Ben Facts

My job has taken me into many of the major culprits of the banking crisis over the last four years: Freddie Mac, Washington Mutual, Countrywide, and many other “mortgage originators”.

Where I first caught wind that something was amiss was at Countrywide in October 2003, when I found out that the acres of cube farms at Countrywide (7000-15000 employees) that were dedicated to loan originations were making well into six figures by originating loans over the phone. After the third loan originiation of the day, every new origination carried a new cash bonus of $500 above their standard commission, so if you could average six a day (many people were averaging seven), that would be $1500 per day above your base pay and bonus package. That seemed non-sensical.

At Freddie Mac in January, 2004, I saw two other faces of the mortgage market. The people on the phones here were the ones dealing with the banks, but four of the five contacts that I had there were part of a scheme that depended on wildly inflated home prices.

Around DC, there was lots of development of townhouses. Before a development would start, the developer would pre-sell the townhouses for 1% down on a sale price of $300,000, with the mortgage starting a year later, when the building was complete. So, the employees at Freddie Mac would put $3,000 down, wait a year, take posession of the townhouse, immediately put it up for sale for $450,000 and have it sold within a week of owning the townhouse. So, for no more than a $4,000 investment, they would turn around a $140,000 profit. And there was no limit for how many times this could happen.

All of this was funded by a housing prices that were rapidly outpacing earnings. As long as housing prices were going up, it would continue to fund the flipping market.

What few seemed to take into consideration was that this was a rapidly inflating bubble that would eventually burst and anyone holding inflated property would be holding a hot potato, and they would be severely burned when it would start to lose value.

At the same time, anyone who owned a home saw the value of their home rise exponentially. So someone who bought a $100,000 home in the DC area around 2000 would have inadvertantly been in a $600,000 home by 2006. But the only way they could capitalize on this would be to sell their house and move to an apartment until after the bubble burst.

So the same banks who were fueling the inflated home prices saw the dollar signs in current homeowners eyes. They hatched a marketing scheme to sell these people home equity loans on the increased values of their homes based on the bubble. All the people who bought and mortgaged a $100,000 house could now be given a $500,000 loan based on the equity on that house, and if the housing prices kept inflating like they had been, that $500,000 could be paid off in a year or two based on the current growth curve. Obviously there would be a market for their 1500 sq. ft. house 30 minutes from downtown DC and someone would pay $1.2 million for it at that point. Or, they would be able to take an additional $500,000 equity loan at that point.

So, the housing prices was a bubble that was being inflated by the banks loaning money to people who couldn’t afford to pay it backon the premise that housing prices were going up so fast, the banks could merely foreclose on the house and sell it for profit. And, for the people who weren’t foreclosed on, they could breathe out home equity loans based on the inflated values of their home.

If someone wanted to calculate the size of this crisis, I think it could be done this way:

• Take the historical graph of median house price relative to median income (based on this graph should be around $195,000)
• Lookat the median mortgaged house value.
• If the median mortgaged house value is anywhere above $190,000 or so, all those houses should fall relatively down to that value, leaving lots of people holding the bag for their over-mortgages (the hot potatos that they got stuck with) or over extended based on home-equity loans that were made above that.

Another way of looking at it that may work is look at the median home value now ($320,000 based on this graph), subtract the “historical price” based on price to income ($195,000) to get the inflated value ($125,000). Then, multiply that by the total number of houses (58.5 million based on data found here) to get the total inflated value of the housing market: (58,500,000 * $125,000) = $7,312,500,000,000 ($7.3 trillion).

So, the housing bubble size is $7.3 trillion.

Many homeowners didn’t tap into the home equity lines of credit. Many people didn’t buy or sell a home  since 2003, so they won’t be affected much by this bubble. But many other people are heavily leveraged in  the bubble and will be heavily affected by it.

Unfortunately, the bubble doesn’t end there. Lots of banks made loans based on that bubble (that’s where the mortgages and home equity loans were based on). All those loans propped up stock prices of those banks. This is the part of the bubble that we don’t know how big it was, or how far the loan values will fall.

But the housing bubble will be somewhere between $0 and $7.3 trillion. And how far the stock prices will fall based on that is what is being sorted out now, by our semi-free market.