John Head doesn’t like to say, “I told you so.” But the Denver real estate attorney who was the soothsayer of the terrible affects of aggressive, exploitative and sometimes fraudulent sub-prime lending does have a prediction:
It’s not over yet. Not by a long shot.
Head has represented victims of aggressive lenders. His clients lost homes they were misled into buying. Head has been a strong voice for consumer protection. He called out Colorado for not prosecuting loan fraud, even as the state suffered the worst foreclosure rate in the country. He helped drive state efforts to help delinquent borrowers save their homes.
More than a year ago, Head knew and said something others probably knew, but wouldn’t say. He said that making billions in mortgage loans to people you knew couldn’t afford the payments would eventually bite someone besides foreclosed homeowners.
“It’s going into other sectors,” Head told me in a recent conversation. “For instance, truck sales are down.”
That, he explained, is because many people finance major purchases with the extension of home equity lines of credit. Home equity dries up in a real estate market forced in the dumper by the collapse of sub-prime loan repayments.
It is all of a piece. And the piece began with the assumptions of people collecting exorbitant fees on the sale of homes to folks who couldn’t afford them. It continued with the packaging of bad loans into mortgage-back securities, which financial institutions sold to greedy investors with the promise of high-percentage returns.
Head was among the few voices who from the beginning swore that it was madness to build investment portfolios with securities backed with even a few loans guaranteed to default.
Today, he still laughs at the notion that Wall Street was capable of blending good and bad loans into investment instruments that could succeed in the long run.
To understand where the sub-prime loan mess is headed, Head urges a look at declines in overall real estate prices. Anyone forced to sell a house right now is going to get screwed by the practice of making home loans to folks who couldn’t afford them.
If I wanted to know where this is going, Head told me to look at a website called ml-implode.com. The mortgage lender web site includes an “implode-o-meter” that reports on the number of “major U.S. lenders” that have “imploded” since late 2006. The number is 144.
There is also a hedge fund “implode-o-meter” for investment groups that are now struggling to pay investors the fat returns promised on mortgage-backed securities. Since mid-2007, the website reports, the number is 14.
The lending scandal that Head warned against more than a year ago has gotten so bad today that the stock market must rely on the Federal Reserve system to bail it out. On Friday, Fed Chairman Ben Bernanke promised to “act as needed” to keep the credit situation from ruining the overall economy.
That probably means a drop in a critical interest rate controlled by the Fed. Such a cut will free up credit.
But even if that happens, it will only be aimed at protecting the broader market, not the folks who got creative in their attempt to line their pockets by exploiting poor and middle class home buyers with adjustable rate mortgages that virtually guaranteed foreclosures.
“It is not the responsibility of the Federal Reserve – nor would it be appropriate – to protect lenders and investors from the consequences of their financial decisions,” Bernanke said Friday during a speech in Jackson Hole, Wyoming. “But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.”
Those effects, Bernanke said, have been nothing less than devastating.
“Although this episode appears to have been triggered largely by heightened concerns about sub-prime mortgages,” the Fed chairman explained, “global financial losses have far exceeded even the most pessimistic projections of credit losses on those loans. In part, these wider losses likely reflect concerns that weakness in U.S. housing will restrain overall economic growth."
Back in Denver, John Head can only shrug and say, “I told you so.”