The Ascent of Money – Summary Chapter 5 Safe as Houses

The concept and desire to own a house is baked into our minds from early in life, take as an example Monopoly which was at the time hugely popular and widespread. “Safe as houses” is the popular expression, also because of its use as collateral for loans. Banks are happy to provide loans to buy a house, and this has increased 75-fold since 1959. In earlier times, it was only the aristocracy that owned both land and houses, and live off its rent. And only house-owners were allowed to vote in the earliest days of democracy. But as inflation rose and industrialization diminished the importance of land, the economic relevance and political power of the land-owning aristocracy decreased as well. A regular job, with a regular income, became more important than titles and land income. In the pre-Great Depression period, the US was a place where not many workers owned a house and mortgages to obtain them were uncommon. With the Great Depression, a lot of foreclosures happened and social unrest was on the rise. F. D. Roosevelt’s New Deal answered the concerns of the huge groups of unemployed Americans who were more and more inclined to listen to communist voices. It increased the opportunity for average workers to afford an own house and lots of public housing was developed. The Savings and Loans, and later the Federal Housing Administration standardized lending, offered low-interest and long-term loans. As the collateral was ‘safe as a house’, a secondary market of these mortgages was created. The Federal National Mortgage Association (Fannie Mae) issued bonds and bought the loans, thereby making the loans cheaper. By 1960, 60% of the population in US was a house owner. There was another dimension to it: most people enjoying the surge in ownership were white. Black citizens were considered credit unworthy and had to pay much higher interest. This resulted in racial unrest and much struggle, but it was only in the 70’s that the situation improved, that discriminating against blacks became a federal offence and that banks were under pressure to lend to minorities. In the UK, the emphasis was much more public housing than on cheap lending. Also there, the property-owning democracy slowly became a fact, helped by a higher inflation in the ’60s and ’70s. The Saving and Loans, mentioned before, struggled with the inflation and later with the increase in interest rates in the 70s and consequently were deregulated. They were now allowed to invest in much more than long term mortgages, but still insured by the state. This created reckless investing and outright fraud, the biggest of which was the Savings and Loan Empire case in Texas. The management rose funding from brokered deposits and was used to develop empty land into business parks and residences, paid for by investor who borrowed from Savings and Loan Empire. By the time the liabilities were far higher than the assets, which could never be sold at the value that they were accounted for. The company went bankrupt and management was convicted, but it appeared that the entire system of Savings and Loans had been running the same scheme country-wide. The total cost to US was 154 billion USD (123 billion to be paid by taxpayers) when the investigations, trials and reorganizations were finalized in 1991. Who was buying the mortgages that all the Savings and Loans associations throughout the US were selling off? A new breed of Wall Street traders bought them at rock bottom prices (in the ‘80s), repackaged them into big chunks and sold them off as bonds. First the government-insured ones, later anything else that could be sold. Securitization was born and took away the natural social bond between lender and borrower. The consequences of this anonymity, leading to poor judgment of the solvency of the underlying borrower, would emerge in the crisis of 2008 and onwards. One often reads about the comparison in return on real estate vs a return on stock indexes. But this is not easily done due to differences in liquidity, volatility and depreciations. Furthermore, should one include dividends and house rents or just look at capital appreciation? What become apparent, by any measure, is that investing in real estate does not give a bigger return than stock, it actually declined quite significantly in some US regions during the last crisis. A part of the problem also comes from ‘subprime’ mortgages, meaning mortgages with borrowers who aren’t really creditworthy and who will run in trouble after the ‘tease period’ with artificially low paybacks ends. These were exactly the mortgages that were repackaged and sold off. Large groups of people, often of ethnic minorities, never had the chance of owning a house and now got it at incredibly cheap rates. The federal government under Bush was even supporting the trend by subsidizing first-house purchases. The assumption was that real estate prices would keep rising, people would keep their job and interest rates would stay low. In the mean time, the subprime loans were repackaged and sold as triple A investments, rated by Moody’s and Standard & Poors, in theory to those who were best able to take the risk, but in practice to those that did not fully understand the risk. The moment that interest rose, the debt became unbearable and showed to be much higher than the assets of a mortgage holder. The fire rapidly spread, and estimates show that in US around 2.4 million foreclosures, the equivalent of 12.7% of mortgage lenders, are likely to hit the real estate market. In the meanwhile, banks parked their exposures in off-balance ‘Strategic Investment Vehicles’ to hide their losses. When the interbank credit market went into a crunch, many banks and investors found themselves in liquidity crisis. As confidence dropped, the subprime crisis triggered a worldwide one. Fannie Mae and Freddie Mac, the companies put in place to facilitate property ownership to a wider public, were largely undercapitalized and had to be sponsored, in fact owned, by the federal state. Another aspect of property ownership is its potential for injecting capital into the poorest layers of society in Latin America and other places. Peruvian economist Hernando de Soto has the following theory: if the process to obtain legal ownership is simplified, it would mean that the poor living in their little shacks in the third world’s overpopulated capitals would have a collateral for a loan, thereby providing capital to unleash their capitalist energies. It would also bring them up for effective taxation and strengthen democratic tendencies. But the model has been tested, challenged, and proven not very effective or fast to provide loans to property owners. It will also, in less secure places, give rise to speculation and eviction of the slum occupants. It seems that the real security lies not in the ownership of a house, but in a steady income. Another way to fight poverty, is to provide micro-credit. The experience has proven that, contrary to practices which existed until the 70’s, women are better credit risks than men, and more likely to successfully invest it to bridge an agricultural season or start a small business. It has proven to be so successful that it has spread throughout the third world, but also to some segments of the developed world. Interest rates can be high, as is the risk, but as an overall business micro-finance is profitable, thereby attracting parties not necessarily interested to fight poverty.

Advertisements

About curiousmanager

In life there are generalists and specialists. Although your job pushes you down towards a certain specialization, I feel it's important to keep your eyes and mind open for new stimuli. And I want to share my journey through arts, literature and sciences with other knowledge workers and managers. You don't have time to read. Let me do that for you and present only the best of the best in my blog!
This entry was posted in Readings for Curious Managers and tagged . Bookmark the permalink.

One Response to The Ascent of Money – Summary Chapter 5 Safe as Houses

  1. Alexa Virdi says:

    The summary of first five chapters of Ascent of Money are great. Do you have summaries of last five chapters please?

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s