Monday, November 24, 2008

Complexity of the Subprime Bubble

I just learned about 'Down Payment Assistance programs' that proliferated in housing bubble. In these programs, a home builder (D.R.Horton) giving a “gift” to the nonprofit (eg, Nehemiah Corporation), then gives the downpayment to the buyer, which then qualifies the mortgage for FHA guarantee! The FHA actually presumed this gift money was 'like' a down payment, and so then meant they didn't have much risk. Indeed, the FHA required the builder to make such a donation to the nonprofit to then be eligible for the mortgage support. This is a very complex set of favors that allow all sorts of butt-covering. Often, the house price is inflated by precisely the amount of the 'gift' (around 5%), so this is just a small little escrow for the builder. The Wall Street Journal discusses how this created no-money down mortgages on $480k properties. This program by the FHA was rescinded in October 1, 2008. Interestingly, the FHA has no data on what percentage of the loans it guaranteed were based on this corrupt practice.

That's the kind of program that just guarantees a bad ending. To see the government agencies involved in so much of this, it really defies credulity to think 'more regulation' would have prevented the crisis, as opposed to making it worse. While the FHA does not allow this practice, it still provides loans for people who merely have 3% of the house price to put into a down payment! For those arguing for 'more' regulation, does that mean more of these loans?


Anonymous said...

the fact that 'sophisticated' playas just learn about DAP, after emitting opinions on the debacle for months, tells you all you need to know why it happened.

Eric Falkenstein said...

I was not an investor in these deals. Like everyone else, I'm very interested in why it happened, and am learning new things about its genesis all the time.

Anonymous said...

not yourself, but the whole class of fund managers. connecticut is far, far, away in a galaxy from what happens in the real world.

fact is, money became too concentrated in a few (mostly incompetent) hands who can distort the markets too easily. see hedge funds ganging on the same names (porsche, GE) w/o much due diligence. GLRE's last call was a peach.