Back on 6/22/2010 I blogged on how Canada has handled home mortgages. In Canada, the government does not get involved in home mortgages. They leave it up to the banks and prospective buyers. If the Canadian bank does not think the home buyer is a good risk, they turn them down or demand a high down payment. Sounds simple doesn't it? Not the USA, our politicians feel that everyone should be able to own their own home no matter how much money they have. Here is how it works in the USA.
I think these numbers are close, but even if they are off a little, I think you can still see the problem. Over the years, the percentage of people in the USA who own their own homes has been between 50% and 60%. The baby boomers, after WWII, earned more in real numbers than prior Americans and thus were able to move the home ownership up a few percentage points. Let's say that they were able to push it up to about 60%. It was during this period that some baby boomers purchased "second homes". This caused the number of homes needed to go up more than just the increase in basic home ownership. We all know about the baby boom and that this sudden increase in population needed homes. See what is happening? Now on top of this, we have the government stepping in and sponsoring and subsidizing home ownership. Recall also that during the great depression and during WWII, home building was very low. Many families "doubled up". Then after WWII they started "undubling". The case that I am trying to set up is that we have had a "one time" event after WWII that is never, never going to happen again. Wake up and get real.
Like most boom and bust situations, they tend to "ring like a bell" or a swing. That is, the system over shoots and then declines until it goes past the balance point. If you know anything about "systems", you will understand this "fact". I think that at the high point, our government had the home ownership up to about 65% or 70%. They did this by forcing banks to originate home loans to people who clearly could not pay them back. The government did this by allowing buyers to get into homes without any down payment. In some cases the government allowed loans to be greater than the value of the home, such that, the home owner got money back. They did even worse things. Like allowing "interest only" loans where the buyer only had to pay interest and nothing toward the principle. With this scheme, the buyer would never own the home. The government, bankers and buyers were blinded by the fact that home prices were going up faster than any other item in the economy, including wages. This meant that if the buyer could make a few interest payments, the home would increase in value so the buyer would have some home equity. Now the bank's risk was "covered". What made all this possible was that our government thru the two Fredie's guaranteed the mortgages so that a note that was really risky got a "AAA" rating. The two Fredie's then bundled the mortgages and had Wall Street sell them to investors all over the world. It was like a merry go round. Banks originated the loans per government rules and then sold them to the two Fredie's who for a small fee turned them into "AAA" bonds. That is it.
Now what happens if the inflation of real estate prices stops or if home prices go down? It was like a chain letter and we all should have known it had to come to an end. What complicated the picture was that insurance companies other than the two Fredie's got into the business of guaranteeing the home loans. Remember AIG? Investors purchased home loan bonds on the basis that they were insured, but the company that wrote the insurance policy did not have the money to back up the bonds if the home owner did not make their mortgage payments and that is exactly what happened. The point is that AIG and the two Fredie's were not the only ones in one this, but they were 95% of the problem.
Now could it get worse? Yes, and it did. Remember that I showed how a buyer could gain home equity if the value of his home went up due to inflation. Many saw this as a wind fall and considered it part of their normal income. Many spent this wind fall just like wages by taking out "home equity" loans. Remember "Country Wide"? We went thru a period where we were spending our wages along with our net worth in the form of "home equity" or the stock market. Now what do you think would happen if the both the prices of real estate were to go down as well as the stock market?
Now back to Canada. Since Canada did not have their government involved in home ownership, they avoided the problems that we dug ourselves into. It is my position that we will not be out of our real estate problems until home ownership is down to about 50%. That means we still have a long way to go. Further, we will not be out of this problem until 50% of the people live in homes that are a lot smaller than the ones they live in now. We should have s statistic like the number of square feet of home per person. I don't know what it is now, but we have to get the number to about half of what it is now. I think I will try to find out what this statistic is now so that I can follow it.
What we needed to have done was to let AIG and the two Fredie's go bankrupt rather than bailing them out. Until we get to the Canadian model, we will not have solved the problem.
PS----
I wanted to talk about the role of "non-recourse" finance. This is where a bank or loan company makes the initial loan and then has the note insured so that it can be rated as "AAA". The two Fredie'd, AIG and the FAA sell this type of insurance. Once the note is "insured" it can be sold to investors like retirement funds. Some call the loans that go bad "toxic", but they are insured by the government (us taxpayers). So who are they toxic for? Not the banks or the retirement funds. There is no "recourse" to the bank if they followed the government rules and 99% did. I think that many banks knew that many of the loans would go bad, but they were following the law. It was against the law to verify a borrows earnings. It was our own government who created this problem. If there had been "recourse" to the banks for the bad loans, they would never have been made in the first place. That is why Canada does not have the real estate loan problems that we do now!!
