Baseball Crank
Covering the Front and Back Pages of the Newspaper
November 11, 2008
BUSINESS: Liar's Poker Folds

I've been waiting for Michael Lewis to write the definitive account of the credit crisis. This is an excellent start.

Here's a few of his vignettes on the housing market madness at the foundation of the crisis, although he has much more on how it worked its way through the financial system:

There's a simple measure of sanity in housing prices: the ratio of median home price to income. Historically, it runs around 3 to 1; by late 2004, it had risen nationally to 4 to 1. "All these people were saying it was nearly as high in some other countries," Zelman says. "But the problem wasn't just that it was 4 to 1. In Los Angeles, it was 10 to 1, and in Miami, 8.5 to 1. And then you coupled that with the buyers. They weren't real buyers. They were speculators."

+++

The juiciest shorts - the bonds ultimately backed by the mortgages most likely to default - had several characteristics. They'd be in what Wall Street people were now calling the sand states: Arizona, California, Florida, Nevada. The loans would have been made by one of the more dubious mortgage lenders; Long Beach Financial, wholly owned by Washington Mutual, was a great example. Long Beach Financial was moving money out the door as fast as it could, few questions asked, in loans built to self-destruct. It specialized in asking home­owners with bad credit and no proof of income to put no money down and defer interest payments for as long as possible. In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $720,000.

More generally, the subprime market tapped a tranche of the American public that did not typically have anything to do with Wall Street. Lenders were making loans to people who, based on their credit ratings, were less creditworthy than 71 percent of the population. Eisman knew some of these people. One day, his housekeeper, a South American woman, told him that she was planning to buy a townhouse in Queens. "The price was absurd, and they were giving her a low-down-payment option-ARM," says Eisman, who talked her into taking out a conventional fixed-rate mortgage. Next, the baby nurse he'd hired back in 1997 to take care of his newborn twin daughters phoned him. "She was this lovely woman from Jamaica," he says. "One day she calls me and says she and her sister own five townhouses in Queens. I said, 'How did that happen?'" It happened because after they bought the first one and its value rose, the lenders came and suggested they refinance and take out $250,000, which they used to buy another one. Then the price of that one rose too, and they repeated the experiment. "By the time they were done," Eisman says, "they owned five of them, the market was falling, and they couldn't make any of the payments."

Posted by Baseball Crank at 10:43 PM | Business • | Politics 2008 | Comments (4) | TrackBack (0)
Comments

I am glad someone is paying attention, finally, to the home price-to-income ratio. I deal in real estate, though ordinarily not in housing, and one of the things I found myself saying too often the past couple of years was "these projections don't make sense." That, and "who is going to buy these apartments?" It is, or was, exasperating, trying to hold a reasonable conversation with people who hadn't experienced a market downturn.

The 3 to 1 ratio quoted may be a historical rate for the United States, but try it in Europe and see how it plays. If memory serves me right there are places in Germany where the ratio is far higher, over twenty to one. Which ,of course, is one of the things that has always made America so attractive to immigrants.

Posted by: dd at November 12, 2008 7:58 AM

The frustration of those of us who live in mainstream America where home prices remained normal is that our jobs and our lives will still suffer in the fallout. For the average person living in flyover country who went to work every day, pays his bills and spends his free time with his family, there would have been no warning. If his investments are limited to the 401(k) at work and his home, and he pays more attention to ESPN than the news, he had no inkling that the left-wing wackos on the coasts were engaged in a stupid, bizarre game of "greater fool" financial chicken.

And he still has no understanding of how much he is going to be forced to pay to save the wackos from losing their homes.

Posted by: stan at November 12, 2008 9:38 AM

I was in a Securities Law class back in the late nineties and my professor read from a few recently filed 10Ks to demonstrate what types of risks companies disclose. We all laughed including the professor because the 10Ks were for skyrocketing internet companies -- and the disclosures read something like: "We have never made money. We don't really know how to make money. And we face expanding competition." The housing and mortgage market was about as practical an investment during the last six years; but the difference is that the federal government did not bailout petshop.com.

Posted by: Patrick at November 12, 2008 9:41 AM

Patrick,

The problem with disclosures like that is that they are given the same credence as drug side effect disclosures. Everyone knows that they are simply an effort to minimize liability and they are ignored.

Posted by: stan at November 12, 2008 11:25 AM
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