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It’s Time to Take a Deep Breath

By Ben Stein
THE NEW YORK TIMES
September 9, 2007
http://www.nytimes.com/2007/09/09/business/09every.html

Who would ever have dreamed that credit could be so thrilling? And yet tremors and shivers over credit, and especially over subprime mortgages, have led to some real panic in the financial markets, and rings of fire in the ventricles of the coldest-hearted financiers.

Despite the oceans of ink that have been written on this subject, it seems to me that a few points have rarely been made, and may be worth making now.

IT WASN’T ALL BAD
The subprime mortgage industry apparently helped some people either get into homes or stay in their homes. Yes, it was far from an unmixed good, as we have seen in vivid hues lately. But because of these mortgages, many thousands of Americans who would otherwise not have their own homes now have homes. (Much of the recent subprime mortgage activity was about refinancings, but not all.)

Owning your own home is generally considered the bedrock of the American dream, so this is a good thing, both socially and individually. Walking into your own home, seeing your own dogs waiting for you there, is a major blessing.

The percentage of those who have defaulted is still fairly small, possibly 10 percent to 15 percent of subprime loans, and maybe less. (And subprime mortgages are very roughly 10 percent to 15 percent of mortgages.) That means that the experiment with granting loans to less-qualified buyers worked to a point. I guess — as I have said before — that there was a reason these loans were called “subprime.”

The lending system, however, did go too far in the direction of laxity. Obviously, there should have been tighter standards at the lower end of the borrowing scale. “Stated” income (in other words, “unverified”) and “no doc” loans were probably not a great idea, except for borrowers who were well known to the lender or already had documents on file. There was excessive eagerness to put borrowers into these loans, and now we are all paying the price for the immense fees that the subprime lenders garnered.

This is what we economists call an externality: a cost associated with the transaction that is borne by society in general, not just the parties to the transaction. That cost will be whatever government programs are enacted to bail out borrowers in trouble — while those who lent the money get away pretty much scot-free.

THERE’S PLENTY OF BLAME TO GO AROUND
There has been major dishonesty about mortgages at every level. Subprime issuers in many cases did not tell borrowers what their full costs were going to be, especially when the interest rate reset. This will clearly become a problem, although we cannot yet measure its impact.

The bundlers of subprime debt into collateralized debt obligations did not always tell the buyers of this stuff — especially the foreign buyers — just how risky this paper was, and now the buyers are suffering. (The amounts at risk because of defaults, though, are generally small compared with the capital of the banks in question.)

Alas, there is a long tradition of the United States not telling foreign lenders just how dicey certain loans are. It goes back to the 19th century and American borrowings from Europe for railroads, bridges, canals and farmland. Caveat emptor. Caveat lender.

Today, some of the foreigners send us their toys with lead paint and we send them our bonds with (sometimes) toxic default rates. This isn’t a good thing, but it’s the way the world works. There are a lot of scammers out there. Foreign lenders have every right to be concerned about American standards of truthfulness and disclosure.

But what is often overlooked is that many borrowers, people who look at themselves in the mirror every morning, lied like madmen to get their mortgages.

Years ago, I spoke to a gathering of mortgage sales representatives. Their tales of buyer fraud were almost unbelievable. These salespeople were pretty aggressive themselves, and I wondered how many borrowers would wind up in tears from what they did. But their customers — so I was told — would say anything, sign anything, to get a loan.

The human animal is often dishonest, and if it takes telling a few fibs about income and money in the bank to get into a house, many people will do it. My only point here is that it is not just the big boys whose lies and entrapments got us into trouble. Plenty of ordinary citizens played along.

IT’S GOING TO TAKE TIME
Real estate crashes do not end quickly. Realtors have a rule: there are no soft landings. Residential real estate is like a huge ship. Once it starts moving, it’s hard to stop. Once it slows down, it’s hard to make it speed up again.

We lucky citizens of sunny Southern California have been through some hair-raising real estate crashes since I moved there in 1976. The worst started in the spring of 1990 (just as I closed on my not-at-all-lavish Malibu home). Prices did not recover for a good eight years. That was harrowing, but there is a lesson here: real estate crashes are not like stock fluctuations, in which the market can lose 10 percent in a month and gain it back a few months later. In many cases, real estate takes a long time to turn around.

There is a good side to this, too. Namely, the time to buy real estate is when it’s down. Now, or some time close to now, buyers will be able to find real bargains. In time, maybe a long time, prices will recover and a new peak will be reached. But when everyone is crying the housing blues is the time to buy. Bargain hard. In many regions, sellers want to hear any offer right now.

GOD BLESS THE FED
We should be thankful indeed for the Federal Reserve. I know that some strict disciplinarians want to let the markets go through hell and let borrowers and investors suffer. Except for the possibility that this could provide them with some sadistic glee, I don’t see the point.

A few weeks ago, the markets were in a genuine panic. The traders were erupting with fear in some cases, and with greed as they went short in other cases. If the Fed had not stepped in to supply liquidity and confidence — and to send these overtired traders to their rooms for a time-out — there could have been real problems. Innocent people could have been terribly hurt.

We are lucky to be at a stage of capitalism when we have a Federal Reserve, led by Ben S. Bernanke, and Alan Greenspan before him, that will stop a hysterical market meltdown that is not based on fundamentals. The free marketeers may want to see suffering. Let them watch a boxing match. There is no reason for the innocent to be impoverished because traders panic. I know that the Fed’s rescue mission saved some rich people from distress, too. It’s a small price to pay for keeping the economy on an even keel.

THIS IS A BIG BOAT
“There is a lot of ruin in a nation.” This is from the greatest of all economists, Adam Smith. There is especially a lot of ruin in a nation with the economic power of the United States. I get to the point of laughing when I read doom-saying articles in the business sections of newspapers or watch Jim Cramer on CNBC.

Yes, there are real problems: housing, mortgage defaults, losses at financial firms, rot in hedge funds. But over all, things will be fine. Unless there is a genuine dollar crisis or a devastating recession (very unlikely), things will work out. This economy is very big and very solid. It cannot be derailed for long by anything we have seen lately.

If I were the editor of the business section for just one day, I would run one immense headline: “Everything Is Going to Be Fine. Go Back to Work.”

Ben Stein is a lawyer, writer, actor and economist.