Who's to Blame? Homeowners


Each day for five days, a different writer from TheStreet.com will make the case for why one of five prime culprits—the banks, Congress, irresponsible home buyers, the Federal Reserve or the rating agencies—is most to blame for the credit crisis and ensuing economic meltdown.

It's tough to wag a finger at those in pursuit of the American Dream: The big house and the white picket fence to call your own.

Yet it flies in the face of reason that someone who earns $50,000 a year could actually believe they could afford to make payments on a $650,000 home. It's a very simple point, a concept that should be easily grasped. Even Saturday Night Live gets it , evidenced by their great skit with a simple instruction: "Don't buy stuff."

But as Paul Nolte, director of investments with Hinsdale Associates, points out, the reckless assumption that housing prices would always rise has brought us to the precipice the economy currently rests on, in danger of falling over.

"The borrowers thought they were getting something for nothing," Nolte said. "They could lever it up because housing prices have always gone up. As it was with the tech bubble, when everyone thought tech was safe, it's the same thing in the housing market. Investors were not conservative in the housing area, just as they weren't conservative in technology in the early 2000s."

Not every borrower is to blame for where the stock market and the economy are now. Some responsible homeowners have always lived well within their means, but a layoff in the household or some other tragedy turned into the tipping point that drove many into foreclosure. These specific cases require some understanding and compassion.

Beyond that, it's tough to find sympathy for unscrupulous borrowers that, simply put, should have known better. There are several types of irresponsible borrowers that need be held accountable: Buyers who took out a mortgage they could never afford, buyers who tried to ride the housing wave without educating themselves well enough, buyers who committed fraud in hopes of netting a quick profit, and buyers who attempted to flip more homes than they ever could manage.

"From my perspective, a lot of borrowers were worried about getting a house today, not worried that down the line the markets wouldn't turn into what they are today," Nolte said. "It's a lack of forethought as to what might happen and not playing things conservatively. What if interest rates rise? What if housing prices don't go up?"

There are plenty of excuses irresponsible borrowers can make. Predatory lenders waived through applications and pressured potential buyers into taking on more debt than they could handle. Wall Street banks like Citigroup (Stock Quote: C), Goldman Sachs (Stock Quote: GS) and Morgan Stanley (Stock Quote: MS) were hungry for complex securities—which sliced mortgages into a thousand little pieces—to offer to hedge funds to trade. Advertisements told America how great it would be if you let your home pay for your vacation. Even the buying and selling of multiple houses for a profit was glorified in television shows like Flip This House and Flipping Out.

But let's be honest. No one forced a borrower's hand to sign the dotted line. Considering that a home is almost always the largest purchase a person will ever make in their life, buyers should have been well aware of the risk they were taking. Enough with the excuses. For every irresponsible lender, there was an irresponsible borrower.

The math it takes to add up your monthly expenses is not hard. It's simple addition, something a child could handle. Either you earn enough to pay your monthly bills or you don't. Everyone who borrowed more than they should have for a home should have known he or she was taking a massive risk, and many turned a blind eye to all of the details and implications.

But some home buyers employed more advanced mathematics, in the name of greed. They leveraged themselves after securing monster mortgages, ones that required interest-only payments, in the hopes they could refinance when the value of the home rose, allowing them to make other purchases. Alas, we know now rising home prices are not a given.

Robert Pavlik, chief market strategist with Banyan Partners, echoes Nolte's comparison of the housing bubble to the tech bubble.

"During the tech bubble, if you weren't day trading there was something wrong with you," Pavlik says. "For those that stuck to the normal practice of buying an affordable home in a range you felt comfortable with, you were viewed as 'not getting it' and 'not participating.' It should've been seen as a bubble, but everyone was seeing such tremendous gains in the real estate market."

Pavlik says the herd mentality also comes into play. If neighbors and friends are taking out massive mortgages and they're doing it successfully, the pressure to go along with the group undoubtedly pushed some buyers into action, he says. "The social pressure to keep up with the Joneses was amazing," he says.

Others, like Rick Sharga, vice president of marketing for RealtyTrac, argue instead that lenders bear more of the blame. They should've been the adult supervision at the party, but "at the first half of the decade they handed the kids the keys to the alcohol cabinet."

However, Sharga concedes that, anecdotally, a lot of buyers who didn't know what they were doing decided to jump blindly into the real estate game, as property values continued to escalate. Prior to 2008, not everyone could give a definition for an option-adjustable rate mortgage, or a piggy-back mortgage, or an Alt-A loan, or even a subprime mortgage. When faced with so many mortgage choices, some uneducated borrowers didn't know what was best for them.

Sharga also points out that there were some questionable actions being made by some borrowers.

"There were some investors that got involved in stuff that if it wasn't outright fraud, it was pretty close," he said. "They would work with appraisers and purposefully overvalue properties they were going to resell. There were a lot of excessive activities that were going on."

Irresponsible borrowers certainly aren't the only culprits in creating the mess out economy has become. Lenders certainly are guilty of relaxing lending standards and making loans they shouldn't have, Nolte acknowledged. That led the Countrywide Financials of the world into the arms of Bank of America (Stock Quote: BAC) and lesser players like IndyMac Financial into federal receivership. Still, it's hard not to argue that the first domino started the chain reaction that forced all of the dominoes to fall.

Perhaps the next major problem the economy and stock market faces is that irresponsible borrowers will not learn from mistakes they've made. If greed and debt caused this meltdown, borrowers need to avoid both if a recovery will ever come.

"People haven't learned how to handle debt to start with," Nolte said. "This doesn't prevent them from running up the credit cards again. They didn't learn a damn thing."

Michael Gannon blames the Federal Reserve and Alan Greenspan Monday.

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