Liar Loans Faulted For Subprime Mess (Market Forecast)

You want to buy a house. You have no job, not enough income to buy the house you want, own a business or for some other reason do not want to disclose your financial information to your friendly mortgage broker. Of course he will ask for financial information, but if you resist, no problem. Welcome to the Liar Loan. Even Jim Carrey would be proud.

If you or your mortgage broker lie on your application it’s fraud, and no doubt there has been ample fraud on both sides of the table in the latest housing boom. But, at some point consumers have got to be responsible for papers they sign during their voluntary conduct of commerce. To now claim that they were swindled in large numbers is a red herring and doesn’t hold much water with me. Moral hazard (the risk to the greater-good of the government not bailing society out of self-created problems) is a complete joke. If you are living in a McMansion and working at a McDonald’s, at some point along the line you might have stopped to ask yourself, how is this possible?

Now Congress is rattling their cage to create more laws to help homeowners who were defrauded. The last thing we need is more laws. Enforce the ones we’ve got – fraud is a crime. Without further proof I would be inclined to believe that in 99 percent of these cases the consumer is at fault. Please do not apply for a loan you cannot reasonably expect to repay – plain and simple. The mortgage brokers are probably not also acting as real estate agents, saying here’s a huge house you can’t afford and I’ll forge the mortgage documents to help you get the loan. At some point, usually the beginning I’m guessing, the consumer became contractually obligated to purchase a house at a price that was both known and negotiated at the time of the deal. Beyond that, the words “teaser rate” and “adjustable” should have been huge clues as well. This is not home ownership; this is called speculation, pure and simple. Buy now with a 2 percent ARM, refinance in two years or put a little lipstick on that pig and flip it for a big capital gain in an ever-rising market – they never go down you know. Caveat emptor lives in my book.

Here’s some other stuff related to this topic. It seems nobody (Garrison Asset and a few others excepted) is paying attention to financial market risk right now. Although they have widened in recent weeks, junk bond and other credit spreads (the increased yield they pay over risk-free securities like treasuries) are the lowest they have been in years. Debt levels, both consumer and government, are huge. Our trade deficits are enormous and growing and the U.S. Dollar is near the all-time lows of the last 30 years. Oh, and the terms have changed too. Twenty years ago during the early days of the junk bond market we had what were called Pay-In-Kind bonds. If the company couldn’t pay cash interest they would simply give you more paper. Today, in an apparent nod to something right out of Teen magazine or the “Junior Investment Banking Journal”, the junk bond market now has something called a “toggle” note. Same thing as a PIK – different name. How cute.

There is currently a huge realignment going on in the subprime lending market and spilling over into collateralized debt obligations, which buy subprime paper and repackage and reprioritize the underlying cash flows, providing more lipstick for the farm animals.  Housing will likely continue to slow, lending standards will improve, consumer spending will decrease at the margin, hopefully no more, and the effects will be felt well into 2008 and 2009 as a huge number of teaser adjustable-rate mortgages are reset.

We’ll continue to monitor this shake-out as to its implications for the broader economy. The Federal Reserve seems to be having a “Goldilocks” moment right now with interest rates and the economy, not too hot and not too cold. There’s talk of the Government providing some form of rate-relief and term extension on the most egregious subprime loans – again, the moral hazard thing, but I am not clear as to why this is necessary, except in the case of clear fraud on the part of the mortgage broker or lender.

My next purchase? I think I’ll buy the Sears tower with the techniques of no-money-down I learned from a late night infomercial. That, a liar-loan and some lipstick – piece of cake. Do you think I can claim I didn’t know? 

(Glenn E. Atkins, CFA, is executive vice president and fixed income portfolio manager at Garrison Asset Management Co., a registered investment adviser in Fayetteville. He may be reached at [email protected].)