The Mortgage Meltdown and Healthcare

What do these two topics have to do with each other?  Well, certainly after the mortgage meltdown the US economy is in need of health care.  Not reform.  Just getting healthy!  But that’s not the topic of this post.  Instead the question is: What lessons from the mortgage meltdown can be applied to the health care debate?  And, as a real estate investor, why should you care?

Without going into an extensive history lesson, here’s a quick recap of the mortgage meltdown:

  1. Government decides to “help” the free market for mortgages by establishing Fannie and Freddie to buy mortgages in the secondary market.
  2. Assured of a buyer for their mortgages, mortgage originators aggressively market them.  They sell it silly.  People buy houses. Values go up and more people buy. Equity happens and life is good.
  3. Private industry sees opportunity and wants to play, but find themselves competing against the “Government Sponsored Enterprises” (GSE’s) Fannie and Freddie.  Mortgage rates are dictated by risk and the implied government guarantee of Fannie and Freddie means mortgages that “conform) (i.e., conforming loans) are cheaper than private industry.  Of course, the consumer will buy the cheaper loan.
  4. Private industry expands into “non-conforming” (i.e. Jumbo, sub-prime, etc) in order to be in the mortgage business without having to compete directly with the GSE’s.  They make money.
  5. In 1999, the Clinton Administration says, “Fannie and Freddie, you need to make it even easier for people to get home loans”, which is code for “lower your standards”.  Fannie and Freddie comply.
  6. Home ownership surges under George W. Bush.  He’s an economic genius.  Home values soar.  Private industry says, “I want some more!” and recruits foreign investors to plow money into “super safe” mortgage backed securities.  The money is directed at sub-prime, alt-a, investors, jumbo, etc.  Now equity is REALLY happening!
  7. Reality sets in.  People who shouldn’t have gotten loans do what people who shouldn’t have gotten loans do: they default.  The sub-prime crisis sets off a chain reaction of well chronicled events that set off The Great Recession.  As a result, the private mortgage business is almost wiped out.  Fannie and Freddie survive on the backs of the taxpayers (the working private sector).

Obviously, there’s a lot more to the story, but what are the lessons?  Here are two of the most important ones:

1. In a capitalistic society, the objective of enterprise is to make a profit.    It’s what motivates the brightest people to work hard and sacrifice to create solutions to society’s problems – solutions that can be sold for a profit.  Profits are what allow people to pay taxes, give to charity, invest in product development and new enterprises that create jobs and enrich society. Profits are not evil, they are essential.

2. When the government, though well intentioned (giving it the benefit of the doubt) enters into competition with private industry, with the goal of making a product or service “more affordable”  (code for reducing or eliminating those evil profits), the result is a) private industry is crushed, taking its jobs with it; or b) private industry is forced to compromise sound business practice in order to survive (like loaning money to people who can’t afford to pay it back) and eventually those unsound business practices result in failure – and the loss of jobs.

And the correlation to healthcare?

The President of the United States has gone on record as stating that one of the “benefits” of a public option is to create a health care insurance program “without a profit motive” to compete with private industry.  When you follow that thought track to its logical conclusion, does anyone see a train wreck?

When you think about how big the health care industry is, you can imagine how many private sector jobs would be lost if it were to melt down too.  And since the private sector economy is the one that pays 100% of the taxes, the smaller it gets, the larger the tax burden will be on those who remain.

Loss of private sector jobs and higher taxes have a DIRECT impact on your real estate investments. When more private sector capital is sucked into government, there is less of it available for private purposes. And what is available becomes more expensive (higher interest rates).

So even though “homes and healthcare for all” are noble and compassionate causes that everyone can support, the methodology of undermining the private sector to accomplish them is counterproductive in the long term IF one is operating in a CAPITALISTIC society.

There is no debate about whether we all want people to have homes, healthcare and abundance.  We all want that.  The debate is whether or not we are committed to capitalism.  If we are (and you should be as a real estate investor), then the solution will be found in the private sector as entrepreneurs work every day in their “enlightened self-interest” to invent, build and sell homes, health insurance, health services and whatever other products or services enhance the human experience.

Diesel engines run great on diesel fuel. Regular gas engines run great on regular gas.  But when you put diesel fuel in a regular gas engine or vice versa, it might run for a little while, but it won’t run well.  Eventually, it will break down and not work at all.

Until someone re-writes the Constitution of the United States, the US is a capitalistic society.  Let’s be careful about injecting incompatible “fuel” no matter how noble the motive.

Hey, FHA! Your Fannie is Showing

Today,  The New York Times ran a story headlined Concerns Are Growing About FHA’s Stability.  Hmmm…that’s interesting.  Especially since a major chunk of the loans funding the fledgling housing recovery is coming from FHA.

Caution: This is a long post.  BUT, if you stick with it, it’s not just food for thought.  There are some practical tips, so power on!

Back when sub-prime collapsed, we were hanging out with a lot of the top dogs in the mortgage business and the mantra was “FHA is the new sub-prime!”  Wow. Be careful what you wish for.

So the mortgage industry re-tooled.  It took some time, but eventually the industry got good at FHA and went out and sold it silly.  Only 3% down!  Cheap rates!  Go! Go! Go!  And there’s NOTHING wrong with that.  It’s their job.  Just like it was when the private sector made cheap and easy money available.  Wonder if the evil mortgage brokers will get blamed if FHA goes down?  But we digress….

What? Me Worry?

The NY Times article says that FHA Commissioner David H. Stevens “assured” lawmakers that FHA would NOT need a bailout and was “taking steps” to manage its risks.

Two things.  First, let’s take a trip down memory lane.  For old times’ sake, we cracked open The Real Estate Archives and found a Wall Street Journal article dated 6/7/08 in which they reported that Freddie Mac’s then CEO Richard Syron said Freddie’s financial results for 2008 will be better than last year’s.  This was part of a conference call to investors where he assured stockholders, “We are quite confident that the positive changes will offset the negative.”  What fire?

A month later, a 7/8/08  CNBC.com article quoted James Lockhart, the Director of OFHEO (not a cookie – Office of Fair Housing Enterprise Oversight – you know, the folks that watch your Fannie Mae and Freddie Mac).   CNBC interviewed Lockhart and he said, “Both of these companies [Fannie and Freddie] are adequately capitalized.”

Just in case you didn’t believe Mr. Lockhart, MarketWatch reported on 7/10/08 (2 days later for those keeping track) that then Treasury Secretary Mr. Henry Paulson “moved swiftly…to defend Fannie Mae and Freddie Mac from critics who have called them insolvent” while testilying to the House Finance Committee.

Sorry, we know this is a blog post, not an encyclopedia, but there’s so much good stuff here.

On 7/22/09 (yes, that would be 12 days later), the Associated Press ran a headline “Congressional Analysts Peg Cost of Propping Up Fannie Mae and Freddie Mac as high as $25 Billion”.  That’s a lot of money, but as we’ll soon find out, if it was ONLY $25 billion, it would be cause to party (not that we need much of an excuse). 😉

In an interesting aside, the same AP article said Republican Senator Jim Bunning (KY) criticized Republican administration official Henry Paulson (yep, the same Henry Paulson) for “trying to ‘ram down’ his proposal to shore up Fannie Mae and Freddie Mac, which Bunning said ‘smacks of socialism'”.  We tossed this side note in just in case you thought the Obama Administration were the only ones being called Socialists.

Anyway, back to Fannie and Freddie….

On July 27, 2009 (we were in Belize that day…it was fun), CNN Money reported “Efforts to use the troubled mortgage finance firms to fix housing market problems are likely to push the taxpayer bill for Fannie & Freddie above $100 billion.”  That’s slightly more than the originally projected $25 billion, in case you were getting dizzy.

The same CNN Money article went on to say that Fannie has actually received $34.2 billion and Freddie $51.7 billion.  Also, considerably more than $25 billion, but who’s counting?

Okay, so that was a long trip down memory lane.  But the points are:

a) when the head guys say “don’t worry”, worry – or at least take a peak behind the curtain;

b) the politicians will pay almost ANY price to save housing. Why? Because voters live in houses. This pressure, like it or not, helps protect real estate values;

c) history provides perspectives you don’t get if you only live in the current headlines.  That’s why The Real Estate Guys keep archives.

That concludes “thing #1”. Wait!  Don’t quit yet. Thing #2 will be much shorter!

Thing #2:  When the head FHA guys says, “We’re taking steps to manage risks”, it could mean tighter money: things like stiffer guidelines, lower limits – you know, the things that slow down a recovery.

For example, the FHA’s very popular Home Equity Conversion Mortgage (HECM) – the only insured reverse mortgage – has been widely reported as getting a “haircut”.   That means lower loan limits.  We’ll talk more about that on another day, but it makes you wonder what else FHA might do to “manage” its risks.  We’ll be watching….

So, what’s the takeway from today’s post?

Track what happens with FHA.   Like an over extended teenage shopper, who runs up one credit card and then moves onto the next, our policymakers have run up the tab on Fannie, Freddie, and now possibly FHA.  When all the cards are maxed, they call Mom and Dad.  In this metaphor, that’s you – the American taxpayer.  But you don’t have any money either, so they’ll get it by taking out new credit cards (in your name) from the Chinese or whoever has money, and then pledge the fruits of your future labors (and those of children and grandchildren) to make the payments.

We’re not saying Uncle Sam and his minions shouldn’t help housing, nor are we saying they should.  But it’s safe to say they will.  And when they do, HOW they do it will affect the values of YOUR properties, the interest rates and availability of YOUR loans, the jobs and salaries available to YOUR tenants, the size of YOUR taxes, and the value of YOUR dollar.

In all of this change, are many problems and many opportunities.  But don’t worry!  Work. Study. Learn. Watch. And when you see the opportunity, take action while others hesitate.

And keep listening to The Real Estate Guys – we’ll help keep you thinking!