June 17-19, 2005

Yes Virginia,
He's Screwed Up More Than Just Iraq

Occasionally when someone yells, “fire!” in crowded theater, it’s because there really is a fire. So...........
Fire!

The US economy is on fire. No, I’m not talking about a new bull market in stocks or real estate. I mean the damn thing is on f-i-r-e. You might not have noticed because it’s smoldering just under the surface, like a peat fire. But it’s heading for a stand of tinder-dry woodlands, and when it hits it’ll be too late to get out.

Those woodlands are the sprawling forest of US homes now financed by risky new adjustable rate and interest-only mortgages. The frenzy to loan money to spendthrift and borrow Americans has become so lucrative for lenders that they have shucked their stiff old green eyeshades and banker’s sobriety and become the lender-equivalents of used car dealers. You’ve seen the Ditech and e-Loan ads. Some would make a local yokel used car dealer blush.

“Are we CaaaaaaaaaRAZY? Go ahead, call us CRAZY. But come in today and buy your new home with a loan from Grabit and Dash Mortgage. NO. NO. NO, I SAID NO MONEY DOWN. But wait! There’s more. NO PRINCIPAL PAYMENTS FOR FIVE.. FIVE.. YES! I SAID FIVE, FIVE, FIVE years.”

And of course, it’s worked. Millions of Americans, many who never would have qualified for a home loan have. The trouble is a lot of these folks would have been politely, but firmly, escorted to the sidewalk a bank security guard just a few short years ago – for their own good, and the bank’s.

I'm a bloodied veteran taxpayer of the savings and loan scandal. So I get a little twitchy when I see institutions, whose chits I might have to cover someday, get loosey-goosey with their lending practices. I remember back in the mid-1980s when another cowboy, Ronald Reagan, was in the White House and supply-siders were pumping nitrous oxide through the national ventilation system. Asset values, they assured us, would go up. So, stop clinging to old-banker bromides, especially those girlie-boy “loan-to-value”rules. If a lender lends 110% of a property’s current value, what’s the problem? In a month or two and the loan will be more than covered by natural property value inflation. And, if problems do develop, the nation will “grow” its way out of it, they said. How? Well by exploiting new “synergies” created by the dynamics of a deregulated banking sector, they assured

Of course it didn’t work quite that way and cost US taxpayers $164 billion to cover those bad loans. (Tip: When you hear someone proposing a loosening of laws regulating the use of other people’s money on the grounds that the changes will create new “synergies,” -- just call the police.)

But memory fades. Today another cowboy is in the saddle and the game is once again afoot. Another prairie fire is about to be set. And here’s the match.

Over the next two years the contractual 5-year “adjustment” on those loans will be triggered. For the first five years borrowers were allowed to make artificially low monthly payments, allowing a lot of people who did not earn enough to afford a $400,000 home to qualify for a loan to buy one. Neither those borrowers or their lenders worried about what was going to happen in five years when their monthly payment jumped from $1500 a month to $2,500 a month. Maybe they would get a $250-a-week raise at work by then. Or, maybe they would sell the house for more. And, if they default, well, the house may be worth more by then to more than cover the lender. Lots of maybe's there that in the past would have had no place in the underwriting process -- and still shouldn't.

But there’s no maybe about this. This is a hard fact. In 2007 lenders will trigger ARM adjustments on more than $1 trillion of the nation's mortgage debt - or about 12 percent of outstanding mortgage debt. That will add over $40 billion in additional monthly payments for those homeowner/borrowers. Yes, $40 billion more. Call me CRAZY, but that sure smells like smoke to me.

Nevertheless, this problem continues to grow. This year lenders report that 40% of the mortgage and refi loans they made were ARMs. As rates begin to go up this year and next, expect that percentage to jump. That’s because the loan-'em-all-they-want feeding frenzy of the past five years has created a glut of lenders. As rates go up it will force consolidation and fierce competition. Expect all kinds of TV teaser rate mortgage ads touting, “low-down, no-down, low-fee, no-fee, low-documentation, no-documentation, approval-on-line, you-don’t-even-need-to-prove-you’re-alive,” loan offers.

All this is particularly disturbing when you recall that the only thing that’s been holding this hollow economy together for the past four years has been the housing market. Automakers, airlines, textile manufacturers, manufacturers in general, are all just trying make it to the next fiscal year without filing for bankruptcy protection. If housing goes into the shitter, everything else follows.

But don’t expect an early warning call from Alan Greenspan, or anyone from Washington, Wall Street or the US Chamber of Commerce. Because those guys hate it when someone yells “fire,” in their theater. It can result in a rush to the exit, and that could leave “stake holders” holding the bag -- and that’s no fun.

Instead they like to engineer what they call “a soft landing.” Sounds nice.. ummm-a soft landing. Of course what they really mean that is they like to beat the rush, to have time to slip quietly from the theater while the rest of us are still absorbed in the movie -- and before we notice the smoke.

So expect Alan and his friends to continue making soothing remarks like, “While there is some froth in the real estate markets in isolated regions, we expect no large scale decline in real estate values nationwide,” and “While long term rates continue low, for reasons we cannot explain, and there appears to be continuing weakness in the manufacturing sector, the economy on a whole remains on firm footing.”

But here’s a tip from a guy who got caught in the last theater-fire: Keep one eye peeled for guys in suits leaving their seats.You might not notice them because they will just stroll up the darkened aisle as though going to the lobby for a popcorn refill.

Follow those guys.