if they didn't. Appraisers are under the total control of brokers and the token state ticket agencies that call themselves oversight functions are no more than ticket agencies, issuing licenses indiscriminately and policing noone. Appraisers are the real estate industry's scribes. Anyone with a little systems analysis smarts can see that the real estate appraisal program is deliberately structured to facilitate the real estate industry.

The average homebuyer is in trouble because they were caught off guard by the utter lack of ethics in the real estate industry. No other business exists on false advertising, pathological liar brokers, realtors and agents, and fly-paper loans.

The FBI labeled the real estate industry "Organized Crime" 5 years ago. They're not stupid either.

The only way to get real estate back on track is to boycott the real estate industry and eliminate the middlemen who falsify applications.

__k said...

Being born in the mid/late 70s and having to take out a lot of school loans is even worse. The loans get paid off a little too late, and then there's about a 10- to 15-year wait before housing will become at all affordable again.

I agree that it would be better for the housing market to correct back to normal levels as quickly as possible. People who bought during the boom will generally only be losing a portion of the appreciation that they got during those years. On the other hand, if prices were to stagnate nominally, it would take approximately 10 to 15 years for inflation to drop home prices back down to normal levels.