AS A SELF-STYLED hipster, I was somewhat perturbed when a new trend caught me off guard this spring. Another school year is closing and students are lining up residences for the fall. I learned that my friends are purchasing homes, and I'm not.
At first, I suppose I was slightly jealous. I can't afford a house. But as I thought more about it, I realized that neither could they.
This piqued my economic curiosity. So I looked harder at what was going on around me. My earlier perturbation turned to concern as I listened to my friends' responses and saw new, disturbing trends emerge.
First, I noticed that some of my friends had already amassed small fortunes in real estate from prior residences and investment properties. This kind of industry is not disturbing. But when I asked one friend about her methods I noted a second trend, and it raised hairs on my neck.
"The real estate market always goes up."
The classic bubble indicator - "irrational exuberance." A twentysomething law student with no training in economics or real estate speculation just told me that the market always goes up. My peers are understandably naive; when the 1980s recession hit, naptime was part of our core curriculum. But we all watched the dot-com bubble burst. Before I could think of another question, she responded with her own question.
"You know, you don't have to own more than one house to invest. Why don't you buy?" I replied that I couldn't afford to buy a house.
"Oh sure you can - I financed 103 percent." My neck hairs stood at full attention.
The third trend: too much credit.
Lending is vital, but like all good things, you can have too much. The stock market crashed when banks started making margin calls on unsophisticated, over-leveraged investors.
"Well, I don't want to take on any more debt, I already have credit card bills," I told her.
She replied: "No problem. You can take out a junior mortgage to pay down your credit card bills. That's what my parents did." I grimaced.
The fourth trend: insolvency.
Many mortgages today are Adjustable Rate Mortgages. The lower interest rates are great for short-term lending at recent historically low rates, but a homeowner who can barely cover his payments now will be insolvent not if, but when, rates rise again.
If default occurred in a vacuum, we might be OK. But a default brings down neighboring home values. So homeowners who expect to pay down credit card bills and a second mortgage with appreciation could be surprised.
"Well," some say in their last-ditch effort to overcome economics, "the government can't let the market fail."
And there it was: the elephant in the closet.
Fannie Mae and Freddie Mac are leveraged into the trillion-plus dollar range with complicated derivative securities. At the same time, mortgages comprise almost a quarter of bank holdings, and most insurers and pension funds are heavily invested in mortgage-backed securities. So, Fannie and Freddie are not only giant hedge funds, they are effectively the largest mortgage bankers, S&L's and portfolio managers in the world.
If Fannie and Freddie haven't done a good job ensuring creditworthiness, sniffing out fraudulent valuations, or matching risk, they could become insolvent (if they aren't already). With the amount of commingled mortgage investment in today's economy, we'd all share in the misery.
The great irony would be that we never recognized the true origins of the Great Depression. The stock market wiped out Wall Street, but it was average people defaulting on mortgages that sank our economy.
Frederic N. Chancellor Smalkin has a bachelor's in economics from the University of Virginia and is a first year law student at the University of Maryland School of Law.
Columnist Steve Chapman will return Wednesday.
