Mortgage debacle

My last posts about building in a recession (#2 and #3) probably sounded a little extreme, but I really believe there’s a similar model that ought to be available to anyone. We need to give primacy to what truly matters in homebuilding and also find a way to give people an opportunity to get what they want and need in a way that suits their abilities and financial constraints. One of the problems our country needs to overcome is the prevalence of low-quality, poorly-performing homes that are also the biggest investment in the lives of most of our fellow citizens.

But first, why do people submit to living in junk?

It has probably always been so, but it’s still somewhat depressing that otherwise smart people can act so stupidly. Bernie Madoff’s victims were eager to believe that one genius guy had figured out how to continuously make money at a constantly generous rate, when all other investment possibilities fluctuate rather erratically. Hundreds of thousands of adult Americans were duped into buying homes they could not possibly afford, apparently happily jumping to the conclusion that it was their good fortune that the rules they learned in 4th grade math were no longer applicable in their personal case. Snake oil, in all its forms, sells well.

Cheery bunkum finds quicker believers than hard truths.

The people who build most of America’s homes are no different. Part of me has wanted to think they are devious characters, but I’ve come to the conclusion that most of them have made a similar leap of blind hope. When the framing lumber is dropped off on the building sites, they have convinced themselves that underpaid and under-skilled people will still work with enough motivation and care to make a decent building. They are sure that stick framing is so easy nothing serious could go wrong and if there are oversights or mistakes, the structures are probably over-engineered anyway. They have further convinced themselves that they are doing the right thing because low cost is the critical factor, not good quality.

Besides, America’s homebuilders have come to understand that consumers really only care about appearances and amenities. It’s cheaper to be fooled than to require authenticity and substance. Nobody wants to pay for mundane elements like foundations and frames and insulation, which are like the hard truths; boring and inconvenient. What people are willing to pay for is the cheery bunkum. Houses are all too often built to minimum standards under conditions that cause them to be even worse than that; defect-ridden underpinnings clad in faux siding and flimsy roofing, but with complex-looking fake rooflines, containing four-headed showers, plush carpets and cavernous, chandelier-bedecked entries.

In the end, though, the illusion of wealth and comfort can come at a very high price. The Wall Street Journal recently ran a story about serious problems in new homes built during the housing boom. The story, “Cracked Houses: What the Boom Built,” reports that “hundreds of thousands of people from California to Georgia say their almost-new homes need costly repairs because of construction defects. The furious pace of home building from the late 1990s through the first half of the 2000s contributed to a surge in defects, experts say. It caused shortages of both skilled construction workers and quality materials.” In some cases, the cost of repairs is more than the houses would be worth on the market, but it’s often the case that repairs aren’t practical at all because the defects are at the foundation level. One man said the losses related to his defective house were worse than his retirement income losses in the stock market.

In contrast to that story, a few weeks ago I did an informal assessment of an old house in a nearby town that is scheduled for demolition. I was asked to help determine how much of the building might have value as salvage. Often old homes have structural parts that can be used again, so it was a good question and an admirable goal. Due to some unusual circumstances, the house has not been occupied for 30 years. It is very weathered and is almost devoid of mechanical systems, as it doesn’t even have indoor plumbing. The new owner assumed its long abandonment condemned it, but I found that not to be the case. It is actually in great structural condition. Although it was built in the post Civil War years (1860-1870) and had been completely unoccupied for three decades, the original building is strong, straight and true. The roof didn’t leak; the foundation didn’t yield and the critter damage was minimal. So, one hundred and fifty years ago, they could build so well that a house could survive over 120 years of use, then fall into complete abandonment for another 30 years and still be structurally sound and secure; yet today, houses are being built and sold that are challenged to survive even their first 30 years.

These contemporary standard houses aren’t very different than a Bernie Madoff scam. In both cases, what appears to be a reasonable investment is actually missing the very essence of what it is supposed to be. A financial investment is supposed to be invested in something; a house is supposed to be a structure, not a teetering theater set.

When will we stop falling for cheery bunkum? Perhaps never, but at least for awhile, I think people will be more attuned to search for real value in their investments, whether in the markets, or in real estate, or in anything for that matter.

This, then, is a good time to promote what I think is the right way to build, whether in a recession or a boom. It begins with rethinking our image of what a house is and how homebuilding should therefore unfold.

As described by Stewart Brand in How Buildings Learn, a house appears to be one thing, but it is better understood as layers of elements that live in time differently. The right way to design and build is to acknowledge the different cycle times, allowing the building to be more easily upgraded and changed to meet its maintenance challenges and adjust to the needs and desires of its inhabitants. Stewart called the layers the "Six S's"

Seen this unique way, only the site itself is ultimately permanent, but the man-made structure which is attached to that piece of the earth ought to be proportionately durable. Therefore, the underlying building structure should be built to last centuries. Protecting the structure is the exterior skin of roofing and siding. This also should last a long time, but it’s likely to need maintenance or alteration every 50-75 years. The interior functioning of the building is defined by the space plan, which is the organization and partitioning that delineate and separate the public and private living areas. The specific plan and rooms are really just a prediction about what will work best and who will live there. Properly built, the space plan should be more mutable and flexible, allowing the occupants to adjust the original prediction more easily as the ever-changing dynamics of their lives suggest and require. Think of this as a 10-20 year cycle. Services are the various (and increasing) mechanical systems that deal with everything from low voltage entertainment systems to heating and cooling equipment. Some of this stuff is almost as permanent as the structure, but most of it should be designed to be upgraded and changed, allowing for new technology and shifting needs. Service systems should be considered to have a 1-15 year life cycle. Finally, there is the stuff of our lives: furniture, equipment, art, books, etc.; all the various baggage of our complex lives. Stuff churns daily, monthly and only occasionally sticks around for as long as the space plan.

Brand’s numbers and organization are a little different, but the concept holds. What we have concluded as we have embraced the truth of it is that long term elements and short term elements should not be entangled. Wires and pipes shouldn’t cut and worm their way through the structure. They should have their own space, which doesn’t affect the structure and gives access for inevitable changes. Similarly, the interior space plan shouldn’t also have long term requirements because it more likely needs to change in time. This kind of thinking has led to what we call “Open-Built,” which is a complete system of design and building, intended to give predominance to a high performance building shell, with interior systems and finishes and exterior cladding that can be installed or uninstalled as needed, as the life of the building plays out from its original construction through all its future mysteries and adventures.

We have based our business model on this concept. How does it relate to building in a recession? This method of building is perfect for owner-builders who hire us to design and build on their behalf. What we actually do in many cases is simply build the high performance building shell, giving our customers themselves the opportunity to manage or execute the exterior and interior finishes and mechanical systems. It also allows buildings to be finished incrementally, as owners can afford it. This is exactly what I did on my own house as described in How to Build in a Recession #3. I think everyone should have the option of building and financing slowly, if they so desire. It’s the best way to get what you need and want, paycheck by paycheck, rather than with the expense of a multi-decade mortgage. It also puts first things first and leads to the high quality buildings which are the ultimate blue-chip investment.

One of the benefits of blogging is in the comments and feedback from readers. I very much appreciate hearing from you. Several of my favorite reader comments have come from Joseph Martini. He doesn’t always agree, but he is thoughtful, and thought-provoking. He took issue with my last entry, More snow in July, and while I was contemplating getting back to him, I discovered he has his own blog, called Give ‘n Go, in which he also posted his response to my thoughts. That inspired me to give him a response in kind, which I’m also posting here:

It would be absurd to get into a tit-for-tat about what Adam Smith meant for his time or contemplated for the future. Still, I will stick to my presumption that he couldn't imagine the effects of the perfect storm of greed we are currently witnessing.

You nearly make my point again when you say this about Adam Smith's philosophy:

He made it very clear that considerable structure was needed before the invisible hand of the market could work efficiently.

For example, property rights must be strong, and there must be widespread adherence to moral norms, such as prohibitions against theft and misrepresentation.

Smith understood that "considerable structure was needed," but "widespread adherence to moral norms" is not structure; it's an assumption about how people will behave in their social and economic relationships. He suggests that there will be a natural amelioration of greed and self-interest as one learns that the common good is a critical aspect of one's own self-interest. If this no longer happens in a natural way, it is probably fair to assume that a more specific "structure is needed."

We also have to remember that Adam Smith's influences and references involved much, much more physical labor and human contact than trade relationships often do these days. In their barter-oriented economy, people learned that their personal gains were greatly dependent on their trade and interactions with others. Too much taking would be inherently self-defeating.

I don't think Smith had any conception of the something-for-nothing mentality that is all too common now. It's a malaise that has infected all social strata and all economic sectors, from the hedge fund managers to minimum wage service employees. Free wealth is alluring, but it's becoming obvious that it's a nasty trap: a pot of gold on the other side of a sinkhole.

I also don't think this is anything like a normal "boom/bust cycle." I've built my business on an understanding of seasons and cycles. I know that winters come with regularity, as do economic downturns. We therefore studiously avoid growth in response to what we see in the summer months or boom times. These ebbs and flows are natural and healthy and it is foolish to fight against them in an attempt to make things always good for our particular industry. The greater good is more important. Thus, I proposed the analogy of the ski industry possibly wanting "snow in July." If it could be granted, the results would be disastrous, even if the ski industry had a short-term boon.

This is one of the reasons I blame the NAHB. If they were advocating for their constituents, they failed quite badly. They know about ebbs and flows in the housing industry. They study it and have the numbers, graphs and charts going back decades to reflect on as a reminder. They also knew that the sub-prime type loans were a big problem. Yet they did nothing. Their knowledge and expertise also comes with responsibility, much like that of medical doctors. It's as if they looked at the effects of a growth hormone, saw a cancer starting to grow, but simply ignored it, perhaps hoping the growth would outpace the disease. Or...what were they thinking?

This massive economic tragedy isn't a part of any cycle we should accept. To the dismay of many, one obvious conclusion is that it turns out we can't trust ourselves. Left to our unfettered inclinations, our penchant for free wealth leads us over even the cliffs we can see. We apparently need a hand to stop this insanity, and to be effective, it most certainly won't be invisible.

I reported recently about Duo Dickinson’s editorial, in which he argued that the architectural profession should have played a larger role in warning “against the rip-off” as the housing bubble inflated beyond reason. I agree that architects should have done more, but if we’re pointing fingers in retrospect at those who should-have-known and should-have-warned about the impending housing debacle, I’d start with the National Association of Home Builders (NAHB). They knew about the inflated values. They knew about the dangers of the risky mortgages. But while homebuilders were setting housing start records in those unnatural and perilous conditions, instead of sounding alarms, they were a chorus of celebration. They expressed their “concerns,” but in reality it was their dreams come true.

In January of 2005, David F. Seiders, NAHB’s chief economist, wrote a cheery article in Nation’s Building News (NBN), the online weekly newspaper of the Association.

“The housing sector turned in a great performance in 2004, thanks largely to the stunning behavior of long-term interest rates as well as to deepening discounts of initial rates on adjustable-rate mortgages by lenders. New records were set for home sales and single-family housing starts as well as for sales of condo units in multifamily housing, and the rental housing market performed reasonably well in the face of record-high vacancy rates.” (Italics mine.)

In fact, 2004 had been a record year, so the real concern was whether the growth potential for housing had topped out. Seiders wanted to assure his hungry builders there was room for even more growth. In his own words:

"The U.S. homeownership rate hit an estimated 69% in 2004, easily a new annual record… The dramatic performance of recent years moved the U.S. homeownership rate toward the top of the list of countries around the world, prompting speculation that the U.S. rate has approached some sort of natural limit.

But there’s still plenty of potential for rising homeownership in this country, public policy is focusing upon some glaring differences across income classes as well as racial/ethnic groups, and structural changes in the mortgage market have extended the reach of homeownership to more marginal buyers. Thus, it appears that builders of single-family homes and condo units can look forward to a dominant share of the housing pie for some time to come…” (Italics mine.)

In other words, if we’re going to build more homes, we need a larger homeownership rate and to increase homeownership we ought to find a way to open up the “American Dream” to those who currently can’t afford it. (The cynic in me rises up when self-serving intentions are attempting to masquerade as benevolence.) To give these poor people the opportunity to own a home, all we need are “structural changes” to mortgages.

Well, they got those “structural changes” alright and only a few months later, in the spring of 2005, at the NAHB Construction Forecast Conference, it was obvious they already understood that creative mortgages were a double-edged sword. The speakers recognized the potential looming problems of the sub-prime mortgages with clarity. One of the speakers was Thomas Lawler, an expert in risk policy from Fannie Mae. Here’s how his comments were summarized in NBN:

“One area of special concern on the financing scene, Lawler indicated, is a shift of sub-prime borrowers away from FHA mortgages to adjustable-rate loans. There were $600 billion in sub-prime originations last year, he said, and the vast majority of them — 66% — were in two-year ARMs.”

“Two-thirds of sub-prime mortgages — which go to borrowers with lower credit scores, less history managing money and less stable incomes — will be reset between now and 2006, he said. ‘If the Fed stopped raising interest rates today, the vast majority of these loans go up 200 basis points.’” (Italics mine.)

That’s a pretty cogent description of a tidal wave of defaults visible on the horizon. These guys were smart and prescient. The Building News article about this noteworthy conference continues:

“They did find… cause for concern over the sustainability of the boom that is occurring largely in parts of the East and West Coasts and worrisome indications that lower-end buyers have been disproportionately taking out adjustable-rate mortgages that expose them to interest rate risks they may not be able to handle.”

It therefore appears that in January, the brain-trust of the NAHB was pulling for sub-prime mortgages to be the ingenious mechanism that would help them sell homes to people who couldn’t afford them, which was basically the only sector left after back-to-back record breaking years of housing starts. To continue the growth, these guys wanted the “snow in July” I analogized in my last blog entry. It wasn’t natural and it wasn’t sustainable. And they very clearly knew it. Still, at the moment, it was excellent for business. At that moment.

After the perfunctory worrying about reality was over, here’s how the NAHB's David Seiders summarized the situation at the May 2005 conference.

“Home Sales activity has easily been hitting records. Just basically, it’s been wow—up, up and away.”

“Wow” is an apt word for what happened. And it had only had a brief additional fling with the word "up;" thereafter, it created the most precipitous freefall in the modern history of homebuilding.



Ref: NAHB website, 11/19/2008

The mission of the NAHB is to “enhance the climate for housing and the building industry,” and to “promote policies that will keep housing a national priority.” It is now quite obvious that this single-minded, self-serving, short-termed, greed-induced agenda that makes the common economic and social good secondary considerations, borders on criminal behavior when you are the public voice of 235,000 members and 80% of the nation’s homebuilders. The NAHB has considerable clout, which can be used for good or ill. They chose poorly.

In early 2005, the little-understood magic mortgage potion appeared to be so good for NAHB’s homebuilders that it seemed worth offering that tempting elixir to even more homebuyers, even though the NAHB economists precisely understood its potential as a poison time-bomb. The thinking was nearly this sick: “Here, drink this. It will provide profits for us this year and happiness for you, at least for awhile.” Walking away, the purveyors of the drink-fest confide amongst themselves that they know it might also cause a massive outbreak of cholera in two years, but drop the conversation because it was dampening their euphoria. So they party-on knowing that “when,” not “if,” things go wrong, it will be the fault of those who were dumb enough to accept the free happy-potion being passed around in their gala of denial.

The fact is that the growth of the homebuilding sector had indeed reached its “natural limit,” probably somewhere in 2002 or 2003. More growth required defying natural seasons and cycles by denying common sense and basic math. Economist Adam Smith didn’t contemplate conscious, rationalized idiocy on such a large scale; his “invisible hand” was no match for such a massive, wanton snow job.

It is good to see that the latest version of the government’s bailout plan is aiming more squarely at the consumer side of the problem. We now know that the road to economic ruin beats up our cars (automobile industry), but it travels right through our homes (housing industry). We got into this crisis because a plethora of gamers—from the world’s biggest banks all the way down to the now proverbial Joe six-pack—converged on the American home in the hope that it would take them directly to fast and easy money. When it led them instead to a massive financial sinkhole, a whole lot of people got a rough reminder that the highest and best purpose of a home hasn’t changed since the dawn of civilization. As cars are for driving, homes are for living. They might also be a good investment, but their underlying value is in enhancing the quality of life, not creating wealth.

The investment banks created the confusion of a home as an investment commodity by developing loans that misled or lied. The virtue of home ownership was the excuse used by the bankers to explain the ruse by which they were convincing one and all to accept the pernicious vice of living far beyond their means. I’m sure those closely involved would say their intentions were well considered and well meaning, but for many of us it always looked stupid and avaricious.

And it is also how that-which-ought-to-be-sacred became instead profane.

I am in homebuilding because I like the direct and good effect we can have on the quality of peoples’ lives. That big ideal was triggered in me in the 1970s, during a lunchtime conversation, while on a remodeling project. I heard this from a fellow carpenter: “Ours is a sacred profession. We build the places where people live.” He then went on to explain his point, and, unfortunately, I can't remember it verbatim, but here’s the gist in my own words:

We make the places where people usually experience the most intimate and formative experiences of their lives. A home is the place people go for comfort and renewal; for joy and celebration; it is nearly synonymous with words like security, loyalty and love. Home is the chapel of all that is personal and familiar, and it is the center of our closest human relationships. It is where love is found and made, where children grow up and develop a sense of who they are and grow into their unique perspective about the world around them. Our earliest memories are often embedded with the smallest details of the place where we lived in our early years. Nooks and crannies, shapes, colors and all the odd eccentricities of buildings are stuck to our psyche and revealed again and again in thoughts and dreams. To paraphrase Winston Churchill, we build our homes, thereafter they build us.

Well, we’re pretty far from all that, but I still stand with all those people whose lives are now decimated by the bills they can’t pay. They perhaps got foolish and greedy and are now imperiled by that choice, but they didn’t mix the Kool-Aid; they just drank it.

Since the government is still looking for a way out of this mess, I have a proposal. It is modest and simple. It punishes everyone, but keeps people in their homes. It separates those who mixed the toxic Kool-Aid from those who drank it. It allows the economy to recover, but slowly. Mostly, it parallels the idea that a home is a long-term value, not a get-rich scheme.

1. Reduce the mortgage payments for all the subprime loans to 1/3 of the family income. Drop the interest rate to a very low level (3%?) and stretch the payment period out as long as is necessary, even 50 to 75 years, whatever it takes to make the formula work.

2. Reappraise the house in five years and adjust the interest rate up or down as necessary. From there on, it would be fixed. The difference would come from the bailout money.

This would achieve several things:

1. If people wanted to stay in their homes, they could. If not, the home would foreclose and they would have a stain on their credit rating. For those who stay, they have a place to live that is affordable, but full ownership may not be possible in their lifetime. It’s a punishment, but it isn't oppressive because equity is still accrued and they get a place to live.

2. Money would flow again, but slowly. And incomes won’t be eaten up with mortgage payments, allowing other sectors of the economy to recover.

3. The banking community would get money, but their desire for fast profits would be severely punished.

4. The bailout amounts would be reduced by the difference between current bubble-inflated values and the values determined by the market in the next five years, which will be enough time to sort out real values.

If you’re planning to shoot holes in my plan, forget it. I'm putting my head back in the sand. I just want homes to mean what they should again.