Clarey behind the housing crash; confessions from an insider (2008)

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Copyright © 2008 Aaron Clarey
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ISBN: 1-4392-0406-3
ISBN-13: 9781439204061
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To Eden


All the stories contained in this book are true.
Names, times, locations, numbers and other identifying information have been changed to protect
the innocent as well as the guilty.


Table of Contents
TITLE PAGE
COPYRIGHT PAGE

PART I: TROUBLE STIRS
1.
2.
3.
4.

An Economist Too Far
The Thin Skinned Economy
The Economic Chessboard is Set
My Ex Was Sub Prime

PART II: BATTLING THE BANKERS
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.

Credit Union Blues – Bob, Bob and Bill
Credit Union Blues – Little People
Adventures in Inept Management
Appraisal Antics
Papers Please
Failing to Do Their Homework

“4”
The Sky is Red
Glut is a Four Letter Word
The Three Musketeers
Getting Away with Murder

PART III: DESPERATE PEOPLE
16.
17.
18.
19.

Desperation
Vindication
Who’s to Blame
What Can Be Done


PART I
TROUBLE STIRS


An Economist Too Far
One of my favorite scenes in one of my favorite movies is the scene from “A Bridge Too Far” where
a young military intelligence analyst named Fuller has mounting evidence the Germans do indeed
have armored divisions and tanks in Belgium which would (and did) cause “Operation Market
Garden” to be one of the largest Allied failures in WWII. In the scene he calls in his commanding
officer and shows him aerial photographs of German Panzer tanks in the Dutch countryside in the
hopes of convincing his commanding officer to call off the operation. Upon seeing the picture of the
tanks, the commanding officer, visibly disturbed, rises from his seat, approaches the screen,

pointlessly analyzes the tanks and nonchalantly says,
“Yes, well I shouldn’t worry about that.”
To which Fuller responds in disbelief, “But sir…you do see that they are tanks?”
Dismissing it, the commanding officer says, “I doubt they’re serviceable.”
“But they still have guns,” Fuller points out.
“So have we!” the commanding officer vehemently responds.
And despite Fuller’s concern and evidence of German tanks, his commanding officer dismisses it all
in one succinct statement that explains the real reason he’s disregarding the tanks;
“Now look here… 16 consecutive drops have been cancelled in the past few months for one reason
or another. But this time the party’s on. And no one is going to call it off.”
Later in the movie Fuller is approached by an officer who summarily “relieves him of duty” by
saying, “You need to rest. You are tired.” For Fuller and his pesky intelligence keeps getting in the
way of Operation Market Garden.
Of course in the end Fuller proved to be right. The German tanks were not in disrepair. Several
divisions of veteran German soldiers were in the area. And when it was all said and done Operation
Market Garden cost the lives of 6,600 Allied soldiers and did not “end the war by Christmas” as
proposed it would.
But today’s Fullers of the world are of a different breed. For they are not so much WWII military
intelligence analysts as much as they are the scores, if not, hundreds of veteran banking industry
insiders, who like Fuller, dared to do one thing;
Think.
Though definitely the minority, there are those in the banking industry who had the intellectual


veracity and independence to ignore group-think, objectively look at data, objectively look at
research or just plain look at what was going on around them and were able to predict the housing
crash long before it occurred. And not only were they able to predict it, they tried to warn
management so that disaster might be avoided. But just like Fuller in “A Bridge Too Far” they were
told “You need to rest. You are tired” and were either lectured, disciplined or “relived of duty.” For
they did not conform and play ball, but were getting in the way of what management believed to be

perpetual commissions and bonuses.
You yourself may know somebody in banking or real estate who for the past three years was saying
this was coming. You may know somebody who works at an actual bank and has regaled you with
stories of lax lending standards, loans being made to people who could not afford them and other such
unbelievable tales. You yourself may be a Fuller and have seen it first hand, trying to toll the bells to
warn somebody, anybody about the impending doom. But while the media and news focus on how
“mortgage brokers” and ignorant, sub prime borrowers were the primary culprits of the housing
crash, what they fail to tell is what was happening behind the scenes in the banking industry that
created the perfect environment for the crash to germinate in the first place.
That it wasn’t just a bunch of renegade mortgage brokers and some sub prime borrowers that caused
this, but it was an industry wide group-think that forfeited quality and credit in exchange for short
term profits, bonuses and commissions that caused a systematic collapse of the housing market, and
spread to the larger economy. That there are criminals and villains beyond the mortgage broker and
sub prime borrower who are to blame. That they were fully warned in advance about the potential for
a housing bubble. And that the Fullers of the world were pressured, silenced, if not fired and
disciplined for not playing ball and daring to have the gall to point out the obvious. And just as it
would be a crime not to have the heads roll for those responsible for 6,600 Allied deaths, so too
would it be a crime not to punish those responsible for a housing market crash, a stock market crash,
an economy in recession and millions unemployed.
For I too am a Fuller.
And I am pissed.


The Thin Skinned Economy
Before the economy, corrupt mortgage brokers, shady real estate developers, and inept banking
management is addressed, key to understanding how the housing crash came about is to understand the
mentality or psychological backdrop Americans had that permitted such an outlandish thing to occur
in the first place. And that is the concept of the “Thin Skinned Economy.”
The Thin Skinned Economy is simply where it is more important to be nice than right. That it is more
important to avoid upsetting somebody than doing the correct thing. That customer satisfaction is

paramount to all other goals, including profitability. And if necessary the viability of the firm should
be sacrificed to avoid telling the customer “no.” In other words, the customers, no matter how
spoiled, unprofitable or irrational are to be kowtowed to like a hotel heiress even if it brings about
the demise of the firm.
The origins of the “Thin Skinned Economy” I speculate came about as Americans and westerners
became so accustomed to the wealth and benefits produced by capitalism that you have nearly two to
three generations who were never told “no” as children. Starting off with the Baby Boomers, passing
their entitlement mentality on to Generation X, and now Generation X instilling that into their
children, nearly all of the American population have never known poverty, never known failure and
never known true strife. And being brought up with every whim and desire satisfied, it is the more
“motherly” approach to child rearing where the child is cajoled into behaving through bribery and
cake, than the “fatherly” approach where a child is told no and enforced through the threat of
punishment that the majority of Americans are accustomed to. This approach has now resulted in
effectively an entire nation that is not used to being told “no.” Worst still, not only are they not used to
it, they are enraged by it, at minimum filing a complaint, if not throwing a full temper tantrum should
they face that unacceptable word “no.”
In other words the concept of “no” has been completely removed from the American psyche resulting
in a very thin skin towards denial or refutation, and if ever faced with it, a person is typically insulted
and angered.
A perfect example was when I was a younger man, all of 24-years-old. I had just put together a
seminar for the local school district’s community education program on how to analyze and research
stocks. This was during the height of “Dotcom Mania” and there was great demand in the public for a
class that would teach people how to read financial statements and value stocks.
The seminar itself was quite involved, lasting over eight hours and was taught over four lessons, two
hours each. Thusly, one could not expect to just jump in at the second class and have a clue what was
going on, as current lessons built upon previous ones. However, that did not prevent a rather “poshly”
dressed 30-something woman, who I had never seen before, from showing up at the very last class.
Thinking she was lost, I asked her, “Are you looking for a particular class?”

“Yes, I’m here for the stocks class,” she replied.
I said, “Well, I apologize, but I don’t know how much good it will do you. It’s the last class and
we’ve had three lessons already.”
And thus her thin skin was pierced.
Angrily she lectured me saying, “Don’t you tell me what I need to know! I came here to take this class
and learn how to buy stocks. I know what I’m doing and I don’t care to hear your attitude or opinion
on whether I’ll be able to catch up.”
Somewhat shocked by the volatile reaction, my natural instinct was to apologize, which I did. But
soon my gut instinct to have a bit of self-respect and give her a retaliatory lecture overrode my desire
to apologize and make nice;
“You know, on second thought, get the hell out of my class.”
The entire class was stunned.
“I don’t care what you think you know. You missed three classes and you actually expect to catch up?
Like hell you will! Now get the hell out of my class and don’t come back!”
She was speechless and her face was nothing but pure shock. Obviously being told no was a rarity in
her life and she didn’t know how to handle it. Without a word she gathered her things and left the
class – and I, of course, later on received a call from the community education director.
Regardless, this is the quintessential byproduct of the Thin Skinned Economy; people with entitlement
mentalities who are insulted when you dare hold them to some standards or requirements. People who
get upset when things don’t go their way. And people who get outright enraged if you deny them
something they want. But it is this mentality that was a vital catalyst in creating the housing bubble
and subsequent crash.
For the Thin Skinned Economy helped bring about the housing crisis in two ways – the first of which
was by artificially and temporarily increasing the demand for housing. This was achieved by
eliminating the word “no” from the vocabulary of bankers and mortgage lenders. In fear of having a
complaint filed against them or losing a customer, nobody was ever denied a loan. If you had a credit
score of an abysmally low 470, you were approved. If you were a young 22-year-old that had no
credit history, no collateral and no income, you were approved. It didn’t matter if you obviously had
no ability, let alone intention of paying back your loan, you were approved with little to no
verification that you could.

This inability to say “no” manifested itself in the creative financing methods banks and mortgage
lenders concocted to “get you into a home” by any means possible. Loan products such as “ARM’s,”
“Interest Only loans,” “Reverse Amortization loans” and so forth were created so if you couldn’t


afford a traditional 15 or 30-year mortgage you were approved anyway. Additionally the
documentation required to get a loan was severely lessened or eliminated altogether. “No doc” or
“low doc” loans were made completely based on your credit score and very little, if any, paper
documentation attesting to your repayment ability. Even worse, many lenders didn’t even bother
looking at your ability to pay back the loan, but instead looked at the property you were pledging as
collateral. This “asset based lending” operated on the assumption you may not pay back the loan, but
they could easily repossess your property, sell it, and get their money back. In short, banks and other
lenders were bending over backwards and doing whatever they could to qualify as many people as
possible for loans regardless of their ability to pay it back.
Sadly, this mentality was universal in the lending world. During my banking career as an analyst not
once where I had determined it would be best to deny the loan would my decision go unchallenged. It
was a practical guarantee, even though there was no hope whatsoever of repayment, that I would have
a banker, a boss or a broker in my office pressuring me to find “some way” to qualify these
hopelessly unqualified borrowers. One boss in particular epitomized this mentality whereas upon
ascertaining the likelihood of repayment of many loans to be zero, he would come into my office and
in his whinny, signature tone always ask, “Well isn’t there a waaaaay?” To them it didn’t matter what
reality said, it was whether we could create our own reality and “find a way” to twist it to our
desires.
But that was just it; there was no way. There was no way these people would ever pay back their
loans. We’d be doing them a favor by telling them no and thereby preventing them from inevitably
having to file for bankruptcy in the near future. Not to mention we’d save the capital of the bank and
prevent what was sure to be a future loss.
But therein lies the problem for it runs afoul of the Thin Skinned Economy;
“…by telling them no. “
And that’s all that has to be said.

Doesn’t matter if the loan was never going to be paid back. Doesn’t matter if we’re trying to do the
right thing. Doesn’t even matter if we have their best interests at heart. People in the Thin Skinned
Economy don’t want to be told no, and as the Thin Skinned dictum states, being told no is to be
avoided at all costs, even if it means a loss for the bank.
The result for doting on the undeserving children of the Thin Skinned Economy and refusing to say no
was quite simple. In approving people for mortgages that had no hope whatsoever of paying them
back, banks and mortgage lenders;
1. artificially and
2. temporarily
increased the demand for housing, thus contributing to the bubble. In approving thousands, if not


millions of undeserving people for mortgages, the banks and brokers effectively flooded the market
with temporary buyers, thereby driving up the price of housing. However, this effect was artificial
and temporary as inevitably these people would default on their loans, resulting in repossession and
thus are-listing of the property on the market. In other words, since none of these people would be
long term owners of their properties, their effect on demand and thus property prices would be short
lived. Sure enough this was realized when the “Thin Skinned Economy” met the “Reality Economy”
and by 2008 people were defaulting on their mortgages and going into foreclosure in record numbers.
The second and often unknown or unrealized effect of the Thin Skinned Economy was on the other
side of the supply and demand equation. While the media and so forth focused their attention on the
sub prime borrowers who shouldn’t have been lent the money in the first place, thus affecting demand,
very little attention is paid to the supply side of the equation. And here the same Thin Skin
phenomenon of “never say no” played out.
For while a borrower wishing to buy a home doesn’t want to be told no, neither do the real estate
developers that build the homes. Building a house, a condo, let alone a hundred of them, requires
financing and while the sub prime borrowers were approaching banks to get approved for their first
home, sub prime real estate developers were approaching those same banks, looking to get financing
to build the latest “luxury” condo development or the newest “Greenwillowsacresoaksparkway”
suburban development.

But here the incentive to approve the loan was even greater. When you deal with the typical
individual home buyer, they’re only looking to buy one house which has a loan amount of around
$250,000. But when you are dealing with a real estate developer, you are talking hundreds of houses
or units being built, which means you’re looking at loan amounts that can easily exceed $25 million.
And the closing costs, commissions, and various fees on a $25 million condoplex development is a
lot more than your paltry 1% on a $250,000 home loan.
This additional incentive only served to worsen the supply side of the equation. While banks were
artificially boosting demand for housing by loaning money to people who couldn’t afford it, they were
at the same time more aggressively approving real estate development loans that would oversupply
the housing market to a gluttonous level simply because the commission and fee revenue the bank
would realize would dwarf what they were getting from their consumer mortgage operations.
This financial incentive only reinforced the Thin Skinned mantra to not “upset” or even “slightly
peeve” real estate developers, making them the darling princesses of the Thin Skinned Economy.
From 2001–2005 real estate developers were the bread, butter, wine and scotch of the banks’
profitability – bringing in multi-million dollar deals and for a significant amount of time paying them
back. You had to worship the ground they walked on and do everything in your power to make them
happy.
But what they didn’t realize is markets do inexorably move towards equilibrium or balance. And
during 2001–2005 real estate developers built enough homes to satiate demand thus attaining this
balance. Normally banks’ economists, analysts and other researchers would have measured and noted
this attainment of balance, and thusly recommended to the banks and developers the construction of


new homes be lessened. But times were too good and real estate developers had too much pull and
influence over the banks.
Accustomed to the glory years of 2001–2005, developers were used to building and immediately
turning around and selling their inventory. Bankers were accustomed to immediately approving,
funding and then getting paid back on their loans and pocketing billions of dollars worth in fees. And
so, despite the market being amply supplied, additional housing developments were approved,
tipping the housing market into oversupply in the hopes the party would continue.

This created a “double whammy” and is the ultimate effect of the Thin Skinned Economy on the
housing market. You had an artificially and temporarily inflated demand for housing, and at the same
time an oversupplied market with inventories of homes that would never sell. The market was
horribly imbalanced. And the reason for this historic imbalance was no one had the spine to tell
people no. Everybody succumbed to the Thin Skin Economy.
Banks and lenders couldn’t say no to buyers.
Banks and lenders couldn’t say no to developers.
Thus, with no controls or checks governing the amount of money being lent to both, the housing market
was flooded with cash on both the supply and demand sides, making it the perfect recipe for a bubble
and an even better one for disaster. Alas, people could believe in the Thin Skinned Economy all they
wanted. They could believe they were entitled to a house. And believe they were entitled to
perpetually increasing property prices. But reality was what they were inevitably going to face.
And that reality is the housing market we have today.


The Economic Chessboard is Set
While the Thin Skinned Economy certainly had its role to play in the housing crash, more important
were the various macro and international economic forces at work that created the economic
environment in which the housing bubble, and subsequent crash, could form. For while one can blame
people with bad credit and banks with poor lending controls, underpinning all of that were amazing
and coincidentally timed economic developments that created the perfect storm in which the housing
bubble could develop. But in order to understand how these various economic forces culminated into
the perfect storm, one has to go all the way back to 1978.
401(k)s and Dotcom Mania
For it was in 1978 that the US federal government instituted the 401(k) plan. The aim of the 401(k)
and subsequent retirement programs (such as the 403(b), IRA, etc.) was to provide the American
public an incentive to save and invest their money for retirement. And they did this by providing tax
benefits for investing in one of these “tax deferred” retirement plans.
However, there is an interesting aspect of the 401(k) most people don’t think about. Previous to
mutual funds, 401(k)s and other such programs, people in the olden days retired on a whole host of

investments that had nothing to do with stocks and bonds. Typically great grandfather Jones would
sell enough cattle, sell some acreage off his farm or live off the family business as he passed it down
to his children. It is only a recent development in the grand scheme of American history that stocks,
bonds, mutual funds and other securities have become the de facto investment vehicle for retirement.
And by the federal government instituting the 401(k), it was more or less the first time a government
has designated or “endorsed” a specific asset or investment for retirement. This provided a great
incentive to contribute to a 401(k) plan, and thus invest in stocks, bonds and mutual funds.
The result of providing this tax incentive was a flood of money into the stock market. Being able to
write off contributions to their 401(k) plans, millions of American workers contributed trillions of
dollars to their retirement plans – dollars that would not have normally flowed into the stock market
otherwise. The effect was predictably higher stock prices. And not only higher stock prices, but
higher stock prices relative to the profits those stocks generated. In other words, the company was
going to generate the same amount of profit; it’s just with the new incentive to invest in stocks, people
would be willing to pay more in stock price to be entitled to that same amount in profit.
This relationship between the price people are willing to pay for a stock and the profit generated by it
is measured by what is called the “Price to Earnings Ratio” or “P/E Ratio.” Very simply this is just
the price of the stock, divided by the earnings (aka “profits”) of the stock. So if the price is $30 and
the company has $3 in earnings per share, the P/E ratio is 10, meaning you’re paying $10 in stock
price for every dollar in earnings.
Historically the average US stock traded around a P/E ratio of 16, i.e., people on average have paid
$16 in stock price to be entitled to $1 in earnings. However, with this new tax-advantaged incentive


and effective endorsement by the US government, the new money flooding into the stock market
without a proportionate increase in earnings resulted in an overall increase in the average P/E ratio.


Most notable was the dramatic increase in the P/E ratio from 1978 to the peak of Dotcom Mania in
1999. During this time the average price a person was willing to pay for a dollar in earnings went
from $7 to $45. People were paying nearly seven times more in stock price to be entitled to that same

dollar in earnings, a full $10 higher than the peak of the 1929 stock market.
This was a scary development as it showed no longer were people investing in stocks for their
profits, but rather they were investing in stocks as a vehicle for retirement. Nobody bothered to read
the annual report or look at the income statement of their mutual funds and the underlying stocks
thereof. Nobody bothered to look at P/E ratios to make sure they were getting a good deal. And
nobody bothered to research their investments to make sure their money was going into good
companies. People just blindly invested in their 401(k)s because they were told to do so by their HR
departments and were rewarded with a tax benefit.
However, this disconnect between price and profits practically guaranteed a bubble would form as
ultimately the only reason a stock has value is because the corporation is going to produce a profit.
Contrary to what most people think, you don’t invest in a stock because “you can sell it for more in
the future,” for what is going to give it more value in the future? By default the only thing that can give
a stock value is its future profits. Therefore, it was only a matter of time before a harsh reminder of
how prices and profits are inexorably intertwined blindsided an ignorant stock market. Sure enough in
1999 and 2000 the dotcoms failed to produce the profits they promised, the stock market crashed, and
the average P/E ratio of your average US stock dropped to a more reasonable 20.
Though separate from the housing market, it is here a key economic development that led up to the
housing bubble occurred. For while Americans were used to religiously contributing to their 401(k)
plans, this was the first time they saw a consistent and significant drop in their stock prices.
Additionally people’s 401(k) and 403(b) plans had significantly more money in them than they did
during the previous stock market crash in 1987, making the Dotcom crash all that more stinging. This
sting prompted them to look to alternative investments for their retirement dollars – and a natural
investment alternative to stocks is property.


In this sense the American investor simply traded in one bubble for another. Taking dollars they
would have normally invested in an inflated stock market, they instead invested it in property. This
was achieved through various methods such as buying an investment property, purchasing a second
home or perhaps even “flipping property.” But with the advent of relatively new securities such as
“exchange traded funds,” “real estate investment trusts,” or “collateralized debt obligations” people

could also invest in property via their retirement programs. Regardless, the engrained and habitual
behavior of constantly contributing and investing for retirement triggered by the creation of the 401(k)
continued. And without thinking, people naturally substituted property for stocks ignoring the
profitability of these investments, only thinking about retirement. The exact same money that helped
create the stock market bubble was now starting to pour into real estate.
The Interest Rate Shuffle
Though significant, the Dotcom crash was only one economic phenomenon occurring at the time that
help set the stage for the housing bubble. Another contributing development was the complete
collapse of the “Crowding Out Effect.”
The Crowding Out Effect is an economic law that if a government runs a deficit, it needs to borrow
money to help finance it. If that deficit is large enough, say $300 billion, that’s $300 billion less for
other businesses, people and proprietors to borrow. With so much less money in the market to
borrow, this drives up interest rates as there are only so many “loanable” dollars at any given time
people are willing to lend out.
With the collapse of the dotcom economy, combined with the terrorist attacks in 2001, the US
economy went into recession, shrinking federal government revenues. And despite two brief years of
running surpluses, the federal government returned to running a deficit, needing to borrow $158
billion to make ends meet in 2001 and $378 billion in 2002.
$536 billion is of course a lot of money and according to the Crowding Out Effect would naturally
drive up interest rates. However, instead of going up, interest rates oddly went down. This flew in the
face of conventional economic theory, however, the Crowding Out Effect didn’t account for one thing;
Other countries.
For another interesting economic development occurring was the phenomenal economic growth of
China, India, and Middle Eastern countries. And not only were their economies growing, they had
huge trade surpluses with the United States; China selling their manufactured wares, India selling
their technology and information services, and the Middle East selling their oil – all of which resulted
in these countries have trillions of dollars worth of surplus reserves. And rather than having that
money sit and whittle away against inflation, these countries decided to earn interest on it by lending
the US government the money needed to finance its deficit.
Not having to resort to borrow from Americans, this effectively negated the Crowding Out Effect and

kept interest rates in the US artificially low. Long term interest rates reached historic lows as scores
of countries bought up not just US government debt but American consumer debt and mortgages as


well. It was no longer friendly neighborhood Jim buying government bonds or lending you the money
for your mortgage, but Chan in Shanghai, Punjab in Bangalore and Rahib in Riyadh.

The effect of these historically low interest rates was naturally increased housing prices. With lower
interest rates came lower mortgage payments. And people, who previously couldn’t afford a home at
8%, could now afford a home at 5.5%. This flooded the housing market with millions of new home
buyers and therefore drove up prices. However, lower, long term interest rates also triggered another
effect; a massive refinancing boom.
With lower interest rates, people who were previously paying 8–9% could now refinance at a lower
5 to 6%. And maybe not just refinance the original balance of their mortgage, but perhaps add an
extension, make some home improvements, redo the kitchen and a whole host of other things to their
homes. These improvements only served to further increase the value of their homes and further drive
property prices up. Additionally, this refinancing boom saved people thousands of dollars in interest
and mortgage payments contributing to yet a third economic phenomenon occurring at the time; a
booming economy.
Let the Good Times Roll
If one were to really look at it, Osama Bin Laden is a complete failure. Islamic terrorists are all
complete failures. For while they tried to destroy the “Great Satan” and wreak havoc upon the country
on September 11th, all they really managed to cause in the US was an economic hiccup. This is not to
trivialize the 3,000 people that perished in the World Trade Center attacks, but if they were alive
today and saw what Osama Bin Laden ultimately achieved, they would probably be smiling, if not
laughing, for he achieved essentially nothing. For while no doubt Osama was hoping to throw the US
into the throes of a recession, maybe cause our entire financial system to collapse, all he managed
was to ever so briefly pause the skyrocketing advance in our standards of living.
Measured by GDP per capita, the average American earned roughly $35,000 in 2000. Naturally as an

economy grows, income per capita grows, increasing our standards of living. But for three short
quarters following the 9–11 attacks this number remained stagnant as the economy halted.
This is a key thing to notice as the economy halted and did not contract, for there is a big difference.
In order for there to be an official “recession” the economy must contract or shrink for two quarters in
a row. This did not occur as economic growth during these three quarters averaged 0%, neither
expanding nor contracting. Though deemed a “recession” in the media and by most others, it
technically was not and goes down as the weakest recession in the entirety of US economic history.

The reason for the weakness was threefold. One, the US economy was fundamentally strong enough
and diversified enough it was insulated from such external economic shocks and could therefore
suffer a terrorist attack like 9–11 and keep moving on. Two, effective, rapid and often unappreciated
action was taken on the part of Alan Greenspan and the Federal Reserve. Not just in terms of
monetary policy with the lowering of interest rates, but actions taken to ensure the integrity and
functionality of the US financial system, ensuring commerce could continue and that the economy
would not grind to a halt. Three, an aggressively expansionary fiscal policy implemented by President
George Bush. With lower taxes and increased government spending, the economy was given a large
fiscal stimulus that increased business investment and consumer spending and helped to stave off a
real recession.
These actions, combined with the strong underlying fundamentals of the economy, rendered the
terrorist attacks of 9–11 pointless. The economy temporarily slowed down, but never entered
recession. And as the US shook off the economic malaise, standards of living continued their
distinctly American climb upward, attaining an income per capita of $38,000 per person just five
years later. In the end, all Osama achieved was on par with his relevance;


However, adding insult to Osama’s impotence, was this temporary “vacation from economic growth”
was more likely caused by the collapse of the stock market than the terrorist attacks. Had the Dotcom
bubble not burst and nearly $4 trillion been misallocated in the first place, the weakest non-recession
slowdown in US economic history may never had occurred. Furthermore, the terrorist attacks may

have had the opposite effect Osama Bin Laden was hoping for as they prompted the government to
pursue such aggressive expansionary fiscal and monetary policies that it laid the ground work down
for a strong economic expansion. Following the recession the US economy recovered, growing at a
brisk 2.7%, unemployment fell from 6.3% to 4.6%, and our standards of living reached all-time
highs.
But our fortunes did not stop there. For as the economy expanded, not only did incomes go up, but
disposable income as well. Not only were people earning more, but with President Bush’s tax cuts,
they had more to spend. This, combined with the historically low interest rates furnished to us by the
Chinese and Arabs, made housing and real estate particularly appealing. Those that already had a
house traded up or maybe bought a second home or cabin. People who never owned a home before
simply because they couldn’t afford it, now could with increasing incomes and lower interest rates.
Even college kids, with the help of their parents, rather than pay rent would get a condo or a house
taking advantage of the favorable interest rate environment and “achieve the American Dream” while
still in their teens.
Furthermore, with a growing economy boosting the demand for housing, those that already owned
property saw their property values skyrocket. People saw the value of their homes jump up by 10, 15
or perhaps even 20% a year. Plus, with increasing home values, people could now extract money
from their homes to buy the things they always wanted. Want a flat panel TV? Just take it out of your
home. Want that brand new SUV? Just get a home equity loan and write off the interest. And did you
want to take that trip to Europe? Go then! Just take some equity out of your house and go. And as the
good times rolled and the economy grew, homeownership boomed reaching an all time high of 69%.
Never before had such a high percentage of the population enjoyed the American dream and never
had we enjoyed such a high standard of living. Things could not have been better in the US.


Which meant they could only get worse.


My Ex-Girlfriend Was Sub Prime
Even before the economic data started to paint the picture a housing bubble and subsequent crash was

a possibility, I knew something was amiss. And the way I knew something was amiss was via my ex
girlfriend, Amy.
Amy was a drop dead gorgeous girl. And like most drop dead gorgeous girls they don’t get by on
their intelligence or degree in chemical engineering, but rather their looks. She had no college degree,
nor any formal college education, only managing to complete one year at the local community college
where she studied “salonistry” or as I liked to term it, “hair.” But even though she couldn’t even
manage an associates in “hair,” she did manage a $300,000 house in the somewhat “schwanky” Twin
Cities suburb of Eagan. And not only did she have a $300,000 house in a schwanky suburb, she and
her ex husband at the time also had a brand new Corvette.
I found this odd because in the back of my head I knew the math didn’t add up. She was working as an
admin at a local trucking supply store. Her husband was a mortgage broker and from what she told
me, only pulled in $45,000 per year. Meanwhile I was living in a renovated basement of a duplex and
renting out the two upstairs units in order to afford living in the not-so-schwanky neighborhood of
Fridley. And while they had at their disposal a brand new Corvette, all I commanded was a two car
fleet consisting of a 1990 sedan and 1996 compact. Even pulling down a salary equivalent to both of
theirs, I never thought I could afford to live in Eagan, let alone buy a Corvette. But what also threw
me off was their youth. They were both younger than I was and I was only 29 at the time – she two
years younger than me, him two years younger than her. Thus, how did two people who were
essentially kids, earning the same amount I did, afford such a luxurious lifestyle? The answer lies in
one more economic phenomenon that was unfolding after the dotcom crash.
As mentioned before, in response to the collapse of the technology bubble and the terrorist attacks of
9–11, both the federal government and the Federal Reserve sprung into action to stave off what could
have been a horrible recession. The federal government under the insistence of President Bush
pursued a very aggressive expansionary fiscal policy, lowering taxes and increasing government
spending on a level not seen since LBJ. The Federal Reserve under the leadership of Alan Greenspan
pursued a similarly aggressive monetary policy, cutting short term interest rates from 6.5% to 1%. In
what could be described as a Batman and Robin dynamic duo roundly defeating their enemies,
Messieurs Bush and Greenspan managed to literally stop dead cold the forces of a terrorist attack and
stock market collapse from throwing the economy into a severe recession.
However, while their actions were completely called for neither they nor anybody could have

predicted the unintended consequences of their fiscal and monetary actions, especially Mr.
Greenspan’s. For in loosening monetary policy Alan Greenspan not only did more than his part to
prevent a recession, but unintentionally provided one of the key ingredients to the creation of a
housing bubble. And that ingredient was lower short term interest rates.
The sole action of lowering interest rates in itself is completely innocent, if not called for during what


could be considered the most critical moment in US history since Pearl Harbor. However, Alan
Greenspan could not have single-handedly caused the housing bubble if it were not for the help of
another group of people; brokers and bankers. For brokers and bankers furnished the second and vital
ingredient to the housing bubble and that was the new and creative financing methods that largely
abused those short term interest rates.
“ARMs,” ‘Interest Only,” “Negative amortization,” or “Reverse amortization” loans etc., were the
direct result of banks and mortgage companies that had grown accustomed to an unsustainable level of
growth in their sales and profits, and would stop at nothing to continue that level of growth. With long
term interest rates hitting historic lows, the mortgage and banking industries enjoyed banner years
from 2001 to 2004. They experienced not only a wave of refinancings, but millions of first time home
buyers who previously could not afford to buy a house. However, once these markets cleared, the
question was, “how to keep sales going?” By early 2005 pretty much everybody who wanted to
refinance did. And pretty much everybody who wanted a house had one. This required lowering
standards and creating new financing methods which would allow those who normally wouldn’t
qualify for a mortgage to get a loan, thereby opening up a whole new market; the sub prime market.
From 2004 to 2006 banks, mortgage brokers and other varied sorts of lenders aggressively pursued
sub prime loans. People with not-so-perfect credit were approved. People with pretty bad credit
were approved. And people with absolutely no credit whatsoever were approved. And as the sub
prime market grew, soon ARMs accounted for nearly 35% of all new loan applications, up from just
8% in 2001;

But in pursuing the sub prime market there was an unintentional side effect. With banks and mortgage
brokers offering sub prime financing, they flooded the housing market with millions of people who

historically never had been in the market, thereby driving home prices up rapidly. Not that increasing
home values was necessarily bad, but with people’s home values skyrocketing this paved the way for
another sub prime product to be abused, “home equity loans” or “HELOCs.”