Constraints relaxation: a pattern of mortgage banking evolution

Y. B. Karasik
Thought Guiding Systems Corp.,
Ottawa, Canada.

There is a TRIZ pattern of evolution: ever increasing dynamism of technical systems. It can be re-formulated as "ever decreasing rigidity of technical systems". And indeed, rigid objects/constructions get substituted by flexible ones all the time. Moreover, the number of the degrees of freedom in a system also increases over time.

More accurately, it increases and then decreases (as Darrell Mann would say). But the times of reduction of degrees of freedom are more characteristic of more advanced systems, such as biological ones, for example. Technical systems are too primitive to reach to this point. Of them another pattern is more characteristic: tightening of technological constraints followed by their relaxation.

For example, an interesting process of such a relaxation is unfolding nowadays in banking. After decades of tight lending policies, banks in the recent years embarked on an unprecedented relaxation of the money lending constraints.

In the past the one who would like to obtain a mortgage from a bank to buy a house, had to satisfy the very rigid criteria:

Then ZERO downpayment option for home buyers became available. Thereby the first constraint was eliminated.

Later banks started to give bonuses to people who borrowed money from them (on the top of the loan that covered the purchase price). These bonuses the buyers usually spent on renovation but actually could spent as they pleased. Thus the new constraints started to look as follows:

Zero downpayments, coupled with bonuses and low interest rates helped to propel house prices.

Based on the TRIZ patterns of evolution, it is not difficult to predict the next move by the banks. Squeezed between rising interest rates and the necessity to prolong the real estate boom, they will relax the requirements on the buyer's income and at the same time will lend them money well in excess of the purchase price. The new constraints will look as follows:

This will allow the buyer to pay monthly mortgage payments not only out of his/her monthly income but also out of the not invested portion of the loan. As long as market booms, there is no risk in this for banks. As soon as the buyer will have spent that portion of the loan and will not be able to cover expenses from his/her income, he/she will still be able to sell the house at a profit and return all money to the bank which he/she owes to it.

Actually in this model the buyer does not have to have any income at all. He/she can live (and make mortgage payments) on money given by bank in excess of the purchase price. Eliminating the requirement to have an income, will tremendously widen the pool of qualified homebuyers. The number of bids per one house will rise. And the prices will thereby surge even further. And banks will be able to return their money anyway.

The only what government has to do in order to not exaust the pool of qualified buyers without income and thereby bring an end to the real estate boom is to bring more and more penniless immigrants to the country. Then banks will have an incessant influx of the potentially qualified homebuyers. And the boom will perpetuade as well as banks' profits.

There will be no need to work anymore. Buying a home (on banks' money), paying all living expenses (on banks' money), making mortgage payments (on banks' money) and eventually selling the home at a huge profit to return all the borrowed money to the bank, will become a job in itself ! The lending criteria

will become an engine of the incessant expansion of economy !

It ought to be said that some people have already tried to implement this scenario in the past. They did nothing but borrowing money from banks, investing them into stocks + covering their living expenses and eventually selling the stocks and returning money to the banks. But it was a risky game because stocks market is incomparably more volatile than real estate market. The latter is readily seen on the example of the systematic failure of all predictions of the imminent demise of the current real estate boom.

Every summer (beginning 2001) various economists predict that the real estate bubble will burst soon. And every fall refutes their predictions. The reason is that all these forecasts are based on the old concepts and models that take into account such factors as the jobless rate, the interest rate, average wages, the inventories available, the number of potential buyers, etc. but does not take into account the lending policies ! This models have been working as long as the money lending constraints were tight and static. But as soon as they started relaxing, the models became irrelevant.

We have just seen that no jobless rate (as high as it may be) and no level of income (as low as it may be) affect the real estate market as long as banks give enough money to buy and keep a house to anyone. Simulation on the computer can reveal that eliminating income requirement coupled with providing loans to cover living expenses and mortgage payments will PERPETUATE the real estate market boom regardless of interest rates and regardless of inventories available (as abundant as they may be) ! If banks give money, people will buy all availabe inventories (as long as boom persists) !

The power of interest rates in containing inflation is grossly exaggerated and is dependent on tight lending policies of the banks. Should constraints become too relaxed as no interest rate can stop eternal boom (and inflation).

It is only a pity that one has to know TRIZ patterns of evolution to read the writings on the wall and to see the future !