Why you and I should not buy houses in Los Angeles County... just yet

My, my, my... If my mailbox and eMail account are any indications, the State of California and the U.S. Federal Government sure would like me to buy a house in my county right now. I have been informed no less than 13 times this month that CalVets and the U.S. Department of Veterans affairs would like me to exercise my right to a VA home loan... real soon. The time has never been better... or so they say.

I don't agree, and I will tell you why.

House prices remain obscene

Much to the dismay of current home owners and mortgage institutions, the price of houses remains obscene. How do I define that? According to classical banking doctrine, you never write a mortgage for more than 2.5 times the annual household income of the borrower. According to various estimates, Mode, Mean and Median household income in SoCal hovers between 76,000 and 85,000. That means that price on an average middle class home should $212,500. That should be the price because that is what the market should bare.

If you have conducted a study of housing prices in the San Fernando Valley of SoCal, you know that the price cap on a middle class home is nowhere near $212,500. 1,500 sqft will cost you $350,000. You can touch 2,000 sqft for the sum of $400,000, but you had better be prepared to do some repair work. In good hood, we're talking about a major fixer.

The consequence of this market structure is very simple: Most middle class people do not own homes. Most middle class people are renting. Those who bought are struggling like hell. Many of them are organizing short sales or being foreclosed. That's what's up in my neighborhood.

This brings us neatly to the question: Why lend no more than 2.5 times the household income? Who wrote that law? Why are we bound to this rule? Why not more?

The answer is pretty simple: We are currently living the consequences of ignoring this unwritten law that was pregnant with the wisdom of the elders. A youth group came up about 10 to 15 years ago that did not understand the reason why, they ignored the rules, we saw massive inflation in the price of housing, and now the mortgage industry is going bust as people cannot afford to pay what they owe.

The elders understood that 2.5X was the limit of what financially healthy people could afford to pay in terms of mortgages. Anymore and you begin to cut into their contingency funds, their health care payments, car repairs, etc. This is an unwise move for a banker to make. You can't cut the throat of the milk cow to bleed her from the neck. The cow becomes unhealthy if you do this, and you will loose your milk supply. Bad move.

Old bankers restricted mortgage loans to 2.5x to keep housing prices in-line with buyer means. Old bankers restricted mortgage loans to 2.5x to keep borrowers financially sane. Old bankers restricted mortgage loans to 2.5x to allow mortgage holders to have enough financial space for a decent life after the mortgage payment was made. This rule was best for all concerned.

Now look where the fuck we are. Houses are now unaffordable by the middle class. Most people I grew up with do not own homes, despite the fact that all our families owned homes. I am 43 and I have never owned a home. I have lived in apartments or a barracks for most of my adult life. There was an occasion when I rented a room in Mill Valley... Those who own homes cannot sell them at all, much less at a profit. Those who need to buy homes cannot afford them. The market is frozen. It is not liquid, vibrant, healthy, functional or alive. Prices have simply reached an untenable point.

The solution is simple: Those who wrote imprudent loans are going to take the ass-end of the coin they flipped when wrote the mortgage. They knew they were taking a risk, now the risk has come up snake-eyes. You lose. Of course they do not accept this! I know they are resisting this conclusion ferociously. They don't want to admit that they have a Forrest of bad paper on the books. Nevertheless, the fact is that they do.

The Market is going to get healthy... soon

Banks used the Bush/Obama bailouts to avoid foreclosing on the bad paper they hold. They only forestalled the inevitable. I believe that the foreclosure wave is coming in March 2010. It takes about 90 days to complete the process of foreclosure and put a naked house on the market. The buying season begins June 1, 2010. To be ready for this, I believe that the foreclosure notifications begin to fly in about 6-8 days. A ton of houses will be on the market June 1, 2010.

The prices will begin to fall at that point. Banks are hoping that putting foreclosures on the market at the hot-point will decrease the rate of decrease, but I think they understand that prices are going to fall. Let's hope it is a lot more than the $50K drop limit they are hoping for. A $50K drop will not restore the real estate market to health. To be frank with you, even a $100k drop will not restore the market to health. A drop from $400K to $300K is still well short of $212K. It is better than nothing, but the price is still steep for mode, mean and media people of SoCal. They really cannot afford $300K.

Uncle Sam would like my help

Of course, Uncle Sam is a wholly owned subsidiary of the Financial Houses on Wall Street. Ergo, Uncle Sam would very much like me to exercise my VA loan entitlement to buy an overpriced house and support the unhealthy market price structure right now.

This is the very best thing for Wall Street and for Uncle Sam. Interest rates are low. This means Uncle Sam won't have to give me much leverage in the mortgage interest tax deduction. This means I will ultimately pay more taxes. Also, if I buy at a high rate now, financial institutions will take a lower loss on the property they sell me from their current supply of bad paper. That's good for the financial institution because I will pay them more money.

I don't want to help

You will pardon me if I am a bid selfish, but I don't want to help. I want the market to get healthy from my perspective. I want to pay less taxes and pay less to Wall Street. I will buy after:

• The wave of foreclosures come
• The rate of interest increases, and my mortgage tax deduction increases.
• Prices go down
• I can buy $100k cheaper

The source of all this economic chaos

After carefully considering most of the key elements of the present economic crisis, I think the origins of the problem are incredibly clear; so clear that several things must be said.

• The formerly fabulous ersatz New York investment banks are at the very heart of this crisis
• The iBanks were up to no good
• The Subprime mortgage movement can be interpreted as an attempt to bring back the days of feudal debt peonage, where serfs are vassals of their patrons for life.
• Selling subprime mortgage backed securities can only be understood as an investor rip-off scheme.

In this piece I am going to state my mind as clearly as I possibly can, so that what I am saying cannot be be mis-interpreted in anyway. I will not soft-pedal.

Richard S. Fuld Jr and his boys at Lehman Brothers were running a confidence game that dwarfs the Enron case in magnitude. It is clear that the damages stemming from the collapse of Lehman Brothers far and away outstrip the damages of the Enron scandal/collapse/bankruptcy. I expect several key players from Lehman to be up on securities fraud charges soon, just as surely as Ken Lay, Jeff Skilling and Andy Fastow were. Just you wait for the FBI to conclude its investigations.

Those are some mighty tall words there, Dave! You got anything to back that up? How else am I supposed to interpret that data? What other conclusion can you draw on careful consideration?

It is already well understood that the subprime market was full of shenanigans. 3rd party mortgage vendors lied about borrower income and forged income documentation. Loan officers with the power to say yes or no performed no due diligence to confirm employment, income levels, residential status or citizenship. Gross sums, totally unaffordable to borrowers, were loaned out on the assumption that the value of the house would increase; a fact which has nothing to do with whether a customer can pay off the loan month to month. Explosive ARM loans were issued with teaser interest rates, sold at high closing costs, and then massive increases in interest were encounters 90, 180 or 360 days later. These interest rate adjustments often turned onerous loan payments into completely unpayable payments. Then you find the "interest only ARM", a super-toxic loan for speculators in which you never pay the principle, only an adjustable rate of interest on the debt. By very nature of the legal structure of the deal, the loan can never be paid off over time. Only a lump sum or bankruptcy ends the loan; all or nothing. Then you have 40 and even 50 year terms for fixed-rate loans. The quantity of interest you would pay on such a long loan is truly astronomical, often making the final cost of the house 3 times the base sales price.

It is clear that groups like Lehman brothers and Bear Sterns kept pushing the envelope regarding just what constituted acceptible loan terms. The terms for the buyers kept getting worse and worse. What can you say about a loan structured in such a way that it cannot be paid off? What can you say about a loan that would make a plumber pay $1.5 million over the course of a 50 year loan on a small rat-infested townhouse in Queens? What do you say about a HELOC? A Home Equity Line of Credit essentially issues a borrower a credit card equal to the perceived amount of potential equity in the house, and then encourages them to go buy groceries, gas and HDTVs, all of which jack up the mortgage balance. This is nothing more than an attempt to re-institute the system of debt-peonage and feudal serfdom; a situation where their homes and land are perpetually owned by the feudal lord. This is an attempt to make every man a financial slave.

The only problem is that the U.S. Federal government has limits regarding how far you can pursue a guy in bankruptcy. I should mention in passing that the financial industry tried to modify our Bankruptcy law many times in the run up to the crisis. They had some ugly successes. Ultimately, they weren't able to clamp people in irons, inside debtor's prisons, in an attempt to force repayment. Thank God for that much.

Worse, groups like Lehman Brothers and Bear Stearns clearly understood that these loans were hot potatoes. The second act of their business was to chop up these mortgages into little 'security instruments' or bonds, and sell this right to be repaid to ordinary rank-in-file investors (including guys like you and me). These were high risk instruments, designed to off-load the risk from Investment Bankers to others. Open up these bonds and you would find a motley collection of bad subprime loans. Good security for the bad bankers. Bad security for the gulible investors. Bake a hot potato in the Microwave and then toss it to an unwary investor. You charge him for the hot potato and you burn his hands also.

I still have no idea why Standard & Poors would give these shit-bonds Tipple-A ratings. Perhaps it had something to do with the Mortgage Default swaps issued by Bear Stearns and AIG... But this is a story for another day.

What should I conclude when I see an organization like Lehman Brothers borrows billions from Citigroup et al to issue subprime loans, only to turn around and sell these rubbish loans as shit-bonds to benighted investors? The scheme is clear:

1. Don't risk any of your own money
2. Borrow from groups like Citigroup
3. Pocket large fees from originating mortgages to people who can't get them any other way.
4. Give those subprime borrowers money from institutions like Citigroup
5. Don't hold the hot-potato. Chop it up with other hot-potatoes and sell it as a security to benigted investors.
6. Get Standard & Poors to rate your bonds as Tripple-A when they are not.
7. Get AIG to ensure the bonds.

What I see is a group of bandits inside Lehman Brothers and Bear Stearns orchestrating a disaster, and largely taking personal fortunes away from the deal. Richard S. Fuld Jr is not a poor man today, despite the fact that Lehman is bankrupt, and the world burns.