The recent housing bubble was driven in part by speculation and fraud accompanied by a complete collapse of mortgage underwriting standards. The short career of Casey Serin as a real estate speculator illustrates this. The wikipedia article on Serin summarizes his career as follows:
... In his early twenties, however, Serin decided to quit working full-time in order to pursue house flipping as a means of generating income. Beginning in October 2005 and continuing through the following year, Serin purchased eight houses in four southwest U.S. states, and then began blogging about the foreclosure process on the properties he was unable to resell. In time, five of the eight properties foreclosed. ...
An USA today article describes some of his activities:
He found a Sacramento couple who'd twice cut the price on their home and were asking $360,000. Aware that the market was softening, Serin successfully bid $330,000, including his closing costs. But he also wanted to pay off his credit cards. So he took out a $360,000 mortgage and asked the sellers to give him $30,000 in cash once the deal closed.
This is a common fraud . The buyer and seller agree on an inflated sales price and then the seller returns part of it in cash to the buyer after the closing. Note it is expedited by the availability of 100% financing. On another deal Serin was able to get $50000 back:
"I basically used up all of the equity... and the market is already going down," Serin says. "But it made sense to me at the time because I'll take the $50,000 (cash back from the seller). I'm finding it takes a lot more money than I thought, and what if I run out of the money I already took out?"
This can continue for a while as you can use the cash back to pay the mortgages (perhaps with low initial teaser rates) for a while but eventually it is likely to all come crashing down as it did for Serin costing his lenders a substantial amount.
This 2005 article on the role of speculation in the housing bubble noted:
A recent report by the National Association of Realtors (NAR) reported that 23% of all homes nationwide were bought by investors. Another 13% of homes were purchased as second homes. In Miami, it was reported that 85% of "all condominium sales in the downtown Miami market are accounted for by investors and speculators". This is clear evidence of speculation.
As the article explains sales to speculators inflate demand as a bubble inflates driving prices up and then increase supply (as speculators lose faith that prices will continue to rise and try to dump their properties) and drive prices down as a bubble pops.
And here is a Wall Street Journal article about "hidden speculators" who falsely claimed on loan applications to be planning to live in the homes being bought. This is something Serin did as well:
But Serin also deceived the bank by saying he'd live in the home. Banks typically charge higher rates and require larger down payments for investment properties.
Along with speculators like Serin who obtained fraudulent loans but did plan to pay them back after flipping properties in a rising market there were numerous complete frauds who never had any intention of paying back the loans and who were just interested in extracting as much cash as possible by for example selling properties to themselves (or hapless straw buyers) at inflated prices with 100% financing.
While fraud should of course be illegal and be prosecuted the best way to minimize this sort of thing is to maintain reasonable underwriting standards and not leave yourself wide open as the lenders did. Prosecution is not much of a deterrent when fraud is as pervasive as it was as it becomes clear to everybody that it is not feasible to prosecute more than a tiny fraction of the cases.
Friday Cat Blogging – 24 November 2017
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