Friday, May 27, 2005

Our local NPR station did a talk show the other day about the possibility of a real estate bubble -- which, of course, had a pro-bubble "expert" and a no-bubble "expert", for balance. One point that was raised repeatedly was that banks, in writing mortgages, are making judgments about the long-term ability of home buyers to pay, and that they wouldn't endanger their own solvency by writing risky or bad loans. Which might be a comforting point, if it wasn't just wrong.

The problem with this argument is that it assumes that the bank will itself be stuck, long-term, with the mortgage. And that's not necessarily so. What instead happens often is that the bank (or mortgage broker) will sell the mortgage. So, the issuing lender really only has to believe that the mortgage will last long enough to flip, and will look good enough to find a buyer. So, it's not the fiscal acumen of the lenders we have to trust, to keep people from getting in over their heads; it's the fiscal acumen of the buyers. Who are they?

The usual buyer of first resort is either Fannie Mae or Freddie Mac. These are large quasi-non-governmental organizations which were established to create a secondary mortgage market, and their own fiscal rectitude is already somewhat in doubt. But, in a sense, it doesn't matter, since the whole purpose of these companies, as Freddie helpfully explains, is to package up collections of individual home mortgages as mortgaged-backed securities. And so the buck gets passed further. To whom? And what can we say about them?

Well, one of the most active players in the current secondary mortgage market is the Bank of China -- their central bank. And why are they buying American securities? They're buying in order to ship the dollars we pay for their imports back out of the country, lest a glut of dollars there reduce the value of the dollar in yuan. Everyone knows that that will happen eventually -- at which point, the value of these dollar-denominated Chinese "investments" is certain to drop as well. It's certainly no secret from the Chinese themselves, and they seem not to care, so long as the yuan stays "pegged" to the dollar over the short term.

In short, these mortgages can only get written if they look good to a player that seems to show no interest in the long-term value of its dollar-denominated investments. This is not such a comfort.

The point almost wouldn't be worth mentioning, except that both NPR "experts" didn't seem to get it -- for most of the hour, they were happily talking as if the bank that wrote a mortgage was stuck with it until it was fully paid off. One of them is a professor at the Wharton Business School; the other is described as the director of the Milsteain Center for Real Estate at Columbia.


Anonymous Mike said...

After listening to NPR for years I've finally started listening to music again. I just couldn't take it anymore. This sort of thing happens too much on NPR, which resembles CNN too much for my tastes now.

6:47 PM  
Anonymous Anonymous said...

I heard the same show. They also failed to take into account the fact that the folks who sell the loans are paid on commission and have incentives to sell as many loans as possible, regardless of whether the bank benefits or not.

I can't tell you whether there really is a housing bubble, but I think we should be worried about the amount of debt Americans are carrying into retirement.

2:29 PM  
Anonymous Frances said...

One good thing about learning by enrolling in a real estate investment course is that you'll get to know beyond what you read in books as well as articles from the internet since the experts who will teach you will be able to explain those things in detail.

2:25 AM  

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