Monday, April 21, 2008

The Great Ponzi Scheme

Here's a short but great opinion piece in the New York Times - "Ponzi Squared" - about the current housing mess, and it sums up one of the issues better than I can.

Frankly I have very little sympathy for "homeowners" who put no money down on funny money mortgages and are now losing their homes. I feel like they were basically renting the house at the bank's expense. But Paul McCulley stated it much better than I could, using financial terms. Here's an excerpt:

"Paul McCulley of Pimco, the big bond manager, gave an interesting speech in which he said the recent subprime mortgage fiasco proceeded to a fourth level — one that he called “Ponzi-squared” — before it collapsed.

At the end, he said, the marginal subprime loan was:

No money down
No documentation of income
Initial below-market teaser interest rate
Negative amortization

That is not a loan, he said. Instead, it amounted to giving the home buyer a call option to buy the house at the current market price, coupled with a put option to sell the house back at that price.

If house prices kept rising, the “buyer” could make the small interest payments to keep the option open, and eventually sell the house. That happened for a time, and led to the conclusion by rating agencies that such borrowers were good risks.

But when prices went down, the “buyer” would suffer no loss if he exercised the put and gave the house to the lender. That is just what happened."

I do sympathize with those that are facing foreclosure due to hardship, disability, or other unfortunate events. But I believe that the majority of those facing foreclosure today have never truly "owned" their homes. They speculated on an investment and lost. Just as I have lost on a number of investments I have made over the past 10 years. (hello internet stocks!).


David J said...

One big problem is that the average American consumer, for one reason or another, has no financial education, and is thus susceptible to this kind of thing. So I can only put so much blame on the consumer--tons of people (coughcoughAlanGreenspancoughcough) who should have known better were saying that no money down ARMS and whatnot were great for the economy.

Kirk Coburn said...

Sad but true. Ignant sonsabitches.