Wednesday, February 25, 2009

The housing crisis: I saw it coming.

To tell you the truth, two years ago I didn’t know the difference between a credit default swap and a collateralized debt instrument, but I knew a housing crisis was brewing. I did not know how widespread it would be or the impact it would have on the rest of the economy, but I knew something was terribly wrong.

I have been Director of Housing Services for a non-profit housing counseling agency for the last sixteen years. For most of this time our primary housing service has been providing prior-to-purchase, housing counseling. We provide two types. We offer single session, eight-hour housing workshops, which we call “Fast-track." We also offer in-depth, long-term counseling, which we call “Homebuyers Club.”

Fast Track is for people who are already eligible for a home mortgage. People are often motivated to take the class because it is required in order to be eligible for certain down-payment assistance programs or preferential interest rate programs. In an eight hour class the client learns all they need to know about working with a realtor; getting a good mortgage; protecting their investment; purchasing homeowners insurance; getting a home inspection; down payment assistance programs; and closing on their home.

Our Homebuyers Cub program is quite different. It is for people who have serious obstacles to homeownership. While clients learn the same things as participants in the Fast Track, the focus is on getting people ready to get a mortgage. Most of the clients in our Homebuyers Club are single mothers. Most are African American. Most are low income. Clients attend class for an hour and a half, once a month, for a year. Many clients are still not ready after a year and they re-enroll and stay in class. For many of our clients it takes two or three years before they are ready to purchase a home.

In a Homebuyers Club, we not only teach the mechanics of home buying but, more importantly, we change people’s values and habits. We teach the virtue of delayed gratification. We teach people how to clean up their credit and improve their credit score. We encourage people to get a checking account and to stop using check-cashing services. We teach money management skills and encourage savings.

Many times, after being in a Homebuyers Club for a while a Club member may decide that, rather than pursuing homeownership at this time, they are better off getting their GED or skills or training that will enhance their potential to earn more money, and then at a later time try to become homeowners. Many participants in our Homebuyers Club never buy a house while in our program but make other positive changes that will improve their lives. While the primary measure of success in this program is the number of people who actually become homeowners, the number of people who improve their lives, yet do not become homeowners, is a greater number. I have always felt like we helped a lot more people than simply the number of people who became homeowners. Since the start of our Homebuyers Club we have had over 735 people become homeowners. Unfortunately, not many of these successes occurred in the past three years.

At one time we had sixteen Homebuyers Clubs and average attendance in each club was about twelve. Now we have four clubs and attendance is only about six per club. About three to four years ago attendance started dropping in our clubs, and when we offered new clubs we had few takers.

Managing a Homebuyers Club requires providing a lot of encouragement to participants. Clients can easily get discouraged. Prior to a meeting, clients get a reminder call and a reminder post card. If a client misses a couple meetings, we try to reach them to find out why they have not been attending.

It was about three years ago that I noticed a disturbing trend. I would call a client and the conversation would go like this: “I noticed you missed the last couple of Homebuyers Club meetings and I just wanted to see what was going on.”

“Mr. Rod,” the client would say excitedly, “I have good news. I bought a house.”

I would immediately have a sinking feeling in my stomach. I knew the client was not mortgage-ready. “Great!” I would say. “Tell me about it.”

The client would start describing her new home. Then I would say, “Tell me about the financing. What kind of loan did you get?”

More often than not, the client did not know. I would ask the client to bring in her mortgage papers for review. What I would find is that our clients were getting terrible loans. They would buy their homes with no money down. They often were getting 80/20 loans with the 80% loan a hybrid adjustable, with a low teaser rate fixed for three years and then adjusting every six months thereafter. These loans had high margins and payments that would adjust steeply after the end of the fixed period. The 20% loan was often fixed but with very high interest rates of 12% to 22%.

Most often the clients had no idea what they had gotten themselves into. If they would have just stuck with our program, they could have gotten a FHA fixed loan but they did not. The temptation to do it the easy way was just too great. Also, the clients were often misled and told they could refinance before the loan reset. They were told this as if it was almost automatic. They were not told that they would have to meet income and debt and credit standards in order to refinance their loan. It was presented as something they could do almost automatically.

After a while the problem was not that our clients were dropping out of our program and getting bad loans, they were never enrolling in the first place. They no longer needed us and the discipline our program required. With “creative financing” they could buy a house without saving any money or changing their habits. They could get a loan without becoming responsible. Income and credit were not necessary. Knowing the clients I was serving, I was shocked that anyone would give these clients a loan in their current circumstances.

I saw this crisis coming. It was like watching a train on a collision course; I knew without a doubt that many of these clients were going to default.

I still believe in the goal of helping poor people become homeowners. If done the right way it permanently helps people escape terrible environments. It causes people to be more responsible. It builds wealth. It lifts people out of poverty for generations to come. It changes lives. Helping low-income people climb out of poverty is good for society and is the right thing to do.

If done the right way, low-income people can be given assistance to help them become responsible homeowners and it does not have to lead to foreclosures. Handing out mortgages to undeserving people, however, who have not leaned new skills, behaviors, and values can be detrimental to society and it betrays poor people in the process.

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  1. It's not just the working poor who have these kinds of problems. The actual majority of mortgages that have defaulted in the last year have been jumbo loans, those over $417,000. (These mortgages are ineligible for assistance under the Obama mortgage rescue plan, which strikes me as a lawsuit under "equal protection" claims waiting to happen.)

    As Dave Ramsey continually emphasizes, financial health is 80 percent behavior and only 20 percent money. Irresponsible behavior cuts across all economic classes. An awful lot of people with jumbo loans should have taken your classes, too.

  2. I think that most people in the real estate industry knew that there was a housing bubble that could not be sustained. I don't think that most people realized how severe the crisis would be once the bubble burst.

    Your Homebuyers Clubs sounds like a great program. I really believe that the concept of homeownership as the American "dream" must be changed in a fundamental way that emphasizes the responsibility aspect of homeownership in real terms, not "dream" terms. Also, I would be interested to know your take on DPA programs and whether they were a real help or hindrance.

    This is a great article.

  3. "Also, the clients were often misled and told they could refinance before the loan reset. They were told this as if it was almost automatic. They were not told that they would have to meet income and debt and credit standards in order to refinance their loan. It was presented as something they could do almost automatically." And also refinancing was contingent on housing prices continuing to go up which as we know is not always the case.

    I worked in the mortgage finance industry--Treasury--and I would see some of the loan docs for some of the loans being processed and I was always appalled at what I saw: no verifiable income, negative amortization loans, low teaser rates for two-three years and then a very high rate. And then there was the skyrocketing home prices that seemed, to me, impossible to last indefinitely. Yup, I could see a crash coming.

    "I still believe in the goal of helping poor people become homeowners." This is my only disagreement with you. My parents came to this country with very little. They worked in the sweatshops in lower Manhattan for years before my dad taught himself a trade that brought in more money. He saved 20% for a down payment which took him a long time but forced the family to be frugal--eventually my parents bought their first home without government assistance; decades have passed and they now own 3 properties and they are retired. While I think that getting poor people out of poverty is a noble goal, I wonder if making it easier for people to take on massive debt (even perceived good debt in home ownership) is such a good idea. Particularly if there is any failure via bankruptcy, taxpayers foot some (albeit small) of the cost.

    Great post BTW.