Sometimes the Market Is Stupid

23 Feb Sometimes the Market Is Stupid reports that even after recognizing the brewing storm of decreasing property values and increasing defaults, lenders continued to make risky loans:

By late 2006, lenders knew that the housing market was heading south. Foreclosure filings took off during the third quarter that year, up 43 percent from 12 months earlier, according to RealtyTrac, the online marketer of foreclosure properties. And home prices began to drop.

But instead of cutting back on risky loans, lenders kept lending. Why?

“Because investors continued to buy the loans,” said Doug Duncan, chief economist of the Mortgage Bankers Association.

Despite their quality, subprime mortgages were as profitable as any other for lenders like Countrywide and Wells Fargo, who were able to quickly securitize the loans and sell them in the secondary market. The loans sold easily because they carried the promise of high yields.

“As long as you could sell the loan, you made the deal,” Duncan said.

Lenders needed the fees that these loans generated because their finances were weakening. Their cost of borrowing money was rising, while competitive pressures were keeping mortgage interest rates low.

“By 2006 many lenders were running into red ink,” said Youngblood.

So, they revved up lending to increase short-term profits. And, to outside analysts, there appeared to be nothing wrong with loan quality.

There are a lot of people who are a lot smarter than I am who are analyzing why the market failed in this instance. They’ll tell you, in a nutshell, that the market analysts were slow to realize that the change from government-sponsored purchase of “conforming loans” to the private bundling of mortgage-backed securities affected a sea-change in the riskiness of those investments. Or, in other words, they didn’t realize that there really is something “sub” about “sub-prime.”

To me, the simplest answer is the divide between the loan origination and collection. The people making the loans weren’t the ones relying on it being repaid to make their profits. If you pay someone to build you a house, you get a house. If you pay someone to start building a house, you might get a foundation, if you’re lucky.

Now that there are proposals in the House and Senate which would allow these mortgages to be modified to save homes from foreclosure, the same folks who created this mess react with outrage to what they choose to call interference with the market, and predict dire consequences if the market is not allowed to correct itself.

Well, folks, the mortgage meltdown threatens to tank the real estate industry and throw the entire country into a recession, or worse. The market failed to perceive the problem quickly enough to right itself. I’m not sure the rest of us have enough time to wait for the market to fix itself.

Sometimes, the market is stupid.

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