Thursday, February 19, 2009

Documentary Review: House of Cards

I just finished watching the CNBC documentary House of Cards (hat tip to Gregg for pointing it out to me). For those who don't want to wait to find out if they should watch it till the end of this should watch it.

I cannot say that this documentary presented the complete picture or even an accurate one, but it does present many of the basic precepts that helped cause our current crisis. It clearly places the blame on Wall Street (what I now refer to as Hubris Street) and very little on government or the people, but from my extensive readings I'm not so sure they are wrong. There is plenty of blame to go around, but Hubris Street deserves the overwhelming majority.

I think I bring an interesting prospective to this current crisis as I and most of my clients lived through it. I moved to Orange County in 1995 and housing prices were fairly low, in fact I was working for Bank of America doing first and second home loans. What I found was that a lot of people were underwater or had very little equity.

I bought a townhome in the OC in 2000 and watched the price double in just a few years. I saw the whole of Orange County come out of its housing slump and boom. What I saw scared me. In 2004 I sold my condo as I thought housing was becoming overpriced. I was quoted in a bloomberg article saying "I think there's a bubble. It's similar to the Nasdaq (stock market) several years ago. I tell any clients who come to me who want to buy a house that there's more downside than upside now to the home market."

I had people coming into my office at least once a week wanting to flip homes and going to community college workshops (Marshall Redick anyone) to learn how to buy and sell property. To my amazement these people were getting loans for several homes at one time. I would tell people that I love real estate and that I think its a great way to build a net worth, however it has to make sense. Nothing that people brought to me made any sense.

Prices continued to go up as I rented a home in Orange County. I decided to move out Orange County as I knew I couldn't afford a $1.5 million home (notice I didn't say I couldn't get a loan for that amount). I ended up moving to Murrieta where I could buy the exact same home for a third of the price and I could afford the payments. I figured that I was willing to take a short term loss of even up to 20% in order to have some safety and stability in my life, I still thought prices would fall.

It wasn't until about 2005 that I started to see and hear more and more about people getting loans that should not be getting loans. I was seeing people buy homes who didn't have jobs and they were financing 100% of the purchase price (technically more as they would bid a higher price in order to get a rebate to pay for closing). But prices continued to go up. My house was at one point appraised at almost 20% higher than I had paid just a year or so earlier. The appraisal felt bogus, I knew there was nobody out there who would buy my house at that price - they'd be crazy. Heck, I figured I had overpaid.

If only I had followed my instincts a little further and attempted to understand better what was going on maybe, just maybe I could have seen what was coming.

Little did I know Hubris Street had been funding huge amounts of purchases and refinances with no money down and low teaser rates for people who couldn't afford a home that was even half the price of the one they were buying. I naively thought that the banking industry was regulated enough to prevent such stupidity. Of course, I was wrong.

The documentary basically ends at this point - after the fall, it doesn't tell us much more about what they think will happen next.

Watching this documentary I can't help but kick myself for not being more of a sleuth. Here I was one of the very few advisors to go on the record with Bloomberg and equate the housing market to the tech bubble and yet the possible consequences of such a meltdown escaped me. I faced ridicule amongst some of my colleagues. In one meeting an older financial planner openly mocked me for my position on real estate values and basically called me a fool for selling my townhome....sometimes I'd rather be that fool than be the person who was right. Of course being right and predicting the outcome of being right are two different things, I never in my wildest imagination expected what has happened in the past six months.

I've now read hundreds of articles and about a half dozen books on the current crisis and have filled in a lot of the back story as to how things got to where they were. I'm now convinced that what we are experiencing is unprecedented and the future is still unknowable.

What I do know is that this mess has to be cleaned up and that it can't be cleaned up by allowing the same set of policies that led us into this mess lead us out. It is going to be tough and heartbreaking, but good people are going to have to be foreclosed on. The market needs to purge itself and prices need to find an equilibrium, this means that homeowners who can't afford their home even under a massive principle reduction program must be foreclosed on. I've outlined a basic framework in previous posts as to how this can be done. Its actually a terrible framework as it relies on government money and is full of moral hazard.....but its most basic element is to begin the purge, find a bottom and then move on. It will take years to work out, quite possibly a decade.

The good news is that if the right plan is implemented I believe that the stock market won't wait until housing recovers to go up, it will rally based on the fact that it sees direction, clarity and a way out. Until the market sees such direction, I believe it won't be able to have a sustained rally. This doesn't mean you should sell.

America's brand has been tarnished, but it hasn't been destroyed. The American people are unlike any other this earth has ever seen and the march of progress will continue, even if slower than we originally thought.

As for talk about a Depression or a Great Depression......I can't discount these feelings, what I can say is that the poorest among us (in America) live better than many of the rich people during the Great Depression. Did you know that penicillin was not widely available during the Great Depression? We have a standard of living that could fall dramatically and still never compare to what the average person went through during the Depression. The Great Depression wasn't America's first Depression, it was something like its was just much worse than the others. At this point in time during the Great Depression unemployement was in the 20% range, we are at 7.6%.

The bottomline after all this rambling is that House of Cards was a pretty interesting story to watch and I think you'll find it entertaining, angering and educational.

I also want to say one thing about Alan Greenspan - for the next several decades, perhaps centuries we will debate whether he caused this mess with his prolonged period of low interest rates - however just because you have low interest rates it doesn't mean that you have carte blanche to eliminate all lending standards....that was done by the Investment Banks, not Greenspan.

Scott Dauenhauer CFP, MSFP, AFI