Soros on sub-prime

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Today’s entry is from George Soros’ book, the The New Paradigm for Financial Markets (Public Affairs, Copyright 2008 by George Soros) and contains an interesting account of the roots of the sub-prime crisis, worth quoting in full:
>”The [real estate] crisis was slow in coming, but it could have been anticipated several years in advance. It had its origins in the bursting of the internet bubble in late 2000. The Fed responded by cutting the federal funds rate from 6.5 percent to 3.5 percent within the space of just a few months. Then came the terrorist attack of September 11, 2001. To counteract the disruption of the economy, the Fed continued to lower rates–all the way down to 1 percent by July 2003, the lowest rate in half a century, where it stayed for a full year. For thirty-one consecutive months the base inflation-adjusted short-term interest rate was negative.

>[This] cheap money engendered a housing bubble, an explosion of leveraged buyouts, and other excesses. When money is free, the rational lender will keep on lending until there is no one else to lend to. Mortgage lenders relaxed their standards and invented new ways to stimulate business and generate fees. Investment banks on Wall Street developed a variety of techniques to hive credit risk off to other investors. …

>Double-digit price increases in house prices engendered speculation. When the value of property is expected to rise more than the cost of borrowing, it makes sense to own more property than one wants to occupy. By 2005, 40 percent of all homes purchased were not meant to serve as permanent residences but as investments or second homes. … Credit standards collapsed, and mortgages were made widely available to people with low credit ratings (called subprime mortgages), many of whom were well-to-do. ‘Alt-A’ (or liar loans), with low or no documentation, were common, including, at the extreme, ‘ninja’ loans (no job, no income, no assets), frequently with the active connivance of mortgage brokers and mortgage lenders. …

>It was bound to end badly.”

What struck me as especially interesting was that statistic that by 2005 40% of all homes purchased in the US were not primary residences. That’s staggeringly high.

Soros also makes the point, rather ruefully, that while many hedge funds took a bearish stance on housing, ‘they suffered such painful losses waiting for a collapse’ that most eventually gave up their positions.

Hmm. Sounds a bit like trying to be a prudent underwriter in a long, soft market.