This is the second of a three-part series examining how explosive growth and the housing market collapse have changed the face of Newton County.
In 1997, several years after moving to Newton County, Rhonda Wilkerson was still going strong. She was making $1,500 a month in the trucking industry and lived in a great neighborhood, in a beautiful house that kept increasing in value. Like many others at the time, she decided it was time to refinance. She started small by using some of the equity she had been amassing to get new carpet.
"I refinanced because everyone was doing it," Wilkerson said. "I wanted to get new carpet because my house had been rented out before and there were spots and stains."
A couple of years later she received a letter from a lender offering $500 if she would take out a second mortgage. She was only paying $650 a month and wanted to spruce up the house. Out went the rest of the equity and in went a backyard deck and hot tub. Her two monthly payments now equaled about $780 a month, still quite manageable.
A year later, Wilkerson suffered a stroke and was temporarily paralyzed on her left side. She managed to recover, but over the next several years medical expenses went up, while wages from her commission-based job went down. In 2003, she decided she needed to take advantage of the low interest rates and refinance by combining those mortgages into one lower payment. She didn’t read the fine print on her new adjustable rate mortgage. A few years later she would give that loan a new name: shyster mortgage.
Land and WagesIn the mid-2000s, Newton County was in a full-fledged housing boom. Low interest rates and comparatively cheap housing had given many first-time homebuyers an entry into the market. As land grew scarcer while demand for homes increased, inflation naturally set in. When combined with a consumer desire for larger and larger homes, prices exploded.
Newton County Tax Assessor Tommy Knight said one of the biggest increases came in 2004, when the combined value of existing homes and land in the county increased 15 percent from 2003. Data from the U.S. Census Bureau shows a similar national trend. In 2003, the median home price in the U.S. was $195,000, while just a year later that number was $221,000.
"That’s a huge increase for one year," Knight said. "A few years ago, gas and milk prices were up, even groceries. One thing that never went up by 15 percent was a paycheck. The rubber doesn’t meet the road at some point."
But the housing car was only speeding up, despite the fact that paychecks were only increasing by between 2 and 4 percent per year, according to the Census Bureau.
Pay Attention to Interest
When the Federal Reserve dropped the interest rate to 1 percent in June 2003, it prompted a major shift in the way people and, more importantly, corporations invested their money. U.S. Treasury Bonds have always been one of the best investments, because they offer a decent return with basically no risk. The U.S. Government has long been considered the safest place to invest.
At 1 percent, however, corporations might as well have stuffed their money under their mattress, or put it into a savings account. Neither was enticing. Investors began looking for a better deal, and they found something that was increasing by 15 percent per year. But instead of investing directly in the land, they chose a longer-term investment with a solid monthly dividend: the mortgage.
The Business of Banking
Before the 1940s, when a bank signed a mortgage it would keep the mortgage and collect the monthly payments. This type of agreement doesn’t lend itself to making large sums of money quickly, because mortgages require a lot of money and tie that money up for a long time. The return on investment over the life of a traditional 30-year mortgage is high, making it a good investment, but not as much for banks, which need liquidity to continue to make loans.
Cue the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp., more affectionately known as Fannie Mae and Freddie Mac. The U.S. government created these organizations to promote home ownership, which is generally a positive thing for the tax base and the stability of families and communities. Fannie Mae was created in 1938 to buy mortgages from banks, which in turn would allow these local banks to then extend more loans and increase home ownership. Fannie Mae received a cheap, abundant stream of money by selling those popular treasury bonds.
The system was profitable for everyone. Homebuyers were able to negotiate mortgages with their local bankers, local banks were able to make a small profit off each mortgage sale and keep their liquidity and Fannie Mae received a solid investment, with a higher rate of return that the bonds they issued.
Fannie Mae went public in 1968, but it was still a government-sponsored company, which gave it extra reliability. Freddie Mac joined the scene in 1970. As with all public companies, shareholders expected solid profits, and Fannie and Freddie turned to a system that had worked for banks – they sold their mortgages. Only this time, the companies had so many mortgages they decided it would be easier to group hundreds of mortgages into packages, Mortgage Backed Securities, and sell these to long-term investors looking for reliability and profitability.
Subprime on the Way Up
Prime, in the lending world simply means a person or company has good credit, and subprime means their credit isn’t quite as good. The subprime market actually started in the 1990s, but it remained small, because the major purchasers of mortgages, Fannie Mae and Freddie Mac refused to buy non-prime loans.
However in their pursuit of consistently high profits for shareholders, Fannie and Freddie actually lied about their profits. The profits were high, but they were also volatile, which can negatively affect stock prices. Most investors like stability. When the U.S. Government discovered this lying in 2003, officials were understandably upset, and Fannie and Freddie retreated from the market they had dominated for decades.
During 2003, 70 percent of all mortgages created were purchased by Fannie and Freddie, because they had money and investors trusted their government-sponsored status. Their popularity allowed Fannie and Freddie to control the U.S. mortgage market, and they wanted conventional mortgages.
When they retreated right in the middle of the housing boom, a void was created, and infamous investors on Wall Street stepped right into this money-making market. Now the investment banks, those big names like Merrill Lynch and Goldman Sachs, whosejob it is to turn large amounts of money into ever larger amounts, took control, and in 2006 only 30 percent of mortgages were being purchased by Fannie and Freddie.
Without Fannie and Freddie’s strict guidelines, banks and an increasing number of specialized mortgage lenders were free to give out more types of mortgages to more types of people. Not everyone could afford or wanted to pay a 20 percent down payment, because there are only a certain number of prime mortgage candidates in the U.S.
According to award-winning CNBC Journalist and Author David Faber, this is why the percentage of the U.S. population that traditionally owned a home hovered around 60 percent of the past few decades. But mortgages were such good investments, that investors demanded more. With the traditional pool of homeowners mostly dried up, subprime borrowers were now the focus. As subprime loans increased in popularity many of the existing prime borrowers asked for or were steered toward subprime loans.
The first step was to drop the down payment requirement to 10 percent, then to 5 percent, and eventually to waive it altogether.
If the monthly payment was too high, no problem, sign an adjustable-rate mortgage, which would have a low interest rate for the first three, five or seven years and a higher interest rate after that. Or sign an interest-only rate, where you begin by paying off only the interest. Basically, buying a house was free.
Lee Waldo joined the mortgage banking industry in 2000 for the same reason as most others: he was looking for a better life. He signed up with HomeBanc, Georgia’s largest mortgage producer, and the company that along with Merrill Lynch created the interest-only loan. It was the company’s bread-and-butter loan, making up 60 percent of its sales.
"Originally it was for high-net worth individuals or for those not on a constant income, like commission-based or seasonal jobs," said Waldo. "But our logic was that if it made sense for the rich guy, then it made for the Average Joe as well."
Waldo said a lot of people in the Atlanta area were only in their house for four to five years, so it made sense to get an interest-only loan if you were going to be selling the house soon. With rising home prices, homes were a great way to make free money.
Waldo, like every other mortgage banker, will tell you that every loan has its place. Even the stated-income mortgage, where a borrower was allowed to tell the lender how much he made, had a purpose. They were for the self-employed, whose incomes weren’t always accurately represented by his tax forms.
"A person could have perfect credit, tons of assets, but his income statement says he makes only $42,000 a year. That’s a case where you can use a stated income effectively," said Waldo. "But it got to the point where some companies would let McDonald’s or Wal-Mart employees state they were making a $100,000 a year."
The products were taken to their extremes and given to people who would have had no chance to afford the mortgage once the beginning teaser rates ended.
Bankers and investors didn’t consider these loans risky, because even if the person couldn’t make their higher-interest rate payments, they could refinance, or if they foreclosed, the house could just be resold, still for a profit.
But banks and mortgage lenders had another way to make these subprime mortgages attractive to investors – sell a lot of them. Investors depend on a rating system to know how safe or risky an investment is. Treasury bonds are rated AAA, the highest rating available. Subprime mortgages are obviously much more risky, but that’s where Wall Street worked its magic.
Mortgage-backed securities are combinations of hundreds of mortgages that are sold to investors. Their diversification makes them a safer investment, because they come from all over the country and from all different types of people. Plus, homeowners had a good history of paying back their mortgages, and home prices were constantly going up
If some diversification is good, then a lot of diversification must be better. Banks started combining hundreds of MBSs, so they now had thousands of mortgages packaged into collateralized debt obligations. These thousands of mortgages were actually sliced apart into three levels, safe, less safe and risky. The safest mortgages offered the lowest rate of return about 3 percent, while the riskiest group of mortgages offered returns of about 10 percent.
Despite how risky the loans were becoming, those safest slices of CDOs, were rated AAA, implying they were as safe as treasury bonds. Even the less safe investments were flying off the shelves because investors wanted higher returns, and the belief was pervasive that prices would only increase.
The demand for these packages wasn’t just coming from U.S. investors, but also from foreign countries and companies in China, India and the Middle East, where developing economies were booming and profits were being made.
And although Freddie and Fannie had taken a seat on the sidelines for the past couple years, they would return in late 2005 and dive head first into the profit-rich subprime market.
Mortgages and their packages were sold so quickly in such a short period of time, about three times in eight months, that no one ever stopped to worry about the risk. Even when the CDO slices got to the investor, he felt safe in his diversification. Many of the people investing and selling these mortgages weren’t old enough to remember the last time home prices actually decreased in value and they never thought of the consequences.
According to Faber, around $3.5 trillion in mortgages were given out every year in the U.S. between 2003 and 2006. By 2005, 20 percent of those mortgages were subprime.
Breaking the Economy’s Back
In Newton and Rockdale counties, business was booming. Many mortgage lenders and realtors get their business through personal referrals, so it’s important for them to treat their customers honestly and fairly. While some local people did that, to the detriment of their short term profit, many didn’t, because competition was so fierce.
"I sold some homes I darn well knew I shouldn’t have, but if I didn’t someone else would have," said Bill Blair, RE/MAX realtor. "People were buying $400,000 houses, with $6,000 monthly payments, and they were putting nothing down and paying interest-only. We knew that wasn’t going to last, but there were 20 waiting to do the same thing if you didn’t."
Blair was far from alone, and most of the homes he sold were to appropriate buyers. But realtors from outside the area didn’t have the same track record. National companies were flooding every market with their workers, while at the same time hundreds of unqualified, local people were jumping into the lending, realtor and building worlds.
The Newton County Home Builders Association’s membership jumped from about 200 a few year earlier to 385 during the 2005 to 2006 peak.
"Everyone was getting into the business, from lumber salesmen to bankers. Even my barber was asking me for advice on building houses," said Steve Dubois, former NCHBA presidents. "We used to call some subdivisions training grounds, because of the inexperienced builders who were constructing some of the cheapest houses."
It was same in every field. Erica Milligan, with the East Metro Board of Realtors, said the numbers of realtors for the Newton and Rockdale county area was 1,200 in 2006, double the amount from just a handful of years ago. Local mortgage lender Faye Bell saw lenders flooding into a business where some people’s profits were increasing by 75 to 90 percent during the boom. It proved to be unsustainable.
"One of my biggest disappointments and where I disagree with some developers, was the mindset of ‘If we build houses, people will come.’ But people weren’t buying some of these homes, and in some cases, people were being imported from other states," County Chairman Kathy Morgan said. "The banker in me can say that’s good business, but the resident in me says that’s a false economy."
And the resident was in her right. People kept building speculative houses, named because the builders were speculating that there would be people to fill them. Cheap credit flowed to everyone, so developers and builders could afford more land and more homes. The number of unsold homes was increasing rapidly, but few realized it, and mortgages, and slices of hundreds and thousands of mortgages, were still working their way through the system.
Eventually the people buying homes couldn’t even afford one of their first monthly payments. No matter what type of mortgage they had, the payment was too much.
With no one left to put into the thousands of homes in Newton County, prices started falling, fast. Everyone in the building industry was finding themselves on the ropes, and all of those homeowners who had been dependent on ever rising home prices, which allowed them to refinance, were out of luck. Even more people lost their homes, putting more houses on the market and prices dropped even further.
It happened so quickly. In the second half of 2007, things began to go downhill, but Newton County ended with less than 350 foreclosures. In 2008, that number jumped to 1,464. Many of those were homes and a lot were vacant lots.
Because the housing market was such a huge employer, comprised of developers, builders, subcontractors, manufacturers, tradesman, realtors, lenders and, now, investors, a dried-up housing market, meant a dried-up economy. As mortgages failed, investors lost a lot of money. Because the MBS and CDO processes take several months, lenders, banks and investors were all trapped with bad debt. Developer Hubert White said developers were also hit particularly hard because their business is so money-intensive. He said he wouldn’t be surprised if some of them had $40 million in debt.
Many of the home buyers couldn’t understand what had happened. Ronda Wilkerson was among them. Her shyster mortgage’s monthly payment had ballooned to $1,063.
"The people were so kind, they took down all my info and everything went so smoothly. I signed quickly, and it was done," Wilkerson said. But then it went bad and she was foreclosed in August. "Not having knowledge of my mortgage and relying on mortgage brokers, that’s wrong. Americans had it so darn easy for so long, we stopped wondering when, why and how, and just signed. When you do that you give up your right.
"Yes it’s humiliating, and yes, sometimes you feel like you want to die, but you have to become wiser and learn from your experience."
The third and final story in the series will explore the aftermath of the housing collapse, where Newton County is now and where the county could be headed in the future.