JoeTaxpayer

So I was thinking on this a bit more over the last few day and have some more thoughts on the combination of events that came together:

1. The anomaly in rates, specifically, the short term rate dropping to record levels, 1%. And of course, the subsequent rise back to more normal levels.
2. The surge in the high end home prices. Of course you can say that the rates drove the prices higher, as the same dollar bought far more mortgage at 3% than it did at 9%.
3. The no-doc mortgages, brokers filling in applications that were signed when still blank.
4. Between fancy computer modeling and ratings agencies that did not do their job, much of the paper got rated AAA when it should be C or less. (my thanks to Douglas Johnson for pointing this last factor out to me)

An article in the August 5th New York Times gave a good overview called “Housing Busts and Hedge Fund Meltdowns: A Spectator’s Guide.” It still leaves some questions unanswered, but it’s worth a quick read.

JOE

How did the housing bubble turn into the current credit meltdown? Well, the system was able to handle the ‘normal’ default rates until recently. A normal default, to me, is one occurring in a real estate market where values are increasing each year (amount doesn’t matter, it’s positive) and when a buyer defaults, the bank is able to recoup say 80-90% of the money owed. A 10% loss on 5% of loans offers manageable numbers. Now, in more recent times, we had a cycle where short rates dropped to 1%, and a standard ARM, was offered at under 4% (this is not the teaser, this was the real rate). Now, with the 1 year t-bill at 5% or so, the rate has adjusted to near 8%. A $250K mortgage payment would jump from $1200 to $1800 over this 2 year period.
Next, add the fact that the homes were over valued and these weren’t $250K loans but two to three times that. Then to top it off, the initial payment in my example wasn’t really $1200, but an interest only teaser rate of 3% offering a payment of $625. (So for a $500K loan the payment rose from $1250 to $3600!)

This all created a cycle where nothing was normal. A large number of mortgages were offered as ARMs that were time bombs, financially, all of which would create a potential problem of some sort. This wasn’t just new homes, there was refinancing as well. Stories of people moving from a 30 year fixed at 5% to an ARM which was destined to go to 8%, to pull cash out to do God knows what, just broke my heart.

The sheer magnitude of the amount of paper involved is the answer to this question. If this were isolated regionally, or to a small number of lenders, it would have less impact. As Nouriel Roubini’s article (what a gem, I didn’t realize he maintained a blog) states, half the mortgages originated in 2005-2006 were of the nature I described.

Then next thing to note is that these loans are not just held by the banks that lent out the money. For some time there has been a market in CMOs (wiki(collateralized mortgage obligations)) which has created the potential for defaults to have an impact which is far reaching. Businesses have invested their hoards of cash in CMOs as have pension funds and 401(k)s. We are now in the midst of a meltdown on a scale not seen since the wiki(Savings and Loan Crisis) in the 80s. Maybe it takes this long to forget the events that precipitate such a meltdown, as if ‘this time things are different’. Once again, those who forget the past…..

JOE

I’ve been sketching out the next few months of articles I plan to publish on my main site. The only way to not miss my monthly deadline is to think a couple months out. So here are my thoughts on the next few months:

1. Getting Started – The first things to do when when you have no money to invest
2. Bi-Weekly Mortgages – Good or Bad?
3. Immediate Annuities – What are they, why do I want one?

I may still post the occasional book review and update the book list randomly, as well as continue the blog posts. Enjoy the weekend.

JOE

I overheard someone saying that the person fortunate enough to catch any record breaking baseballs likely worth $500K or more would be immediately subject to tax, and therefore, since most people don’t have $150K available to pay the tax on the assessed $500k or so, would have to sell the ball at auction just to cover the tax. I found one article on WSJ that discusses this, but claims the IRS refused to comment definitively, so for now, we don’t know. I think the tax should only be due upon the sale of the ball. There are no analogies that really for a good basis for comparison. At least someone going on a game show or winning a lottery knows, or should know what they are in for. Catching a ball you just can’t keep just doesn’t seem right.

JOE