The Law of Equivalent Exchange

Humankind cannot gain anything without first giving something in return. To obtain, something of equal value must be lost. That is alchemy's First Law of Equivalent Exchange. In those days, we really believed that to be the world's one, and only, truth.

Alphonse Elric, Fullmetal Alchemist

Last Sunday night's 60 Minutes did a piece on the whole subprime mess. Even though they were exploring known territory it was quite sobering to see lines of people get credit counseling and the footage of foreclosed homes.

There are segments of the program that really hit a nerve or two.

Most of the mortgages issued in Stockton, and half of those now in default or foreclosure, were something called subprime loans, meaning less than prime quality. The borrowers often had sketchy credit, were financially strapped or lacked sufficient income to qualify for a standard mortgage. After a year of artificially low payments, the interest rates on subprime loans jumped all the way to ten or 11 percent.

But Jerry Abbott, who runs the Coldwell Banker office in Stockton, says it didn’t concern the borrowers, many of whom were getting mortgages for more than their houses were actually worth.

"They were getting loans in excess of 100 percent of the value of the property," Abbott says. "That type of thing. So, most of 'em were actually putting a little bit of money in their pocket at close of escrow."

"So, they were getting paid to buy a house?" Kroft asks.

"They were getting paid to buy a house. Yes. Yeah," Abbott says.

And strangely enough, it didn't seem to bother the lenders either, who were collecting huge fees just for landing the loans.

"Whatever they wanted to state for their income. The bank accepted that at face value and made the loan based on that income," Abbott says.

Abbott says borrowers got the money, without a down payment.

Jim Grant calls it an invitation to fraud. "You apply to a bank, or a mortgage broker for a loan. And you would fill out a form. And you would say, 'I have an income of, oh, $400,000 a year.' They say, 'You do? Fine. Just sign right there.' And they would nod, and because they were being paid, not by the veracity of the information, but by the consummation of the deal. The lending office would say, 'Ah. You have verified this?' 'Why, yes, we have.' And the lending officer would say, 'Great. So do I,'" Grant says.

"And he got a cut, too?" Kroft asks.

"Yes, oh, yes. Everyone gets a cut," Grant says.
Cheap money and plenty of it to go around and when you throw in some greed you get this mess.

Almost all of the people involved in the transactions made huge amounts of money, then passed the risk onto someone else. Instead of keeping the dicey loans in their own portfolios, the big banks and giant mortgage companies that originally underwrote them, resold the mortgages to big New York investment houses.

Firms like Bear Stearns and Merrill Lynch sliced the loans into little pieces and packaged them up with other investments, then sold them to their best customers around the world as high-yield mortgage-backed securities, turning sows' ears into silk purses, all with the blessing of rating agencies like Standard & Poor’s.

"At every step in the way, somebody has his or her hand out, getting paid. And everyone, for the time, is happy. The broker got paid. He or she was happy. The lending officer, ditto. The rating agencies got paid for passing judgment on these securities. They, too, were pleased, and their stockholders were happy. And on and on. And it would never end, except that it did," Grant says.

It was all predicated on the idea that real estate prices would keep going up, and up and up, and for a long time they did. But by the summer of 2005, speculators flipping houses in Stockton had helped drive the price of that four-bedroom house to more than $400,000 and the market began to soften, then to tumble.

All of a sudden those subprime borrowers who had taken the free money found themselves upside down, owing more on their new house than it was worth.

It’s not exactly clear how a mortgage broker was able to qualify Phil Fontenot and his wife Kim Monroe for their $436,000 house, from which they run a small day care center. They say they wanted to move to a better neighborhood. A mortgage broker approached the Fontenots and offered to get them a loan. They told her the most they could afford, at most, was $2,500 a month. But the monthly payment on the adjustable rate mortgage she gave them quickly jumped to $4,200.

"Did you understand any of this?" Kroft asks.

"No, not really. Not much of it," says Phil Fontentot, who also says he didn't have a lawyer look over the paperwork.

"But you knew this was a big decision, right? You were borrowing hundreds of thousands of dollars," Kroft remarks.

"I didn't really look at it like that," Fontenot says.

"How did you look at it?" Kroft asks.

"I looked at it as far as my family. I can get my family off of this block," he replies.

"And that we could pay the payments that she said that we could pay," Fontenot's wife Kim adds. "But after it was all said and done, and the paperwork was drawn up, it was something different."

But Matt and Stephanie Valdez say they knew exactly what they were doing when they bought a small two-bedroom for $355,000. They could afford the initial payments and planned to refinance the mortgage before the interest rate jumped to 11 percent. But they couldn't do it because the value of the house had fallen below what they owed on the mortgage. They say they can afford the higher payments, but see no point in making them.

"The house keeps going down, payments keep going up. Where's the logic in that? And how can we fix it? I mean, that's what this whole thing's about for us is how can we fix this? And if we can't fix it, then what do we do?" Matt Valdez asks.

"Why pay a $3,200 payment on a 1200-square-foot home? It makes no sense," Stephanie Valdez adds.

"That's what you agreed to do when you bought the house," Kroft points out.

"Fine. If the value is going up. But we're not going anywhere. The price or the value is going down. It makes no sense because we will never be able to refinance and get a lower payment. There's no way," Stephanie Valdez replies.

"You're saying, essentially, that you're going to stop making payments on it? You're just gonna let it go into foreclosure?" Kroft asks.

"You know, that's the only advice we've gotten so far is walk away from the home. We don't want to do that to our credit. Why can't our mortgage company work with us?" she says.

There is a certain cold logic to just walking away.

Kevin Moran, the real estate agent who gave Kroft the tour of foreclosed houses in the Weston Ranch subdivision, says it is happening every day. They were never really invested. Most of the people who lost the houses didn’t lose any money because they never put any money down. Though their credit is damaged, and they could face legal action in some circumstances, they got to live in a new house for a couple of years, and some of them even managed to get some money with home equity loans or by refinancing.

"Nobody seems to be saying, 'Look, I made a contract with you. I borrowed money from you. I'm gonna do everything I can to pay off that obligation.' People just seem to be saying, 'Look, take the house. Good-bye. I'm leaving,'" Kroft says. "There was a time, I think, when people felt really bad about not paying off a debt."

"Yeah, I think in those days, loans were made by your local banker or building and loan associations or savings and loan. They were guys you saw in the grocery store. They were on the little league team with you, the PTA, the school. And I think as mortgages became securitized and Wall Street became involved, they became very transactional and there was no relationship built with the borrower and the lender. And I think that makes it easier for someone to see it as an anonymous party at the other end of the transaction and just walk away from it," Moran says.

"Just a business decision," Kroft says.

"A business decision that has to be made," Moran agrees.

"It turns out that if you give people free money, they will take it without really worrying too much about giving it back. Because after all, it was free," Jim Grant says.

Asked if it's a case of greed, Grant says, "Greed, sure. Greed on both sides of the table."

"What do you mean?" Kroft asks.

"Lenders and borrowers," Grant says. "Everyone was gaming the system."

That is not to suggest that there aren’t huge losers in all this and much suffering and particularly hard-working people who have lost their dream. Home values are plummeting, and the housing sector - one of the largest and most vital parts of the American economy - has ground to a standstill, pushing the country towards recession.

The Wall Street and foreign investors are now stuck with the millions of distressed properties on Sean O’Toole's map, the unsold condos in Miami, the unfinished apartments on the Vegas Strip, the developments in Atlanta that are sitting idle and the thousand stucco houses in Stockton. Not even Kevin Moran, who has copies of the foreclosed mortgages, can figure out who exactly owns them.

"That’s the fascinating part of this whole debacle we’re in. Mortgages are sold in mortgage backed securities, so they’re pooled. I’ve seen everything from some of the largest financial institutions in the country, and you see 'Deutsche Bank' in a series and a series of numbers and letters to a mortgage pool," he says.

The pools are part and parcel of those high-yield mortgage backed securities everyone gobbled up a few years ago, and are now stuck in the windpipe of the world's financial system. No one wants to buy them, so no one can sell them.

"Bonds marked triple-A are now quoted at 50 cents to the dollar, 40 cents on the dollar. Some of them, much less," Grant says.

"How much on the dollar, do ya think?" Kroft asks.

"Some of them are worth nothing on the dollar. Nothing on the dollar. This is the worst thing that has happened to Wall Street in a long time," Grant says.

Asked how many of these securities are out there, Grant says, "A trillion with a T-plus."

Asked who bought them and owns them, Grant says, "You know, state pension funds, the hedge funds bought them. Foreign central banks own some of these things, if you please. So the ownership is very widely dispersed, which accounts for the general anxiety, and the persistence of anxiety."

Frontline recently did a report on the effect of the online world has on teenagers one of the issues they examined was narcissism and from one study it appeard that America was becoming more narcissistic than ever.

Not only do I agree with that study but I would also add a new term which is financial narcissism. Bottom line is that no one wants to take any responsibility for the decisions they have made.

Aside from people like the Fontenots who had no idea what they were getting into, a large segment of the population were gaming the system and were trying to get a free house plus some extra cash on the side through refinancing and maybe a home equity loan.

Whether these were flippers or serious buyers, they got caught before they could unload. So they act as their own loan sharks and suck out as much as they could from these homes and pull a bust out by walking away from their homes.
It completely took me off guard that callousness of the Valdez’s.

"Why pay a $3,200 payment on a 1200-square-foot home? It makes no sense," Stephanie Valdez adds.

"That's what you agreed to do when you bought the house," Kroft points out.

"Fine. If the value is going up. But we're not going anywhere. The price or the value is going down. It makes no sense because we will never be able to refinance and get a lower payment. There's no way," Stephanie Valdez replies.

"You're saying, essentially, that you're going to stop making payments on it? You're just gonna let it go into foreclosure?" Kroft asks.

"You know, that's the only advice we've gotten so far is walk away from the home. We don't want to do that to our credit. Why can't our mortgage company work with us?" she says.

Then why the hell did you buy the house in the first place? Did you not do your due diligence? Did you not see the worst-case scenario? Did you not take a hard look at finances to see if you could afford this home in the long run?
There is no sense of shame or responsibility. The only thing that matters is what’s in it for me. Although I am alarmed at these attitudes, I can understand where it comes, after all they see these everyone else make a ton of money and be able to walk away from trouble. Why can’t they?

This is no longer an equivalent exchange. What we have now is some heavy interest tacked onto this exchange but I am not just talking the money aspect, I am talking about the emotional, psychological and spiritual interest that this is all going to be with us for a very long time.