This Week's Clue: The New Mortgage Fraud is Political

Following is the essay you can designate as Volume 10, Number 49 of This Week's Clue, based on the e-mail newsletter I have produced since March, 1997. It would be the issue of December 10.

Enjoy.

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There's a new kind of mortgage fraud stalking the land, the quick political fix.

It's a game both parties can play, unfortunately. A moratorium on foreclosures bails out thieves who signed for loans they had no intention of repaying. The industry's "freezer-teaser" plan gives the impression of progress, but it's really just a way for lenders to pick through the rubble.

Jesse Jackson has proposed that the government take on the loans which are going bad, leaving you and I on the hook for bad loans. He misunderstands what the Depression-era RFC actually did, which was mainly micro-lending to good risks, at a profit.

Here are the plain facts:

1. Housing prices have to come down. That's the only way to make housing affordable.
2. Lending practices have to be tightened. No more teaser rates, no more interest-only except to investors, and simplified documents must become mandatory.
3. Incentives need to be adjusted, and responsibilities attached to everyone in the mortgage process.
4. The criminal law must be applied for fraud by both borrowers and lenders.

It's this last which is most essential. It's obvious a lot of fraud took place here on all sides.

1. Investment bankers created crap, mixing-and-matching bad loans with good.
2. Mortgage brokers pushed bad loans on poor people, and didn't tell them.
3. Many buyers grabbed cash with both hands.

Laws are going to have to be changed, and people with gazillions of dollars in the bank are going to have to face prosecution, not just here but in other countries as well.

Here are my own modest proposals:

1. An international financial conference to standardize rules on the creation of traded securities, resulting in a set of market reforms which the European Union, U.S., China, Japan and the Arab Emirates all agree to have passed.
2. Accelerated fraud prosecutions which drive those who lied out of the market permanently.
3. Reforms aimed at making everyone in the process responsible for what's in the papers they're getting people to sign, along with simplifying terms and limiting the kinds of agreements which can be signed.
4. A delay in every foreclosure based on an adjustable rate note until negotiations and mediation between borrowers and their actual lenders can be attempted.
    

This won't stop the pain. Most it consists of closing the barn door after the horse has gone. A lot of foreclosures are going to take place, and housing prices are going to continue falling.

The last is inevitable. Even if all the current proposals were passed it would be inevitable. No new money is coming into this market, except on strict terms most borrowers can't meet. The amount of capital available under strict terms can't meet the current supply, until prices crash.

That's right, kids. Crash. The average home today is worth about twice what it should be. That means second mortgages and other notes based on higher values are also subject to being called early. That domino has yet to be considered, let along fall. Get another loan, pull more money out, the biggest no-brainer in the history of Earth? That was a big part of the problem.

Ending the problem kills a ton of capital and makes loans harder to get for a long time. That's the way the bubble pops.

Meanwhile, enjoy this video of another bubble which must pop as the amount of capital available for investment declines during the next few years: