By Paul V. Montesino, PhD, MBA.
Most of us like to issue the famous phrase “I told you so.”
Like most humans I must confess-here the confession goes again-I am not immune and I feel tempted occasionally to fall for the trap. And I call it a trap, because it is an egotistical expression, one that solves nothing and serves no one and no purpose. When I warn you or others about what I think is going to happen and it does, I really does not fix the basic problem. All I am saying is that you did not listen to me and are paying for the consequences. That is not nice. I really do not like you to pay for your own mistakes just to make me happy.
But having explained myself I guess I have to tell you that I told you so. I have been writing these articles about the home mortgage crisis for several tiring months now and warned you that the crisis was going to outlast my writings. Indeed it has. So much has happened from that date when I first covered the issue that I am starting to think I should change professions and become an astrologer. But no, don’t tell me what your sign is. Not yet.
I don’t know if you have seen those movies where the Roman charioteers, whip in hand, and their chariots run around the Coliseum, the horses pulling and stressing trying to get away from the punishment of their masters. I have. It is not that the horses are trying to go anywhere, they are trying to get away from their masters and the whip. It is not a positive movement, it s more like a “I want to get out of here.” And I have to tell you that this mortgage crisis looks to me like the same with one big difference: I am not the charioteer, the horses are, and the chariot seems to go nowhere I like. But I will try to find out. At some point I have to go back to my I told you so point of view.
Some time ago, someone made a familiar meaningful comment to me that I never forgot: it takes two to tango. Having said that, I want to move now into the catastrophic dance that both consumers and bankers, investors and their representatives have been performing in this new stage where the economic health of this country and part of the world have been damaged seriously. I will start with the consumer, you and I.
During the past several years, homeowners have been enjoying an ever increasing value in the equity of their homes. As you know, equity is the difference between what you own and what you owe. It seemed that the sky was the limit. Typically Americans used that abode equity to trade up into better and bigger homes as our families’ needs and ambitions went up. More rooms, more bathrooms, basements, the works.
Builders and others who made a living in the construction business added to that frenzy by building bigger houses as well and tempting us to go for broke in order to get them, literally and figuratively. It was not difficult to convince a family who owned a home with a healthy equity to use that equity not only to buy a bigger home, but also to travel, get luxury cars and pay children’s educations with it. Nothing wrong with that; it is called the American dream. But as we have seen recently, the dream has become a nightmare for some.
It was not difficult to convince the homeowners to proceed on that optimistic course because we were always convinced that the equity would continue to go up allowing us to refinance again and again when we needed to tap it to get more cash. And that equity became a temptation not only for the folks who owned the properties but also for those who witnessed with envy that suddenly acquired wealth and wanted a piece of the action.
So, the first tango dancers were the homeowners who wanted to go where no other human in their experience had ever danced before, to paraphrase a well known fictional series television program, but this was when the other tango dancers made it to the floor asking the question: “Shall we dance?” A question that was promptly answered by the proud targets: “Where should I sign?’
There was a plethora of dancers waiting in line. Builders who wanted to create the next home for the buyers, realtors working on commission, lenders, lawyers, bankers, investment bankers, investors, absentee or otherwise, the works. There were so many waiting for the chance to cash a moment on the dancing floor that in order to cover the cost, the interest rates that the borrowers had to pay and the equity to support it had to be high and getting higher. No one anticipated that those equity values would ever go down and that interest rates, many of which were adjustable, no matter how high they were, would become so high that they could not be renegotiated with the lenders through refinancing deals. Unfortunately that optimistic outlook did not happen.
Like the deals we mentioned in the automobile loans examples of the previous articles, many of the folks who had borrowed ridiculously high mortgage amounts at sky high rates that were resetting much higher found themselves unable to afford the payments or get new terms. The equity on the homes they owned had maxed out in value and could not be renegotiated and the lenders were knocking on the door asking for their money. The domino effect was quick and bloody. People who saw the equity of their homes fall below the amount of their loans decided that it was not worth to keep them and told the bankers to stuff it. In the rush many even threw out that sacred symbol of their family structures, their pets. There are many such orphans in the dog pounds these days. Banks, of course, are not in the business of owning homes and renting them out, they want their money back, so they sold them in the market at distressed prices fueling the down price spiral still more. It was not only their money, it was also the money they owed the investors who were anxiously waiting for their return.
This would not have been a problem if you and me had been the only ones affected, but when the number of defaults is in the millions you can see what is going to happen to the country and even beyond to those who participated in this tango. And this is where my chariot stops this time. In my next article I will cover the solutions, both individual and government approved, we should expect sooner rather than later I hope. In an optimistic speech the president of the United States gave in 2006 he bragged about the increase of home ownership during his administration. What he forgot to mention, because he did not anticipate it, was that the increase was a balloon that would eventually burst. Lately he has recognized the problem. A habit that seems to affect everything he touches, whether it is the economy or his foreign policy
And that is my point of view today.
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