[Read Part 1 here.]
Let's say you're a young professional couple from Cleveland, eager to pop out some kids. It's 2004. You want to do what young professional couples eager to pop out children have done at least since World War II: own your own house in the suburbs. It's the American Dream.
Okay, you're not quite a young professional couple - more like an aspiring professional couple. Neither of you have been able to get a remunerative job in your chosen field yet, but you're getting by, and you think your prospects are good. You've been ambivalent, thinking about renting a few more years until you can get up on more solid financial footing. Then the president helps you push away your fears. You hear his exhortation, in June of 2004: "The more ownership there is in America, the more people have a vital stake in the future of this country." You put aside your doubts. For you deeply admire President Bush, deeply trust him.
You assemble your pay stubs for your appointment with the mortgage broker to document your too-meager income with fear and trembling. (You're working at Comp USA, waiting for a job worthy of your computer science master's to kick in. Your wife, a teacher, isn't working full-time at all.) Then a friend tells you something remarkable: he's just returned from the mortgage broker's himself, and lo and behold, he had not even been asked for documentation of his annual income - just to state it. Your friend, fudging a bit - he, too, feels his current income incommensurate with his true prospects - gives the number he expects to be pulling down next year, once that job he's interviewed for comes through.
You put away your pay stubs, and decide to make like Dick Cheney describing Iraq. Your assent into the upper-middle-class will be a cakewalk. You prepare to tell the broker your income is 75 percent more than it actually is, but still steal yourself for disappointment. You know what the mortgage deal was like for your older brother, the doctor, ten years ago, and there's no way you can afford those kinds of terms.
You turn out to be pleasantly surprised.
The interest rate? Next to nothing for a start, he says. We bank on people like you, whose incomes can only go up, up, up. We're able to do that by customizing a low, low interest rate for now, when you're just getting on your feet. It will "reset" to something higher in two years, and you smile confidently: you'll be doing great in two years. No need to pay down the principle on your mortgage for ten years, the smiling salesman then adds - you can pay it in a lump sum ten years down the line. By that time you'll be doing just fine, you tell him about how you might be buying into a cousin's contracting business in Fresno, California, where houses are popping up like dandelions after a summer rain. "I know," the salesman smiles. "We're doing a hell of a lot of business out there. I just read a magazine article that listed Fresno as one of the new 'headquarters of the American dream.' 'Ownership Society' and all that!"
You smile - a fellow Bushie! - and exchange a joke about John Kerry shooting himself in the foot in Vietnam.
Though even the lowest monthly interest payment he can offer you looks a bit prohibitive - you and your wife are choking on student loans from professional school already, and he's talking about taking 50 percent of your gross income here. Apparently your not-so-poker face betrays you. Brother Mortgage Broker smiles that used-car-salesman smile. Though you don't see it as a used-car-salesman smile; you just think he's your friend. He explains that, just for you, he'll give you an "option ARM" loan in which you can pay less than the stated amount of interest each month, simply by adding to the outstanding balance, you figure if he's willing to take that risk, why shouldn't you? You figure his faith in you can't be misplaced, after all, for if you can't repay this mortgage, isn't he as screwed as you are?
"I tell you what," he adds, with a look that suggests a guy at the track taking you into his confidence with a can't-miss tip. "My bosses are letting me try something new - no down payment. We'll just 'piggyback' it - combine a first and second mortgage into one.
That sounds a bit dicey. You put aside your doubts. The guy who holds your mortgage, after all, is your business partner, right? You don't pay, they don't get paid. There's nothing in it for them just to get you to sign some piece of paper. Right?
You tell a friend about your great deal, and he's dismissive: he got the same deal himself. Says you'd been suckered by bothering to show up at an office in the first place. He was able to do it all with a broker over the Internet and pay a much lower fee. You feel a bit taken, but also a bit superior as well. Your mortgage broker is solid, trustworthy. What kind of fly-by-night outfit sells mortgages on the Internet?
The broker's name is Fred. The customer leave Fred's office at 10:30. Fred charges into the conference room, shaking his head, relating his latest triumph to high-fives all around. He's just unloaded a NINJA--a "No Income, No Job, No Assets" loan. "I give this kid three years before he forecloses." The other brokers make their own predictions, adding you to the office pool. Fred returns to his cubicle. Then, with a few keystrokes on his computer, he does what it is mortgage brokers do in order to make money: he dumps the new mortgage onto the "secondary market" - another strand in a complex bundle that will sold to investors as a security in the "booming" housing market. People are still buying these things like hot cakes. The prices of the homes are appreciating so steadily and so fast that these real estate securities feel like licenses to print money. Over in Fred's shop, the brokers aren't sure the prices will hold. Some of the brokers are betting the housing bubble will burst, and have hedging their bets by dumped their own positions in the housing-securities market.
They have not, however, hedged their bets by stopping the pushing of NINJA loans on penniless professional coupes just starting out. For that, indeed, is a sure bet. They've already earned their money--from customer fees, and from selling the loans to Wall Street. They don't care if you can keep up with your payments, or even if you foreclose. They've earned their money either way. They have no incentive to be responsible. In fact, their incentive is just the opposite. Their incentive is to do what has just been done unto you - a wildly irresponsible loan combining all of the most colorful innovations in their bottom-feeding field: a "ballooning," or interest-only, payments until the lump sum comes due in a decade; a "liar loan" in which the borrower need produce no documents of his income; an "option ARM" with a "teaser" rate; a "stretch loan" that even with all these blandishments still eats up 50 percent of the borrower's (notional) income; a "piggyback" feature in which a first mortgage is structured to build in a second mortgage that requires no down payment.
No used car salesman could get away with this stuff, and Fred knows it. He takes his pals out for a leisurely lunch. He orders the most expensive wine on the menu. They toast to their firm's lobbyists in Washington and the state capital - the boys who've made it all possible...
[Tomorrow's installment: you move in. Then you move out.]
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