Conspiring bankers successfully manipulated the housing market
A cabal of bankers conspired to remove the supply of homes from the MLS so when they later foreclose on their delinquent borrowers, they can recover more money on their bad loans.
In a conspiracy a group of people band together to act in ways that benefit the group. Often these actions are contrary to how the individuals would have acted on their own. When the group is a business it acts as a cartel, usually with the intention of controlling prices through manipulation of market supply: OPEC is a classic example.
Since the collapse of the housing bubble, I posit that a cartel of too-big-too-fail banks conspired to manipulate pricing in the housing market by engaging in actions that ordinarily would have hurt them, but when performed in concert with the others, their actions benefited all of them.
Banks and the housing bust
Prior to the housing bust, when a borrower stopped making loan payments, the bank would foreclose on the property, calling a public auction to recover its original loan capital so that they could put that money back to work and earn a return on their capital. If a borrower is delinquent and a lender doesn’t foreclose, that lender earns no return on their investment; therefore, a lender’s incentive is to foreclose as quickly as possible and recycle the money.
Unfortunately for lenders, the collapse of their toxic mortgages that fueled the housing mania resulted in over 10 million delinquent mortgages. In 2007 and 2008 when they followed their standard loss mitigation procedures as their incentives suggest they should, the result was a flood of distressed inventory that caused home values to crash. They had a classic tragedy of the commons problem: each lender’s individual incentive to foreclose spawned a catastrophe for the whole group.
If lenders waited to foreclose, the foreclosure activities of other lenders would cause prices to drop further, so the lender who didn’t act lost more money than those that did. This dynamic causes a stampede to exit before prices fall any further. Once prices start falling, the urgency to sell increases, resulting in a rush to sell that causes prices to fall even faster. It’s a downward spiral that increases in intensity until everyone sells everything — the worst possible scenario for lenders.
Changing the rules to facilitate a cartel
When faced with the insolvency and likely bankruptcy of our entire banking system, legislators changed the rules to help the banks feign solvency until they could earn their way back to health. The government suspended mark-to-market accounting in April of 2009 to allow lenders to avoid loss recognition on delinquent loans where collateral value was far lower than the face value on the note. If mark-to-market accounting rules were enforced, banks would have recognized loan losses, foreclosed on the homes, and subsequently sold the properties. This would have exacerbated the price crash.
With the pressure removed from lenders to foreclose, it was time to try everything possible to make prices bottom and go back up, breaking the feedback loop spiraling prices downward. Accomplishing this task would require a larger conspiracy, a conspiracy involving the presidential administration, Federal and State legislators, the federal reserve, and too-big-to-fail banks.
In 2010 despite changing the accounting rules (administration), lowering interest rates from 6.5% to 4.5% (federal reserve), and providing huge tax incentives (Federal and State legislators), the powers-that-be failed to create market momentum and put in a durable bottom. Prices did go up for a while, but they later (and quite predictably) reversed course and declined for 18 consecutive months from August of 2010 to February of 2012. The first attempt at manipulating the housing market failed.
Unfortunately for lenders, failure was not an option. If house prices had continued falling, their losses would have wiped them out.
The banking cartel exercises its power
OPEC succeeded in raising oil prices by getting every oil producer to agree to cut production. This created a worldwide oil shortage that caused prices to rise rapidly and remain elevated for many years. Similarly, lenders succeeded in raising house prices by convincing other lenders to stop foreclosing on delinquent borrowers to reduce the supply of properties on the MLS.
How did lenders accomplish this task?
First, lenders modified non-performing loans, cutting deals with any borrower who would make even a partial payment. By modifying loans lenders obtained some return on their investment, and they could avoid foreclosure while they waited for house prices to recover, when they finally can foreclose and get their money back.
Second, lenders control the foreclosure process by slowly processing their long-term delinquencies. Those borrowers who refused to accept the terms of the loan modifications they were offered were allowed to squat in the homes they weren’t paying for. Eventually, and at random, lenders will foreclose on these borrowers, but they must control the flow to levels the market can absorb without negatively impacting house prices.
Third, lenders control the approvals of short sales, so they can disallow sales of properties if the seller can’t repay the original mortgage debt, effectively trapping people in their homes until prices reach peak values again.
Since lenders modify loans, hold non-performing loans on their books, and allow delinquent borrowers to squat, they control the flow of properties through the foreclosure process. Also, they control the approval of short sales; therefore, they control the flow of properties through the short sale process. Since distressed sales of foreclosure properties and short sales flooded the market during the bust, lenders controlled the bulk of the supply on the market.
Once lenders gained control of the supply, they exercised their power by halting foreclosures and denying short sales. The housing market bottomed in early 2012 due to conspiratorial behavior from a cartel of too-big-too-fail banks.
Is this conspiracy a bad thing?
Many reading this will say “so what?” Some will even cheer this result. The result of the manipulation of house prices to restore collateral backing to bad bubble-era bank loans is a boon to homeowners. Those who still had equity in 2012 when prices bottomed now possess a great deal more of it. In short, reflating the housing bubble made many homeowners rich.
But what about those who weren’t homeowners?
What happens to the entire Millennial generation who must now pay bubble-era prices to bail out the mistakes of previous generations?
Future generations must now pay much more for housing than they otherwise would have if the banking cartel had not driven up house prices. The activities of the OPEC oil cartel was decried by millions of Americans during the 1970s. While this made large fortunes for a few Texas oil barrons, it impoverished everyone else with high gas prices and caused a series of deep recessions in the 1970s.
Are high house prices any better? High home prices don’t benefit everyone. High house prices that keep rising higher certainly don’t benefit buyers who must pay higher and higher prices to own their homes. They bear all the costs but obtain none of the benefits — at least until future buyers push prices even higher.
Low house prices are important to stable economic growth. Low house prices are good for the economy because low house prices make for low loan balances and less debt-service. When borrowers carry excessive home debt, the excess comes directly out of disposable income. Since consumer spending is such an important component of the economy, the excess interest payments are a direct financial drain.
So is the conspiracy to drive up home prices a bad thing? I suppose it depends on whether you currently own a home, or if you intend to buy one. When today’s buyers are forced to pay prices 30% higher than they should be, they can thank the banking cartel and their supporters in power.
One of the hardest hit markets during the housing bubble was Las Vegas, Nevada. relative to historic valuations based on rent the crash there has been epic. As has been the case with other markets, the worse the mortgage distress the more supply has been withheld from the market (see: Low housing inventory is an indicator of residual mortgage distress). Bubble reflation is strongest where supply restrictions are the most extreme.
When the economy crashed, Las Vegas’ housing market was among the hardest-hit nationally, choked by foreclosures and underwater borrowers.Residents missed mortgage payments amid sweeping job cuts and lost their homes to lenders, emptying subdivisions valleywide. Home values also plunged, leaving the majority of borrowers underwater, …
21 percent of Las Vegas-area homeowners with mortgages were underwater in late 2015, according to home-listing service Zillow. That’s down from a peak of 71 percent in early 2012 but still highest among large metro areas and well above the U.S. rate of 13 percent.
The high percentage of underwater borrowers means that Las Vegas’s housing supply will be restricted for many more years. Those underwater borrowers are not listing their homes for sale because the lender won’t approve the short sale, and if they wait, they may be able to get out without a loss.
Las Vegas home values have climbed in recent years, but they have more room to grow than in any large metro area to reach peak levels again.
The median home value in the Las Vegas area in February was $201,900, up 9 percent from a year earlier. …
Locally, home values remain 34 percent below their peak. …
Home price appreciation will slow in Las Vegas because it is becoming less affordable, but the market still has a long way to climb before in encounters any supply resistance.
Las Vegas’ gap was largest among the 35 metro areas listed in the report, highlighting Southern Nevada’s rapid home-value growth last decade and devastating crash.
Several cities have recouped their post-bubble losses and reached new highs. According to Zillow, home values hit new peaks in 26 markets during the past year or so — but not in Las Vegas.
“In some markets, these new highs are a return to normalcy,” Zillow chief economist Svenja Gudell recently said. “The fact that other markets are still off by double digits may not mean those markets are far from being recovered. It just highlights how extraordinarily inflated home values had been during the housing bubble.”
The bubble, bust, and recovery were caused by changes in bank policy
First, the housing bubble was caused by lenders making loans with toxic terms they invented to borrowers who were not properly screened through underwriting procedures they circumvented.
Second, lenders facilitated and deepened the crash by following their loss mitigation procedures in response to the delinquencies on the unstable loans lenders never should have originated.
Third, lenders then modified their loss mitigation policies to remove the distressed supply from the MLS and create an artificial shortage of supply, a shortage that persists to this day.
Hopefully, we are back to a Housing market where prices are expensive, affordable, stable, and boring, but if we do have unnecessary excitement going forward, you can comfortably rely on the fact that it will be a direct result of some future change in lender policy.