The Mortgage Mess, the Real Estate Bubble and the Role of Alcoholism
The Mortgage Mess, the Real Estate Bubble and Alcoholism
This may seem a stretch, but humor me while we celebrate our third anniversary. We’ll get to plenty of real life stories in which alcoholism is proven in the “Runners-Up” and other sections below (rarely have alcoholism-fueled antics so filled the news). This month’s top story is based on theory, anecdotes and understanding how the mind of the alcoholic works and the consequential behaviors. While theory comprises proven hypotheses and anecdotes are real-life stories, extrapolating theory and individual stories to herd psychology hardly meets the criteria of scientific proof. However, this is a good time to make the attempt because it’s becoming obvious that we are witnessing the hissing sound from air being let out of one of the great bubbles in the history of mankind (see my alter-ego Wealth Creation Strategies newsletter in which such real estate commentary began in late 2004, particularly the top stories in the 2005 editions, at www.DougThorburn.com). While there is no hard evidence to prove the assertion I will make beyond a reasonable doubt, as I often say in regards to identifying addiction–our minds are not courts of law.
Alcohol and other-drug addiction causes egomania, which is at the root of most behaviors destructive of others. Perversely, the egomania-impelled need to wield power sometimes results in grandiosity and even overachievement, which can provide unexpected benefits for society. Partly because of the extreme variance in behaviors and outcomes, addiction is not easily diagnosed by those outside this close circle.
Among those who can be particularly challenging to diagnose are leaders, whether heads of state or leaders in manias. Yet, alcoholism and alcoholics have a number of attributes supporting the idea that the disease could be at the helm of many manias. Let us count the ways.
1. Alcoholism causes brain damage to the frontal lobes, allowing the lower brain centers–including those responsible for emotions and the herding instinct–to ride roughshod over the neo-cortex, the seat of reason and logic. We might hypothesize that this allows alcoholics to better connect with others at an emotional level and to lead them, for better or worse. Manias require this sort of leadership.
2. According to the testimony of countless recovering addicts, they were the world’s best salesmen when using and, as they often put it, could sell ice to Eskimos. Manias, disconnected from any economic or other reality, require just this sort of hucksterism.
3. Cult leaders are usually alcohol or other-drug addicts. Cults can do enormous damage despite the fact that followers need not be alcoholics and are often simply extreme codependents. As mentioned in Drunks, Drugs & Debits, “Jim Jones, an amphetamine and prescription drug addict and likely alcoholic, led 900 men, women and children in Jonestown, Guyana, to mass suicide in 1978.” By no means were all of Jones’ followers alcoholics. Likewise, Charles E. Dederich convinced former AA members to join his cult, Synanon, even while Dederich had long since relapsed. Many if not most of his followers remained sober. In similar fashion, we could argue that manias, which lead people to buy or do things they would never in their right minds consider at those prices or under similar sets of circumstances, could be taken to greater manic extremes by cult-like leadership.
4. Alcoholism causes the addict to experience distortions of perception and impaired judgment, one result of which is a feeling that he can do no wrong. This sense of invincibility leads to extraordinary risk-taking behaviors, including the commission of crime such as fraud and, on the other side of the coin, overspending. Fraudulent appraisals and loan applications became a large component of the real estate and lending mania, as did financial optimism on the part of debtors. This led many to spend and borrow far more than prudent and provided the funds with which to do so. Manias are driven by this sort of risk taking.
5. Alcoholism is also one of the causes of what appears to be Bipolar Disorder, or manic-depressive behavior. Manic periods are characterized by excessive optimism and result in both an “I can do no wrong” and “nothing can go wrong” attitude. Manias require such excessive and unrealistic optimism by leaders and followers alike. And it’s difficult to resist the infectious enthusiasm and all-too-believable lies of an addict who promises the moon; followers are far more likely to follow such charismatic types than an old fogy realist or pessimist.
6. The same impaired judgment leading to extreme risk-taking can also result in more frequent involvement with “get-rich-quick” schemes. James Woods’ coke-addicted character Lenny Brown in the movie, “The Boost,” jumped into one such scheme after another. In real life, Charles Ponzi, who perfected the pyramid scheme that bears his name and led countless victims into a financial nightmare in the early 1920s, was an alcoholic. Since roughly 85% of felons are alcoholics and committing financial fraud is, generally, a felony, 85% of con artists are probably also alcoholics. Unfortunately, as mentioned in the top story from July 2007 (L.A. City Attorney Rocky Delgadillo and his wife Michele), while the press corps is relatively diligent in outing celebrity addicts they are not as dogged when dealing with CEOs, politicians, professionals and ordinary business people.
7. Alcoholism causes egomania, often resulting in a pervasive “rules don’t apply to me” attitude. This, too, leads to criminal behaviors such as loan and appraisal fraud, which helped to fuel this bubble. I am personally aware of an alcoholic real estate agent who forged loan documents and almost cost her supervising broker, a good friend of mine, his license. As the bubble deflates, we will see many more stories like this and there are likely to be few that do not involve an alcoholic in the driver’s seat.
8. Egomania also prompts many alcoholics in the early stages of their disease to overachieve. As a result, alcoholism is not an impediment to high office. Many alcoholics become successful CEOs and politicians until recklessness and impaired judgment does them in. We suspect (and have confirmed in a few instances) that at least some of the top brass at companies such as Tyco and Enron were alcoholics. A Wall Street Journal story on the rise and fall of New Century, one of several dozen recently imploded subprime lenders, reported a “party-hard” culture and a company that “took its employees on a boozy cruise to the Bahamas and threw one bash in a train station in Barcelona, Spain.” One story does not an addict make, but the fact it was even reported is an indication there may have been far more alcoholism-fueled goings-on beneath the surface at such companies.
9. Due to excessive risk taking and a willingness to go to extremes, radical innovations may be far more common with alcoholism than without in areas as diverse as music, sports, sex and philosophizing. One of these areas may include finance, which has undergone extraordinary innovations in instruments such as subprime loans and collateralized debt obligations. Parties without any alcoholics can be relatively dull affairs, while an alcoholic or two may disrupt things just enough to get a party going. It is in the nature of addiction to increase instability, which is a necessary pre-condition for a boom and bust.
Please don’t misunderstand. Not every real estate cheerleader calling for inexorably rising prices, great salesman, leader, or even criminal is an addict. However, addiction increases the ability to connect with the mark at the emotional level and get victims to do things they ordinarily wouldn’t. As we have shown elsewhere, the disease dramatically increases the odds of criminal and unethical behavior, including overstating income on mortgage applications. In one recent study, 90% of a sample of 100 “stated income loans” reported “significantly” higher incomes than the borrowers claimed on their tax returns. While certainly not every borrower was an addict, we might surmise that most of the loan officers who countenanced such behaviors could be. Simply put, addiction greatly increases the odds of engaging in financial misbehaviors. Yes, the bubble was stoked by such devices as securitization of mortgages, which increased moral hazard, thereby encouraging loan brokers to approve loans regardless of buyers’ ability to repay and cooperate with “liar loans” (no- or low-doc loans). However, financial shenanigans were a necessary component and alcoholics are far more likely than others to engage in questionable practices and may even be more likely to create and have the ability to sell such questionable financial innovations.
The recriminations will, of course, fly as anecdotes continue to surface. In one Los Angeles Times story, a self-employed handyman blamed his loan broker for failing to explain the terms of a loan on which his house payments jumped beyond his ability to pay, forcing him into bankruptcy. Yet he had purchased his home 19 years earlier, during which time real estate in his home town of San Diego appreciated by 300-400%. While he may have had to use equity to pay for treatment of a child’s cancer, how many in similar situations refinanced to buy yet another car he couldn’t afford or another boat he didn’t need, or to pay off credit cards used for what may have been alcoholism-fueled overspending? How many times might he have figuratively walked into a bar and, big man that he is, offer to buy everyone a drink? Grandiosity, driven by alcoholism, has helped precipitate many financial debacles.
Extreme risk-taking behaviors including fraud likely rooted in alcoholism helped take this mania (and perhaps most others) to far greater extremes than in the absence of addiction (just as alcoholic-free parties are far more sedate than others). Some might object, “But addicts comprise only 10% of the population; therefore, they couldn’t have been responsible for more than 10% of the mania and consequential price rises.” However, home prices–like all other prices–are set by the marginal buyer and seller. Only 2% of all shares of stocks traded on Black Monday 1987 and, therefore, what may have been only 2% of shareholders decided that shares were worth 20% less by the end of the day than on the preceding Friday. This gives a glimmer of the effect the last few buyers and sellers can have in determining prices. Prices would have likely settled far lower at the peak without the subprime borrower and speculators who got in with zero down and, therefore, no personal risk. (As I have said in my client newsletter, Wealth Creation Strategies at www.DougThorburn.com, easy loan terms helped sellers by driving demand for houses far higher than would have been the case without.*) This suggests that without the extraordinary herding instinct of alcoholics, booms and busts would likely be far more moderate.
* Andy Laperriere wrote in The Wall Street Journal (March 21, 2007), “Home prices–like all prices–are set at the margin. It was the marginal buyer, particularly the subprime borrower and housing speculator, who drover prices higher [who could operate as they did ONLY with easy loan terms]. The easing of lending terms increased the demand for homes, and since the supply of homes is relatively fixed (or inelastic), this increase in demand quickly translated into higher prices. As the loose lending practices are inevitably reversed–and there is a wide chasm between current lending practices and prudent lending terms–fewer people will be able to afford to buy a house, which will reduce demand and push home prices lower.”