Saturday, November 24, 2007

Apocalyptic Mortgage Failures

I blame the banks, of course. Your average person is expected to be an expert on whatever he does for a living, and maybe a few other things he has interest in, but not everyone is deeply interested in finance.

I can do a little research, 15 or 20 minutes on the computer and I can tell you what any given home in my market area should sell for, what it has sold for in the past, how much that neighborhood has appreciated (or DE-preciated) in the last given number of years, and what all the neighboring homes sold for last. Etc.

I don't expect other people to know how to do all this, or to even have access to the data to easily do it. I often run into wannabe sellers who have the most exaggerated ideas of what their home will sell for. Almost always they are wrong on the up side, not the down.

But when we go to a bank for a mortgage, one of the first things they do is appraisal of the property. They are not supposed to lend any more than the property is worth. The property is, after all, the collateral against which the money is lent. So if the borrower can't pay, the bank simply takes back the property and sells it again. In theory, the bank should always come out ahead. They have been paid something over however many months the borrower did manage to pay the mortgage, plus they can resell the property if they have to take it back. Minus their transaction expenses of course.

So why are the lenders in trouble?

Appraisals are a big game. Banks want to lend, buyers want to buy, sellers want to sell (for a gain), and everyone is happy if the property just happens to appraise for a hair over what the buyer is offering. How wonderful.

What the home is appraised for and what it can be sold for are two very different things, as banks are again finding out. The lender is supposed to look out for his own interests, and incidentally not trap borrowers into debt beyond what they can afford. They are failing badly on both counts.

I make my living off of commissions. The more the house sells for, the more money I make. This is a clear moral trap. I have often told people that if the bank tells them they are good for 'X' loan, they should strongly consider only actually borrowing 75% of that. That advice hurts my bottom line, but I have to live with myself, not just live. Lenders have pushed too many people into bankruptcy by over-lending. And this helps the banks how?

I don't expect non-experts to be experts, and neither should banks. A little honest advice, a little credit counseling at this point might have avoided much of the trouble we are in. I want to see bankers' heads rolling. A little unemployment might be a good learning experience for them. It probably won't make them any more honest, but it might make a few of them more cautious.

'"We haven't faced a downturn like this since the Depression," said Bill Gross, chief investment officer of PIMCO, the world's biggest bond fund. He's not suggesting anything like those terrible times -- but, as an expert on the global credit crisis, he speaks with authority.
"Its effect on consumption, its effect on future lending attitudes, could bring us close to the zero line in terms of economic growth," he said. "It does keep me up at night."
Some 2 million homeowners hold $600 billion of subprime adjustable-rate mortgage loans, known as ARMs, that are due to reset at higher amounts during the next eight months. Subprime loans are those made to people with poor credit. Not all these mortgages are in trouble, but homeowners who default or fall behind on payments could cause an economic shock of a type never seen before.
Some of the nation's leading economic minds lay out a scenario that is frightening. '

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