Altercasting The Homeowner

-- By DanKarmel - 11 Apr 2010

The Collapse

According to Leff, the pitch for an effective sale or swindel must explain the mutual wealth being created for the parties. For the housing bubble, this was the “mysterious thin air” of real estate appreciation. When we discussed the collapse of the mortgage industry in class, Eben solicited suggestions for what had gone wrong. One person stated that the problem was the widespread societal assumption that home prices would never stop appreciating. This wasn’t the answer Eben was looking for, but at some level it was correct. With few exceptions, home prices had grown steadily for generations. Borrowers were willing to accept adjustable-rate mortgage (ARM) loans because they were confident that by the time the rate on their mortgage was due to adjust, they would have almost certainly generated wealth in their homes simply by living in them, and they could refinance their mortgages before the more onerous rates kicked in.

As Eben pointed out though, this was only part of the story, since lenders and investors made similarly poor decisions. The question isn’t why most lay people thought housing was never going to die, the question is why didn’t all the really smart Wharton investment bankers know it? First of all, some did. Yet some of the legitimately most qualified minds in finance actually did buy into the hype. Personally, I recall a friend who received a Finance degree from Wharton telling me how her professor used to sing the praises of the subprime securitization invention – it had made the dream of home ownership possible for millions of people, and all the while at very little risk.

Hot Potato

The critical element uniting all the players, whether they believed that real estate was never going to die, or whether they were prepared to make billions pushing it over, was that no one bore the risks for their bad investments. Mortgage lenders originated the loans and would generally sell them in huge pools to investors within weeks, sometimes days. The loans were then passed along and cut up through various entities, all the way up to the government-sponsored Fannie Mae and Freddie Mac. At both the front and the back, the ones usually left holding the bag were the original borrowers and the government-sponsored corporations. Even the major credit rating agencies, like Moody’s and Standard and Poor’s, the entities most in need a proper perspective on risk, were paid by the banks issuing the securities they were rating, and thus similarly created risks for which they were in no way accountable. As one writer wrote, it would be like if “Hollywood studios paid movie critics to review their would-be blockbusters." So to answer the question of why the really smart finance guys didn't figure out that they were building a house of cards - they had no incentive to.

After The Sale

For whatever went wrong in the mortgage collapse, the originations themselves do not appear to be swindles in the vein of those mentioned by Leff. Several critical elements are missing, especially a fabricated back story or the artificial creation of some reason why the con man and the mark must work together but not with others. One could argue that the mortgage companies needed a particular borrower for any given loan, since only that borrower had purchased the home, but that would be a somewhat strained interpretation, especially within the open and competitive market that existed for mortgage lending. That said, which mechanisms identified by Leff help explain the way that borrowers act after the sale, especially when their mortgages are underwater?

Wall Street was playing the game. They took their risks and they certainly knew how to walk away from a bad deal. Why aren't individual borrowers allowed to play the game too? Instead, they are the ones being called upon to make good on the moral obligations that are somehow being read into the contracts. What are the things that mortgage companies do to altercast their borrowers into a certain role? For one, they call the borrower a “homeowner.” Of course, there’s a difference between that and owning your home free and clear. Yet the mortgage industry wants you to be a homeowner right away, regardless of what sticks you get in that bundle - because why would a homeowner walk away from the home he owns?

It's not only the actor that's being cast in a certain light, but the deal itself which is being burdened with all sorts of extraneous notions. Leff notes that we are a society that is skeptical of gifts - "You don't get something for nothing." For borrowers whose homes are under water, the problem is not that they were mistakenly convinced they were giving something in return, but rather that they're mistaken about exactly what that something was. When you take a mortgage, you borrow money in exchange for a promise to either pay it back or forfeit the security. Banks can lend money to the government for 30 years at a rate of 4.625%. Borrowers need to look at the rates they're paying on their mortgages and ask one simple question - why are they charging me more and what does that mean about the promise that I made? Once they understand what that promise actually was, they will know it was not to help the bank hedge its bets.

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