Monday, July 12, 2010


Well, they're at it again. Some opinion pieces over the weekend pointed fingers at the financial reform bill(s) making their way through Congress and in particular at the fact that nothing is done therein to address how Freddie Mac and Fannie Mae "pushed" banks and other lenders into unsafe lending practices. The next sentence will invariably be something about all those greedy home buyers who bought homes and took out mortgages that they couldn't hope to pay. I've already addressed this here where I lay out why the "bad borrowers" idea is just so much BS so I will try not to repeat too much. But there is another way to look at the borrower part of the equation.

In the big wide, wonderful world of finance there is a little something called Leverage. A business with, say, $20,000 in cash puts that money down towards the purchase of a $100,000 asset. The business has leveraged their position by using a small amount of money to get a much larger effect. If the business used only $5,000 for the same loan, they would just be more leveraged in their position. That's what businesses do.

When you or I use the exact same idea in the purchase of a home though, it's now viewed as a bad thing. During the inflation of the real estate bubble that is exactly what borrowers were allowed to do; use small or 0% down payments to be able to borrow the moneys needed to buy a home. They used leverage. And, once again, no, these folks did not know that the price was too high, or that the market would implode, or that they'd be laid off in a year. These people, in the main, thought that they would continue to make a sound income and that their income would increase over time. It's called the American Dream, remember. No one entered into a mortgage that they knew they couldn't afford.

So the next time someone tells you that's it's all the fault of the greedy people who bought more house than they could afford, just look em in the eye and say, "yep, pretty good use of financial leverage wasn't it!" It'll just be so much fun to watch their heads explode when they try and explain around that little fact.

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