Thursday, September 18, 2008

A Morning meeting and Finances


Well, as you might remember, my last morning walk was rather quiet.
Not so this morning.
It looked like a neighborhood fire drill.

My first mile and a half or so was the usual crickety quiet.
Then I saw the bus in the church parking lot.
Then I saw all the cars and trucks of the people who were going to ride on the bus (I presume) in the church parking lot.

On the back half of my loop there was the man with the yipping dogs (who were yipping).
Then there was the two joggers whom I have seen before but never been close enough to speak to until this morning.
Then there was the black man on the black bicycle rolling along in stealth mode.
And THEN the old man with the shillelagh.


For those of you who pay taxes, congratulations are in order.
By virtue of the actions by the Secretary of the Treasury today, you are now a co-signer on several hundred thousand (or more) home loans that the current mortgagees cannot pay for.
So, if they default on their loans, YOU get to pay for it.
With your tax dollars.
And thus you own one 138 millionth of their house.
Woo hoo.

This is because of our old friend Billiam Jefferson Clinton, and the Congress, way back in the 1990's.
He signed legislation pushed by the liberals of them days, that required mortgage companies to loosen credit standards to allow more "marginal" applicants to qualify for a loan on real estate.
This was the financial equivalent to affirmative action at your local bank.
So, the banks dreamed up loan programs to lower the monthly payments of prospective loan applicants.
But lower payments equal slower payback.
Or no payback.
(ever heard of an Interest Only loan? This is a loan were all you pay each month is the interest on your loan. If you never pay anything on the principle, how long do you think it would take to pay back the loan? Try forever.)

But many of these folks could not really afford even these "lower" mortgage payments.
So, the bank gets the house back, to re-sell again to someone else, who, hopefully, can better afford the payments.

Then there are the derivatives.
This is where it got complicated.


It works like this...stay with me....
Bank A has made 2000 home loans this month.
They sell 1000 of these loans to investment company B.

[why does the investment company want to buy these loans?
Because they have "guaranteed" value over a long time (15 or 30 years).
The homes have value and can be resold, even if the owner defaults on the loan.]

Unfortunately, mixed in with good loans are these "marginal" loans.
Only, investment company B does not know how many of the loans are "marginal".
Historically, only about two percent or less of home loans fail.
Based on this, investment company B discounts the total value of the 1000 loans it purchased from Bank A about two percent.
But because many more of these loans are "marginal", the likelihood of more defaults on these 1000 loans is greater.
But remember, investment company B does not know this.
Or at least, it does not know the actual percentage of "marginal" loans are in the 1000 loans, so they cannot accurately discount the value of the package.
Investment company B then goes out and uses this package of loans, and others like it, as collateral for other investments based on their assumed value.

Other companies, called Rating Agencies, whose business it is to put a value on the investments of these companies, vouched for the assumed value of the investment company based on the assumed value of the investments it had made.
Note "assumed".

Then some of the people who took out the loans on their homes began to fall behind in their payments.
Then the loans started to fail.
And more failed.
And more failed.
And, suddenly, the total value of all the loans bank A owns is not worth as much as it thought.
Banks determine their total business value by how much total money it is owed to it by all of its customers. (plus total deposits of actual money.)
If too many loans fail, the total value of the bank goes negative.

And investment company B finds that more of its loans (purchased from the bank) are failing than expected.
And, suddenly, the total value of all the loans it bought from bank A is not worth as much as it thought it was.
When this happens, it cannot borrow as much money to make more/other investments.

And the Rating Agencies, when they find out that the value of the investment company's investments are not worth as much as they thought they were, must lower the value it ascribes to the investment companies.

Then, other investment companies, who used to buy mortgage loans from banks realize that these are not as "safe" and stable as they used to be.
So they stop buying them.
If the banks cannot sell them, they lose more income.
If they lose more income, they make less loans.
They hold on to more reserves to cover anticipated increased defaults of their real estate loans.

Can you see a house of cards here?

Multiply this scenario by thousands of banks and set the default rate, not at two percent, but at ten or twenty percent, and you can see why we have a problem.
There are billions of dollars tied up in individual house/real estate loans.

And one more thing.
When a bank finds that its income from the mortgage payments of its customers begins to fall, it cannot loan out as much money as it used to.
And if the bank officers think that more of its loans are going to fail, it will hold on to more of its money (reserves), "just in case".
When it loans less money, your local business person (maybe your boss) cannot get the small , short-term loan he needs to keep his business going and growing.
Then the whole economy starts to slow down.
Small businesses start laying off workers.
Laid-off workers start to fall behind in their house loan payments.

No comments:


April 15 th of 2013 was my last year to work for HR Block. I disliked the corporate pressure to make us call customers to try ...