Fear and Loathing in the Housing Market

I was not a part of the sixties. I was alive then; I just had zero connection with or interest in what became known as the "counterculture." I got my MBA in 1963, went to work for a Fortune 500 company, got married, and started a family. This gives you a firm grounding in understanding REALITY. I was more like the Man in the Grey Flannel Suit, the epitome of the 1950s sensibility. I saw "flower children" but didn't relate to them.

For reasons that are quite obscure even to me, I have just read Hunter S. Thompson's cult classic book Fear and Loathing in Las Vegas. I must say that I honestly don't know quite what to think about the book. If you haven't read it either, it is for probably the same reason I didn't read it until more than 35 years after its publication.

What is the purpose of that book? Well, its subtitle is "A Savage Journey to the Heart of the American Dream" and it is Thompson's story of a wild trip to Las Vegas. Arguably anyone who goes to Las Vegas searching for the American Dream already has a reality disorder.

Ultimately, the book was a writer's attempt to tell a story that was relevant to his life and times in his segment of the world. It is probably part fiction and part a distorted view of reality seen through a drug-induced haze. I will leave it to others to say whether he is a good or bad writer because whatever talent he has is, it seems to me, lost in the distortions produced by over-use of serious drugs.

So what's my point?

I think it a mistake to distort REALITY. In fact, I have spent most of my career in real estate finance as a representative of REALITY!

The lending community has a realistic view of the world based upon years and years of lending. The Underwriting Rule Book came out of years of analysis of the performance of loan portfolios. The result was that the loans that were done in that in the last several decades on the 20th century were good loans and losses were low, less than 1%. That is still true today of loans underwritten under those rules.

But in the early years of the 21st century, lenders started tinkering with the Rule Book. The societal excuse was "Expanding Homeownership Opportunities." There is no question that if you relax the rules you will create new buyers, If you allow people to put down only 5% instead of 10%, for example, you make buyers out of people who have 5% but not 10% to put down.

Other rules were relaxed too, like demonstrated creditworthiness and provable income that demonstrates the ability to support the housing payment. The problem was that while this was happening, no one said, "Let's see what effect these changes have on the quality of our loans." BIG MISTAKE!

The other factor was the invention of new kinds of loans where the initial interest rate was much lower than "teaser rates" had existed in the past. In the olden days, the teaser rates were maybe 1% or so below the "real" rate. When they adjusted, the changes were modest. In the case of these new loans, however, the teaser rate might have been 4% or 5% below the real rate. That would make the adjustment to market rate a lot more severe. The other feature of these loans was that the adjustment from the teaser rate to the market rate was a lot sooner. You can see that this is a toxic combination, as has proven to be the case!

Borrowers signed up for these loans in part because they were told, "Don't worry; we'll be able to refinance your loan when it comes time to adjust." Of course, implicit in that promise was the assumption that property values would continue to rise. We know how that turned out!

For years and years everyone knew that the way to buy a home was to save money for a down payment. That requires the discipline to spend less than your income and save the difference. We also know that you have to have a steady income and pay your bills on time. Unfortunately, that description of "potential homeowner" leaves some people out in the cold — forever.

Nonetheless, people wanted to buy homes, especially when they saw their friends buying homes only to find out they were worth $100,000 more a few years later. So when some real estate agents went blowing in people's ears and saying, "This can be yours too," it was hard for some people to resist.

So why did people sign up for these loans? I suppose it's for the same reason that people go to Las Vegas. They think that the normal rules of how the world works don't apply to them. They think that they can go to Las Vegas and take the casinos for a bundle of money. But the billions of dollars that built those casinos came from suckers who thought the same.

They left their money in Las Vegas. Did they ever acknowledge REALITY? No. Those folks didn't find the American Dream in Las Vegas. Those who fell for the smooth-talking real estate agents and mortgage brokers didn't find the American Dream either.

Thompson's book is partly a condemnation of the personal greed and commercialization that infects Las Vegas. I believe that you can just as easily condemn the various forces that created the subprime market and the borrowers who were, ultimately, victimized by them.

Words of Wisdom: The old rules still apply, and if you conduct yourself in a responsible manner financially, you can become a happy homeowner someday too. And when someone blows in your ear, keep moving. Find some advisors who will talk to you about REALITY!