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Dateline Detroit: Welcome to Subprime City (II)

How do the financial troubles of a Detroit family belie the notion that the United States is a consumer paradise?

October 18, 2007

How do the financial troubles of a Detroit family belie the notion that the United States is a consumer paradise?

After months of being in default, a date for auctioning the house is set by order of the court. Desperate to save the house, they turn to Ralph, a shady realtor.

He quickly offers them a tempting deal. Ralph will buy the house at the auction, Gary, Cathy and the kids can stay in it — and, at a later date, they can repurchase their former property.

But the deal has a fatal catch: Ralph’s generosity comes with a huge price tag. Not only does he charge a high commission for the bailout, he also demands Gary’s beautifully maintained 1959 Chevrolet Corvette as “collateral.”

And he asks for an interest rate of 17% on the money he spent on the bailout. The presumable miracles of what is often so charitably described as the world’s most liquid — and deepest — debt market keep churning, though.

Seventeen percent? Who cares? Aren’t the interest payments on most credit cards even a bit higher? Sounds like we got ourselves a deal.

Surprise, surprise: After a year, Gary and Cathy are able to buy back their house. But once again, there’s a catch. They have to take out a new mortgage, which runs them even deeper into the red.

As Gary finished their story, Cathy sighs. “We relied too much on our jobs.” And then she adds; “We should have read the fine print in the contract.”

Many borrowers walk right into the trap of the fine print. Somewhere in the last paragraph on the bottom of page three or four of the contract, the really important information is hidden.

That is especially true if the contract is about an ARM, or Adjustable Rate Mortgage. There, you can read all about how high interest rates will go once the “teaser rates” have expired.

The only sad thing about these lofty claims is that they never offer a decent form of consumer protection.

In Gary and Cathy’s case, they now pay $1,700 per month in interest only. Doesn’t sound like that much? Think again. “This is roughly the equivalent of three quarters of our total income,” Gary says. And it is obvious how hard it is for him to reveal the magnitude of their financial calamity.

“This story can be heard 10,000 times in Michigan,” says Eddie. Eddie is a broker with GMAC-RFC. GMAC exclusively used to do the mortgage and realtor business for General Motors — until 2006. Then GM sold 51% of the shares to Cerberus, which in turn bought the GM competitor Chrysler from Germany’s Daimler AG.

So Eddie is in the midst of the Detroit auto misery. And so he hears so many stories of people who have gone way over what, with any sense of realism, are their debt limits.

Stories of people who should have never applied up for a larger line of credit — and who got ripped off by down-and-dirty by dubious money lenders.

Under those circumstances, the much-vaunted “freedom” and “consumer power” translates into nothing short of the — very alienable — right to go into debt with no abandon.

Eddie, for his part, only comes into play when the borrower’s misery is already in full swing. If a house returns to the ownership of a bank after a borrower has failed to make his payments, it’s Eddie who then tries to sell the property.

As a result, Eddie witnesses how some people go bust — and how others are building their fortune on the backs of the others’ misfortunes and/or blissful short-sightedness.

So you wonder how this financial chicanery can be executed given the ominous circumstances of the proposed transaction, including a seemingly unbearable debt overhang.

The way to resolve that little dilemma for the books was to operate on the basis of false, inflated appraisals. In theory, appraisers go out and value houses in order to have an estimate of their actual market price.

But appraisers can do just the opposite: They can overestimate the value of a house. For example, an owner of a house hires an appraiser who rates the real estate at $140,000 — instead of its real value of $70,000.

The property — now equipped with a paper-born “asset” of a $140,000 price tag-is put on the market.

If a potential buyer takes the bait and buys the house for that inflated amount shortly afterwards, a sealed envelope changes hands — stuffed with a minimum of $20,000.

That’s the nice little premium for the appraiser’s inflation job. If the appraiser’s cover blows, not to worry.

He or she can resort to another U.S. state and continue the “appraising” business there — without much risk. “The states are technically not able to square the data on bad apples masquerading as trustworthy appraisers,” says Eddie.

As we are leaving Brightmoor, Eddie is crossing once again 8 Mile Road. A run-down Kentucky Fried Chicken restaurant, a heap of old tires and a shabby car repair shop are flying past the car window.

“I am no longer scared now, I’m free as a bird,” Eminem raps in his song “8 Mile.” “Then, I turn and cross over the median curb, hit the ‘burbs — and all you see is a blur from 8 Mile Road.”

Editor’s Note: Read Part I here.