How We Got from There to Here
Greed, fear and indifference all played roles in bringing the mortgage market to its current state
By Gregory J. Martin, executive vice president of corporate development, Lender Support Systems Inc.
When the government
placed Fannie Mae and Freddie Mac under conservatorship, several critics balked against what they
called a “bailout.” They characterized the
government intervention with the backing of
taxpayer funds as a negative occurrence.
On the other hand, proponents say that
if our economic boat is sinking, we should
be bailing it out as fast as we can.
Lost in the discussions of the government bailout of these companies and others in recent months, however, is what
brought the economy to this point. Ultimately, market efficiency was reduced.
Certainly, with loosened lending guidelines and lax products, mortgage brokers,
lenders and others played a role in bringing
the market to its current state.
It can be argued that certain human
factors crept in — specifically greed, indifference and fear. When examining the
current mortgage crisis, it is clear that all
three factors were at work.
Greed played a critical role in pushing the
mortgage market out of efficient bounds.
To a greater extent than likely was prudent,
market participants pursued their own
■ Home-builders built a majority of new
homes priced well greater than local median
home prices to maximize their profits;
■ Mortgage brokers and banks greatly
boosted their revenue by relaxing lending
standards at the front end of a capital conduit to homebuyers;
■ Investment bankers reaped profits creating the back-end source of the capital conduit through selling dubiously risk-adjusted
mortgage bonds; and
■ Ratings agencies failed to exercise adequate diligence in monitoring the activities and risk profiles of the securities
related to mortgage-backed debt and to the
companies participating in the mortgage-banking market.
In addition, to varying degrees, homebuyers and homeowners refinancing their
mortgages ignored simple truths about
home values, affordability and excessive
use of credit.
If you add the residential construction
industry and the suppliers to the homebuilding and home-product industries,
you would probably find more than half
of all U.S. households benefited in some
way from the growth in the mortgage-finance market.
Collectively, residents in this country
knowingly participated in an increasingly
dubious run-up in mortgage loans.
The risks were by no means a surprise.
In fact, some members of the financial
markets began betting against mortgage
bonds as early as 2005.
“Fear is creating a
situation where the
continued unraveling of
home loans will create
substantial damage to
the economy that could
take decades to repair.”
Together, greed and indifference made
the markets inefficient. They allowed huge
profits to flow to residential finance, construction, manufacturing and related
service companies, abetted by insatiable
consumer demand financed with mortgage debt.
Fear did not really enter the picture until
spring 2007, when the most-obvious lending errors became apparent. Although
their volume was only a fraction of
the larger prime- and Alt-A-loan pool,
nonprime loans exposed the greed and
indifference to risk of even some of the
largest financial institutions.
Even the vaunted transparency of public firms that forms a key component of efficient markets was not evident during the
nonprime run-up. Several public nonprime
lenders declared bankruptcy, and the unraveling of the mortgage-banking conduits’
front end picked up pace.
By summer 2007, broader economic
fear began to take hold. Rather than an
efficient assessment of risk and reallocation of capital, the credit markets panicked
as banks pulled critical credit lines from
mortgage lenders across the board.
When August 2007 rolled in, the financial markets had almost seized up as
financing was pulled even from business
loans. This choked the economy in a way
that precluded an efficient correction to
the problem in the mortgage-banking
With the unwinding of nonprime loans
marked by accelerating defaults and foreclosures, new decelerating forces buffeted the economy, and recessionary fears
clouded effective decisionmaking.
Fear actually is creating a situation where
the continued unraveling of home loans will
create substantial damage to the economy
that could take decades to repair.
If more than half of the U.S. population participated — whether directly or indirectly — in the run-up of the mortgage
market, it’s possible to argue that taxpayers should participate in fixing an economy
that is not capable of acting efficiently.
There is no financial institution large
enough to affect the U.S. economy broadly
and to break the cycle of the current market’s operation beyond its current boundary of efficiency.
With $2 trillion to $3 trillion in home
equity at risk, bailout proponents have
argued that quick and rational action
was necessary. Acting decisively to provide solvency and adequate oversight may
limit the damage to less than $1 trillion
(hard costs plus decreased asset value)
within another nine to 18 months of economic correction.
Collectively, players in the real estate
and banking industries made a series of
financial mistakes with open eyes.
Perhaps it is time to learn from our
mistakes and act collectively to help push
our economy back into the range where it
can start operating more efficiently.
Gregory J. Martin is executive vice president of
corporate development at
Lender Support Systems
com), a 25-year-old mort-gage-technology enter-
prise. Martin has broad experience in corporate
management, finance and marketing. He guides
Lender Support Systems’ strategic partnership
and investment activities, along with serving as
interim CFO. Past roles include working as a
mergers-and-acquisitions intermediary, managing director of a Hong Kong company and a Navy
pilot. Reach Martin at gmartin@lendersupport.
com or (858) 268-7100.
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