Subprime mortgages and the American Honesty Index (AHI)

The failure of Bear Stearns in the sub-prime mortgage fiasco has the press all aflutter, predicting that this is the beginning of a long, painful downturn of the economy. (Well, Bear didn't really fail, it just got acquired by JPMorgan for about 10% of it's Friday value, rather than filling Ch. 11).

I am not an economist, nor do I watch the markets very closely. Not a whole lot of my money is in stocks, actually. But, when I look around, I don't see a whole lot of problems, contrary to doom and gloom stories like this one.

Actually, I think this is what will happen: people will get foreclosed on and will move to cheaper rental housing, or move in with the folks. Housing prices will continue to drop, and construction will slow tremendously. Lot's of people's credit will be ruined (well, it was already bad to only qualify for a sub-prime, so really it will just get worse). Some of the lenders (like Bear Stearns) will go out of business, or at least get gobbled up for nothing as with the JPMorgan buyout for 10% of it's worth. And the economy will keep chugging along.

This was a badly needed correction that anyone could see coming *years* ago. Housing prices were (and are) way too high. People started overextending themselves to get in on the action, and lenders were all too happy to play along. Both parties were acting unwisely, and now they're paying the price.

The people who bought that debt were also being unwise. Hopefully investors who buy debt will pay closer attention to what they're really buying. Indeed, I think a lasting effect of this fiasco is a critical blow to the American financial sector's credibility with foreign investors: apparently our institutions cannot be trusted to sell viable debt.

Many economists have said (but please don't ask me to list them!) that one reason the American economy has been so strong for so long is the fundamental honesty of the American businessman. Honesty yields huge efficiencies in deal-making because much less effort need be expended on fact checking and contract enforcement. Ever since Enron, I believe that the American Honesty Index (AHI) has been on the decline, and this mortgage crisis is just the latest big datapoint.

Institutions like Countrywide and Bear Stearns deserve to go out of business. Their investors deserve to lose money. Borrowers deserve to lose their homes. Home prices should come back down to earth. Yes, it hurts. But when you do wrong, pain is the inevitable result. The key is to take it, learn from it, and not let it get you down. It's just life, man.

With any luck, another long term effect will be a simplification of the home loan process. "Mortgage" is just a fancy name for a loan used to buy a home, and they can be fiercely complicated. There is an obvious market need for mortgages with simpler terms. Dare I say it, but there is also a need for mortgages with better terms, too. But you can't really get better until things get simpler first: markets don't work when the consumer is systematically kept ignorant. (This is also the problem with the healthcare industry.)

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