Mortgage Credit Crisis: Homeowners Also Need to Look in the Mirror

There is more than enough blame to go around for the sub-prime mortgage crisis, and the unraveling financial disaster. But I believe the fundamental blame lies in two places: A purely American NIMBY myth about homeowners being the only genuine contributors to their communities and a capitalistic axiom, presumably started and perpetuated by a troika among realtors, homebuilders, and mortgage lenders, that the only way for middle-income Americans to truly create wealth is through homeownership.

The main mechanism for translating these two, fundamentally flawed “principles” into an action plan was hatched not under the rightly derided George Bush but the widely considered economic stalwart, Bill Clinton. It was Clinton who in his second term decided that what the United States really needed was to become the greatest nation of homeowners ever. The goal: Move the country from roughly 64% homeowners to over 67%.

It was the role of the two Government Sponsored Entities, Fannie Mae and Freddie Mac, to oblige this national imperative by creating very aggressive mortgage products that, for all intents and purposes, diluted the true nature of homeownership by drastically reducing the level of investment and commitment on the part of the homeowner. Loan-to-value ratios (LTVs) rose, in some cases above 100% of the home’s value so that closing costs and other expenses could be financed as well. At the same time the amount of a homebuyer’s “skin in the game” dropped precipitously, sometimes below zero, with some homebuyers walking away from closing tables with their front door keys and cash.

Some of us in the development community were alarmed by these aggressive first-time homebuyer mortgage products. Homebuyers would be shoe-horned into homeownership, putting little to nothing in to initiate the transaction. However, as soon as interest rates climbed or home value fell, these first-time buyers were left hopelessly overextended. This disaster-in-the making was compounded by the commodification of what was once a personal asset.

The bundling of mortgage loans into mortgage-backed-securities (MRBs) completed the separation of borrowers from their lenders. At the same time, the home itself was transmuted from fundamental shelter to an investment instrument (as the realtors association likes to refer to it, the main wealth creator for middle-income Americans).

As soon as there was any cushion at all between the principal amount of the mortgage and a home’s fair market value, it was often immediately monetized through a second mortgage or equity line of credit. At the same time, owners of MRBs had to rely on mortgage servicers to manage and monitor timely mortgage payments and overall collateral values for huge mortgage pools and parsed segments thereof, often secured by a wide array of homes in disparate markets and sub-markets across the country.

And yet, policy makers, the housing and mortgage industries, and capital markets all touted this great new system for wealth creation. Why?

Because, after all, housing prices will just continue to go up, right?

That was the fundamentally flawed foundation on which this house of cards was built, with everyone along the way—homeowners included—pocketing the cash from what were double-digit, annual increases in value in some markets. The positive consumer sentiments from the good economic times of the Clinton years, that not even the 9-11 tragedy could quash for too long, dovetailed with a blatant disregard from Main Street to Wall Street to our Nation’s Capitol for the incomprehensible national debt that was accumulating, mirrored by record consumer debt. Spend, spend, spend became the national mantra and motto. We had been transformed from a producer nation to a consumer nation.

Whether it was houses, cars, electronics, apparel, home furnishings, appliances, entertainment, dinners out, whatever you can think of: If it was for sale, Americans were buying it and in record numbers. Much of these manifestations of perceived wealth were financed by the seemingly never-ending appreciation in home values and the astronomical mortgage-related debt that was being amassed in reliance on unrealistic expectations regarding those values.

To be sure, there are a lot of lower and moderate-income households --- many of whom are immigrant families targeted specifically as potential first-time homebuyers --- who were sold a bad bill-of-goods in the form of subprime mortgage products. If anyone deserves a bailout, it is probably them. But most Americans knew what they were doing and now should pay the price.

This includes a large number of people who could afford a home but couldn’t purchase the McMansion of their dreams with a conventional mortgage. So they went with something a little more exotic and much, much riskier that allowed them to stretch just a little farther, to continue their conspicuous consumption and help the domestic economy keep rolling along.

So in the end, it’s neither fair nor accurate to blame just the big guys on Wall Street: This crisis was also made by ordinary Americans as well, egged on by flawed policies about homeownership and wealth-creation, allowing obsession to overtake reason.

If, as Gordon Gecko said in the movie Wall Street, “Greed is good,” then as a nation, we’re about as good as it gets. There is plenty of blame to go around indeed.

Peter Smirniotopoulos, Vice President – Development of UniDev, LLC, is based in the company’s headquarters in Bethesda, Maryland, and works throughout the U.S. He is on the faculty of the Masters in Science in Real Estate program at Johns Hopkins University. The views expressed herein are solely his own.