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The moral of the housing crisis

Michael Lewis on the sub-prime mortgage crisis

The real moral is that when a middle-class couple buys a house they can’t afford, defaults on their mortgage, and then sits down to explain it to a reporter from the New York Times, they can be confident that he will overlook the reason for their financial distress: the peculiar willingness of Americans to risk it all for a house above their station. People who buy something they cannot afford usually hear a little voice warning them away or prodding them to feel guilty. But when the item in question is a house, all the signals in American life conspire to drown out the little voice. The tax code tells people like the Garcias that while their interest payments are now gargantuan relative to their income, they’re deductible. Their friends tell them how impressed they are-and they mean it. Their family tells them that while theirs is indeed a big house, they have worked hard, and Americans who work hard deserve to own a dream house. Their kids love them for it.

Across America, some version of this drama has become a social norm. As of this spring, one in 11 mortgages was either past due—like Ed McMahon’s $4.8 million jumbo loan on his property—or in foreclosure, like Evander Holyfield’s $10 million Georgia estate. It’s no good pretending that Americans didn’t know they couldn’t afford such properties, or that they were seduced into believing they could afford them by mendacious mortgage brokers or Wall Street traders. If they hadn’t lusted after the bigger house, they never would have met the mortgage brokers in the first place. The money-lending business didn’t create the American desire for unaffordable housing. It simply facilitated it.

It’s this desire we must understand. More than any other possession, houses are what people use to say, “Look how well I’m doing!” Given the financial anxieties and indignities suffered by the American middle class, it’s hardly surprising that a lower-middle-class child who grows up in a small house feels a burning need to acquire a bigger one.

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11 Comments

  1. Mike O says:

    At any given time, in a normal economy, 3 or 4 percent of all loans are past due. So, that 9 percent is really 6 percentage points above normal.

    Right now, the percentage of defaults on second homes is much greater than primary residences, but I don’t have any hard numbers. Second homes generally are a half to a whole percent mor interest rate, indicating that the market is aware of the risk. Part of that 6 (above) is from second homes. And, the purchase of second homes has been much greater in this boom.

    How much are people buying above their station? How much are they just buying, instead of renting? Let’s kick this around?

  2. [...] 26, 2008 by Tim Jordon Cooper posts a couple of very interesting paragraphs about the moral of the housing crisis from this article.  I’d love to just shake my head at [...]

  3. joseph says:

    I think this is bang on. I’ve watched people here in Edmonton acquire or build large houses at the top of the market bubble. The number of 40 year mortages is phenomenal. Until recently I worked at the U of A, and I couldn’t even count the number of students whose goals in life included “a house bigger than my parents’ house”.

    One moment which sticks out in my mind came when an acquaintance was commenting that he & his wife were not going to have any more children (they had 2) because their house was not big enough. I think their house is about 170% bigger than mine. I don’t know. We have 4 kids and just under 950 square feet of house. Yeah, it’s housing lust.

  4. Jordon says:

    Mike O, why do people need second homes? Are we talking resort properties?

    My understanding is that people bought too much house because of the really low interest rates and massive mortgages made available with the idea that they would just keep refinancing or could sell for a profit rather than be hit with the higher adjustable rate mortgages. In the end people stopped seeing their homes as “homes” and started to use them as a bank with second and third mortgages.

    When the bubble burst and the economy took a slight down tick, the housing interest rates in addition to an obscene amount of credit card debt lead to foreclosures.

    I don’t know who to blames. When Wendy and I went to the bank a decade ago for a mortgage, they offered us a $250,000 mortgage without batting an eye. Meanwhile we decided one a $60,000 house which saved us when times were tougher and now a decade later we are almost mortgage free.

    So who is to blame? The banks for trying to make us max out our mortgage? People who don’t realize they won’t be able to survive a downturn? Too much short term debt from credit card companies?

  5. [...] Maynard has written a great post about the $700B and there is also an interesting article here h/t Jordan Cooper It’s this desire we must understand. More than any other possession, houses are what people use [...]

  6. Mike O says:

    Second homes – I think a lot of people wanted a vacation that was “easy” – just drive to the vacation house, instead of the hassle of flying, etc.

    I do think a lot of people used their houses as “piggy banks” and, as the equity went up, they borrowed more.

    In my lifetime, I rarely ever remember living in an apartment. When I rented, I would rent a room in a guy’s house – which was a typical 3 bedroom basic house. Or a room in an old 17 room victorian mansion owned by some investor or old lady who inherited the monster. When I drive through “mansion country” (Blackhawk, Bent Tree, …) I wonder if my kid, when he’s a youg adult, will be renting a room in one of these mansions? :)

    One thing to bear in mind is that the total value of all defaulted mortgages right now is around $ 60 billion. And the underlying assets have some current market value – at least 40 billion. Even including the ones that have been stripped, damaged by termites, etc. Besides giving Wall Street bosses bonuses, what’s the other $ 640 billion going to?

  7. Rob says:

    Nice article. I found it very refreshing to see someone placing some blame on people mistaking their “wants” for “needs” instread of throwing all of the blame at Wall Street (not that they don’t have their share of blame, as do Democratic and Republican politicians and their backers).

    I’m a pretty hard-core Conservative from Alberta (though I do admit to voting for John Turner when I lived in Quadra) but I have to say that when I recently took some interest in learning about Marxism, I found that there were some interesting Marxist theories about false realities being induced by the capitalist agenda.. and while I’m as far away from a Marxist as you could imagine, I think there is some point to say that as we point to material acquisition as the source of happiness, we induce a false economy socially and financially.

    We need to, collectively, reduce our focus on financial interests as the focus of what we do – and all governments do it. Conservatives are focused on maximizing the interests of business, which too often is limited to improvement of financial return, Liberals and NDP by contrast, are also too often concerned with re-allocation of financial resources, suggesting if we just spend more money on the poor and the disadvantaged, those problems will go away.

    What no one really wants to perhaps press is the need for accountability. Businesses who pollute need to be made more accountible. People who don’t properly care for thes selves or their families need to be made more accountable.. including letting people swing when they lose their houses that they purchased but couldn’t afford.

  8. Jordon says:

    Well from what I have heard is that the Fed’s reserve is around $800 billion and most of it has been borrowed and backed by now worthless mortgage backed securities. As many are saying, is this a payback to the Federal reserve which may be broke. When you look at the money loaned out versus the little bit of information online about the Fed’s balance sheets, it looks like the Fed may be a little over leveraged right now.

  9. Mike O says:

    Another financial time bomb