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The Mortgage Meltdown... And Who’s Responsible

Thursday, August 30, 2007

by Alexander Green

The other day I read a Wall Street Journal article about a young couple with an important investment decision to make.

A little over a year ago, they had decided to speculate on an expensive beachfront condo, buying it pre-construction with a $100,000 down payment. Now the closing was looming. Yet similar units in the development were already selling for $220,000 less.

They were agonizing. Should they walk away from their $100,000 down payment – and forego the deal entirely – or follow through with their plan and hope the real estate market eventually rebounds?

I only wish every investment decision was this easy. They should walk away, obviously. If they could buy an identical condo for $220,000 less, why not?

Of course, the real reason they’re terrified (and mortified) is because of the six-figure loss, which is nearly twice their annual income. Given the licking they’re about to take – and the current state of the real estate market – it’s unlikely they’ll buy another condo anytime soon, no matter what the price.

In a less politically correct time, this was called "learning the hard way." But in today’s culture, many believe that somehow the government – or business – should pick up the tab.

Funny, I don’t remember hearing anyone offering to share their real estate profits when things were going straight up a few years ago. Yet today a rising chorus of voices claim that the rising foreclosure debacle "is everyone’s responsibility."

Some are calling for an outright government bailout. As one fellow told me recently, "Uncle Sam bailed out Chrysler, why not homeowners?" An excellent example of why the government had no business bailing out the auto maker…or any other poorly-run company.

Other pundits, like Orlando Sentinel columnist Mike Thomas, stop short of a bailout, but think the government should still play a major role.

Thomas notes that "an alarming number of people in Florida will lose their homes in the next two years. It’s time for state officials to get involved." He believes government should force lenders and other businesses to make concessions in order to protect the housing market, the Florida job market, and people who make foolish decisions.

He invited readers to respond, and so I did.

"Mike,
Markets only work when smart risks get rewarded and poor risks get punished. You say you’re not for a government bailout. That’s good– because there are so many billions of dollars worth of bad mortgages out there right now, Uncle Sam couldn’t bail them out even if our elected mis-representatives were granted their fondest wish, a lifetime of incumbency.

However, neither is the solution to "pressure lenders to convert more adjustable rate loans into fixed loans, without high fees." First off, government shouldn’t be pressuring a law-abiding business to do anything. In most cases, these borrowers took out adjustable rates loans because they either couldn’t afford fixed ones (and hoped rates might come down) or they were speculating that property prices would continue to rise. Both turned out to be bad bets. Now the piper is about to be paid.

But let’s be honest. No one was defrauded. The banks wanted to lend and prospective homeowners wanted to borrow. Homeowners who took on too much debt will get punished. Lenders, and their shareholders, who hold subprime mortgages will get punished. And hedge funds and "mom and pop" investors who thought they saw an opportunity in collateralized debt obligations will take their lumps, as well.

Punishing law-abiding businesses for the sins of others - whether it’s to "save" the economy, the job market, or the housing market - isn’t going to work.

It may sound harsh, but in free markets the stupid have to pay. That’s how they learn. And what keeps the rest of us from joining them."
Don’t get me wrong. I’ve made more than my share of investment mistakes over the years.

Many of these, especially when I was in my 20s, were both expensive and psychologically painful. But, quite frankly, that’s how most of us learn.

I never expected my family, my friends, the government, business, or "the rich" to bail me out. Whenever I needed to point a finger, I’d go stand in front of the mirror.

We all know people who miscalculated or overreached over the past few years. Today many of them are facing real estate losses, foreclosure... or "no bid" on their mortgage securities.

The economic repercussions are only beginning to be felt – and are likely to be wide-ranging. That’s regrettable.

Perhaps Ben Franklin warned us best a couple hundred years ago. "Experience is a dear school. But fools will learn in no other."

Good Investing,

Alexander Green,

Chairman, Investment U    http://www.investmentu.com
Investment Director, The Oxford Club    http://www.oxfordclub.com
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