Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [43]
CNN’s personal finance editor, Gerri Willis, exposed despicable lending practices. She told The Daily Show’s Jon Stewart that in 2007, “two million people (in the United States) went into foreclosure,”7 and in a CNN segment in which she and I both appeared, she asserted “the cards were exactly stacked against [the borrowers].”8 I told her that some borrowers were “actively misled” and these loans on aggressively appraised homes: “were presented as gifts, but they were Trojan Horses you could ride to your financial ruin.”9 Many minorities are stuck with an insurmountable mountain of debt and many have declared bankruptcy.
The net effect is a huge wealth transfer from minorities to builders, fee-earning mortgage lenders, and bonus seeking investment bankers.
Warren Buffett promoted affordable housing and sound lending practices; he runs a well-managed corporation that has increased in value thus benefiting shareholders; he has bequeathed most of his wealth to benefit those less fortunate. Meanwhile, mortgage lenders and the investment banks that enabled them stole from naïve borrowers—and investors (such as municipal governments).
Many people did not understand what they signed. Stretching funds to participate in what appears to be a rising housing market is merely speculation. No one is entitled to credit for speculation, and credit was pushed on people with the promise of refinancing before interest payments rose, and low-money-down loans were touted as a way to wealth in an unsustainable market in which housing prices were propped up by temporarily cheap borrowing rates. Sign here, you want to own your dream house and get rich, don’t you?
The idea that minority homeownership would increase was used as a justification for a lot of bad lending. Predatory lending practices were cloaked in a mantle of moral self-righteousness, as if steering borrowers into risky mortgage products was a public service instead of an act of malicious mischief by savvy financiers.
It is true that some borrowers knowingly overreached, but many were duped by confusing and risky loan products. More pain will come due to mortgage loans originated in 2005, 2006, and 2007. Mortgage brokers offered 40-year or 45-year adjustable rate mortgages (ARMs) in which homeowners built up virtually no equity in their homes in the early years of the mortgages. Approximately 80 percent of 2006 loan originations were ARMs of varying maturities with interest payments that reset sharply upward in two, three, or five years. For example, a 2/28 hybrid ARM has a fixed interest payment amount for the first two years, and then resets to an adjustable rate for the remaining 28 years. For a typical subprime 2/28 ARM, after low “teaser” rates of around 8 percent, many loans will reset to LIBOR plus 600 basis points, which as of summer 2008 would be around 8.46 percent.This borrowing rate, however, may be much higher by the time the actual reset occurs, particularly since the Fed will likely have to raise interest rates to head off inflation to avoid further depression of the dollar. For example, using June 2007’s LIBOR rate, the interest payment would have been 11.32 percent. And here is the conundrum facing the Fed: If it raises rates, more bad loans will default and prolong a recession. But low rates fuel inflation, which leads to rising costs such as for gas and food, and the United States may slump into stagflation.
Some mortgage loans are interest-only (IO), meaning that the homeowner does not accumulate equity by paying down principal; the only way the home owner can build equity is if housing prices rise, but as a result of profligate lending, housing prices are falling. Some of these loans were made with very low (or no) down payment, so the homeowner