Monday, August 25, 2008

How About Subprime Scuttling?

Here's more proof that people do really care about real life--people are still talking about the subprime mortgage mess. We finally have a real world topic other than the invasion of Iraq that lasts longer in the media than Tom Cruise jumping on Oprah's couch or Britney Spears shaving her head. There may be hope for us yet. But let's not get too optimistic. There is still talk of "bailing out" borrowers who are defaulting or about to default on their mortgages. And by "bailing out" I mean using the money of people still able to pay their mortgages and of people who don't even have mortgages to cover the principal that the defaulters cannot cover.

There are several plans that have been proposed by several people, but there is one basic idea common to all of them. To recap the mortgage crisis, people who could not afford the house they bought and lenders who did not care if the buyers could afford the house they bought, bought houses and lent money, respectively. But then the lenders, who would have cared a lot more if they maintained ownership over the loan, sold the loan. If I loan you $10 at 10% interest, then sell that loan to someone for $11, it doesn't matter to me whether or not you can come up with $11 because I'll have made my money already. That's what lenders did. Only to make things worse, they packages the loans and sold them in bulk to groups of investors. That then diluted the perception of risk. So if I sold your $10 loan to my friend Joe, he would definitely care if you could come up with $11 in the future to pay off the loan. If you didn't seem like the type to be able to pay, he surely would not buy the loan from me. But I could sell your loan to 10 people for $1.10 each, and given the dilution of risk, they may not care quite so much if you could pay up in the future. That's what happened to these subprime mortgages.

So of course, these borrowers began to default on their mortgages. And as more and more of them defaulted, the owners of the loans (now sold, or "securitized" and dispersed) began to fully appreciate the risk of owning part of these loans. Of course, they would like to ensure that their investment in safe, but they cannot, because that is the point of buying loans. So as defaults become more frequent, the investors' risk of losing money rises quickly. After all, a defaulted loan pays no principal nor interest. Without principal, the investor gets none of his initial investment back, and without interest he makes no profit. So an investor can either stomach the risk and quite possibly lose a lot of money, of he can sell his stake of the loan. And that's what investors did. And the banks that sold the loans had to "buy" back the loans from the investors, albeit at a lower price. That leads to massive writedowns by the banks and loss of a bank's capital.

Okay, so it's more complicated than all that. But the flow of money and passage of the buck is true. Now so far, nothing has occurred that should make anyone believe the government needs to bail out these fools who bought a house they could not afford. That is where the supposed aftermath comes. What happens if a house in your development goes into foreclosure because the owner defaulted? Statistics say that neighboring house values drop about 4%. It goes up more if more owners default and lose their houses. That means that Joe Schmo loses home equity and cannot take out a HELOC (Home Equity Line Of Credit) because his house has little or no equity now, and so he cannot put in that backyard pool, or buy that BMW X5. Joe then theoretically spends less overall and that hurts the economy, and maybe your business then feels the crunch. Also, property taxes will fall because now homes are worth less. That means your district/city/county will have less to spend on potholes and teacher salaries (or on kickback endorsed construction contracts and high school athletics). So you can see how the greed of several million people affect everyone financially.

What's the solution, then? Well, according to the "experts", the solution is to bail out the borrowers. Most could care less about the banks and investment institutions, who are blamed for lack of disclosure to borrowers regarding risks and lending to borrowers at high risk of defaulting. And how do we bail out the borrowers? We reduce all their mortgages to an amount closer to the new price of their houses. The government takes over the mortgage and steps in if they default on the new lower price mortgage. But don't you worry, general public, not one cent of taxpayers money will go towards this schema unless the borrowers default on the new loan and Uncle Sam has to step in the foreclose. The foreclosure process does cost money, after all. Thus, the default and foreclosure rates will level out and decline, neighboring house prices will stabilize and climb, Joe Schmo will take out a HELOC and spend spend spend, and your community can keep it's inflated budget going strong. Everything will be all right.

Excuse me? Why are we simply giving these people a lower price mortgage? And they still get to keep their house? So we are essentially treating the bad borrower as an innocent victim? The only way that will ever happen is if you divert the public's attention by saying the economy is going to implode if we don't...oh, that's already happened.

The inherent problem that is not being addressed in that the vast majority of borrowers who are now defaulting did not buy a house to have a home. They bought a house to have a cash cow. They bought a large house with a little money and a lot of unfounded optimism that the real estate market would continue to grow. An important point to make is that even people who have had mortgages for over a decade and are worried about their house value falling bought a house for a cash cow. A house is an investment. Investments are risky. If you cannot handle the risk, you shouldn't make the investment. The correct solution is to refinance the bad borrowers for a slightly longer period of time (40 years), but not too long in case they aren't around to pay, and for the SAME AMOUNT as the original mortgage. They would get to keep their house in this case. Alternatively, they can LOSE the house and have to pay the difference in original mortgage and selling price of the house (as though they simply sold at an inopportune time) and possibly with a longer term on the new mortgage. Both ways preserve the nature of investing as a risk and allow some leniency to ensure payback.

The poor handling of the mortgage crisis is a clear case of capitalist gains and socialist losses. Capitalism works both ways. If you want the chance to ride the real estate bubble, you have to accept the chance it'll burst on you. And you'll have to suck it up and take the loss like an American, because this is one ant that isn't going to help you come winter, grasshopper.

Monday, August 11, 2008

Skipping a Generation

It's baby mania! Who can resist the cuddly cuteness of a baby? It inspires only gushes of awe at the miracle of birth and hope for another generation. And what about twins? So cute! Triplets? Cuter! Sextuplets? Can we take them home? How is it that babies of multiple births are more like kittens of a litter than people? A discussion for another time. There are two trends in pregnancy that are making headlines more and more frequently. The first is that women are waiting longer to have babies. This means that more and more women are older when they have their first child. The second is that there are more and more women having multiple births--twins, triplets, quadruplets, sextuplets, etc. From the individual woman's standpoint, it makes sense--establish your career and other dreams while you're young, then have a child that you can comfortably raise in this financially troublesome world. From a sociological standpoint, there are broader ramifications on the balance of society.

First let us clarify some points. I don't know if the average age of first pregnancy is rising or falling. That more and more women delay pregnancy into their thirties and forties would suggest that the average age should be climbing. But taken with the data that the average age of first sexual experience is falling over time, you would expect that many females are getting pregnant earlier as well. I would believe that the average age of first pregnancy is not changing much at all. I would believe that the ranks are swelling at both extremes of the spectrum--younger and older.

There are also data that demonstrate a large increase in the incidence of multiple births. Looking at twins alone, which is obviously the most common multiple birth outcome, that incidence has increased over time. Within twins you can have monozygotic and dizygotic twins. Monozygotic twins come from the same egg, and dizygotic twins from different eggs. With the coming of age of fertility medicine, and with more and more older women using fertility drugs to get pregnant, you can guess that the incidence of dizygotic twins has increased, whereas the incidence of monozygotic twins has not. Fertility drugs to increase ovulation results in a higher chance of fertilization of not just one egg but multiple eggs. Also, implantation of multiple fertilized eggs increases the chance that not just one but multiple zygotes will attach and thrive in the uterus.

Let's look at the celebrity news. Celebrity baby news has always been a front page story. I don't remember when there were this many multiple births among celebrities--Angelina Jolie, Marcia Cross, Julia Roberts, the list goes on and on. It seems that these twins are also dizygotic or fraternal twins as well. Now I can't comment on whether or not these celebrities had fertility treatments, nor do I care what their publicists tell the magazines, but the data implies the answer. And while not of the same gossip caliber as celebrities, older women all over are seeking fertility treatments to help them have children. It is not just for women who have had severe endometriosis or intrapelvic scarring or primary hormonal imbalances anymore. It's become the botox of obstetrics.

What is the ultimate impact of all this? If we accept that there are more women getting pregnant at both extremes of age--teens and late thirties to older, then you would have a very interesting scenario. Let's follow two hypothetical females, Andrea and Betty, both are 17 years old, making them Millenial-Gen Yers. Andrea gets pregnant on her prom day, while Betty waits until much later and gets pregnant at age 37. That puts their children in two separate generations. While that may not seem so unusual these days, it was quite rare just a few decades ago. But with the advent of fertility medicine and the increase in women delaying childbearing, you can see that it will become more and more likely that there will be a wider and wider generation gap between parents and their children. We can already see some of this in families that must maintain a two income stream in order to survive. Many of these families rely on their parents for daycare, resulting in childcare by a generation two steps back.

It is difficult to predict how this will affect family and societal dynamics, but one thing is for sure, it will something that neither Norman Rockwell nor the latchkey kid have experienced.