Racine Journal Times, WorkLife Section, July 15, 2007

It's not easy being green

The American dream is turning into a nightmare for a multitude of homeowners.  With almost $590 billion of variable-rate mortgages due to reset at a higher interest rate between now and the latter part of 2008, the mortgage mess has yet to hit half-time.  While Congress tries to sort it out, homeowners are walking away from homes they couldn’t truly afford.  Many characters played their part in this tragedy; this wasn’t a one-man show.  The lead roles were played by those you can spot when you follow the money trail.

First, the lenders.  In years past, lenders had stringent standards about lending money.  Lessons learned during the Great Depression helped shape the mindset of Mr. Banker to carefully review the financials and character of Ms. Borrower.  Because her loan would stay on his books, he wanted to make sure, as best he could, that her loan would be repaid at a minimum.  Ideally, he’d get his interest payments too, but protecting his capital was most important.  As our financial markets evolved, Mr. Banker found it easier to package those loans and sell them on Wall Street.  Because Mr. Banker no longer carried the loan on his books, he wasn’t as concerned about getting repaid.  In other words, his money trail stopped at the point where all he had to do was to make sure his loans met standards established by the second set of characters:  the Investors.

It’s easy to spot the money trail blazed by investors.  After all, money is their agenda.  Yield-starved investors in a world of 1% cash interest rates played the perfect role of capitalist.  Any good capitalist would jump at the chance to borrow money at 1%, lend at 6%, to make a spread of 5% with (what appears to be) a low-risk strategy.  Some have dubbed this the carry trade.  Like most parties, it was fun while it lasted.  Now, the hangover is being felt by highly levered hedge funds playing said low-risk strategy.  What and whom can they thank?  An interest rate policy set by our third set of characters:  the Greenspan Fed and global central banks alike.

Like a two-headed monster, Greenspan’s Fed offered an open bar with cheap liquor then crashed the party when everyone got a little too drunk.  Knowing full well that its overly-accommodative interest rate policy (read:  too low for too long) was partially to blame for those teaser- and variable-rate mortgages catching fire and the perfect storm brewing in residential real estate, the Fed did nothing more than offer a limp word of caution to Congress.

Apparently, Alan Greenspan wanted to go out on a high note, so he left Ben Bernanke holding the bag.  And with an ironic twist Shakespeare would be proud of, Greenspan recently set up shop consulting for large institutional money managers about the state of the economy, part of which is the mess he helped create.  It’s a bit more difficult to see Greenspan’s money trail, but it’s still there.

Another set of characters in our tragedy is Congress.  While the Fed played its part with monetary policy, Congress played its role with fiscal policy.  Whenever tax has to be paid, especially a lot of tax, people take notice and modify their behavior.  In fact, much of our tax code was established to gently prod us to do some worthwhile things such as give to charity, save for retirement and own a home.

Not too long ago, home owners had to pay tax on any capital gains when they sold their home.  The tax, in effect, was a disincentive for folks to sell their home.  When Congress changed the law, which allowed most people to avoid capital gains tax on the sale of their primary home, it was like popping a champagne cork – just with a slight time lag.  Retirees who had long owned their homes in more arctic climes were better positioned to move to a warmer climate. Others figured that flipping homes and condos could be quite profitable, sans the tax.

At first blush, it appears that this tax law modification wouldn’t create a money trail to Congress, but it does.  While counterintuitive, cutting taxes does sometimes lead to an increase in tax revenue.  Congress lost out on the capital gains tax, but there was probably more gained from other sources which were the direct beneficiary of more housing-related economic activity.

While all these characters played their roles in this tragic drama, they just threw gasoline on a fire that was already lit by the green monster.  After all, a lender isn’t going to offer a mortgage to an unwilling borrower.  Millions of our American neighbors were willing to play their role in this tragedy, and much can be learned from it.

An anonymous sage once said, “The only person worth envying is the person who doesn’t envy.”  Give Mr. and Mrs. Jones a rest and turn your attention to what’s best for you and your loved ones.  Purchasing a home is a major transaction, and one that shouldn’t be taken lightly.  Do your homework.  Be prepared.  Don’t be afraid to ask questions.   Listen – really listen – when your questions are answered.  Take your time to understand everything you’re committing to and the papers you’re signing.  Get advice from a trusted source.  Follow your instincts.  Home ownership can be truly wonderful when you write your own story rather than playing a role in someone else’s tragic drama.

Michelle Ouzounian, CMFC, is the founder and President of Verity Investment Counsel, Inc. (www.verityinvcounsel.com), a fee-only, independent registered investment advisory firm in Racine. Michelle can be reached at 262-898-8400, or m.ouzounian@verityinvcounsel.com.