Bernard Madoff was arrested December 12, 2008 for an alleged $50 billion investor fraud and released on $10 million bail. While the press heralds this as the biggest ponzi scheme in history, it’s a pittance compared to the real estate schemes that have created the present financial crisis.
Like Madoff’s scheme, the house market became dependent on a steady price increase. Buyers were willing to pay high prices with the expectation that they could later sell for a profit.
Eventually, without substantial inflation, houses had to become unaffordable. House prices had reached levels that often required most of a household’s income. Subprimes were just a frantic attempt to continue this pyramid. Like every ponzi scheme, some means must be found to get more money from new “investors” to payoff old.
As a result of constant lobbying by the real estate and banking industry, the government promoted homeownership as the “American Dream.” It subsidized it by mortgage tax deductions, inflation and the willingness of Freddy and Fannie to continually raise the loan bar. After the bailout of the saving and loans in the ‘90s, mortgage lenders came to believe that the Feds would always support rising house prices.
The real estate agent industry and the commercial real estate agent industry, with the acquiescence of a heavily lobbied government, has created the homeowner myth by a constant stream of propaganda. We were told that as the price of goods inflates our savings dwindle, but house prices consistently appreciate and are a hedge against inflation.
Also, we were told that our house is an investment, and, for most of us, our biggest investment. It consumes most of our income. According to this “reasoning,” by building “equity,” we can refinance and reduce our payments, and as our equity grows, we can “trade up.”
We were told that buying any house will “get our foot in the door.” A hole in a wall is thus a “starter,” “fixer-upper,” or a “diamond in the rough.” If we dared to complain about the stratospheric price of houses, we were told, “Hey, it’s just the natural law of supply and demand!” Homeowners were hoodwinked into believing that their home was a nest egg. Houses are not capital goods; they’re consumables.
The real value of property depends on its location – proximity to schools, police, fire, social services, roads and other infrastructure. All of these are paid by taxes, yet many politicians ran on platforms to reduce taxes. Their constituents were led to believe that high mortgage payments were inevitable, and that tax reduction is the only way that they could make ends meet. As tax bases fell, civic programs were cut. The price of the property increased, but it real value declined.
One major difference between Madoff and the mortgage schemes is that Madoff was arrested while the mortgage bankers are being bailed out. Even programs created by the government ostensibly to help homeowners in foreclosure are actually geared to help the mortgage bankers. According to the Congressional Budget Office, the $300 billion “Hope for Homeowners” program begun Oct 1 has not helped a single homeowner!
In my next post I will present ideas on how nationalizing Freddie and Fannie can create a mortgage bank, produce affordable housing, and reduce the risk of foreclosure. I would like this to be an open forum that will solicit ideas and suggestions.
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