Chinese melamine in the US housing markets? by gimleteye

In the Sunday New York Times, the authors of “Freakonomics” Stephen J. Dubner and Steven D. Levitt take a look at mortgage fraud in an essay called “Payback Time”.

“… some people employ the most time-honored solution for getting what they don’t quite deserve: they cheat. In some cases, the cheating involves an illegal sleight-of-hand maneuver known as the cash-back transaction. As one of the trickiest forms of mortgage fraud — there are many others — the cash-back transaction is hardly unknown among real estate insiders, but it has largely escaped academic scrutiny. Until now."

Eyeonmiami has looked closely at instances mortgage fraud we found in random searches of property tax records in Miami-Dade County. Our forays into the public record show why Miami is the index case for crashing housing markets.

We have also noted how the political roots of the housing boom, now unraveling at an accelerating pace, are in Florida and began with the election of Governor Jeb Bush in 1998, a decade ago.

Dubner and Levitt conclude their NYT essay:

“At first glance, these cash-back transactions, while illegal, might seem a victimless crime. After all, the seller gets his house sold and the buyer gets to move in with his family. The real estate agent, the mortgage broker, the attorney and the appraiser are all paid their commissions or fees. Even the bank that made the loan comes out ahead, since it earned its fees on the transaction before passing along the mortgage to investors.

…Ben-David argues that there are at least two potential losers. The first is the honest buyer who won’t take a cash-back offer and therefore can’t buy a house — all while the illegal cash-back transactions are artificially driving up home prices in his neighborhood.

The second loser is the investor who bought the mortgage-backed securities. If a house purchased with a cash-back transaction goes into foreclosure, it is soon discovered that the home is worth less than the value of the loan. This, plainly, is not good for the shareholders of such assets. While people who hate rich people may get a thrill from the idea of wealthy shareholders being swindled by a bunch of small-time mortgage hustlers, keep in mind that mortgage-backed securities are the sort of conservative investment widely held by pensioners and other regular folks.

There’s a third potential loser as well: the subprime buyer who does accept the cash-back payment but still ends up defaulting on the loan. Although his criminal act will probably never be prosecuted, he stands to face an even harsher sentence: moving back in with the in-laws.”

It's only a little bit amusing, to wrap up the mortgage fraud mess with a family drama.

Freakonomics writers glide past the biggest loser of all: the power of US monetary officials to persuade allies who are fearful that their own economic growth is at risk from the excesses supported in the United States.

Although financial institutions have lately been tightening mortgage requirements with alacrity, it is widely known if only reported in dribs and drabs that trillions of dollars of mortgage pools are contaminated by fraud and excess just like melamine from China in pet food supplies.

Yesterday, the Wall Street Journal reported that a Bear Stearns fund based on subprime mortgages is down 23 percent for the year.

While it is widely known that foreclosures rates are skyrocketing—and not just in subprime loan markets—the trillion dollar derivative market is not required to price its holdings until they are sold.

Failing to ‘mark-to-market’ is keeping bad news out of the mainstream media—much worse news than has been published to date—but not out of the hands of central bankers in Europe who are anxious to defend their own economies from what ails the United States: an appearance of buoyancy built on a foundation laced with fraud.

Obscured behind the assertions of American government officials that job growth statistics are reasonable, if not as strong as expected, and that the US economy is neither “too hot nor too cold” like Goldilocks is the increasing prospect that the better metaphor is 'Earthquake!'

It is increasingly hard to conceal, as US officials have tried to do, that the sharp downturn in US housing markets is dragging down economic growth. As it becomes more obvious, European allies--with stronger currencies--are taking note.

The US homebuilders are jawboning the White House and monetary officials to lower interest rates in order to prime the consumer pump for a recovery in the housing sector in 2008.

But European economic ministers are not as susceptible to our local lobbyists and more wary of imbalance in their own economies from an over-hanging housing sector.

As in everything else, power is a matter of perception and it is increasingly observed that the contribution to the US economy of a bubble in housing, backed by fraud and other speculative practices, is not a model to emulate.

Whether addressing global warming, war in the Middle East, or interest rate policies of the Federal Reverve: US leadership in the world today is a dim star.

This leads to a unique change in post-war (World War II) relations. Sooner, rather than later, economic ministers in Europe will decide to raise interest rates and US interest rates will have to follow in order to fund the national debt.

European buyers have been very active, for the past decade, in Miami real estate markets. Because of the strength of the Euro, great real estate has been available at a significant discount, on the order of 30 percent to their native currencies.

But these investments only work in rising markets and stable interest rates.

Now markets are tanking, the perception of US leadership in economic and international relations has been badly bruised, and with rising interest rates in Europe-- the risk of a stronger currency, the Euro, weighed with the risk of falling property values in the United States makes wildly overvalued Miami property a really, really bad investment choice.

The word is out, but scarcely reported that way in the local press. It is all in how the story is told.

Today’s Miami Herald society page offers the fascinating portrait of a fallen real estate ‘Master of the Universe’, Carlos Justo. “Justo, who catered to millionaires and became one himself, says: ‘I am considering filing personal bankruptcy. I’m fighting for my financial life.’ He, along with some investors, lost $2.35 million in a deal at 3 Indian Creek Island, he says. He is in foreclosure on another property—at 40 Indian Creek Island, where he now lives. He bought it in ’05 for $6.85 million.”

Justo says his total debt is over $30 million. “The market is slowing down. Everybody knows what’s happening in the Miami market because of the condo oversupply. It is going to be a bloodbath out there. You know what the buyers are saying? ‘Let me wait, why should I pay $10 million for a house when it might be down to $8 million next year.”

Justo's complaint is a personal tragedy and innocent enough in the context of a very wealthy real estate broker washing up on the shoals of a real estate market propped up by a weak dollar and strong Euro.

But manifestly, the oversupply of condos in downtown Miami is not the problem: in that market, vulture funds are snapping up the inefficient application of capital on the bet that condo prices will recover quickly enough for a short-term gain.

US equity markets shrugged off the subprime mortgage fiasco and threat to the trillion dollar markets for financial derivatives so long as there was a good chance that the US Federal Reserve would comfortably slip back into priming the pump of the housing markets with lower interest rates.

In the past few days, those markets have reacted badly to signs of higher interest rates in Europe. Indeed, why European central bankers allow their economies to be shaken by the same instability promoted as a virtue by US financial institutions, developers, and politicians?

Europe and the rest of the world might be inclined to buy “cheap” US goods, had we not allowed our manufacturing sector to wither away to nothing except for commercial aircraft.

We'll still get visitors this summer, turning the United States into a cheap tourist attraction. But with so much fraud underlying US financial assets, who can blame our allies for planning to keep our troubles at arm's length?