2005: Did 0% down mortgages in the '90s affect the country's savings rate?

AUDIENCE MEMBER: Hello, my name is Robert Piton (PH) from Chicago, Illinois.

And on that note, maybe a merger of some sorts between Berkshire and Microsoft is in the works.

WARREN BUFFETT: I keep hinting but it doesn’t do any good. (Laughs)

AUIDENCE MEMBER: The question that I have is, do you think the shift in the banking system during the ’90s to finance home purchases with zero percent down impacted the overall savings rate, as home purchases are the largest investment most people make, and the overall rise of home prices driven by these marginal buyers?

If so, how would you suggest that we correct the problem.

WARREN BUFFETT: Yeah. Of course, any time a home is constructed, it represents somebody’s savings.

I mean, the home buyer may buy it for nothing down, but that means he’s borrowing 100 percent of the mortgage through a mortgage that somebody else has saved somewhere, maybe intermediated three or four times or something of the sort.

But home construction comes about through savings.

Now there’s no question that terms have become easier and easier, and I’ve talked to certain mortgage bankers about this subject, but terms have become easier and easier as prices have increased.

Now, that is absolutely counter to, you know, how people think about lending in general. Generally, the more the asset class becomes inflated, the less a prudent banker will lend.

But of course, in this country, now you have mortgages intermediated in a way that the person buying the mortgage, in the case of — I’m thinking of Freddie [Mac] and Fannie [Mae] and other forms like that, so we’re talking about the lower-priced houses — but the mortgage buyer does not need to care about what kind of mortgage — what kind of a financial transaction the purchase is.

All they have to do is look at the guarantee, and they look at that rather than whether somebody’s put any money down, or anything of the sort.

So I think you’ve had easy financing facilitating a boom in real estate prices, even at the higher levels. And I think that that that, which has occurred in other asset classes in the past — I mean, that farm bubble I talked about was facilitated by the fact that banks in small towns, who generally had been very conservative in lending, went crazy around 1980 and they lent amounts that the farm itself could never repay.

They started saying a farm was an asset appreciation investment, not an income investment.

And once you talk about something that’s an asset appreciation investment, ignoring the underlying economics of what you’re lending on, you’re really talking about the bigger-fool game.

You’re saying, you know, this is a silly price but there’ll be a bigger fool that comes along. And that actually can be a profitable game for a while. But it’s nothing that bankers should engage in.

So I would say that easy lending, obviously, does contribute to, overall in the country, to a lower savings rate. But, in effect, somebody has to save for somebody else to borrow.

And what is happening now is the rest of the world is saving. So then in the U.S. — in global terms, I’m talking — but the rest of the world is saving.

And they’re sending us $2 billion — I mean, we’re sending them, in effect, claims for ownership of $2 billion — they’re investing $2 billion a day in the United States.

But they — a lot of economists will say, well, that’s what’s really going on. The world loves our assets so much and they have so much confidence in America that the present current account deficit is driven by the fact they want to invest.

I don’t believe that at all. I think it’s just silly, frankly, to make that argument. They are investing because they have to, because of our consumption habits, and not because they want to. And I think the declining dollar is evidence of that.

Charlie?

CHARLIE MUNGER: I’ve got nothing to add to that. It’s obvious that the easy lending on houses causes more houses to be built and causes housing prices to be higher, probably, in the new field.

Eventually, of course, if you construct enough of new anything, you can have a countervailing effect.

If you build way too many houses, you’d eventually cause a price decline

WARREN BUFFETT: I’ll give you a fanciful illustration.

Let’s just assume that Omaha had a totally constant population. No one was allowed to leave. No one entered. Birth rate equals death rate, all of that sort of thing.

So the population was constant, and nobody could build any more houses. We just passed a city ordinance to that effect.

But every year, everybody sold their house to their neighbor. So, first year, everybody sold their $100,000 house to their neighbor, and they both switched houses, and that was fine.

And then the next year, they agreed we were going to do it at 150,000. And you’d say, well, how could that be?

Well, we would all go to Freddie or Fannie and get our mortgages guaranteed for a larger amount, and somebody in New York or Tokyo or someplace would buy the Freddie or Fannie paper.

And we’d have an influx of $50,000 per household. We’d all have the same number of houses. We’d all be living one house to a family. And we’d have marked up our houses, and we now have a bigger mortgage, but we’d have $50,000 more of income that year, just to service a little higher mortgage.

And we’d do the same thing the following year for 200,000, and so on.

Now, that would be very transparent, and people might catch on to the fact there was something funny going on in Omaha.

But you can have an accidental aggregation of behavior that somewhat leads to the same effect.

I mean, if you keep marking up something, and in the process, the payment for the marked up price comes from someone else who feels they are bearing no risk because they’ve got the government guarantee in between, the money can just flood in and everybody feels very happy for a long time.

And we don’t have anything like the fanciful thing I’ve set forth, in terms of Omaha. But we have certain aspects of that, I think, going on in the economy.

Charlie, would you — I’m throwing this one at you. Would you agree or not?

CHARLIE MUNGER: Yeah, I do agree with that.

You have varied Ponzi effects in various parts of any modern economy. And they’re very important and they’re very little studied in economics.