The Prague Post Online: Opinion: Mortgage meltdown

November 22nd, 2008

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Mortgage meltdown

U.S. sub-prime loans have something in common with Ponzi schemes
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September 5th, 2007 issue

By David Brown

Recent international stock market gyrations caused by the unraveling of the U.S. sub-prime mortgage debacle are interesting for what they say about U.S. politics today. Nothing much happens until the well-to-do are affected or until disaster strikes.

While technically the sub-prime debacle may not precisely fit the definition of either a Ponzi scheme or a pyramid scheme, it certainly has much in common with them both. Like such schemes, it was from its inception unsustainable. It was doomed to collapse from the start — it was just a matter of when. U.S. officials supported it, pretty much from the beginning until recent weeks.

Just what is this kind of loan? It’s a mortgage given to home buyers who can’t possibly afford to pay back the loans unless the properties they buy continues to rapidly appreciate.

Those home buyers need to be able to sell the properties or to take out new loans based on the increased worth of their properties. This means that even relatively poor people can become homeowners rather than renters. It works out fine, as long as housing is appreciating as part of a speculative bubble that the loans themselves are helping to fuel. While the going was good, the government wasn’t about to argue against the poor getting their slice of the American dream.

Sub-prime loans in the United States attracted not just the poor but also middle-class speculators who bought housing with the intent of turning around and selling it a few months later for a substantial — sometimes spectacular — profit.

The term of art for this rapid turnover is “flipping,” and for a while it seemed that flipping was all anyone talked about. You had to be almost stupid not to get in on the latest craze. When the housing bubble burst last year, many already had made a lot of money and gotten out. But some combination of the ignorant, the innocent, the duped and the greedy were left holding the bag.

I can’t help but think back to a somewhat analogous situation when I arrived in Prague in January 1996.

All the talk of that time was about how Czechs had the magic economic touch. How was it that they were able to transition from communism to capitalism so smoothly? How were they able to devise a privatization scheme that worked so well where so many others had failed? No one had a real explanation — other than that the Czechs had innate good business sense and talents and proud memories of a dynamic First Republic were still intact.

It didn’t take long until this rosy assessment of the privatization scheme turned completely around. A year later, every Czech newspaper was filled with stories of tunneling — the Czech version of corporate asset stripping — and nearly overnight there was universal agreement that the privatization scheme had been rigged for a few insiders at the expense of the majority shareholders from the start.

One also can’t help but think back to the collapse of the Albanian government in 1997 as the result of the government’s support of a series of pyramid investment funds. When Americans heard of the Albanian situation, most could only scratch their heads and wonder. Sure, Americans had a little bit of sympathy for those who through no fault of their own were terribly ignorant about the ways of capitalism. But most Americans couldn’t help but feel that to some degree people who thought they could get something for nothing deserved what they got.

The transition from communism to capitalism has been a rocky one from time to time — more so for some than others — to be sure. Therefore, the Czech privatization scheme and the Albanian pyramid investment funds came as no great surprise.

But what is the United States’ excuse? Such a query is not to suggest that every time something goes economically astray it is necessarily anyone’s fault. Capitalism, even when managed well, has its challenges. Recessions occur, businesses fold, sometimes for reasons beyond anyone’s control. Individuals lose their jobs, sometimes unfairly.

This is not what happened with the sub-prime debacle. This was not just a part of the normal business cycle. This was a disaster waiting to happen — one that many an informed citizen would have long ago predicted. Why did the U.S. government sit idly by and watch?

My only explanation is that, in the United States, the welfare state is so thoroughly discredited and what Americans refer to as the “laissez faire approach,” or what Czechs call “primitive capitalism,” is so deeply entrenched that it no longer occurs to those in government to step in to regulate a business transactions until disaster strikes. By then, it is essentially too late.

One wonders what today’s U.S. government would say about loan sharking were it not already illegal. Perhaps officials would argue that poor people deserve to have access to financing, no matter what the ultimate costs. Perhaps government officials would say, “we see no problem here.”

Or what about child labor laws? One can only imagine that many in the current government would argue that most parents have the best interests of their children at heart, so why should the government stick its nose in family affairs? Current American deference to business transactions and dealings affecting everyday people hasn’t been this acute seen since before the time of Franklin D. Roosevelt.

Now that the stock market has been so largely affected, there is some discussion about finally stepping in and doing something to address the mortgage problem. It reminds me of those in government who want to step in and do something about the Iraq fiasco. I agree that something has to be done — better late than never, I suppose. But what does it say about the U.S. government that it can’t seem to anticipate problems, but can only react?

— The author is an American lawyer who worked in Prague and other former Eastern bloc capitals from 1996 to 2001.

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