I make no secret of my disdain for the behavior of bankers during the housing bubble. I’m not so extreme that I consider all borrowing and lending to be evil; however, I draw a clear distinction between what I consider good debt, useful for economic efficiency, and bad debt, useless and unproductive that results in misallocations of capital and human suffering. Surprisingly enough, the line separating the two is clear and easy to calculate and quantify.
Signatory versus asset-backed debt
Not all debt is created equal. asset-backed debt is collateralized by a cashflow-producing asset. The income stream is being used to repay the debt with interest, and if for some reason the borrower unwilling to pay back the loan, the lender can take back the property and obtain a cashflow equal to or greater than the payment on the debt.
I had the good fortune to meet a gentlemen who provides asset-backed debt from a major lender. His company provides debt for property, plant, and equipment to other major corporations. When he analyzes the collateral for a loan, he considers it’s useful life, the recovery and resale value, and the cashflow the asset may generate (if any). He assumes the debtor’s word means nothing and any recovery of capital will come solely from the collateral pledged to cover the loan. In his world, there is no signatory assurance of repayment. There is only collateral repossession, cashflow, and resale.
Asset-backed debt is essential to the functioning of our economic system. Many businesses could not raise the equity to obtain the property or equipment necessary to it’s operations. Lenders can loan against working capital at very low rates with little risk. If businesses have their money freed up to grow the business, our economy grows and prospers. In short, asset-backed debt is useful and freeing.
On the other hand, signatory debt is slavery. Signatory debt is money given to a borrower simply based on the borrower’s promise to repay. It has nothing to do with an asset, and if the borrower chooses not to repay, recovering signatory debt can be very difficult because it is not backed by tangible collateral.
Signatory debt provides no useful purpose. It provides a short-term economic boost as demand is pulled forward, but once it is consumed, money that would ordinarily have been spent by the borrower on consumer goods is instead diverted to the lender for debt service. It’s only when signatory debt is expanding that the economy is stimulated. The expansion of signatory debt is a Ponzi scheme.
Signatory debt creates Ponzis
The problem with signatory debt is simple: people don’t want to keep their promise to repay when it is inconvenient. Ponzis live to consume. They will take money under any terms offered, and when it comes time to pay the bills, they will seek more borrowed money to keep the system going. Borrowing money to repay debt is the essence of Ponzi living. Has anyone been watching events in Greece unfold?
Ponzis will inevitably spring from signatory debt. Not everyone who borrows with no collateral is a Ponzi, but Ponzis could not exist without signatory debt. The losses created by Ponzis are the only deterrent from lenders giving out free money. In our current home mortgage lending system backed by the government, without strict controls, Ponzi borrowing with home loans is inevitable.
Signatory debt is unnecessary
Someone will invariably argue that signatory debt is necessary and beneficial because it stimulates the economy. This is nonsense. Signatory debt allows buyers to accelerate purchases they otherwise would have had to defer until they had sufficient savings, but it doesn’t add anything. In fact, once consumed, the borrower must pay the bank interest rather than put the money into savings and earn interest. The difference between what they pay and what they could have earned is a net loss to spending — a loss that goes into the pockets of bankers.
Signatory debt is a crutch. It’s the only way those who don’t save can make discretionary purchases of assets costing more than a small portion of a single paycheck. If everyone saved money, signatory debt would be unnecessary as people would simply wait until they had sufficient savings to make a purchase. The proliferation of signatory debt shows just how poorly educated most Americans are when it comes to personal finances. Even the lenders have to spend money “educating” borrowers on how to use their “products” responsibly. I think people should be educated on how not to use their products at all.
Conflating asset-backed debt and signatory debt
Lenders are keen to conflate the distinction between asset-backed debt and signatory debt by over-loaning on assets. The housing bubble is a classic example, but lenders do this with car loans, commercial loans, and personal property loans.
A home loan has a component of asset-backed debt. The portion of the cost of ownership (payment, interest, taxes, insurance, HOA) equal to rental is asset-backed. If the loan balance is limited the size supportable at rental parity, the property could be rented for an income stream capable of sustaining the debt service.
However, once the cost of ownership exceeds the cost of a comparable rental, the only assurance the lender has of getting repaid is based on the signatory promise of the borrower. Therefore, the loan is part asset-backed and part signatory. When lenders cross the line from asset-backed to signatory debt, they turn good debt into evil debt and inflate asset bubbles. Lenders did this in both the residential and the commercial real estate markets during the 00s.
Once lenders cross the line from asset-backed debt to signatory debt, they are inflating an unsustainable Ponzi scheme. Inevitably, prices will crash back to asset-backed levels determined by rental parity. it’s not a matter of if, only when. We are seeing this play out across America right now with the deflation of the housing bubble.
The evil that lenders do
Lenders don’t want to make a distinction between good debt and bad debt because they profit from both kinds of loans. And since some debt is useful and productive, lenders are keen to ignore the evil they do when they cross the line. They even have the temerity to chastise the borrowers they enslave when the surfs rebel and quit paying. Lenders need to look at the distinction between good and bad debt, asset-backed and signatory debt, before they start pointing fingers in judgement when a borrower defaults. If lenders only made “good” loans, defaults would not be a cause for alarm because they could recover their capital from collateral. The lenders who complain the loudest about the bad behavior of borrowers are the lenders who provide “bad” debt only backed by the “good word” of the borrower. If signatory debt were eliminated, lenders would have far less to complain about, and a nation of debt slaves would emerge from their self-imposed bondage. That would be a good thing.
Coto de Caza is a hotbed of Ponzi living
Coto de Caza consistently ranks near the top of my monthly ratings for the best bargains in Orange County. Prices there are more than 50% below their historic relationship between prices and rental parity. There’s only one reason for this: Coto de Caza is loaded with Ponzis.
The Real Housewives of Orange County with their pretentious ways call Coto de Caza home. As it turns out, most of them were faking it, creating an image through Ponzi borrowing and blowing their future for a moment of conspicuous consumption. Since Ponzi behavior was so common there, many of these people have exhausted their sources of new credit to sustain their fake lives, and they are succumbing to the enormous and unsustainable debt burdens they took on during the housing bubble. The former owners of today’s featured property are one example of the easy-money Ponzi lifestyle rampant in Coto de Caza.
- Today’s featured REO was purchased on10/8/1998 for $595,000. The owners used a $476,000 first mortgage and a $119,000 down payment.
- On 4/13/2000 they refinanced with a $508,000 first mortgage.
- On 12/2/2002 they refinanced with a $630,000 first mortgage.
- On 5/14/2003 they refinanced with a $638,000 first mortgage.
- On 6/30/2003 they obtained a $150,000 stand-alone second.
- On 10/15/2003 they obtained another $150,000 stand-alone second.
- On 6/15/2004 they refinanced with a $901,250 first mortgage.
- On 12/27/2005 they refinanced with a $1,000,000 first mortgage.
- On 10/19/2006 they obtained a $125,000 HELOC.
- Assuming they maxed out the HELOC, the total property debt was $1,125,000, and the total mortgage equity withdrawal was $649,000.
They quit paying the mortgage in early 2009, and they were allowed to squat for three and a half years because the banks knew there was no market for houses in this price range. By the time the bank took back the property, the first mortgage debt had ballooned to $1,189,993. The bank is going to lose over $300,000 on this one.
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31572 VIA COYOTE, Coto De Caza, CA 92679 (MLS # S721445)
(all data current as of 5/25/2013)
| Price | $824,900 |
|---|---|
| Beds | 5 |
| Baths | 4 full, 1 half |
| Home size | 3,400 sq ft |
| Lot Size | 6,000 sq ft |
| Days on Market | 95; |
Exceptional design for this custom home on a flat lot which opens up to breathtaking views of serene hills and trails. Enjoy formal entertaining as well as large gatherings in the spacious family room open to a huge gourmet kitchen with a large nook area and a wine room. Main floor bedroom & bath. 5th bedroom is an office with custom built-ins. The spacious yard features BBQ area as well as a custom fireplace. New paint & carpet. A rare find in the village. Don't miss it!
Property Type(s): Single Family, Residential
| Last Updated | 4/2/2013 | Tract | Village (Village (TV)) |
|---|---|---|---|
| Year Built | 1998 | Community | Coto De Caza |
| Garage Spaces | 3.0 | County | Orange |
| Total Parking | 9 |
Listing information deemed reliable but not guaranteed. Read full disclaimer.
(view all details for MLS #S721445)
Proprietary OC Housing News home purchase analysis
31572 VIA COYOTE Coto de Caza, CA 92679
$899,900 …….. Asking Price
$595,000 ………. Purchase Price
10/8/1998 ………. Purchase Date
$304,900 ………. Gross Gain (Loss)
($71,992) ………… Commissions and Costs at 8%
============================================
$232,908 ………. Net Gain (Loss)
============================================
51.2% ………. Gross Percent Change
39.1% ………. Net Percent Change
2.9% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$899,900 …….. Asking Price
$179,980 ………… 20% Down Conventional
3.48% …………. Mortgage Interest Rate
30 ……………… Number of Years
$719,920 …….. Mortgage
$167,405 ………. Income Requirement
$3,225 ………… Monthly Mortgage Payment
$780 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$225 ………… Homeowners Insurance at 0.3%
$0 ………… Private Mortgage Insurance
$95 ………… Homeowners Association Fees
============================================
$4,325 ………. Monthly Cash Outlays
($717) ………. Tax Savings
($1,137) ………. Equity Hidden in Payment
$198 ………….. Lost Income to Down Payment
$132 ………….. Maintenance and Replacement Reserves
============================================
$2,801 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$10,499 ………… Furnishing and Move In at 1% + $1,500
$10,499 ………… Closing Costs at 1% + $1,500
$7,199 ………… Interest Points
$179,980 ………… Down Payment
============================================
$208,177 ………. Total Cash Costs
$42,900 ………. Emergency Cash Reserves
============================================
$251,077 ………. Total Savings Needed
The property above is available for sale on the MLS.
Contact us for a comparative market analysis, a cost of ownership analysis, or information on how you can make an offer today!
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22 Responses to “The distinction between good debt and evil debt”
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Optimism and False Urgency Should Prompt More Homebuying: Fannie Mae
Uncertainty over the fiscal cliff negotiations did little to shake consumers’ confidence about housing in December, according to the results from Fannie Mae’s latest National Housing Survey.
Consumers continued to show increased optimism toward home price, rental price, and mortgage rate expectations, a sign that home purchase activity may see a boost in the coming months.
“Combined with consumers’ growing mortgage rate and rental price increase expectations, the positive home price outlook could incentivize those waiting on the sidelines of the housing market to buy a home sooner rather than later and thus support continued housing acceleration,” said Doug Duncan, SVP and chief economist at Fannie Mae.
The average 12-month home price change expectation jumped from 1.7 percent in November to 2.6 percent in December, the highest level since the survey’s inception in 2010. To compare, the average price change expectation a year earlier was only 0.8 percent.
The share of respondents who believe home prices will rise over the next year also reached its highest recorded level, increasing 6 percentage points to 43 percent. The share of those expecting price declines fell to 11 percent, while the share who believe prices will stay more or less the same fell to 40 percent.
Twenty-one percent of respondents said now is a good time to sell, a decrease of 2 percentage points from November’s record high.
Now is the time to participate in a transaction that wil generate a commission
Isn’t it always? At least according to the NAR…
Sheeple rush in where Angels fear to tread…
Price gains expected to moderate in 2013
National home prices finished 2012 with a strong yearly gain, but prices fell flat quarter-over-quarter in December, according to a report from Clear Capital.
Prices in December saw a 0.9 percent quarterly increase, remaining mostly unchanged from the 1 percent quarterly improvement in November, Clear Capital reported.
Year-over-year, national home prices grew by 4.9 percent. The data provider expects to see continued growth into 2013, but estimates the increase will be slower at 2.1 percent.
Among the four regions, the West ended the year with the strongest quarterly and yearly increases at 2.1 percent and 11.8 percent, respectively. Clear Capital projects the slower growth in 2013 for the region at 2.8 percent as “buyers adjust to a higher price market.”
Both the South and Midwest saw prices rise by 0.6 percent quarter-over-quarter in December. In the South, prices increased by 4 percent yearly, and in the Midwest, prices were up by 3 percent during the same time period.
The data provider projects 2013 growth in the South to stand at 2 percent and for the Midwest to be slighter higher at 2.3 percent.
The Northeast saw the smallest quarterly and yearly gains, 0.3 percent and 1.5 percent, respectively. The 2013 forecast for the regions is for prices to increase by just 1.4 percent.
“2013 should be interesting for the housing market, where national gains should continue to see upward growth but likely at a more modest rate. Keeping in mind our current gains are off market lows at the start of the year, 2013 gains will be measured against a higher price floor after a full year of recovery,” said Dr. Alex Villacorta, director of research and analytics at Clear Capital.
I still don’t understand how these entities are making home value predictions when don’t what the tax laws, federal programs, and the definition of a qualified mortgage. All three of these variable will probably change this year.
That’s because you haven’t quite wrapped your mind around the possibility that they just make it up. Seriously. Oh, I’m sure they have some numbers and graphs of lines to show you. They have an argument for their numbers, just the way an astrologer has a logical argument for why you should marry a Pisces.
But it’s an argument based on fantasy assumptions and completely invalidating levels of ignorance, e.g. about the factors you mention. You probably think they have sufficient shame to not publish confident definite statements based on numbers somebody in the back room essentially pulled out of his ass. Not the case.
LOL! I haven’t read the truth of the matter put quite so eloquently. Thank you.
BofA Dumps Servicing Portfolio with 11.5% Delinquency Rate
Bank of America and Fannie Mae reached a $10.3 billion agreement Monday to resolve repurchase claims on loans originated from 2000 through 2008. The agreement also requires BofA to pay the GSE $1.3 billion in compensatory fee obligations.
BofA simultaneously announced its intent to sell the servicing rights of 2 million mortgage loans to specialty servicers. These loans are owned by Fannie Mae, Freddie Mac, Ginnie Mae, and private label securitizations.
BofA will repurchase 30,000 loans for $6.75 billion and submit a $3.6 billion cash payment to Fannie Mae.
“Together, these agreements are a significant step in resolving our remaining legacy mortgage issues, further streamlining and simplifying the company and reducing expenses over time,” said Brian Moynihan, CEO of BofA, with Monday’s announcement.
The agreement settles $11.2 billion in unresolved claims from Fannie Mae as of the end of September, “subject to certain claims Bank of America does not expect to be material,” according to a press release from BofA.
Fannie Mae claimed Monday’s agreement as a victory for taxpayers, with Bradley Lerman, EVP and general counsel stating, “A favorable resolution of this long-standing dispute between Fannie Mae and Bank of America is in the best interest of taxpayers.”
“Fannie Mae has diligently pursued repurchases on loans that did not meet our standards at the time of origination, and we are pleased to have reached an appropriate agreement to collect on these repurchase requests,” he continued.
Edward DeMarco, acting director of the Federal Housing Finance Agency, Fannie Mae’s conservator, called Monday’s arrangement “a major step forward in resolving issues from the past and providing greater certainty in the marketplace.”
Of the 2 million sales of mortgage servicing rights, about 232,000 are 60 or more days delinquent. Both BofA and Fannie Mae suggest specialty servicers will be able to mitigate losses on some of these past-due loans.
“We are resolving legacy mortgage issues while balancing the needs of our customers, mortgage investors, our shareholders and communities,” said Ron Sturzenegger, BofA’s legacy asset servicing executive. “The sale of mortgage servicing rights to highly rated specialty servicing companies is an important step in that process.”
We are sort in the worst place. We have a signatory debt based system where the tax payer is on the hook for all the ponzi. I’m thinking more and more just require everyone to put down 20% for purchases. And then you can’t have refinance LTV greater than 80%. We would go through some pain, but in 20 years we would have very stable system based on incomes not affordability products. Our banking system is now focused on assisted squatting by loan modification federal programs.
I strongly favor capping cash-out refinancing at 80% LTV. Texas has this law, and it’s one of the main reasons they didn’t have a housing bubble there.
Mike you make a great point. We are in the worst place. Gov guarantee means innocent citizens will pay for the mistakes. the losses will be socialized via inflation.
IR is in favor of more regulation (meddling), but fails to see that government involvement, regulation, and meddling in the banking sector is the source of the problem. Yes – government guaranteed bank accounts on a fractional reserve system, the grand folly.
Excellent post.
Although, in a fractional reserve system, ALL debt should be considered evil simply because the debt is created but the interest is not.
The federal government sells treasuries to the federal reserve to cover debt service, so they create interest as well as part of the government financing Ponzi scheme.
Government financing Ponzi schemes are the only kind that are theoretically possible (although the end is yet to be proven). A currency issuer can always print more money to sustain the Ponzi scheme. If the Ponzi scheme grows too large, rather than collapsing, it merely fizzles out in a massive bout of inflation.
Operation false hope is now 43% complete. OH, FYI tomorrow we might be a small view of the “Qualified Mortgage”. I’m not too hopeful that it will require 20% down.
About 43% of Americans expect home prices to rise
By Christina Mlynski January 7, 2013 • 9:06am
The share of surveyed Americans who believe home prices will tick up in the next year reached the highest level to-date, at 43%, up 6 percentage points from November, according to Fannie Mae’s December National Housing Survey results.
The Fannie Mae National Housing Survey polled 1,002 Americans to assess their attitudes toward owning and renting a home, mortgage rates, homeownership distress, the economy, household finances and overall consumer confidence.
Consumer confidence in the housing industry continued its upswing as home prices, rental prices and mortgage rate expectations increased in November.
Thus, the growing confidence that housing indicators will continue well into 2013 is expected to boost home price activity during the year.
“Combined with consumers’ growing mortgage rate and rental price increase expectations, the positive home price outlook could incentivize those waiting on the sidelines of the housing market to buy a home sooner rather than later and thus support continued housing acceleration,” said Doug Duncan, senior vice president and chief economist of Fannie Mae.
The average 12-month home price change expectation rose to 2.6%, the highest level since the survey’s inception in 2010.
The percentage of those surveyed that believe mortgage rates will rise continued to increase, rising 2 percentage points to 43%, the highest level recorded since August 2011.
About 21% of respondents suggest it’s a good time to sell, down two percentage points from last month’s record high. However, this is still a 10-percentage point increase year-over-year.
The 12-month rental price expectation hit the highest level since the survey’s inception in 2010, at 4.4%, up 0.4% from last month.
About 49% of those surveyed said home rental prices will go up in the next year. Also, the share of respondents who said they would buy if they were to move declined slightly to 66%.
However, consumer outlook toward the economy and personal finances due to the fiscal cliff and debt ceiling caused volatility in perceptions of the larger economy.
“This uncertainty seems to be prompting a growing share of consumers to expect their personal finances to worsen and may contribute to weaker near-term economic growth,” Duncan said.
Those who expect their personal finances to worsen over the next year increased to 20%, the highest level since August 2011.
About 37% reported higher household expenses compared to last year, a 3-percentage point increase from last month and the highest level since December 2011.
Offers down 17.5% in December as buyer demand evaporates
December saw mixed signals in terms of housing demand, according to Redfin’s latest Real-Time Demand Pulse, a measure of offer and tour data from thousands of customers in 18 markets nationwide.
According to the data, the number of customers requesting home tours fell 7.0 percent in December. While a decline in tour requests is normal for this usually slow season, buyer interest proved stronger in 2012 than it did in 2011, when tours declined 11.3 percent.
The matter of signed offers, however, was a different story. According to Redfin, the number of customers signing offers dropped 17.5 percent in the last month of 2012—a dramatic decline compared to 2011’s 10.5 percent decrease.
While the year-over-year increase in tour requests shows demand didn’t fizzle in December, it does seem to indicate that buyers weren’t particularly impressed with what they saw, Redfin blogger Tim Ellis says.
“It seems that the few buyers who were willing to spend their holidays house hunting were hopeful as they toured homes for sale, but ended up disappointed in what they found, leading to offers falling faster than a year ago,” Ellis writes.
Government Mortgage Enterprises Averaged 30% Risky Loan Purchases from 2001-2008
Posted by anthonybsanders (on his blog)
According to data gathered by the Federal Housing Finance Administration (FHFA), the government mortgage enterprises (mostly Fannie Mae and Freddie Mac) averaged 30% risky loan purchases from 2001-2008.
My definition of risky loan is 1) FICO score of less than 660 and 2) a low-to-value ratio of 80% or less.
This table is just for fixed-rate mortgages. Notice that Enterprise purchases peaked in 2003, but the percentage of risky purchases rose from 27.43% in 2005 to 36.79% in 2007.
(It’s very graphic oriented, but it’s good post.)
Still in my home after all these beers! I could rent and have someone else pay my mortgage, but I’d rather just let it foreclose and be done with all the risk, but only in 3-4 years so when I retire I can declare Chapter 7 and get rid of all the tax burdens and debt. Until then, I’ll pay much less than rent, knowing that my “home” will never rise in value, and I have at least 6 months of free living in the future.
Don’t hate the player, hate the game. After all, every one of you who votes is responsible for voting the politicians in charge that created all this. I’m glad I figured the game out in early 2008, as it has paid off handsomely for my personal goals and finances. I’m glad I listened to Planet Reality, he was right.
If you hang on for a few more years, they might even give you a HELOC, and you’d have some free money for more beer.
“…knowing that my “home” will never rise in value…”
You sound just like the rest of the herd did from 2000-2008 when everyone was saying that “real estate only goes up.”
Homes in my neighborhood keep increasing in price. Most are now selling very close to their 2006-2008 initial prices (the exception being the smaller condos that are still selling at ~20% discounts to their peak pricing). I never thought I’d see an increase in our home’s value, but its FMV is probably $150k higher than it was in the trough (2009-2010) when all of the sales were distressed. Anecdotal, but nonetheless true – prices can increase after the bubble, quite significantly.
Absolutely agree that the borrower’s signature is a piffle. Title to a repossessed property is all that can matter in the end. I’m a private mortgage lender, and I laugh at Dodd-Frank’s requirements that I investigate the income and credit of the borrower. These things are irrelevant too. DOWN PAYMENT is all that matters – large enough to reduce the loan amount to match the likely resale value – though it does help that the large down payment motivates the borrower to hang onto the property. I used to do “no doc” lending, because I believed the likely resale value of the property was the only important parameter. Now D-F requires me to be able to document my investigation of the borrower’s income and credit, although this requirement would never be “enforced” against me except in the event of borrower’s default and my attempt to repossess. It’s a waste of time, like so many government requirements.
I can see why they require documented income even in cases when the LTV is low. An unscrupulous lender could give predatory loans to borrowers with no capacity to repay just to obtain the collateral or onerous fees and charges via the foreclosure process. No borrower should be given a loan they can’t repay even if the lender doesn’t have risk of loss.