September 23rd, 2008


(no subject)

So I've been trying to understand the complex mess we're in. One way to do that is to separate the mess into its parts. At one end we have the housing market. At the other end, we have the Wall Street equity houses. In between, we have the mortgage companies, banks, and other institutions that write the mortgages, collect them together and package them for the equity houses to buy and/or to provide 'insurance' for. Domestic and international investors and funds provide the money for the equity houses

Okay, so there was a bubble in housing construction. Before the bubble burst, many individuals and groups were convinced this hot market was a good place to invest money. They used house mortgages to increase their buying power. And if one house was good, wouldn't two be better? And families, pushed by ever increasing house prices, decided they should upgrade to that bigger house now rather than wait until it was easily affordable. After all, wouldn't it be a good investment? A number of first time buyers, worried that the price increases would forever put houses out of their reach, decided to buy.

There was a lot of money to be made by the companies who constructed these houses. Why worry? The more you build, the more you sell. Oh, and more money is made from a large house than a dinky one. It's also easier to sell.

The in-between banks and mortgage companies were flush with investors (equity companies) wanting to underwrite loans, Where better to invest it than in the booming housing market? In competition to write mortgages, the in-between companies started offering to write loans first at 100 percent and then at greater than 100 percent to cover closing costs and the down payment. Traditional down payments were twenty percent on an old house, ten percent on a new one. Some loans were written for an even higher percentage of the original house cost to finance house payments for the first few years. People who couldn't qualify for an ordinary loan were offered a 'sub-prime' one. The idea with sub-prime was the buyer would pay only the interest on the principal for several years, then, because house prices are always increasing, the buyer could refinance with a standard loan before the sub prime loan converted to the higher payments, dramatically higher because of the first few year's grace.The idea was to let several years of inflation pay the down payment. But by then, the house was worth less than the loan. A lot of money was made by the loan writers, Bonuses were paid to the top performers.

All these mortgages fed into the Wall Street equity houses who eagerly competed to suck them up. The volume of loans soon surpassed available equity. Not to worry. These were smart, capable, high-paid financial experts. A few years before, some of the rules about the allowable debt to equity ratios were changed. Add that to almost-zero oversight by the government, an artifact of the Bush administration. Derivatives, leverages, houses-of-cards, smoke and mirrors, call it what you want. Basically, the equity houses underwrote orders of magnitude more loans than they and their associated investors actually had money to cover. They made a lot of money handling these loans. Bonuses were paid to the top performers. Sounds a bit like Enron, doesn't it.

One has to understand the housing construction industry has never proceeded on an even keel. There are always great highs and great lows. That's investing 101. Every investor knows or should know that. The other thing to understand is that it always recovers to provide long term gain. Sometimes it takes twenty or thirty years; usually it's three or four. Sometime in the future, well before the loans are paid off, those houses will recover their value. That is, barring a drastic decrease in the population.

I've seen this happen several times in my life. When we bought our second home, I remember it as being in 1974, maybe 1975, new houses so glutted the market that we received a $2000 tax credit just to buy one. Five years later, we had no trouble finding a buyer and sold that house for twice what we paid for it. I would have thought George W. would have learned from his father's mistakes. I can remember the savings and loan debacle of 1989. It took three or four years for the housing markets to recover from that.

My point is: given time, what seems to be a bad loan today can be a good one in the future. Right now, trim 20 percent off (the deferred down payment for many) the loan, drop the interest rate a bit if it's too high, and let those willing stay in the house pay off the loan. Give a tax credit to the mortgage company for doing the trimming. Recap the money by collecting the amount from the owner when the house is sold so it doesn't become part of their profit. To those unwilling or unable to take this deal, say goodbye and allow them an easy trip through bankruptcy court. Trim another 10 percent off and sell the house and loan to someone else. Again, let the mortgage company do it and get a tax credit.

That takes care of the mortgage companies and the house owners. For the Wall Street equity houses, I'd have a special bankruptcy category for them. Don't allow 'golden parachutes' or severance for anyone who leaves, Review salaries. Loan the company only enough to pay bills and meet commitments so they can continue as an equity company, but with new rules concerning the debt-equity ratio. They lose the special bankruptcy status when they pay off the government loan.

I think GWB is rushing to get this problem handled before the election. I think his approach is flawed, costly, and rewards the equity companies. I also think increasing the national debt is a serious mistake. The right-wing talk show pundits are blaming all this on subprime loans. I think this is an over-simplification, and it's mainly an attempt to direct the blame away from the real culprits, the equity companies, who took on so much debt they crumpled when the loans started defaulting. In hindsight, which is always easier, if the government had done more six months ago to solve the loan default problems...

Remember, I'm always right...except when I wrong!