Matthew Ferrara, Philosopher

Fannie Madoff

We all know there’s no such thing as a free lunch. But for a while, homeowners, buyers and real estate agents thought a “heavily discounted” lunch was ok. Especially when it was Uncle Sam handing out the brown bags. Now the real estate and mortgage industries are paying the price for Fannie Mae’s free-lunch fraud. Looks like the people who couldn’t afford “affordable housing” most weren’t just , but its most vocal advocates. Talk about bad strategy.Make no mistake: Fannie Mae lied. Possibly, committed fraud. In a recent report in the Wall Street Journal by Edward Pinto, chief credit officer at Fannie Mae from 1987 to 1989, the “market failures” might just have been caused by the entity, not private lenders:

…from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A….Market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system in late 2006 and early 2007. Of the 26 million subprime and Alt-A loans outstanding in 2008, 10 million were held or guaranteed by Fannie and Freddie, 5.2 million by other government agencies, and 1.4 million were on the books of the four largest U.S. banks….

To be clear, the subprime lending crash was not due a failure of private banks. Whistleblower Pinto tells us that systematic “mislabeling” of subprime loans by Fannie Mae – a government entity – was rampant. Call it what you want, but the Fannie fraudsters withheld critical information from the market. Private banks, encouraged (at regulatory gunpoint?) by HUD and Fannie to offer loans to marginal borrowers didn’t have the facts necessary to properly model the mortgage backed securities necessary to do it. It wasn’t greed but mismanagement by the largest public and regulated entity in the market that laid the seeds of the crash.

It was a ponzi scheme worthy of Bernie Madoff.

Pinto suggests reasons why Fannie Madoff cooked their books: Perhaps they wanted to keep the patronage of Congressman Barney Frank, who hoped to “roll the dice” with the housing agency for social engineering purposes. Perhaps the GSE’s could not otherwise comply with the law mandating at least 55% of their lending be in pursuit of “affordable housing.”

Either way, the real estate industry is paying the price of this lie. For years, much industry operational and growth strategy was based upon their public patron’s policy of risky lending. When the financial scheme crashed, it took with it a decade of “home selling” strategies that brokers had built up – around a lie.

The real estate industry and homeowners lost a decade of growth and equity because its strategy was underwritten by government fraudsters at Fannie Madoff.

But why bother revisiting history? Because the industry was more than happy to go along for the ride – and it’s doing it again today. Real estate professionals based their entire sales strategy upon “affordable housing” – and developed training classes, certifications and seminars that led both agents and the public down that path. They never questioned the causes of the price inflation they were enjoying – even though it was historically unjustified – because they had a vested financial interest to not ask questions. Just cash the checks and go on. It was an age where rookie agents earned more in their first year in the business than veteran counterparts.

And it’s happening again. Fannie Madoff received another blank check from its Rich Uncle. And her sister, FHA Madoff has exploded her exposure to risky loans in the last twelve months.

Once again, REALTORS are going along, straight to the slaughter.

Just as once the REALTORS were the biggest voice (or most silent supporter, you choose) for affordable housing, and the exotic loans that made it possible, agents continue to pursue the go-along-with-someone-else’s-plan-to-pay strategy. FHA, tax credits, cramdowns are simply new chapters in outsourcing sales strategy to the whim-of-the-day by anyone: the media, the government, the Madoffs.

Either real estate is a commodities industry with market mechanisms for establishing, trading and financing market goods, or it’s just a flea market, where agents help consumers haggle over price and pay with someone else’s credit card. When that credit card runs out – as it will again shortly – there’s going to be another market crash.

Funny how the Fannie fraud story has disappeared from the news. Maybe it’s been overshadowed by the recent report of 80,000 more jobs lost in December. That’s the trouble with economic reality: fraud is easy to hide, but people without jobs still cannot pay the bills.

Real estate agents need to develop a better strategy – one based upon selling and financing real estate like any other commodity. That means people paying for the goods with real money backed by real credit and supported by real likelihood of repayment (ie., jobs).  Otherwise the industry cannot control its own destiny. The industry remains “sad” about foreclosures – right on political cue – when any other commodity trader would rationally price it down, clear it out, wipe out the excess and move on.

Meanwhile, everyone’s gaga about the extended tax credits – Madoff Scheme 2.0. is just as risky as the last version. How else can they sell homes, it is argued, if there isn’t some money on the table to “induce” people to do it now?  How soon we forget when plenty of homes were sold without subsidies or exotic finance – for decades. Does nobody in America have any credit, cash or equity any more? Makes you wonder.

Entering 2010, it’s high time for REALTORS to have a real strategy for future success. One that does not even consider listing overpriced properties. One that does not expound the virtues of preventing foreclosures. One that does not hail as profitable an agent who shows buyers 200 homes.  It’s time for a strategy that means business – and does not need handouts or gimmicks to do it. One that requires agents to find buyers who have real equity and ability to buy a home.

Because one of these days, Fannie Madoff may actually go to jail. And the free miracle money will dry up. Then what will REALTORS do?

The other lie to be discovered is called FHA default rates; count on it – someone is about to notice. In conjunction with unsustainable debt and public outcry over spending, plus many more months of unemployment, the market is set to fall further – this time from from a historic low point. Once the free lunch line is closed (think, May 1) it will be REALTORS who again suffer the consequences of letting everyone and anyone else set their strategy on how to be a real estate industry.

  • Matt, you left me…Speachless (and I almost never am) for a moment… and now…

    I love the 2010 strategy for agents. But, it’s been the standard for many of us for a very long time. The first time I read of this post, I thought that you were taking stabs are the real estate industry (I thought that was funny, because you are such a huge part of it).

    But, after reading it several more times, I see that you have a strong and powerful message that should not get lost…You are cautioning the industry to not be complacent about how we do business…You are telling us not to count on the propped up, artificial environment now in play.

    However, it’s not just the agents that can fix the ills of the market and the economy.

    “‘There is no need to sally forth, for it remains true that those things which make us human are, curiously enough, always close at hand. Resolve, then, that on this very ground, with small flags waving and tiny blasts of tiny trumpets, we shall meet the enemy, and not only may he be ours, he may be us.” Walt Kelly

    There is not a single source of blame for this mess… a few I can easily think of:

    -Leadership (those are the politicians that mandated and/or went along with the wholesale loosening of credit) …Fannie and Freddie have their interesting “quasi” standing as government sponsored enterprise–that means that they are government run–isn’t it convenient that Fannie and Freddie go back and forth between being private entities and government entities depending on who/how the finger is being pointed and who is taking responsibility.

    When I first heard of high debt ratios; no and/or limited appraisals and no income verification loans, I wondered how it could work (now we know it didn’t). It was so contrary to the standards of prudent lending practices that had worked so well in the past (credit used to be a 3 legged stool: character (the track record of a borrower to pay his bills), capacity (the income/cash flow to repay) and collateral (the house that is tied to the loan)–take away any one component and stool falls over).

    -Lenders who packaged and sold to the secondary markets; some who may have pressured the vendors that serve the system to go against their better judgment (resulting in the wacky layered fox in the hen-house, one-way street of HVCC, the complete extreme opposite side of the pendulum that also does not serve the interest of the public, that we are now dealing with); HVCC as a solution punishes all for the violations of a few and the extreme application of this rule, currently in play, is contrary to a real recovery…

    -Wall Street and Investors could take some blame (episodes like Enron and the acts of Madhoff and his ilk, undermine confidence).

    -The industries that support real estate (we all know that there is a huge sub-industry associated with the successes of this industry–those involved in selling stuff to the real estate industry, including sign companies, trainers, forms companies, software vendors, ad agencies, web developers etc…) fed into the idea that the robust levels were like Snoopy dancing on the dog house… going to dance forever.

    -The public is also to blame to a certain degree (even when it was “affordable”, some didn’t verify that the debt they were taking on was reasonable; some lied about occupancy, income and/or ability to repay hoping to “flip” their way out of debt). This was the first time in modern history that real estate was considered by the masses as a short term investment. Those who commit loan fraud should not benefit from the work of others… they should not be rewarded with bails outs… Of course, sometimes, bad things happen to good people–Job losses have played a huge part in this problem–those are not the “public” to whom I refer.)

    -The media fed the frenzy too, as real estate became “entertainment” with an irresponsible lack of information on the real ramifications and costs associated with “flipping”; good buying practices and the real cost of home improvement and the real added value to the home (not 100% of cost on an immediate basis) of the finished improvements.

    -Home improvement companies and a plethora of others also fed into the frenzy… Many, many entities have played into this mess and it’s going to take all of us, those that were directly involved and those that were not, to get us out.

    I agree, the fix is not in temporary “band-aids” to prop up any industry or in the pitting of one segment of society against another through unfair tax burdens; but in the return to something that resembles a “free market”

    However, the track record for bail-outs does often have a short term positive impact, one must recognize it’s short term and I can’t believe that anyone is naive enough to think it’s a long term cure.

    What gets me is that we keep running down the same path. Doesn’t anyone remember the other bail outs (auto industry, rail roads, the banking industry and airline is not new)?We typcially don’t bail them all out at once though… how about the S & L crisis (inflated appraisals played into this one big time–talk about a bail-out, it took down the FSLIC)? ; Loose lending practices of the past ‘(Negative amortization” put many, many that couldn’t afford the payments into homes they couldn’t afford, in a time of high inflation and appreciation didn’t keep pace,”self-Insured” high loan-to-value ratio loans that went bad, dragging the under-insured financial institutions under, uncapped ARMs etc.) We need to be SURE that once things get back to normal, we don’t shoot ourselves in the foot again!

    Unfortunately, “Those who cannot remember the past are condemned to repeat it,” George Santayana

    When are we going to learn?

    We need JOBS and not “make work” jobs. We need a country that goes back to making things that are valuable here and overseas. A country that feeds itself and the rest of world with the crops it grows. We need to PRODUCE! We need a country that believes in itself and doesn’t feed on itself. A country that is willing to tighten its belt and work toward a common goal. I know we can do it.

  • Napoleon Hill said it best in Think and Grow Rich when he said (not direct quote) – look around at what others are doing and do the opposite, you’ll be the one making the money. Advocating setting up businesses that are sustainable not just quick hits is what most of us need to focus on in this and any market.

    The role of a Realtor has been diluted part in fact because the information they controlled for years is easily accessible to anyone from anywhere in the world via the internet. However I have many Realtor clients who have continued to expand their business year after year by being the expert in the market, not simply the source of the listings.

    Knowledge (training), a great team and passion for what you do are truly the only way to succeed.