This is a chicken and egg kind of discussion about what caused the housing crash.
It's not that there's a right answer (but I am right) or a wrong answer, it's about looking at what happened to determine whether it's going to happen again. It is.
I'm always right.
Really, it's about America's middle class mostly, and the vise they're caught in.
Notice, the title here poses that as a question. Are they caught in a vise?
I say, "Yes!"
But, I'll get to that.
First, it's back to the chicken… or the egg.
Did borrowers over-borrow because they were greedy? Or, did lenders over-lend because they were greedy? Yeah, yeah, we all agree. They both were.
But what precipitated it?
Of course I want your opinion. But, first you're going to have to hear mine. And since I'm always right, you may just want to come along with me and be smart. Just kidding!
It's simple to me: You can't borrow if lenders won't lend.
There. I rest my case.
Oh, you want more depth, more color? Okay.
But let me first put aside something that I know will come up anyway. The Community Reinvestment Act didn't cause the subprime surge.
Did the surge happen when the government forced banks to reach into underserved areas to offer loans to folks who weren't over-banked – and who didn't have ATM machines on every corner of their neighborhoods – only to have those same banks create subprime loans that would later default?
Yes it did.
But the number of defaults in the subprime category within the boundaries of CRA-demarked neighborhoods is a drop in the bucket compared to the national corral, where subprime loans were drawing out, and creating subprime borrows out of better than subprime buyers – with higher creditworthiness.
Look at borrowers as the chickens. They had to be hatched. Not from eggs, because they were already in the market. Most of them would have been far too afraid to risk over-leveraging themselves on something they knew they couldn't afford if they were charged the kind of interest that high-risk borrowers face.
To fatten them up, hard-boiled lenders gave those chickens legs and dreams – and a means to fly out of their old neighborhoods and roost in fancier digs.
Most people forget – or didn't know – that prime borrowers had been pretty well exhausted by lenders bending over backwards to get them into new homes.
Interest rates were kept artificially so low for so long, which left investors clamoring for yield. Prime borrowers were getting harder and harder to find, so bankers grabbed the two-for-one throttle and pulled subprime borrowers into their origination factories. Then they did a "pool "em and fool "em" maneuver – for yield-hungry investors, that is – and put them into mortgage-backed securitization, get "em off my balance sheet, schemes.
And it worked. Well, at least for a while.
Middle Class Mistakes?
So, what does all this have to do with the middle class being in a vise?
Bloomberg Businessweek is a great publication that I highly recommend. This week's issue, February 18-24, 2013, has a piece titled, "Oh, Craps. U.S. Homeowners Are Repeating Their Mistakes."
The gist of the article is that, for folks with a "very high risk exposure – a low wealth-to-income ratio, more than three-quarters of their assets are in housing or stocks, and (have) debt greater than a quarter of their assets," which serves as my definition of the middle-class in America, lost 47% of their wealth between 2007 and 2010.
What bothers me about the article is that it presupposes that homeownership makes it hard to diversify. It states that, "since 1983, for the richest 20 percent of U.S. households, the principal residence as a share of net worth has been around 30 percent. For the next 60 percent – most of us – housing has risen from 62 percent to 67 percent of total wealth."
So, what's the problem? Those Americans leveraged themselves to get into their homes and borrowed against them.
We know what happened next.
But, it's not just about middle-class America's homes as their source of wealth. The article states, in its opening paragraph, "If there's one thing Americans should have learned from the recession, it's the importance of diversifying risk. Middle-class households had too much of their net worth tied up in their homes and were too exposed to stocks through 401(k)s and other investments."
In other words: WAKE UP AMERICA – you idiots who have been struggling to get into the middle class and you idiots in the middle-class (thank goodness that idiot class is shrinking, right?) have it all wrong. You shouldn't just be buying houses and stocks.
It's not Bloomberg. They're just putting this out there. I don't want to insult one of my favorite magazines, but WHAT THE…
What is the middle class supposed to do? Trade derivatives?
It's not ironic, it's sad – no, it's disgusting – that the two principal sources, or steps up the aspirational ladder in America – home ownership and an equity portfolio – are… well…
I'm not going to call them schemes, though there's a part of me that wants to. That would be hyperbole to the max…
Those two steps up the ladder in America are manipulated by bankers and brokers for their own self-serving benefit.
That's why I think – no, that's why I know -that America's shrinking middle class is caught in a vise.
Do I have answers for this dual problem?
You bet I do.
But, first, I want to hear what you have to say.
The floor is open. Let me know what you think in the comments below.
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Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
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