Essays on Rebuilding America:

Rebuilding America – The Mortgage Crisis

by Col. Frank Ryan, USMC Ret.

“They” made me do it! I finally understand it, I think. Indeed, Congress must pass a law that makes “they” illegal. The mythical “they” caused all the lenders and home buyers to purchase homes against their collective will.

Once again all the woes in the world are someone else’s fault. Just as happened in the stock market “irrational exuberance” of the late 1990’s, “They” drove up prices. “They” forced us to buy inflated stocks. “They” made us believe that earnings do not matter.

The financial services industry is at a crossroads. The mortgage crisis is not a crisis at all as long as people react calmly. What we have now is a timing problem. As someone who specializes in keeping organizations out of bankruptcy, I can assure you that this crisis will pass with time, financial discipline by borrowers, and with sound fiscal polices by lenders to develop creative solutions to the over lending which took place over the past few years. What is needed is creative, market driven solutions devoid of government intervention. The role of the Federal Reserve, FDIC, and OCC should be to contain the problem rather than to cure it. Allow the market to dictate the cure.

Lender patience and borrower fiscal self-discipline in dealing with soon to be reset mortgage interest rates will generally lead to the problem being resolved through equitable market solutions. Foreclosure seldom benefits anyone other than attorneys, real estate investors, and distressed debt management companies. In cases of fraud, deal with those activities with foreclosure but short of that, financial executives are encouraged to think long term.

The last banking crisis in the early 1990’s saw substantial overreaction which caused a tremendous transfer of wealth unparalleled in our nation’s history. History is about to repeat itself if financial institutions and Congress overreact. Thus far, substantial wealth has already been transferred with the distressed assets sold. The per share values of financial institutions, most of whom had limited exposure to high risk lending, have also been negatively affected in the equity markets. Just witness the number of banks buying back their own shares of stock. Someone apparently understands value.

As financial institutions package problem loans to sell at deep discounts, more properties are subject to foreclosure. Generally, this increase in foreclosures reduces values of real estate which then puts most home equity lines of credit for other financial institutions at risk further contracting the credit markets and increasing the likelihood of recession.

One alternative to the current mortgage crisis is for lenders that made high risk loans to maintain temporarily lower interest rates on those loans. This has the effect of reducing the threat of foreclosure for most borrowers who in return would consent to some equity participation in the property when sold. What is needed is regulatory patience by not forcing loan reclassifications into non-performing assets when a loan restructure will have the desired effect. This solution has the effect of “punishing” lenders for such loans due to lower profitability in the short run until the loans are worked out. It also temporarily “punishes” borrowers for overextending themselves by allowing some equity participation in the property. In effect, the participants in the transaction are forced to deal with the results of their decisions.

Requiring all borrowers to purchase mortgage insurance, as some have suggested, will solve nothing other than punish those who did not participate in the scheme in the first place.

Nor will greater government intervention solve the problem. The buyout of distressed mortgage companies by the government does nothing but convince society that such practices will be rewarded in the future. The problem is that social policy decided that greater home ownership was a desired social objective without considering the severe social costs associated with an economic downturn. Once again, “feel good” programs, do not feel so good when they go awry. You encourage home ownership by building a sound economy, not be legislating people into homes and then claiming ignorance when the real estate market softens.

Frank Ryan is a member of the Lincoln Institute Board of Directors and lectures for the AICPA and BLI on management related topics. He can be reached at [email protected].