AUTHOR: Ken Verrett is the owner of Acorn Appraisal Associates, a 22 year old firm offering a wide range of quality appraisal services to the Financial and Business Communities in the greater Houston SMSA
Runt Rants has written several times on the Sub Prime Crisis. Its an old story now, winding down through the system, taking its toll on the various parties, some deserving, some simply caught up in the market adjustment.
We've talked about the folks that were the worst players in my view; the Investment Banking Firms. (Wow! Such a moniker! No wonder they changed it from Snake Oil Salesmen. Much better ring to that new title. However, something about a tiger not being able to change it's stripes comes to mind.)
Investment Bankers either knew what they were selling was junk and didn't care, or they didn't know what they were selling was junk and didn't care. Same result: disaster for the buyer, disaster for the market.
Now, one of my favorite blogs, Back Talk, has taken on the Sub Prime Story and decided to research it.
I couldn't wait to read his thoughts and conclusions! I mentioned last week that I have been reading Back Talk for a number of months, and I have been impressed with his research skills, his relatively balanced assessments, his ability to back his conclusions with facts, often presented in easy to decipher charts.
Back Talk doesn't trust the media. He preaches that we shouldn't either, that it is our responsibility to do our own research, look at all sides of an issue, and decide for ourselves. That's my view of the appraisal profession, and my goal in Runt Rants. Present some facts, perhaps alternate views, and let you conclude what you will, which will then allow you to make the best decisions for your business.
I wasn't disappointed in Back Talk's assessment. Its worth your time. Here are some excerpts.
"Economic growth in the United States is expected to slow to a crawl of just 0.5 percent this year, which would mark the worst pace in 17 years, the global finance body said. The United States won't fare much better next year; the IMF projected the U.S. economy will grow by a feeble 0.6 percent in 2009, when measured by an annual average."
The IMF (International Monetary Fund) is a good source. They have a reputation of calling it like it is, where others might have turf to protect, axes to grind. Their point: the sub prime crisis is a big deal and will be felt for the next two years. Your business will be affected at least that long.
Another excerpt:
"This economic crisis has nothing to do with basic economic policies (e.g., tax rates, free trade agreements, etc.) and everything to do with lending practices that were designed to allow low-income renters to purchase a home. There are at least two parts to this story: Part A Sub Prime Loans generated by the Lending Industry and encouraged by politicians and regulators (my underlining), and Part B Mortgage Backed Investments (MBIs)."
I hadn't highlighted that political and regulatory pressure in my posts on the Sub Prime problem, but it is true. The roots to the problem go back into the 1990's with a coordinated effort by our politicians and regulators to encourage lenders to ease credit standards and make more home loans. Back Talk documents that well. If you didn't realize this point, you will now.
Another excerpt:
"Perhaps the greatest scandal of the mortgage crisis is that it is a direct result of an intentional loosening of underwriting standards - done in the name of ending discrimination, despite warnings that it could lead to wide-scale defaults."
Appraisers don't typically see the loan terms that are contemplated in the assignments they receive. But if your experience was similar to mine, you knew by the mid 1990's that lending criteria had loosened. Think about it. Do you remember doing inspections of properties, observing the clues of income status of the borrowers and wondering "why is this loan being considered?" It began with me in the mid 1990's, and continued through last year.
Back Talk documents the policy decisions that were made, well intentioned decisions in my view, but the encouragement to lenders was excessive, and the lenders bought into it and allowed themselves to over react which resulted in imprudent risk decisions. Yep, that's exactly what happened.
True to Back Talk's even handed approach, he concludes;
"I suppose this issue could be a bit like illegal immigration. In that case, many argue that both political parties see some advantage. That is, the left sees a poor population that will naturally gravitate towards the race-based and class-based solutions favored by liberals, whereas the right sees a poor population that will work hard for next to nothing, thereby benefiting big business. Is it that way in the case of lending practices? That is, are both sides to blame? At first glance, the case from the right seems a bit more plausible to me, but I don't completely rule out the possibility that the right's preference for less regulation contributed to the problem. For the moment, I'm just fascinated at how different the world can seem through the eyes of the left and the right."
Yeah, I'm fascinated with how our biases can effect our world views too. We see that so frequently in the Appraisal Profession just now. We buy into the spin and see things in the black and whites the media paints, whether our preference is liberal or conservative, and as a result we are polarized into opposing camps.
If we allow that to happen, we each end up defending our flawed positions, we harden into believing that the other side is totally wrong, and we of course are totally right, when neither is likely the case.
In the case of the Sub Prime Crisis and the politicians and regulator's roles in contributing to the problem, we have another example of that very thing recurring in our last big economic crises: The Great S&L Scam. That one was blamed on bank management fraud, with appraiser willing compliance. That was the media conclusion, and we bought it.
The truth is somewhat different. The regulatory agencies, years after that crises was over, published the most extensive study of cause and effect, long after political pressure could alter the findings. It’s a good read. The study was published in the FDIC Banking Review, 1998, Volume 11, No. 1. You can get a copy here.
Like Back Talk, its not an easy read. Fifty eight pages, lots of charts, graphs, lots of "on the other hand"s. The reader has to think and draw his own conclusions. But there are some interesting nuggets there.
For example:
"Tax breaks enacted as part of the Economic Recovery Act of 1981 greatly enhanced the after-tax returns on real estate investment, and the Garn-St Germain Act expanded the nonresidential lending powers of savings associations"
Translation: the government encouraged lenders to expand and take on more risk. The lenders did.
Here's another:
"As a percentage of total bank assets, total real estate loans rose from 18 to 27 percent between 1980 and 1990, while the ratio for nonresidential and construction loans nearly doubled, from 6 to 11 percent. A pervasive relaxation of underwriting standards took place"
Does that sound a bit like the growth of the Sub Prime market? It should.
Then, government changed their minds. See this:
"The downturn was aggravated by the Tax Reform Act of 1986, which removed tax breaks for real estate investment and caused a reduction in after-tax returns on such investment.) At many financial institutions loan quality deteriorated significantly, and the deterioration caused serious problems."
Not only did the Tax Reform Act remove those tax breaks, but they made that change retroactive, one of the few tax law changes that had been retroactive.
Investments that folks made in real estate under the Economic Recovery Act of 1981, when passive losses could be taken on their personal tax returns and actually reduce their income taxes, where suddenly not an eligible deduction anymore. That brought an instant, major reduction in the value of real estate across the country. Suddenly the investor had to make up those passive losses out of his own pocket, not out of tax savings. Suddenly the lenders had massive loan problems as borrowers couldn't make the loan payments, and the value of the underlying collateral collapsed.
All because Congress changed their minds!
There were many other factors involved in the S&L Debacle, but those listed above are major contributors in my view. However, that government encouragement and then reversal of policy was a major contributor that was never widely acknowledged.
As Back Talk notes, government played a role in the Sub Prime Crisis. To me, it is history repeating itself. Government played a major role in the last major financial crisis. We've not learned much, have we?
AUTHOR: Ken Verrett is the owner of Acorn Appraisal Associates, a 22 year old firm offering a wide range of quality appraisal services to the Financial and Business Communities in the greater Houston SMSA.
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