The money pool and housing push meant trouble

Up until about 2000, a family house cost about three times annual earnings. Since then it has gone up to near five times. There were two pillars behind this. One was the massive money pool looking for a return on value and the other was a social imperative for home ownership. The combination was ugly. E. James Welsh describes how the result in It’s not rocket science, his investment letter for April 20.

The decline in lending standards however exposed a fatal flaw in the securitization of mortgages. If there are no negative financial consequences when a prospective home buyer can purchase a home with no money down, a mortgage broker can help a prospective homebuyer directly or indirectly falsify data, and a lending institution doesn’t have to maintain lending standards if they know they’re going to bundle the ‘bad’ loans and sell them to be securitized, an open season for fraud and abuse is created. Everyone involved got to make a lot of money, as they shoveled the bad loans to unsuspecting buyers of mortgage backed securities. This type of fraud was allowed to develop over a period of years, while the Federal Reserve, Federal Deposit Insurance Corporation, and Office of Thrift Supervision did nothing.

Another recent report described how thousands of houses in Las Vegas were vacant and more undergoing foreclosure while builders were busy trying to meet the demand from folks who could not compete in the market to buy the vacant houses. This sounds odd but it is an illustration of the money pool desperately seeking something better than the extremely low cash instrument rates of return or the highly volatile stock market. That money pool is the retirement fund for both private investors and public pension plans and they want both security and a high rate of growth. Those goals are at odds with the idea of using capital for business growth. That puts it in competition with the basic needs of families as illustrated in the Las Vegas housing market. It will take a while to figure out how that is going to work, especially if the failed paradigms of socialist efforts from the past are to be taken to heart.

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