The Million Dollar Trailer, Part II
The Daily Reckoning PRESENTS: One of the prime examples that the housing bubble is coming to an end: when the 21st century first budded out, only 5% of mortgages were of the so-called ‘sub-prime’ variety, now, five years later, one in four were to sub-prime borrowers. Bill Bonner looks at this phenomenon – and more – in the conclusion of this two-part essay…
THE MILLION-DOLLAR TRAILER, PART II
In the year of our Lord, 2005, on the Pacific coast of the North American continent, a two-bedroom trailer was offered for $1.4 million. This was hardly a first…or even a most. Other mobile homes have been sold for $1.3 million and $1.8 million. Still another was on the market for $2.7 million.
Why would people pay so much for mobile homes? The $1.4 million trailer, we were told, was in a gated community and on a ‘triple-wide lot.’
“Location, location, location,” a quick-witted reader might think to himself. And he’d be right; the views were said to be spectacular. But in this case, the buyer of the million-dollar trailer did not buy the location. He only rented it.
Unlike most single-family dwellings, trailer owners don’t own the land upon which their houses rest. Instead, they are permitted to park their mobile homes on someone else’s land – for a fee…and for a while. In addition to a mortgage, the typical million-dollar trailer buyer has to pay ‘space rent’ – which, for the $1.4 million mobile home was $2,700 a month. Not a fortune, but still a drain on your money.
And oh yes, we mentioned ‘mortgage.’ But mortgages are hard to get on trailers, because the trailer might be pulled off the land…and then what would it be worth? Almost nothing. In Malibu, in 2005, the average house sold for $4.4 million. A trailer is not an average home; it is more modest. But put it on a lot overlooking the Pacific…and it is worth a fortune; at least it was in the great bull market that lasted from ’96 to ’06.
Meanwhile, in Florida, buyers were taking up condos that hadn’t even been built yet. In Miami, ‘flipping” condos came to be a profitable speculation in the early 21st century. Speculators would buy a group of five or ten condos – even before a single shovelful of dirt had been displaced. The idea was to sell the contracts to other speculators while the place was being built. The second buyer would then sell to yet another buyer when it was completed. Neither the first, nor the second, nor the third buyer had any intention of living in the condo.
The trouble was that the object of their speculation looked rather lonely and forlorn when it was finally put up. Driving by at night, it was noticeable that few of the condos had lights on. Most were empty…waiting for their ultimate buyer; the poor sap who would actually live in the place and, presumably, pay for it.
This eventually became such a problem for developers that they tried to squeeze out the speculators, insisting that buyers take up only one of the condos…and move in within a specified period of time. In some projects, developers announced special offers…which had prospective buyers camping out all weekend in order to get a good place in line to buy when the doors opened on Monday morning.
While buyers were leaping from one absurdity to the next, the lending industry fitted them out with special shoes…with wings!
In the autumn of 2006, the regulators began to wonder. A group of regulatory agencies looked up at the sky and had a fright. They suddenly realized they had allowed too many marginal buyers to take off. The air was full of them…and many were beginning to crash. Even Ben Bernanke, speaking last week, warned that borrowers ought to have some flying lessons; a little more ‘awareness’ of lending practices was what was needed, said he.
Bernanke’s comments followed the release of a new set of standards, in a report entitled “Interagency Guidance on Nontraditional Mortgage Product Risks.”
And then, about the same time, the Comptroller of the Currency, John C. Dugan, spoke about the innovations of the mortgage industry:
“Lenders who originate these types of loans should follow sound underwriting practices that consider the borrower’s repayment capacity.”
Traditionally, the lender judged both his man and his market, we recall pointing out. If both were deemed solid, he would take a chance, lending the man a mortgage and hoping that the market was strong enough to allow him to recover his money if the man failed.
But the new lenders were of a different breed. They didn’t care about the man at all. In fact, they rarely knew him and hardly met him. It was the market that they cared about. And when they judged the market, they found it foolproof.
Longtime sufferers of the Daily Reckoning know that no market is proof against the ingenuity of fools. Lenders seemed determined to prove this was so – by making outrageous loans to both fools and knaves.
Reading the popular press – not to mention the advertisements in the popular press – we learned about the number and variety of non-traditional mortgages that have flourished in the last six years. Adjustable rates, of course, became common. But so did mortgages with zero down payments, alluringly low starter rates…including interest-only mortgages, flexible payments, and ‘stated income’ applications…in which the borrower is left to use his own imagination in describing his financial circumstances.
When the 21st century first budded out, only 5% of mortgages were of the so-called ‘sub-prime’ variety – that is, mortgages to marginal borrowers. Five years later, one in four were to sub-prime borrowers.
Also in 2000, only 25% of these sub-prime mortgages were of the ‘stated income’ variety. Only 1% consisted of ‘piggyback loans’ – junior mortgages designed to eliminate the need for a real down payment. And none were I.O., or interest only.
By September 2006, 44% of sub-prime loans had ‘limited documentation,’ 31% were piggyback loans, and 22% were interest only. This was the very moment at which regulators were asking the lending industry to be more careful – that is, after they had already let the weasels in the chicken yard.
Do you remember, dear reader, how we laughed? The stated purpose of both the federal government’s housing policy and that of the lenders themselves was to ‘help Americans buy their own homes’ or words to that effect. Easy credit was meant to increase homeownership. (Renting a house was a kind of social failure, like dropping out of high school or driving an old Pinto). They had ‘democratized’ the credit market, they claimed. Yes, now not only rich speculators could lose their shirts. The common man could lose his too!
The obvious effect of all these innovations was to turn Americans into a race of housing speculators, not of homeowners. Instead of actually buying and paying for a house, marginal buyers were enticed into these innovative mortgage products, which were more like options to buy a house rather than an actual purchase of one. An I.O. mortgage gave the speculator the right to buy the house sometime in the future – if things went well. And as the I.O.’s, limited doc, flexible payment ARMs reached farther and farther into the general population of homeowners, fewer and fewer people really owned their homes at all. More and more of them became gamblers, betting that property values would rise fast enough so they could refinance again.
But we felt a little uneasy when we laughed, because the joke was on the people whom could least afford it – the gullible borrowers of the sub-prime market. But how we roared at the gullibility of the sub-prime lenders!
A man can make a fool of himself whenever he wants. Generally, he pays the price himself and the rest of the world goes on with its business. But in order to get a real public spectacle going you need to separate cause from effect. Because it is only when a fellow thinks he can get away with something that he really lets loose.
One of the great innovations of the lending industry during this period was that it broke the link between the person who made the loan and the person who would suffer the loss if the loan went bad. That was what made the housing bubble possible. While the marginal lumpen took out I.O. low-doc ARMs, the hedge fund, pension fund and insurance fund geniuses bought MBSs – mortgage-backed securities. The securities were backed by the mortgages, which were in turn backed by the imaginary incomes of the borrowers and inflated house prices.
The credit agencies rightly judged the quality of the mortgages as less than perfect – BBB – and then with the miraculous powers of modern finance these same mortgages were put into MBSs and turned into triple-A credits! This transformation of bad credits into good ones, in front of the very eyes of Ph.D. mathematicians and hedge fund quants, must be rated along with Christ’s performance at the marriage of Cana, where the Nazarene turned ordinary tap water into wine. Scientists often suggest that the Gospels lie. But as to the veracity of modern finance, they are mute.
When asked to explain, the institutional salesmen resorted to logic little different that of the ordinary homeowner. The component parts may be a little oily, they said, but put together the sliced and diced, processed mortgage packages were less risky than individual mortgages. It was as if you were less likely to get sick from eating a can of Spam than from eating any particular cut of meat. How that could be, was never explained. Presumably, the glop that went in didn’t get any better by mixing it with other glop of similar provenance.
But that insight seems to have never occurred to genius investors at hedge funds and other major investment firms. The sophisticated buyers did not merely buy the packaged mortgage debt; they ate it up. Cheap suits, expensive suits – when you got down to it, they all fell for the same line of guff.
Just how bad some of this glop was became apparent only recently. As reported in Forbes:
“The real estate market has never offered such opportunity for graft. Since the housing market started to soar in 2001, mortgage fraud has become the fastest-growing white-collar crime, according to the FBI. Last year crooks skimmed at least $1 billion from the $3 trillion U.S. mortgage market.
“Now that the market is slowing, fraud is only rising. As business dries up, there’s increasing pressure on lenders, brokers, title companies and appraisers to be profitable. That means loan and title documents aren’t scrutinized as carefully as they might be, and courts – many of them so low-tech they resemble Mayberry – can’t keep up with the volume of paper.
“Then there’s the mad rush to sell, particularly by people who paid high prices for homes and suddenly can’t afford the mortgages.
“It’s like a tasting menu for con artists and grifters, so tempting that in some cities drug dealers have turned to mortgage fraud, plaguing lower-income neighborhoods with crooked mortgages rather than crystal meth.”
The Forbes article told the story – related here last week – of a pair of thieves, known as the Bonnie and Clyde of mortgage fraud. The two did very naughty things – pretending to be who they weren’t, borrowing money to buy houses at inflated prices, forging documents, stealing identities, defrauding sellers and lenders alike – and made off with millions of dollars.
Elsewhere it was reported that lenders made millions in mortgage loans to inmates in the Colorado prison system. A whole group of miscreants issuing out of the Rocky Mountain state pen were able to buy 17 houses for inflated prices and take away $2.1 million in excess loan proceeds.
According to the report, hundreds of houses were sold in what was called ‘price puffs’ – at prices above real market value. The price puffs began modestly – with buyers taking out $5,000 to $10,000 at the time of settlement. But amounts grew until they were walking away with 30% of the purchase price, or amounts over $100,000. By the autumn of 2006 these houses were going into foreclosure at the rate of one out of every thirteen.
Then, the feds got on the case and people started going to jail again. But that is how these stories tend to end – in regret…in court…in workout…in chapters seven and eleven.
Every public spectacle ends in correction of some sort…often in a house of correction. And if the force of the correction is equal and opposite to the deception that preceded it, this one ought to be a doozie.
The Daily Reckoning
November 10, 2006
Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).
In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt – now available in paperback – just click on the link below:
First, the voters decided.
And then ‘The Decider’ decided.
And now you have to decide…what next?
Is it the world that Ed Yardeni sees:
“I don’t think the economy’s ‘landing.’ I think the economy’s doing great… It’s better than Goldilocks quite honestly. This is the greatest global boom of all time.”
Or is it the world we see from the Daily Reckoning’s various command posts around the world?
We have been exploring the link between cause and effect…between decisions and their aftermath…between truth and consequences. The greater the distance, we conclude…and the less the decider suffers from his own decisions…the worse the results.
At least…in theory.
This may seem like another Daily Reckoning rant…but it’s an important one. When you make an investment, dear reader, what you’re concerned with is what is really going on. If you’re right – that is, if you see reality correctly – you will be successful. If you are wrong, you will fail.
This is true, of course, in all things…not just investments. If a plumber fails to understand his pipes, his work will be a mess. If a writer doesn’t understand the sense of his words, his oeuvre will be nonsense. If a husband misperceives the virtue or intentions of his bride, the marriage is likely to be troubled. Being a success in life is a matter of correctly understanding what is going on – or just being dumb and lucky. Since we can’t count on being lucky – it is completely out of our control – we have to do the best we can to understand reality and make the most of it.
In private life, the connection between ‘the decider’ and ‘the results’ is usually very close. A man decides to step off the curb; if he fails to recognize what is really going on in the street in front of him, he may get hit by a cross-town bus. Likewise, when you make your investments, you get what you’ve got coming.
But public life is a bit different. Just read a commentary by our favorite columnist, Thomas Friedman. Hardly a week goes by that the columnist fails to flog his readers – we should do this…we should do that. But the ‘we’ in Friedman’s column is a greasy kind of ‘we.’
Friedman’s exhortations are expected to stir the masses to action. They are supposed to write letters to the congressional representatives; they are supposed to organize themselves for political campaign; and they are supposed to vote…but for whom? For the meddlers, of course!
For the ‘we’ extends not just to private citizens voluntarily wasting their time and making fools of themselves, but also to our government which – using the police power of the nation state – is meant to undertake all manner of lamebrain programs – including, most recently, the war in Iraq. So Friedman can advocate his projects day and night, knowing that he will neither have to pay for them, nor suffer from them.
In Friedman’s particular case, the man is immune to most of the damage done to the lumpen ‘we’. He is probably America’s richest hack – having first married into a billionaire family, and then made a fortune on his insipid books and columns. Increases in taxes or the price of gasoline are merely a nuisance to the man. And when he urges the Pentagon to send more troops to some distant hellhole, you can be sure that Thomas L. Friedman will not be among them.
But we are not writing today to criticize the New York Times’ columnist, or to offer any more ‘we told you so’s’ on the Iraq war. The war, of course, is a disaster in every sense…and to everybody except Islamic terrorists, who can hardly believe their luck.
No, today we’re writing about your investments. After all, the Daily Reckoning is a financial service, of sorts. And the service we offer is aggravating readers into thinking more deeply about the real world around them.
So what is the ‘reality’ of the markets? The reality is that most stocks are very expensive…and that the correction that began in January 2000 was never permitted to become the MAJOR correction that the market needed. The force of a correction is equal and opposite to the deception that preceded it; you’ve heard us say that before. The whopper market of 1982 to 2000 took prices up 11 times. Our guess is that a huge correction is still waiting to express itself.
Another big reality is that market sentiment is cyclical. Investors are NOT ALWAYS bullish. And they’re NOT ALWAYS bearish. Instead, they tend to go back and forth in long, long cycles that last a couple of decades in each direction. So, if investors were very discouraged and bearish in ’82 – remember, that is when Business Week magazine announced the “End of Equities” – it will probably be in 2022 or so that the next major trough of despair is reached. And if that is so, you should expect a slow, agonizing and frustrating tumble of expectations for the next 16 years.
On top of these NORMAL realities are the EXTRAORDINARY realities of 2006 – China, Iraq, Iran, North Korea, commodities, trade deficits…and the big one, the explosion of U.S. dollar-based credits. It is very difficult to say what any of these realities actually mean. The world has never, ever seen anything like them before.
What we believe they insinuate is an increase in RISK. You know, not Rumsfeld’s known unknowns, but the things we do not know we don’t know. Among the many things we do not know we do not know are some things we are bound to learn. Our guess is that the instruction will be more costly than investors are now prepared for. Risk is under-priced, in our view.
Justice Litle, reporting from Reno, Nevada…
“The barbarians are amassing along the Canadian border. But these barbarians don’t wear bearskins and wield clubs. They wear Armani and wield wads of cash.”
For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening.
And more thoughts…
*** One of the measures by which risk is under-priced is gold. We don’t know what unknown will reach out of nowhere and grab us by the collar. But we hope to have at least a Krugerrand or two in our pocket when it does.
Yesterday, the price of gold shot up more than 18 dollars. What reality did the gold market see? Fanatics in Iran…Democrats in Washington…a lame duck in the White House…? We don’t know.
GoldCorp, meanwhile, told the world that it expects the price of gold to reach $850 within two years. And who knows?
*** We had a bizarre dream last night. In it, we were hot. Really hot. As in, the temperature was around 90%…and we couldn’t get away from it. And then we realized – Global Warming!
Yes, in our dream, the tipping point had already been reached. The world was getting hotter – not at glacial speeds…but at TGV speeds. We were all stewing in our own greenhouses juices.
A sense of futility washed over us. We splashed around, feeling completely defeated. What could we do? Where could we go? It was all hopeless now. What good were all those hours we spent writing the Daily Reckoning? What did it matter how many gold coins we had saved? Who cared about anything…the fact was, we were all going to Hell on Earth!
It was just a dream…we hope.
*** The papers have been quiet about the housing market. What’s going on? People don’t seem to know.
But on Wednesday, came this headline: “In Arizona, ‘For Sale’ Is a Sign of the Times.”
“Until recently, this fast-growing area was a paradise on earth for home builders,” began the report from Phoenix. “Fulton Homes’ developments, for example, were so popular last year that it was able to raise prices on its new homes by $1,000 to $10,000 almost every week.
“‘People were standing in line for lotteries,’ recalled Douglas S. Fulton, president of the company, one of the largest private builders in the Phoenix area. And they were ‘camping overnight begging to be the next number in the next lot in the next house.’
Now, instead of standing in line to buy a house, buyers are waiting to sell. The backlog of unsold homes in the area has grown to nearly 46,000. Eighteen months ago, it was only a few thousand. Even when customers have signed up to buy a house, they often don’t follow through. They simply walk away from their deposits rather than buy the new place.
*** But the money is still flowing on Wall Street. Manhattan business rental rates are at a record high.