Bait for the Two-Legged
Feb 5, 2009
I have often said that humans
are like rats in that they are extremely ingenious when it comes
to looking after their personal interests. Lock a rat in a metal
box and it will almost be able to figure a way out. Almost. A
human would actually have a shot at it.
In the debate about what went wrong with the economy and how
to fix things, the topic of loose credit standards usually arises
early in the discussion. And correctly so. Due to loose credit
standards, people without the financial resources to own a home
were practically carried across the threshold by predatory lenders.
Well, at least that's how the outraged political class and their
adoring punditry see things.
According to that section of the jeering crowd, these lenders
were so avaricious, greedy, and downright dastardly that they
would actually hand the keys to a $500,000 house to an individual
with not just poor but pitiful credit and with little or no money
Of course, as a former banker (shudder), I have a somewhat different
Because no matter how devious or dastardly a lending institution
might be, it wouldn't even contemplate making such loans if it
didn't have a fairly well-reasoned plan in mind to actually get
paid back... with interest.
Enter the government in the form of the Federal Housing Administration
(FHA) and the quasi-state-owned (and now absolutely state-owned)
Fannie Mae and Freddie Mac. Absent their guarantees, the private
sector would never, but never, have made the loans just described.
(a) loan officers actually
take professional pride and go to great lengths in assuring that
the money they loan out comes back. In fact, failing to get loans
paid back with even a sniff of regularity is quick cause for
a pink slip followed by a solemn escort to the front door for
the approving loan officer. And...
(b) foreclosing and all the attendant activities are difficult,
time consuming, and costly. To wit, trying to get juice out of
a rock gets you little more than dust.
As a result, within the acceptable
tolerance range for any human endeavor, banks are historically
careful in setting lending standards.
But add into the equation a rate-slashing Fed looking to stimulate
things a bit, side by side with a bloated Uncle Sam looking to
engage in some social engineering by putting people without the
credit or means into a house, and the picture quickly changes.
The FHA, the world's largest government insurer of mortgages,
whose "loans require small down payments" and provide
"more flexibility ... than conventional loans," as
its website states, has currently 4.8 million insured single-family
For the record, there are about
55 million single-family mortgages in the U.S., so the FHA has
about 10% covered.
But the FHA is just one of
Uncle Sam's kissing cousins. Others, including the aforementioned
Fannie and Freddie, guarantee another 31 million mortgages
between them. So, in total, U.S. taxpayers now stand behind about
65% of all home mortgages in the U.S. But it is worse than that,
because ever since the credit crisis began, over 80% of all new
mortgages generated have been "conforming" in order
to go onto the books of a government agency.
Thanks to Uncle Sam's largess
and no-risk lending guarantees - warmly applauded by the nation's
banks and sundry money shoppes, to be sure - since 1992 there
has been about a 50% increase in U.S. homeownership.
Is it any wonder, therefore,
that until recently you could spot loan officers by the
wide smiles on their faces, as well as their ink-stained fingers,
the result of producing prodigious quantities of freshly printed
The way it all worked was very simple. Uncle Sam shouts for all
lenders to hear, "Bring me your poor, your unqualified,
your liars, and your wannabe speculators, and I will buy up their
loans, allowing you to make a quick profit for generating them,
and then passing them like a hot potato into my portfolio."
Given the opportunity to make money by giving money away - not
a real hard sale - the lenders rose to the occasion. A rat, sniffing
out a crust of bread down an unguarded alleyway, would do much
Likewise the masses, equally quick to discern the opportunity,
can hardly be faulted for scrabbling to take the house, oftentimes
along with a loan that put extra money in their pockets in the
No one was much concerned about paying for the homes; the lender's
risk was assumed by the government and the unqualified buyer
didn't have much of any money in the game, and besides, everyone
was certain that house prices could only go in one direction,
up. As for the government, well, the government doesn't really
pay much if any attention to the money it spends, because it's
not their money. It's yours - if you are a U.S. taxpayer, that
Of course, as the smell of free cheese and wealth without end
spread throughout the ether, more and more two-legged rats acted
on what they perceived to be their self-interest, causing a steady
influx of new buyers to stream into the alley of homeownership.
And the next thing you know, you have a housing bubble of historic
But you know all this, so why am I repeating history? Well, because
this week, I stopped in at a local sandwich shop and, to occupy
myself with something other than looking out the window, took
hold of a regional real estate guide that, as part of its editorial
features, includes a table showing all of the lenders who do
business in the area - 16 in all.
Among other information, the lenders' table displayed whether
or not the various lending institutions offer "Mortgages
to Buyers with Less Than 20% Down?"... and whether they
"Offer Mortgages with Credit Scores Under 600?"
Even today, after all the news and global angst, 9 out of 16
still advertise that they offer loans to individuals with credit
scores below 600, and four of them actively promote the fact
that they'll go down to 580 - which is roughly the credit rating
of an escaped felon on the run for credit card fraud. But such
a loan, each of the listing institutions further qualifies, is
available "Only w/FHA."
And 12 out of 16 will still give you a loan with less than 20%
down... in fact, "w/FHA," the solid majority will still
provide a loan with less than 5% down, and one touted the availability
of a 103% loan.
Alas, despite the understandable desire of lenders to earn yet
more cheese by generating poor-quality mortgages for Uncle Sam,
borrowers now believe real estate can only go down. Given the
oversupply, they are largely right for the foreseeable future.
On that basis, they whiff the downside, spot the trap that waits
behind the front door of Home Sweet Home, and scamper
The lesson in all of this, other than that once I get pounding
away on the keyboard, I seem to have no off-switch, is that the
real cause of the housing-led crisis was a failure to appreciate
the similarities between humans and rats. Every government interference
in the market, no matter how well intentioned, carries the seeds
of dangerous unintended consequences. Just ask the twenty-something
welfare mothers of the 1980s who, when offered monthly pay for
each new offspring, quickly converted their wombs into baby factories.
I wish I could say that this lesson - that humans, like rats,
will always figure out a way to pursue their self-interest, even
if it requires chewing through a real or proverbial wall - has
been understood, thanks to the crash. Chances are it hasn't.
Fortunately, there is consolation to be had from the current
trend towards more and bigger government. Namely, if you can
fully understand what's going on and what's coming next, you
have a rare opportunity to - in the words of a stock promoter
who used to speak at conferences some years ago - get "stinky,
filthy, sloppy rich."
Even in a deep crisis like
the one we're seeing right now, windows of opportunity open up
all the time - if you only know where to look. Recognizing, analyzing,
and profiting from emerging trends in the economy is the objective
of The Casey Report. Learn how to get handsome rewards
by making the trend your friend - click