Was Alan Greenspan to blame for the mortgage mess
Alan Greenspan is either loved or hated for how he handled the economy as the Chairman of the Federal Reserve Bank. Beginning in 1987, he was thrown into the fire quickly with the October stock market crash. He is credited with leading the economy to its longest ever expansion in the 90's and has been praised for handling a variety of crises including the stock market crash of 87, the dot com bubble, 9/11 and corporate scandals. In the early part of this decade, he lowered interest rates to historic levels in order to keep the economy functioning post 9/11 and high tech meltdown but potentially sowing the seeds of the current real estate and mortgage mess.
In a 60 Minutes interview this coming Sunday, the never talkative and rarely clear speaking former Chairman will tout his new book, "The Age of Turbulence" going on sale this Monday and will talk about being late to see the problems caused by subprime lending.
When the stock market fell dramatically in the early part of the decade coinciding with historically low interest rates including a fed funds rate of only 1%, many investors who used to "play the stock market" switched their investment strategy to "playing the housing market" by taking advantage of the quickly rising appreciation of real estate in many parts of the country and leveraging their investment with little to no down payment and utilizing new and exotic loan products. The day traders seemed to morph into flippers.
When prices stopped rising dramatically and in some areas began to decline, if they couldn't sell the houses to cover their debt, there was no reason for these speculators to cover their bets and many walked away from the house. Those are now be foreclosed upon.
Then there are the ordinary homeowners who got caught up in the housing frenzy and some took out loans that they never should have. With affordability diminishing and prices rising, many borrowers made ill advised choices. The lenders offered products such as negative amortization loans designed to make the initial payments even lower and the borrowers in many cases chose to ignore the potential consequences of what they were signing. Now we are hearing that those borrowers can't pay as rates have and will reset higher and some are claiming that predatory lenders didn't explain that.
Of course, in most if not all cases, it was explained but the borrower didn't want to hear about it, they just wanted to buy a house and make money as prices continued to climb. As Mad Magazine's Alfred E. Neuman said, "What, me worry?"
Now subprime is even more interesting. Lenders decided to loan money to borrowers with a history of not paying their bills in a timely manner. Does anyone remember the definition of insanity?
Both Einstein and Benjamin Franklin have been credited with this definition, doing the same thing over and over again and expecting different results. OK, so you are going to loan money to someone who has not paid their bills again and again and expect them to now pay their bills. Worse, let's start with a teaser low interest rate, no down payment required, no documentation and what does it matter because we're going to sell this loan and we get paid right now.
Now, I seriously don't believe that Alan Greenspan is responsible for all that but I did think that the Chairman of the Federal Reserve should have been a tad quicker at catching on. He is also being taken to task for his advice that homeowners should not borrow 30 year fixed rate mortgages but should choose an adjustable rate mortgage (ARM). Once again, I don't think that was bad advice when it was provided.
An ARM is not a bad product. If you are only planning on living in your home for 5 to 7 years which is the national average, then if you can get a lower rate for those years by choosing an ARM, you will save money. We did that and had a 4% ARM which was fixed for 5 years and we sold in 2 years so it didn't make sense to pay 5.625% for a 30 year fixed. Today, there is not much savings by taking an ARM, the rate is very close to a 30 year fixed so I would recommend the secure approach of a fixed rate product.
The problem with ARM's is the teaser rates, good only for a short time, resets much higher after the initial period, prepayment penalties, and all of that buried in the fine print. When it is made available to someone with little likelihood of being able to make the payment and a history of not paying their bills in a timely manner, you have the current subprime mess.
Let's hope current Fed Chairman, Ben Bernanke can figure a way out without costing the taxpayer too much money. My personal opinion, the lenders, investors and those crafty folks on Wall Street who packaged these securities should not be bailed out for bad decisions. An effort should be made to help the homeowners in trouble by giving them an opportunity to refinance with a reasonable and affordable mortgage. As to who is going to lend it, I have no idea.