What has caused it?

What can be done to fix it?

In order to answer these questions, we need to first understand what the problem is.

Here's my attempt to explain the mortgage crisis and its causes.

First, it must be understood that it is the job of banks to lend money. It is through investment (what we call loans) that banks make their profits. There are lots of different types of investments, but they all essentially come down to this: they give money for a period to someone. In exchange for that, they earn interest on that money. The more interest they earn, the better the investment, all other things being equal.

Second, it must be understood that banks do not own the money that they lend/invest. That money comes from depositors. The banks have a fiduciary responsibility to make sure that money deposited with them is safe and that the depositor gets his money back.

Third, because banks do not own the money that they lend and have to borrow it from their depositors, they must pay the depositors interest as well, which cuts down on their ability to earn interest for their own profit. Furthermore, while borrowers might want to borrow money at a fixed interest rate, depositors want to earn money on their deposits that floats with the market, or else they will take their money elsewhere. This creates a risk for the bank that the amount that they pay to their depositors might exceed the amount they earn from loans. This is called interest rate risk.

Fourth, there is a limit to how much money any bank can lend at any one time... that limit being equal to 90% of the amount they hold on deposit. (The FDIC requires that banks maintain 10% of deposits on hand at any one time in order to cover day-to-day needs of depositors.) This is a significant limitation to how much lending any bank can do at any one time.

So the limitations to bank lending are 1) interest rate risk, 2) liquidity limitations and 3) fiduciary risk to the depositors.

In order to mitigate these risks, bankers came up with the idea of taking the loans that they were making and bundling them together and issuing bonds backed by these loans. Here's an example.

A bank lends $100,000 at 7% to an individual for a mortgage. It 100 bonds valued at $1000 each and "sells" them on the open market at an interest rate of 6%. What this means is that they are borrowing $100,000 from 100 people at an interest rate of 6%, and those loans are secured by the value of the real estate that secures the mortgage that they made to the individual.

The result is that they have not use depositor money to make their loan, which mitigates the fiduciary risk and liquidity limitations. Since the loan in at a fixed rate of 7% and the bonds are at a fixed rate of 6%, they have mitigated the interest rate risk.

This worked great until the roughly 1938. As part of the New Deal, FDR saw a need to increase bank lending. He therefore created the Federal National Mortgage Association (FNMA or Fannie Mae). The purpose of FNMA was to secure the bonds being issued by the banks to make them more desirable, and thus increase the amount of liquidity that banks could obtain to make more loans. If a borrower failed to make his mortgage payment, or if the value of a home failed to cover the mortgage when it was sold, FNMA would cover the loss, making the bondholders whole. FNMA's sole job was to secure mortgage-backed bonds.

This, in and of itself was a fine idea. The problem is that FNMA's job didn't remain so simple. Instead of only securing the bonds, they started PURCHASING the bonds, and eventually started purchasing the mortgages for themselves. They stopped being simply a guarantor and became a secondary market through which banks could sell loans. They saw this as part of their mandate, because by buying the loans in the secondary market, they made sure that the banks that originated the loans had the liquidity to make more loans.

That's where the biological waste material started hitting the rotary impeller.

You see, at that point banks stopped making loans that they would hold onto themselves. They started making loans with the intention of selling them to Fannie Mae for a profit. And since the banks no longer had to hold the loans themselves, they stopped being careful about whether borrowers could really repay the loans they were making.

In the late 60s Congress saw two problems taking place. First, they saw the Fannie was no longer doing their original job of guaranteeing mortgage-bonds, they were becoming the sole organization in a brand new market... essentially a monopoly. They sought to fix this by doing two things. First, in order to break FNMA's monopoly as the sole purchaser of mortgages in the secondary market, they created the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) who's sole purpose was to act as competition for FNMA in the secondary mortgage market. And second, they removed the responsibility for guaranteeing mortgages over to another new organization called the Government National Mortgage Association (GNMA or Ginnie Mae).

So in order to fix the problem of a monopoly by a quasi-government agency, the government created ANOTHER quasi-government agency that did exactly the same thing... and which worked for and answered to the same people, Congress.

Since approximately 1970 or so, banks have been making loans specifically for the purpose of selling those loans to Fannie or Freddie. The banks quickly learned that the more loans they could make, the more they could sell for a profit. And Fannie and Freddie learned that the more loans they could buy, the more control they had over the entire mortgage industry, and the more profit they could make as well. Over the years, banks made riskier and riskier loans that they knew that Fannie and Freddie would buy, and Fannie and Freddie condoned and encouraged these risky loans by continuing to buy them.

In fact, Fannie and Freddie, (at Congress' behest) started creating newer, riskier loan products designed to help people who could not afford a home to buy it anyway. Congress (or at least certain members of Congress) saw it as their job to help the poor people who could afford a home become homeowners, and saw Freddie and Fannie as the vehicles to make that happen. Such loan products included ARMS and HELOCS and no-doc loans, and 120% financing products, etc. The banks were happy to make the loans, since they could sell them to Fannie and Freddie without any risk to themselves. Additionally, seeing how much money was being made by Fannie and Freddie from these products, the banks started keeping some of them, and started creating GNMC-guarateed bonds of their own. And many investors purchased such bonds, either from Fannie and Freddie or directly from banks.

But the loans themselves were poorly underwritten. The banks, the investors, Freddie, Fannie and even Congress became so enamored with the profits to be made by trading in the secondary mortgage market and trading mortgage-backed securities that they stopped looking at the strength of the loans themselves, and looked only at how quickly they could book loans or purchase new bond issues.

Now... please look at the phrase that I bolded up above. I'll repeat it here:

Congress (or at least certain members of Congress) saw it as their job to help the poor people who could afford a home become homeowners...


THAT is the essence of the problem. These people could not afford the homes they were buying, but they were being suckered into buying them anyway. And they eventually began to realize that they STILL couldn't afford to buy those homes. The admirable intentions of Congress, to help the poor become homeowners, was the very thing that guaranteed that this disaster HAD to happen eventually.

PEOPLE WHO CANNOT AFFORD TO PAY THE MORTGAGES SHOULD NOT BE PURCHASING HOMES BECAUSE THEY WILL EVENTUALLY FAIL TO PAY THEIR MORTGAGES.

This was Congress' mistake in encouraging such loans. This was the mistake of the banks who made those loans. THis was the mistake of Fannie and Freddie who purchased those loans. This was the mistake of GNMC for guaranteeing those loans on behalf of the government (which means in behalf of the tax payers). And this was the mistake of the investers who purchased the bonds that were secured by those loans.

The really idiotic thing about this is that until 1938, the system was working just fine without government interference. There was no need for the government to guarantee the loans because the banks were making sure that they were properly underwritten, since if they were not, they would lose their shirts. Until 1938, investors would do their due dilligence to make sure that the loans that secured their investments were sound, because there was no government guarantee. But once the government got involved, the investors saw no need to do any due dilligence because the government was securing the bonds, and the banks stopped being careful because the government was there to bai them out if they screwed up. If the government had left well enough alone, this entire problem would never have taken place.

Just one more example of the stupidity of the statement "I'm from the government and I'm here to help."

So, how do we fix it?

I'm of two minds on this subject.

On one hand, the hard-core conservative in me says that Fannie and Freddie should NOT be bailed out. Let them dig themselves out. If they suffer a loss, good. It will teach them the same lesson that banks have had to learn about underwritting bad loans. And frankly, it would serve as a cleanser for the system... a way to clean out all the bad loans and bad LENDERS and INVESTORS, while retaining only the strongest and the best to continue doing business. Furthermore, bailing out Freddie and Fannie just encourages Freddie and Fannie to continue business as usual, without changing a damn thing about how they do business. So I am against the Freddie and Fannie Bailout. This is where my natural insticts lay.

But on the other hand, we cannot allow the two government agencies that hold more than 50% of the nations mortgages and owe more than 50% of the total debt of mortgage-backed securities to simply fail. There are too many investors (individual and institutional) who will also fail if that happens. The ripple effects are too big for us to not do SOMETHING to mitigate the effects. Fannie and Freddie have to be bailed out to keep the rest of the economy from being taken down with them. That is why I think the government is right to bail them out. (If natural market forces had been in play, no bailout would have been necessary... either there never would have been the crisis described above, or else it would have been on a much smaller scale that didn't require government intervention.) Lehman and AIG are both in serious trouble because they relied on Fannie and Freddie and Ginnie to bail them out. THey relied on Ginnie's guarantees of the mortgages that secured the bonds they owned and they relied on Fannie and Freddie's ability to cover those bonds. Allowing Fannie and Freddie to fail is what made things so bad for Lehman and AIG, not to mention Bear Stearns and Indymac. (I won't go into the Chuck Schumer thing right now, because that only exacerbated an already existing problem. I'll leave that for another thread.)

That said, I believe that Fannie and Freddie should be phased out of existence. The loans that are on their books and the bonds that they owe should be collected/paid-off over time, and NO NEW LOANS SHOULD BE PURCHASED AND NO NEW MORTGAGES ISSUED by them.

If the banks wish to continue to buy/sell/trade mortgages in the secondary market, let them do it without Fannie and Freddie. Let there be no government guarantees, and let the lenders, borrowers, investors, and traders do their homework before doing a transaction. And if there is no Fannie and Freddie to pawn bad loans off to, all parties will be more likely to be careful about what they do and with whom. That is how things work in a real free-market system. Mistakes still happen in free-markets, and investments fail, but not on a scale that requires government intervention. We can still trade MBSs and sell loans to each other without government agencies being involved.

So that is step one of the fix... keep government out of the real estate market.

The rest of the fix is simply TIME. Time for banks/lenders to recoup as much as they can of their losses and regain their courage. Time for borrowers to refinance or sell their properties and find new homes that are more affordable. And time for everyone to recover from a massive economic body-blow.

Also, now is probably NOT a good time to raise ANYONE'S taxes... not if you want to increase employment and create new jobs to stimulate the economy back into health. The poor can't afford any kind of tax increase right now, and the rich who have also gotten hit badly in this crisis don't need a bigger hit in taxes that will keep them from spending their money. Remember, spending money is the only way to stimulate the economy, so making those who actually have some money to spend less likely to do so is probably NOT a good idea right now.

So... that's my take on the mortgage crisis.

Comments are always welcome.

"Congress (or at least certain members of Congress) saw it as their job to help the poor people who could afford a home become homeowners..."

Exactamundo... and right on key Obama "laid the blame squarely on the policies of the Bush Administration (http://www.usnews.com/articles/news/campaign-2008/2008/09/15/barack-obama-john-mccain-react-to-lehman-brothers-crisis---with-wildly-divergent-opinions.html)."

"now is probably NOT a good time to raise ANYONE'S taxes... "

And yet that is precisely what Obama plans to do, raise taxes on capital gains and dividends, enact a windfall profits tax on oil companies and roll back the Bush tax cuts. I have yet to understand how making it less attractive to invest, stealing business profits and returning to higher taxes helps the economy. Oh that's right, it doesn't, it just helps fund more government handouts, more government bureaucracy, makes it harder to do business and invest and makes more people reliant on their nanny government.

Awesome thread there ET.

As is being seen on this side of the pond, the banks have been driving the market through their own greed for far to long and now they are being brought to book.
Not only with the sting of the whole sub-prime market, but also by systematically fleecing their own customers, the depositors, without whom they would have no money to invest anyway. The consumer driven revolt centred around penalty charges and unenforceable credit agreements will haunt the financial institutions for years to come.
Why do the banks believe that it is their right to vast profits from peoples ultimate misery?

Yes, we all want the good things in life, but easy credit from profiteering lenders is not the way to achieve this...

"Congress (or at least certain members of Congress) saw it as their job to help the poor people who could afford a home become homeowners..."

Exactamundo...and right on key Obama "laid the blame squarely on the policies of the Bush Administration (http://www.usnews.com/articles/news/campaign-2008/2008/09/15/barack-obama-john-mccain-react-to-lehman-brothers-crisis---with-wildly-divergent-opinions.html)."

"now is probably NOT a good time to raise ANYONE'S taxes..."

And yet that is precisely what Obama plans to do, raise taxes on capital gains and dividends, enact a windfall profits tax on oil companies and roll back the Bush tax cuts. I have yet to understand how making it less attractive to invest, stealing business profits and returning to higher taxes helps the economy. Oh that's right, it doesn't, it just helps fund more government handouts, more government bureaucracy, makes it harder to do business and invest and makes more people reliant on their nanny government.

I was trying to keep my discourse as apolitical as possible... just a non-partisan analysis of the facts. I don't disagree with you, but my purpose was simply an analysis and a discussion of solutions, not finger pointing.

Elliot

Awesome thread there ET.

As is being seen on this side of the pond, the banks have been driving the market through their own greed for far to long and now they are being brought to book.
Not only with the sting of the whole sub-prime market, but also by systematically fleecing their own customers, the depositors, without whom they would have no money to invest anyway. The consumer driven revolt centred around penalty charges and unenforceable credit agreements will haunt the financial institutions for years to come.
Why do the banks believe that it is their right to vast profits from peoples ultimate misery ?!

Yes, we all want the good things in life, but easy credit from profiteering lenders is not the way to achieve this...

Agreed

Understood, Elliot. Unfortunately the 'solutions' will likely be entirely political.

ETWolverine, you rock! Thank You!

Thanks for that Elliot. Very interesting indeed. The crisis in America has a significant impact on our interest rates down under here as costs borne by our lending institutions have increased due to the trouble over there. Obviously as the banks costs increase so do our interest rates.
Although we recently had a slight interest rate cut by the Reserve Bank to try and stimulate the economy a little.

They also yesterday pumped more than $1.3 billion into Australia's financial markets as a precautionary measure to keep liquidity levels up for local banks and is expected to make more funds available in its regular market operations today.

Inflation was going through the roof here under the prior government so we had 13 consecutive interest rate hikes. Now people aren't spending enough money our economy has stalled a little. In saying that our economy is fairly resilient and doesn't necessarily slump as hard as other parts of the world.

Thanks for the interesting read!

What's your take on this comment below?

"But the private-equity boom from 2006 and 2007 is the real time bomb silently ticking away in the mind of every executive of a major bank. In those two years, inexperienced thirtysomethings with inflated egos and overblown salaries scoured the globe buying businesses about which they knew nothing, with borrowed money, at grossly inflated prices.

"It was an unprecedented debt binge that drove global stockmarkets in those years, and the fallout has yet to impact on the banking system.

Figures compiled by Thomson Financial show that in the year to June 30 last year, private equity firms spent $US1.06 trillion snapping up businesses.

The idea was to gut them, load them up with debt and sell them into a booming stockmarket in 2009 and 2010 and repay the loans. That's never going to happen now."

The next big bang is private equity | smh.com.au (http://business.smh.com.au/business/the-next-big-bang-is-private-equity-20080915-4h1g.html)

Hi Elliot-

I've been too busy nursing a cold to hit the boards lately. This is a really good subject and timely. The last few weeks has been rough with hurricanes and now two more financial titans biting the dust.

NAFCU: National Association of Federal Credit Unions | Housing - Predatory Lending (http://www.nafcu.org/Content/NavigationMenu/Legislation_Regulation/Legislation/Housing_-_Predatory_Lending/Housing_-_Predatory_Lending.htm)

The above article is good. But I think since it was written, some of those regulations are in play. However, in short, regulations are meaningless if they are not followed, heavily monitored, including fines if necessary. In other words we want to promote business among lenders, yet within a capitalistic society comes responsibility. Sub-prime or prime loan, lender and customer must know their limitations.

Investor's Business Daily: Lehman Failure Tests Limits Of U.S. Bailouts (http://www.investors.com/editorial/IBDArticles.asp?artsec=16&issue=20080915)

"Recent actions reinforced that idea. Take the buyout of troubled Bear Stearns last March by JPMorgan Chase. (JPM) Bear Stearns was purchased for a bit over $1 billion — a hefty discount from the $13 billion in market value it had a year earlier."


As part of my work, I'm on the phone with JPMorgan several days in the week usually with check verifications or wire transfers. They appear more consistent with being responsible than other financial institutions. I have a personal story to share. When I was shopping for a housing loan around 1999, I sat down with a JPM Chase rep and shared with him my hopes, goals, and my finances. Unlike many lenders he did not try to squeeze me for a second job income just to buy a bigger house. The rep spoke the facts to me and saw me for what I was available to afford at the time. With other lenders I could had easily qualified with a first and second mortgage (two loans) and by manipulating the numbers based on stated income, but that would had been damaging to me as unaffordable and eventually JPMorgan Chase. It was a good educational experience that helped me personally understand staying within the boundaries of one's financial means. A good rep will always look out for his client.

IMO neither political party has minded the school... and not the Feds and Treasury. Sure everybody wants to do something now that it's already late in the game, as we now watch AIG waiting for the next domino to fall. Off the top of my head I think currently the State of California is first, then Nevada, followed by Arizona in our nation's foreclosures. In Nevada our populace in Clark county (Las Vegas) lead the nation in growth (until recently) for about a decade. Along with our boom came predatory lenders and ignorant consumers, which made for a combustible mix.

What's your take on this comment below??

"But the private-equity boom from 2006 and 2007 is the real time bomb silently ticking away in the mind of every executive of a major bank. In those two years, inexperienced thirtysomethings with inflated egos and overblown salaries scoured the globe buying businesses about which they knew nothing, with borrowed money, at grossly inflated prices.

"It was an unprecedented debt binge that drove global stockmarkets in those years, and the fallout has yet to impact on the banking system.

Figures compiled by Thomson Financial show that in the year to June 30 last year, private equity firms spent $US1.06 trillion snapping up businesses.

The idea was to gut them, load them up with debt and sell them into a booming stockmarket in 2009 and 2010 and repay the loans. That's never going to happen now."

The next big bang is private equity | smh.com.au (http://business.smh.com.au/business/the-next-big-bang-is-private-equity-20080915-4h1g.html)

I have heard it said that the personal mortgage crisis is only the tip of the iceberg. Commercial credit has yet to rear its ugly head.

First of all, there are commercial mortgages, which have not yet begun to start showing the level of failure that the private mortgage lenders are showing. And we have no idea how this credit crisis is going to affect non-real-estate commercial credit.

So the argument goes.

I'm not sure I buy it.

As I mentioned above, the problem with personal mortgages was exacerbated by government 'guarantees' that eliminated the need for banks to be careful. For the most part, such guarantees never existed for the commercial credit and commercial mortgage industries. So banks, for the most part, have been more careful about how they loaned money to businesses. They didn't have a safety net to rely on, so they did better due diligence. There are exceptions to that rule, of course. The SBA guaranteed commercial credit up to 80%. But SBA lending is a relatively small portion of total commercial credit, as compared to Fannie and Freddie, which made up over 50% of the personal mortgage market. So the very thing that drove the credit crisis, government interference, never existed to the same degree for commercial credit. We commercial lenders have always been more careful than the personal mortgage guys.

That's not to say that there aren't tough times ahead for commercial lenders. The cost of money is higher. Credit standards are going to get tougher. It will be harder for companies to borrow, which means that some of them will fail due to lack of capital or liquidity. The mortgage crisis will therefore have a trickle-down effect on the commercial credit business. However, I do not expect the wholesale failure of commercial credit the way we have seen with personal mortgages.

Still, no matter how you slice it, we're in for tough times ahead.

Thanks for the question, Skell. It's a good one.

Elliot

Good response Elliot. Makes sense. Good thread indeed!

It sure looks as though things are going to get worse before they get better. That's a scary prospect. I'm in the construction industry / property development and the current situation sure isn't helping with consumer confidence.

ETWolverine,

Your presentation is logical and true but I do have a comment. I am one of those Poor people who would not have a home without Fannie Mae. I am a single woman, blue collar, my income would never be high enougth for the housing market. I still have my home and am not in default and likely will not be. Fannie Mae sent me a program I had to study before I received my loan. I did study it. I have a fixed rate and no other debt but my home and utilities. I have just been approved for Social Security Disability. My house payment will be 1/3 of that income.

Part of the problem is people creating additional debt and not educating themselves. I believe the banks took advantage of it by telling them it would be all right and they believed because they were the professionals. Greed is the culprit for profit and not fiscal responsibility. I believe they should be bailed out but not the banks, their turn is coming. Sadly many people are going to be hurt because of the banks actions.

Frankie

See my posting and see where certain legislators in charge of oversight were dipping their hands in the piggy bank.

https://www.askmehelpdesk.com/current-events/freddie-fannie-enron-steroids-258796.html

This Investor Business Daily editorial also calls out the abusers :
IBDeditorials.com: Editorials, Political Cartoons, and Polls from Investor's Business Daily -- The Real Culprits In This Meltdown (http://www.ibdeditorials.com/IBDArticles.aspx?id=306370789279709)

Here is an open letter by Fred Thompson :

Friend,




The Danger of Government Guarantees


I'll bet it came as a surprise to most folks that the financial stability of the world as we know it depends upon the survival of a couple of outfits called Fannie Mae and Freddie Mac. Yet that's what the so-called experts are telling us. Moreover, we taxpayers are now being asked to guarantee Fannie and Freddie's tab, one that could make the $124 billion S&L bailout of the late 1980s look cheap.

So how did we get stuck with this bill? Well, Congress wanted to “do something” about what it saw as a “housing problem.” To them that meant that they should create an even bigger problem.

So Congress passed laws that made it easier for hopeful home-buyers to buy houses … even when they couldn't afford them. Then the Fed and other regulators helped, in the form of easy money and loose credit standards for mortgages.

Not surprisingly demand for houses grew, home prices rose, lenders financed additional questionable mortgages, fueling even higher prices and so on. You get the picture. This is called a bubble.

Then an amazing thing happened – apparently impossible to foresee. Home prices did not continue to rise forever! Home prices came down and easy money dried up, causing the above mentioned cycle to reverse. In other words, the bubble burst.

So you'd think the in-over-their-heads homebuyers and the mortgage bankers would take the hit, and the market would right itself. No reason for an international meltdown here, right?

Not so fast my friends. Years earlier Congress established Fannie and Freddie as purchasers of these mortgages, which they could bundle up, repackage and sell to investors, freeing up more mortgage money. As government creations tend to do, the two companies grew until they either owned or guaranteed about half the nation's $12 trillion dollars in mortgages.

Fannie and Fred were “government sponsored enterprises” which means heads they win, tails you lose. If they make money stockholders, creditors and Fannie and Freddie employees – some making millions annually – get the benefit. But now that mortgages have hit the skids, with mounting losses, the taxpayers potentially face trillions in exposure. This is because there is an “implicit” (read “actual”) government guarantee of Fannie and Freddie's obligations and both are now too big to be allowed to fail. This is called the “bailout phase,” which will probably lead to a bigger bubble in the future.

Lost in this immense, complex mess is the root problem most people are missing: the government is gradually becoming the guarantor of seemingly every important aspect of American secular life, creating incentives and bureaucracies that cause failure and invite fraud.

In Fan and Fred's case, it was in no one's interest to turn off the bubble machine. Just the opposite. The system induced borrowers to take on financial obligations they could not afford and lenders to lower lending standards. Fannie and Freddie went along because their managers' compensation depended on the firms' short term financial performance. And investors continued to buy complex security packages they didn't understand, because the securities were viewed as government-backed.

Heavy campaign contributions by those benefiting from this scheme induced Members of Congress to avert their gaze from the ugly mess that was unfolding.

You'd think we'd have learned by now: when the backstop of the federal treasury makes it easier for politicians, lenders, borrowers, welfare recipients, government contractors, or anyone else, to serve their own self interest at the expense of the taxpayer, many will do just that.

That is why we continue to see self-dealing, moral lapses, outright fraud and lack of management and oversight in a wide array of programs and government-sponsored entities, from housing to Medicare, education and the Small Business Administration, all costing taxpayers billions, even trillions of dollars.

Our Founding Fathers knew more than a little bit about human nature. It is one reason why in the Constitution, the federal government was given certain delineated powers and no others. I hate to burst another bubble, but our government simply doesn't have the authority or the capability to be the guarantor or insurer of our every need or desire. Isn't it time we started sending that message loud and clear to the big enablers in Washington?

What has caused it? What can be done to fix it?Hello El:

Sounds like a lotta banker hoo ha, to me. It's a lot simpler than that. What caused it? De-regulation. What can be done to fix it? Re-regulation.

Even McCain agrees with me, if he can be believed. He said he's going to "..clean up Wall Street"... You don't do that by DE regulating them further.

excon

I will state up front that I am certainly no expert on economy. I only have to make my own accounts balance out.

I have a question that I would like those of you who are well informed to answer.

I understand that the mortgage market is collapsing due to bad loans in the first place. So what happens when the houses are foreclosed? They still have value, maybe less than the debt on them, but not total losses. Why can't those houses be re-sold, or even re-financed at more liberal terms? There would be loss, but wouldn't it be relatively minimal compared with what I have been hearing? Someone is going to buy those properties at some price. I think in normal bankruptcy, assets are sold and the proceeds paid out to creditors on a percentage basis. What am I missing here?

Galveston-

How are you doing? I take it that you and you're love ones are safe and healthy? Update us all on own your adventure with Hurricane Ike, thank you.

Read the following links for a primer...

Foreclosure and Eviction – Debtor Foreclosure FAQ (http://www.debtworkout.com/forefaq.html)

Foreclosure - Does The Bank Really Want To Repossess Your House? (http://www.foreclosuredataonline.com/blog/bank-foreclosure/foreclosure-bank-really-want-repossess-your-house/)


To the consumer that loses their house basically look at the house as having only been rented for however many of payments occurred, plus you say bye-bye to your initial down, points paid at original closing, and fees, etc... For example you paid $1500 a month on your mortgage for 5 years, then for whatever reason you lost your job and couldn't make further payments. Bingo. Usually four months behind in most states has the foreclosure ball rolling. OK. Now your out of house and pride, usually had little or no equity considering today's market on recent purchased homes. Actually most homes purchased in the past three years ago until recent, lost value big time, especially in California, Nevada, and Arizona. Of course many of these people filed bankruptcy beforehand, packed-up and move on.

The financial institutions want the house back on the market asap because it's a pain for them. In other words, meaning they make a decision to sale based on the condition of the home as is, or pour more money into it as another investment to fix it up. In either case with our current economy (and the housing market prices going down) they will usually try and sale at current appraisal for the neighborhood comps or end up with less. Where it gets tricky is if the original loans was sold and resold again to another financial institution which often happens. Dumping high risk loans in the first place means somebody else gets caught holding a loser. Elliot can get more into that if he wishes, I do the retail side of credit in the gaming industry. The interest on the loans, among other products sold such as insurance, are how these financial institutions make their payroll for their employees, pay the overhead, and hopefully make a successful profit to keep their doors open for business. The interest rates, obviously are not there any longer when payments are not coming in on a regular basis. Everybody then tightens up their belts and occasionally jobs are scaled back. BTW Barclays, whom I have a credit card with, purchased a portion of Lehman Brothers today, so fortunately for some of the former Lehman employees they still have jobs.

Bloomberg.com: Worldwide (http://www.bloomberg.com/apps/news?pid=20601087&sid=a7CZXEXhlocI&refer=home)

The person owing the mortgage does have some leverage if they want to stick it out and make a deal with the bank. I got caught in the real estate bubble burst in the late 80s . I held onto the home as a rental for a few years but I am not suited to being a landlord.

I put the home on the market for about $50,000 less than purchased knowing that would not cover balance of the mortgage due . So I negotiated with the bank to call it a wash. I lose some ;they lose some .

They agreed to it because they really don't want to be property owners and they would lose more in foreclosure.

They agreed to it because they really don't want to be property owners and they would lose more in foreclosure.

There are many options. Short sales are common, and occasionally an addendum to contract w/stipulations. The banks, FCU, and other financial institutions, don't want the burden of a foreclosure if there is an alternative. BTW under bankruptcy Chapter 7, if you had a homestead on the house, your home is protected as long as payments are current.

So I guess my question is: With the residual values in the properties, will the net loss be as great as is being stated?

Thanks for asking, Bobby. We are about 75 mi East, and a little South of Dallas, Texas. There was wind on both sides of us, but thankfully, all we got was rain, which was not excessive. I have a daughter and her family with us until the electricity is restored in Conroe, just North of Houston. Folks down there are looking at maybe a month without power. Gasoline prices here are up only 10 cents, as of today. If it takes them a whole week to get the refineries back on line, that will likely get worse before it gets better.

ETWolverine,

Your presentation is logical and true but I do have a comment. I am one of those Poor people who would not have a home without Fannie Mae. I am a single woman, blue collar, my income would never be high enougth for the housing market. I still have my home and am not in default and likely will not be. Fannie Mae sent me a program I had to study before I received my loan. I did study it. I have a fixed rate and no other debt but my home and utilities. I have just been approved for Social Security Disability. My house payment will be 1/3 of that income.

Part of the problem is people creating additional debt and not educating themselves. I believe the banks took advantage of it by telling them it would be all right and they believed because they were the professionals. Greed is the culprit for profit and not fiscal responsibility. I believe they should be bailed out but not the banks, their turn is coming. Sadly many people are going to be hurt because of the banks actions.

Frankie

Hello, Frankie.

I understand that you have been helped to buy a home by Fannie. And from your perspective that is a good thing. I hope that you enjoy your home, and that you see many good, happy healthy years in it.

But that doesn't make Fannie and Freddie right for putting you into a home that you wouldn't be able to afford without government assistance.

I do believe, as you say, that you have not and will not default on your mortgage. In fact, for all the problems that Fannie and Freddie and the mortgage market as a whole are seeing, fewer than 3% of sub-prime mortgages are going to go into foreclosure, even in the worst-case scenario.

But that doesn't change the fact that under normal market conditions you would NOT be a homeowner. You would be a renter, like more than half of Americans.

Why is that a bad thing?

You see, Frankie, the problem is the blithe assumption that EVERYONE deserves to own a home. That is simply not true. Or at least it wasn't until Congress decided that real-estate ownership by EVERYONE (whether they can afford it or not) constitutes the American Dream, and that they (Congress) are in charge of making that dream come true.

And the result of Congress messing with the natural workings of the economy is the mess we are seeing today.

I'm sure that there are many cases of people who own homes because of Fannie and Freddie, and who own those homes in good standing, without any mortgage problems at all. But that doesn't mitigate the problems caused by those who HAVE defaulted on their mortgages. And that number is higher than it should be because the government stuck their hands into the pie. Annecdotal evidence that Fannie and Freddie did good things for some people doesn't change the fact that Fannie and Freddie have done some very poor things for the economy as a whole, and EVERYBODY (yourself included) are feeling the pinch caused by the results of their actions. In fact, I would venture to say that the very poor people that Fannie and Freddie were created to help in the first place are the ones who will feel the crunch caused by the mortgage crisis the most.

Elliot

Hello El:

Sounds like a lotta banker hoo ha, to me. It's a lot simpler than that. What caused it? De-regulation. What can be done to fix it? Re-regulation.

Even McCain agrees with me, if he can be believed. He said he's gonna "..clean up Wall Street".... You don't do that by DE regulating them further.

excon

No. What caused it is the very existence of Fannie and Freddie in the first place. THe only sensible and permanent fix is the ELIMINATION of Fannie and Freddie.

I'm not in favor of either de-regulating or re-regulating Fannie and Freddie. I'm in favor of getting rid of them COMPLETELY. They never should have existed in the first place, and it is their very existence that caused a need to regulate them.

IF Fannie and Freddie didn't exist, there would be no sub-prime loans, because no bank would make such loans without some sort of guarantee that the bad loans were covered, and without Fannie and Freddie no such guarantee would exist.

So the sensible solution for getting rid of sub-prime lending is to get rid of Fannie and Freddie.

Elliot

I will state up front that I am certainly no expert on economy. I only have to make my own accounts balance out.

I have a question that I would like those of you who are well informed to answer.

I understand that the mortgage market is collapsing due to bad loans in the first place. So what happens when the houses are foreclosed? They still have value, maybe less than the debt on them, but not total losses. Why can't those houses be re-sold, or even re-financed at more liberal terms? There would be loss, but wouldn't it be relatively minimal compared with what I have been hearing? Someone is going to buy those properties at some price. I think in normal bankruptcy, assets are sold and the proceeds paid out to creditors on a percentage basis. What am I missing here?

In essence, that is what will happen. The proceeds of those sales will go to pay down a portion of the outstanding loans, just as you suggest.

However, the foreclosure process is LONG and DIFFICULT. It will take many months, even years, for courts to issue foreclosure orders, during which times the banks are still sitting with the bad debts of their books. (Judges tend to give multiple extensions to the borrowers before finally ruling in favor of foreclosure.) As I mentioned before, every loan that a bank has on its books is money that they can't use for some other purpose... which means that money is tied up in a bad asset. And current banking regulations also call for even more money to be tied up in order to have a "reserve against loan losses" in addition to the loan amount itself. So for all those months, the bank is sitting with money that it cannot use... a drain on liquidity and a cost to their bottom line.

Then there is the fact that once they take control of the property in the due course of time, they have to be able to sell the property. And until they sell the property they have the cost of maintaining the property, which includes any repairs of damage that might have been caused by weather, natural disaster, wear-and-tear, or by ticked-off former owners who want to stick it to the bank. They also have to cover the property taxes. These are expensive items. There's also the cost of selling the properties (real estate attorney fees, closing costs, the legal fees for foreclosing on the property in the first place, etc.)

The cost of foreclosure and sale of a property is high, and the amount recouped from the sale, after all costs are taken into consideration are MINIMAL at best. The idea of foreclosure is not as simple as it might seem to an outsider. It's a COSTLY procedure.

Elliot

ETWolverine,

The material that I had to read was informative and educational, but no one stood over you to read it. You just had to confirm that it was read and studied. I believe many people did not do their "homework". I gave the information on a high risk loan and what to do to make sure you did not get in over your head, because I read it I did all the advice that was given, even though the bank wanted me to do an adjustable rate.
I agree with you about the consequences to the economy, I agree with who it will hurt in the long run. I do not agree with you about the government giving the opportunity to give people like me the chance for homeownership. No bank would touch me despite a credit rate over 700, my income was not high enough. I have no debt and I was paying higher in a rental than my home payment.
I lay the blame for the economy mess on the banks not government. Corportate greed caused them to do high risk loans.

Frankie

Frankie,

I agree that there was corporate greed involved. But it was a greed that said "We can make all the loans we want and we don't have to worry about loans failing because the government will cover us." If the government had not said that they would cover those bad loans, the banks would have never made those bad loans in the first place. Yes, banks are to blame... but the mechanism by which they abused the system was created by Congress in the form of Fannie and Freddie.


I have no debt and I was paying higher in a rental than my home payment.

Then your banks weren't doing their jobs.

As a lender, I can tell you that if your total housing payment goes DOWN when you purchase a home, and if you have been covering you old housing payment, there is no reason that I wouldn't lend you the money. However, if the payment for housing costs goes up, and you cannot demonstrate the ability to pay the new housing cost, then you would NOT get the money.

It may be true that with a Fannie "special" mortgage you can cover your housing costs. But what if you had to get a traditional mortgage? Could you cover that amount? If not, you shouldn't be a homeowner. If you could cover it, there's no reason that you shouldn't have been able to get a standard mortgage.

So as an expert in this field, one who has been doing this for 15 years, I really must question why no bankers would want to have anything to do with you. Something about your story doesn't track. Something is missing, some critical piece of information that makes you a high risk, even though you can demonstrate the ability to cover your housing costs. What are we missing?

Now, as I said, if the government had never created entities that guarantee bad loans, the banks would not have made those bad loans. Ergo, there would be no mortgage crisis, because there would have been no sub-prime loans made by banks in the first place.

You can feel free to disagree with that point, but I'd like to know on what basis you are disagreeing. Do you truthfully believe that banks intentionally make bad loans without some sort of safety net to rely on for when those loans go bad? That would be somewhat counter-productive to greedy banks looking to MAKE money rather than lose it.

Elliot

IBDeditorials.com: Editorials, Political Cartoons, and Polls from Investor's Business Daily -- Congress Lies Low To Avoid Bailout Blame (http://www.ibdeditorials.com/IBDArticles.aspx?id=306632135350949)

The wife and I were talking about this massive boondoggle and she said, "why don't we just make up the difference between what these strapped home buyers can pay each month and what they need?" Something like a second mortgage to be paid at the end of the first mortgage. Granted, we don't understand high finance, but it would probably be cheaper in the long run.

IBDeditorials.com: Editorials, Political Cartoons, and Polls from Investor's Business Daily -- Congress Lies Low To Avoid Bailout Blame (http://www.ibdeditorials.com/IBDArticles.aspx?id=306632135350949)

Thanks for the link:




But the crisis began much earlier. The Carter-era Community Reinvestment Act forced banks to lend to uncreditworthy borrowers, mostly in minority areas.

Age-old standards of banking prudence got thrown out the window. In their place came harsh new regulations requiring banks not only to lend to uncreditworthy borrowers, but to do so on the basis of race.

These well-intended rules were supercharged in the early 1990s by President Clinton. Despite warnings from GOP members of Congress in 1992, Clinton pushed extensive changes to the rules requiring lenders to make questionable loans.



Thanks ET for the banking primer.

I think it is all greed -

Investment banks, hedge funds, banks using leverage to make money.
Consumers for buying into the McMansions, house flipping, upgraded kitchen, put everything on the credit card mindset.

What do you think of:


"If it doesn’t pass, then heaven help us all,” responded Mr. Paulson,

Do you think financial armageddon is possible or was this a power / political play?