Adolfo Pesquera: Gaming the finance system: breaking down the Housing Jungle
When housing construction was going full throttle --- hmmm? --- how was quality control keeping up? Simple answer: what quality control? In fact, many good craftsmen left the housing industry during its peak, because they took pride in their work, and wanted a pay grade subcontractors were not willing to pay...For builders and lenders, it's all about eliminating risk during the process of making a profit. Less risk equals more profit. No risk equals piles of ill-gotten profit. Homebuilders were, still are, masters of eliminating risk. Warranties written on homes are designed by homebuilders...five years ago...for every four homes sold each month, one house was going into foreclosure.
Gaming the finance system: breaking down the Housing Jungle
September 15, 2009
Adolfo Pesquera
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President Barack Obama's recent warning to Wall Street about ending business as usual may have impressed the choir, but I'm pretty sure the people that really needed to get the message are snakes.
Do snakes have ears?
That may sound harsh, but I spent the first half of this decade covering the real estate industry and I learned a few things about financing and business as it relates to housing construction and mortgages.
The first and last rules of business in these industries are the same: Rules are made to be broken.
Every step of the process has its lizards, system gamers who exploit their position in the chain of production to the detriment of the homebuyer.
Those bit by the snakes know better, but a lot of people still have little understanding of the corrupt, slippery steps taken along the way toward home ownership. Let's play out a scenario with a young couple's first visit to a new subdivision.
John Q Homebuyer and his wife, Mrs. Fleeced Homebuyer, drive into a new production housing development. There is a sales office and a lot of vacant lots flanking a brand new residential street.
The lovely couple enters the sales office, is greeted by an eager salesperson who is an employee of the developer. There is a cascading series of events about the unfold, many of which the couple will remain ignorant of throughout the homebuying process.
They should be aware that the salesperson is an employee of the developer. But they may not be aware of a lot of other things, such as:
- The lending institution the homebuilder sends their paper work to is often a "captive" lender (a mortgage bank owned or closely affiliated to the developer - that bank is strictly in the business of approving as many loans as possible FOR the Homebuilder, and holding the risk for no more than a few months; when was the last time a homebuyer in a major development did not see their mortgage company change within the first year?)
- The title company where the couple goes to sign papers and take possession, is likewise often a "captive," another subsidiary of the developer.
- The third-party "independent" appraiser the captive bank used to set an inflated value on the house is beholden to the banks he does business with. If he keeps setting prices below what the bank wants to get for the loan, he won't be getting any calls for new business.
- Homebuilders (usually synonymous with subdivision developers) are not likely to encourage homebuyers to hire a house inspector (aka real estate inspector). The good inspectors know what to look for and the housing industry is infamous for taking short cuts. Most homebuyers do not hire a third-party inspector.
- People tend to think city building inspectors fill the role of an independent third-party inspector. City inspectors are overworked and generally cannot keep up with the pace of construction (at least that was the case when housing construction was going full throttle). The majority of new housing tends to go up outside of city limits, in county districts or suburbs where the inspection process is even more lax.
- When housing construction was going full throttle --- hmmm? --- how was quality control keeping up? Simple answer: what quality control? In fact, many good craftsmen left the housing industry during its peak, because they took pride in their work, and wanted a pay grade subcontractors were not willing to pay. (Why pay a craftsman who takes his time and gives you back talk when you can hire anybody off the street for less and he'll do what he's told?) Most major homebuilding companies do not actually build anything. They do not lay down one foundation or set up one roof; their independent subcontractors do all the real work and "homebuilders" and completely dependent on the skill and reputability of these third-party companies.
- For builders and lenders, it's all about eliminating risk during the process of making a profit. Less risk equals more profit. No risk equals piles of ill-gotten profit. Homebuilders were, still are, masters of eliminating risk. Warranties written on homes are designed by homebuilders who pool warranty liabilities through companies that, again, are more beholden to the homebuilder than they are to the homeowner. The imaginary couple is buying into a crap shoot; their odds of winning in Las Vegas are better than getting a favorable outcome should a home defect issue arise.
- Avoiding risk through worthless warranties is just one component in the homebuilder's "pass the buck" game. Remember those captive mortgage and title companies? They repackage the mortgage loans to bigger banks who repackaged them to bigger institutions, still. And on it goes, or went -- something everyone with a radio in their car has heard about ad naseum (listen to NPR once in awhile). And around the world they went until there were so many of them defaulting that they came back with enough momentum to pull the rug out from under Wall Street and Main Street.
- When the loans fail - and they fail spectacularly - they are churned through mortgage servicing companies owned by the bankers, and anyone who has dealt with a mortgage servicer with a troubled mortgage has never met a more unresponsive organization. Mortgage servicers are set up to pile on fees (think of checking account banking fees times ten!); when you're in trouble, it's their job to keep you in trouble, all their bank's marketing about having a heart to the contrary.
Yes, a ton of loans went to people who should not have been eligible. And people like that, people with shaky credit, won't be getting home loans in this climate. But those who blame the consumer ignore the suppliers and their methods at everyone's peril.
Who built houses that should not have been built? Who made the valuations that should not have been made? Who approved the loans that should not have been given? Who lied to the secondary markets, passing on bundles of loans that were riskier than represented?
Snakes, lizards, alligators and dragons.
About five years ago, I went to my editor at the San Antonio Express-News with a story I put together based on my own math and the records of Bexar County foreclosures, new home sales and pre-owned home sales. The lead was impressive enough that the newspaper put the story on the front page. What the story said was for every four homes sold each month, one house was going into foreclosure.
That bears repeating. We had a ratio of 4 to 1, in Bexar County. For every four homes sold the previous month, one house sold at some point in the previous two or three years was being lost to foreclosure.
The story made no waves. More than two years before the housing market crashed, with everything going great, nobody wanted to hear that. And it was easy to disregard my lonesome warning. The experts basically said, "So what? The pool of homeowners is so large, the number of houses failing is so small."
Well, all I knew then was something was very wrong. Whatever it was that we were doing that so freaking great, it was obvious to me that it was not sustainable.
And here we all are standing in the dust of a crash that locked down the credit markets. Here we all are trying to be optimistic, looking for hope, stroking words like "free markets" and "capitalism" like they're the shiniest beads on our rosary.
Get a clue America. De-regulation means no regulation, as in no rules. The law of the jungle.
The system that got us in this mess is still fundamentally intact, and most of its worst players are just resting with their golden parachutes, sleeping off their last conflated meal.
And waiting for the next.
I see a fat, fire-breathing dragon smiling in the jungle.
http://www.examiner.com/examiner/x-18960-San-Antonio-Community-Examiner~y2009m9d15-Gaming-the-finance-system-breaking-down-the-Housing-Jungle
Comment by Janet Ahmad:
Adolfo Pesquera:
A great factual commentary
All the warning signs were there. Getting someone to listen was the hard part.
As for homebuilder âItâs all about eliminating risk during the process of making a profit. Less risk equals more profit. No risk equals piles of ill-gotten profit. Homebuilders were, still are, masters of eliminating risk.â Soâ¦..to eliminate all risk the giant homebuilding industry and Bob Perry spent millions to built themselves a state agency, the Texas Residential Construction Commission (TRCC) to eliminate risk and stifle its victims.
Homebuyers should not be denied something as basic as a home that is built right the first time. The respectable thing for the industry would be to just construct homes with pride. Instead TRCC assured that a new home warranty was not a warranty but an expensive FIGHT, assuring builders their ill-gotten profits.
No where but
Texas
does it seem possible that builders would flaunt its millions to cheat families who dare to dream the dream. It all seems so senseless. The building industry has brought this country to the brinks of destruction and gone unpunished for their shameful misdeeds.
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