Loan Sharks

Here is a quote from Kipplinger.com

"The shifting market is prompting investors to demand higher standards for loan approvals. Loans for 100 percent of a property's value required a minimum credit score of 580 last year, but now require at least a 600 score, said David Zionts, owner of Connecticut Mortgage Lenders LLC.
A high-value loan with no income verification could be had last year with a credit score of 620 a year ago but now needs a minimum score of 640, he said."

Let's see, a 100% loan, if the house value drops the bank gets to keep it, if it goes up the owner sells it and makes a profit.

This is a loan that has done considerable damage to our economy. The sharks writing these loans have no scruples. By increasing the credit scores to qualify, they're doing the same old thing to people with a higher rating. A 100% loan is gambling with other people's money.

When Wall Street decides not to insure the Sub Prime and Alt-A stuff, who do you have left to sell it to? The bad thing about the 100% loan disappearing in the next couple of weeks, is that it virtually eliminates a lot of the potential California home buyers (at current prices). That's going to smart a bit!

Forget the phrase "Soft Landing." Consider the phrase "Hit the Fan!"

After some of this stuff works its way through the courts you're going to hear these lenders being charged with "Financial Turpitude." Lets face it, "Responsibility" left the building, the minute that it became a 100% loan.

Do You Know Where Your Money Is?

The question has to come up sooner or later. Why put money in the bank with these lousy interest rates?? Using the rule of 72, when you divide the savings rate into it (3%), you get the number of years for your money to double. In this case, it's 24 years. The inflation will eat you alive. A $100,000 in 1964 dollars is equivalent to $1,000,000 in purchasing power by today’s standards. So, to make it simple, over the last 44 years, we have had 90% inflation. The decimal point has been moved one space to the right. In 1964 gas was 30 cents a gallon and a house cost $20,000. Today gas is $2.65 a gallon and a house is around $200,000 (definitely not California!).

Examine a concept that is being glossed over and not taken at face value. Every house, stock, bond or mutual fund share has an owner at every instant in time. The certainty is, selling at the top is good and buying at the top is bad. Every dead horse has an owner (owning one is not a desirable thing unless you process dog food).

So let’s see, we have a zillion houses out there that are empty. We have 424,805 bankruptcies and 154,910 foreclosures nation wide according to foreclosure.com. The question comes to mind, who’s footing the bill? The money has been spent, just whose money was it?

It looks like the next thing to drop dead is going to be a credit card company. Wouldn't that be a real mess! Every layoff is a potential no pay. How many credit cards do you have in your wallet??

Any way you look at it, somebody OWNS all of this junk that is going bad. Its almost a forgone conclusion that whoever it is, has no idea of their vulnerability or their potential liability. Naturally this will all go away if we just close our eyes. My retirement fund or mutual fund couldn’t be that stupid or could it?

The Funnel Effect.

A lot of bloggers are waiting for real estate to fall flat, and I think that there is going to be a long wait for them. Not that it won’t happen, it’s almost a certainty that it will. But by the time it does come to fruition, it will be a moot point.

Here is a concept, let's call it the "Funnel Effect." Individual items drop into the funnel and combine with others. As they drop through the funnel as a group they become more concentrated.

The easiest way to view the funnel effect is from bad housing loans and Visa and Master Card accounts. If you are a credit card company or a real estate lender, these problems are quite apparent; they could have hundreds if not thousands of people in a distressed state. This funneling effect of each individual, demonstrates what happens higher up in the retail/wholesale chain. We have consumers all over the world that purchase goods and carry on with their lives. When the economy starts to go bad, we have a situation where many people cannot manage to live in their accustomed manner and cut back on consumption in some form or manner.


Using a Starbucks Coffee Shop or Home Depot, the funnel effect (lack of consumption) would be reflected as a drop in sales. Individuals decide to spend less or not pay for an item like real estate taxes. Notice, that these choices of not to consume or pay a bill, converge into a group category. Housing funnels into lenders who made the loan. Bankruptcy’s funnel into credit card losses for the card issuer. The real estate tax base funnels into County Governments and School Districts.

Each home owner facing foreclosure will fight hard to survive and keep his house. What will happen, will be the Funneling effect of their lack of consumption. They may go into foreclosure, but the lender's pain is far more evident earlier on, than the individual homeowner.

The thing that is not realized until it’s too late is that government expected receipts are projected out several years. In a declining market, this optimistic view of the future can lead to severe cutbacks in government spending. It's kind of like hitting a brick wall at 20 miles an hour. The wall wasn't there a minute ago.

The government is the ultimate “Canary in the Coal Mine.”

The City of San Diego is a deer in the headlights!

The Stealth of Inflation

A while back I decided to collect the American State Quarters. Every time I got a newly issued coin, I would press it into the coin book and the thought would run through my mind, these coins look kind of cheap. No quality or high relief in the coin (Chucky Cheese has better looking play tokens). Compared to a 1995 quarter, quality is very apparent, the new ones look phony.

A 1964 quarter made of Silver looks quite impressive. These coins are different; you don’t see them in circulation any more, they are worth a lot more than their face value.

It really strikes me as funny, here I am complaining about the difference in quality of two quarters produced 5 years a part 1995 vs. 2000. But think about it. The 1964 quarter won’t see the light of day unless it’s in a coin shop. Your government has found a way to produce coins of lower quality even cheaper. It’s kind of on the level of using butcher block paper for toilet paper. It works but yet it doesn’t.

So if the Silver quarter represented value, the non Silver quarter (before 2000) represented quality, and the present one represents what ever you have left after you take away VALUE and QUALITY.

A $10 bill in 1964 would buy 40 packs of cigarettes. A hundred dollar bill today will buy 30 packs of cigarettes. So when you see that Silver has climbed to $13.50 per ounce, ask just one question; How can an ounce of Silver still buy the same amount of cigarettes as it did 44 years ago?

Silver didn’t jump in price, the dollar fell in value. Perspective is the issue here. Our perceived concept of inflation is measured from year to year. It’s gradual and not really noticed.

So you want to put your money in a bank and collect interest? Well, 3% isn’t much of a deal. Why not spend it and buy something? A lot of people are doing just that. When they wave that card and say “Charge It,” my mind thinks inflation.

Why not give Gold and Silver a shot? Three percent from the bank is chump change. The thing to think about is the rest of the world. A world wide depression would wreck some governments financially and their citizens would try to secure their assets by purchasing Gold and Silver. It never hurts to be first in line and buy before it becomes popular. The demand for the time tested store of value that Gold and Silver have to offer could become quite pronounced.

The real question you have to ask yourself, is the real world rational with Google at $475 per share? If you smell smoke, move towards an exit. Under no circumstances yell the word “FIRE.”

Lies, Damn Lies and Statistics

Mark Twain had a way with words and humor, the title is a quote of his.

Lately we have been watching the real estate collapse and things are not as they appear. A lot of us have been following Bubble Markets Inventory Tracker with baited breath. The numbers don’t seem to support the collapse or do they?

One item not really examined for its full import is REO’s (real estate acquired by a bank through foreclosure). When we look at the statistic for homes sold during the month, we make the assumption that these people are new buyers. In a collapsing market this is not a valid assumption. The lender acquiring an REO on the court house steps is considered a “new buyer”. Their bid is the value of the first trust deed (we know the second is toast). So if they held a 100% loan for $800,000 on the house and its now valued at $600,000, there will be no bids to buy the house at the Trustee Sale. Notice what happens here. This house will be listed in the statistics as a new sale at the loan discharge price of 800K.

Let’s pick the San Diego area. December sales were 3,613 units. Realty Trac showed and increase of REO's for the month of about 500 units (I could be off a bit on this, up or down, I wasn’t writing the figures down until now). So instead of 3,613 sales, subtract the REO’s and we have 3,113 sales.

Now if you have followed this far, notice that with the REO’s, the sales price is not determined by present perceive value, but rather by the amount owed the lender. There is no one waiting in line to buy the house, the sale will take place. The lender gets it for the amount due on the note, and the sales price gets recorded. The price has no relationship to current market sales data.

Common sense says that the median price should rise with this sort of book keeping and yet the San Diego Union Tribune today announced that the median housing values had dropped $20,000. The only conclusion to come to here is that the drop could be a tad bit more than stated with all of the "Creative Bean Counting."

Let’s take the worst case scenario. San Diego has run out of "Loons" wanting to buy houses. Let’s say that we have 3,000 foreclosures in the month. This would be counted as 3,000 sales at pre 2007 prices (full retail less the second trust deed). The statistics would indicate that its time to buy into this "Rising Market." I think that Mark Twain was right. Statistics can distort reality, Caveat Emptor.

Junk Second Trust Deeds

Imagine a fictitious company called ABC Loan and it has 100 $100,000 second trust deeds with a 12 year life span. Right now, we know 3 of them will go bad this year and because of foreclosure, the second trust deed will drop off of the title rendering it worthless.

So ABC Loan has 10 million in second trust deeds at say 7% interest. Net interest on 10 million at 7% is $700,000. Subtract the 3 foreclosures. Now the interest for the year is $400,000. The following two years could be just as risky, considering the market. After 3 years, the loans are pretty well seasoned and your going to be back in the banking business. So for three years, your business model which worked in the good old days, kind of sucks. You're only getting 4% interest on a high risk loan for the first 3 years. (I could be shot for over simplification!)

Now if you examine all of these sub prime borrowers that were given second trust deed mortgages, it doesn't take much math to realize that 8 no pays out of 100 pretty much puts the lender in survival mode. Add on top of that the number of lawyers who have decided to save these foreclosed borrowers from themselves by suing the "Fog-A-Mirror" Mortgage writer. On top of that we have predictions that 20% of all loans from 2004 to now could default.

Sounds unreal so far doesn't it. But let's ask only one more question: Where is the money coming from for these loans? Its not coming from the banks, they still remember the banking fiasco of the 1990's.

Who is willing to pay almost Treasury rates for unadulterated crap? The word retirement fund comes to mind. I hope I'm wrong, but the answer to the question should be self evident within the coming year.

Critical Mass Meltdown

We have touched on the obvious foreclosure problem. The graph on Bankers Worst Nightmare has a new point to plot 9,900 foreclosures February 1, in California. That’s pretty close to the 10,000 projected. Now we have financial lenders dropping dead and closing their doors at an increasing rate. The Bakersfield Blog has been on top of this particular item. I've included them in the Links list on the left for easier tracking.

There is some confusion about whether or not the right choice of words for the financial loan writer is a “bank” per se or “mortgage lender.” These entities’ closing their doors don’t seem to have all the attributes of banks. Who ever they are, they are writing the 80/20 loans with no PMI. And right now the 20% part of the loan is toast.

Notice how the interest rates on secondary paper is starting to climb. As a footnote, if you want to sell a $100,000 second that is written at say 7% you may have to discount it to say 10% interest in order to move it off the books. The discount would be $30,000. The face sale of the note would be $70,000 (Interest paid by the note is $7,000). A lot of the major banks are reducing their exposure to the secondary trust deed market.

The housing market might not be the first thing to collapse. It could be an institution that supports it. Right now, lenders are closing their doors. They are getting out of the loop as fast as they can to avoid being sued. I can’t really blame them.

If you look at the graph on Bankers Worst Nightmare ,you see that the doubling of foreclosures projects about 20,000 homes at the beginning of May of this year. Here is where it gets interesting. The hedge funds have insured all of this 80/20 risk with derivatives. Question, if they were able create a multiplier that increased their wealth by say 10 times with the use of derivatives, doesn’t it make sense that it works in reverse as well as it did going forward?

So let’s see the chain. Homeowner--> Foreclosure -->Loan Originator -->Loan Insurance--> Hedge Fund -->10X multiplier -->Critical Mass! The hedge funds have insured these loans. In an up market, everything is business as usual. In a down market things can get fugly. There could be a call to satisfy the contract against loss by the bank to the Hedge fund. This could signal the beginning of a hedge fund melt down.

It doesn't look like its too far away at this point in time.

Been There Before, (In My Previous Life)

Today we read that the savings rate in the US has dropped to a negative one percent. It is also mentioned that it hasn’t been this bad since the Great Depression years of 1932 and 1933. The following is an article from way back when, that appeared in the Saturday Evening Post, CCV (November 5, 1932), pp. 3-4 titled" What about the Banks." It was written by Frank A. Vanderlip, former president of the National City Bank of New York. Bear in mind that 1932 was three years into the Great Depression. So if we carry forward to today, this would have appeared in the future year 2009. So we are not really where he was at, when he wrote this.
I had to type this in by hand, no cut and paste. There could be an error or two.

----------------------Begin Quoted Article----------------------------------

The present economic disturbance has been so severe that it as make even some changes in our language. No longer is it an apt metaphor to say that anything is “as safe as a bank.” The word “securities” has almost become obsolete. An investment that drops in price to a tenth or, perhaps, even to a twentieth of its former range is not a security; it is a jeopardy. The page of stock-and-bond quotations might well be headed Quotations of Risks and Hazards. To call them securities in the light of their fluctuations is ironical.

In 1720, a financial debacle added to the English language a phrase which has persisted in common world-wide use for two centuries. A hopelessly exploded financial venture is to this day called a South Sea Bubble.

The South Sea Company in its time was the rival of the Bank of England. It was the ambition of the Tories that it should supplant the Bank of England. When the bubble burst, the extreme decline in the price of the stock was from 1,000 to 135. The company withstood the shock, however and continued in business for eighty years.

Here is an example from out own times: United States Steel and General Motors stocks, the two leading industrials of the country, declined from the high quotations of 1929 to 8 per cent of that price. The decline in the stock of the South Sea Company was only to 13 ½ per cent of its highest quotation. Take another: The stock of what has long been one of the premier banks of the country declined from 585 to 23 ½. That is to say, it fell to 4 percent of its highest quotation. The decline in the market price of this great American banking institution was therefore more than three times as severe as was the fall in the stock of the South Sea Company.

That illustration is by no means a unique one. There were innumerable American bank stocks which made a more distressing record. Between October 1, 1929, and August 31 1932, 4,835 American banks failed. They had deposits aggregating $3,263,049,000. . . . .

The decline in the price of bank stocks was only a minor phase of our debacle. The quoted value of all stocks listed on the New York Stock Exchange was, on September 1, 1929 $89,668,276,854. By July 1, 1932, the quoted value of all stocks had fallen to $15,633,479,577.

Stockholders had lost $74,000,000,000. This figure is so large, that not many minds can grasp it. It is $616 for every one of us in America. It is, roughly, three times what we spent in fighting the World War (WWI). . . . . . .

Not only did our investments shrivel in the last three years but we even frequently lost our pocketbooks. Cash in hand, left for safekeeping in a bank, often went the way of our investments, and worse. Almost $3,000,000,000 of our daily-used cash funds were sequestered in the doubtful assets of the 4,835 insolvent banks. Widespread communities were left with only the mattress as a safe depository, and with little to put into it. People became so frightened in regard to the safety of the banks that they locked up in safe-deposit vaults, or secreted elsewhere, more than $1,500,000,000.

--------------------End of Quoted Article-------------------------------

In the Great Depression there was a very good reason for being negative in 1932 and 1933. The interest only mortgage loan had ruined many banks. If you had any money invested, it was probably gone by then. Age 65 ready to retire, it must have been depressing to some.

It’s kind of unsettling to be negative so early into the downturn this time around.

On the positive side, I recommend buying Google at $8.00 per share, it shows promise!