Tuesday, April 20, 2010

Mortgage Market Meltdown (reprinted)

This piece was written August 4, 2006. I thought it might bear a review.I get irritated when I watch the PBS feeds of the Congressional committees, who ask why no one saw this real estate mess coming? Congress has to assume the biggest share of the blame. If I could see it, they could too. Of course this was bringing in a lot of tax dollars, which they could spend on new toys; Spend-------ad infinitium.

Lets look at an organization named Fannie Mae. Picture it as a 4 x 4 x 4 foot black box with the words Fanny Mae printed in white on it. Envision Mr. or Ms. "Mortgage Market" dropping into the box all of their 80% finance loans and when the box gets to $1 million it spits out an investment certificate for 1 million paying 5%, face amount guaranteed, which is purchased by Mr. or Ms. "Unknown Entity," AKA "mark" or "sucker."

The little black box is a great transformer and redistributer of debt. Nobody wanted to touch that crap until they built the little black box. By God everyone is entitled to the American dream of home ownership rah! rah! rah!

So we have this box and the question arises, "What the hell do they do inside that box?" My guess--absolutely nothing.

There is really no problem with the design model aspect of the black box. It will perform within its parameters. After all, its rather absurd to have a real estate market drop 20% isn't it? (Believe that, and I have a bridge to sell you). What is not realized is that the market can drop 50 to 70 percent. In this scenario, the little black box fails to function as expected. It doesn't have the funds necessary to back the claims it made in the past. What funds does it have for back up of bad loans? My guess, is none. Say you need one or two trillion dollars to back up the investors who bought these certificates---total tax collections for the US of A is about 1 trillion a year. Sounds like someone is going to get short sheeted!

The question arises who's holding all of the crap and who is going to get burned?

My guess is mutual funds and IRA's and I could be wrong.


Meena said...

Good article..

rob in ns said...


Man you called this in 06. Maybe with the SEC charging Goldman and Bill Black appearing before Senate finance committee the fraud will now be exposed for all to see.

Anonymous said...

Goldman makes several billion dollars a year in profit.They will settle with the SEC for maybe $250 million , with NO admission of liability.
Chump change to Goldman- just the cost of doing business.

Jim in San Marcos said...

Hi Rob

I'd be surprised to see any real fraud issues. They didn't have to do anything illegal to rake in all that cash. I think if the Senate decides to go for the jugular, its going to be Bernanke, Paulson and Geithner that get hung out to dry.

Plus Goldman has their notes from the Great Depression. Their investment trusts; Shenandoah Corporation and Blue Ridge Corporation ruined millions of people during the big one.

I don't think they got their just rewards from the 1930's disaster, maybe they will this time around.

Tyrone said...

Who knows?

Havenstein Moment
As the Globe & Mail observes, these circumstances prevail today. Prices of goods and services are rising, but as it warns, the quantity of dollars in circulation is “shrinking, after taking into account inflation.” This “shortage of money” is being widely misinterpreted as deflation, which is exactly what happened in Weimar Germany shortly before the Reichsmark was swooped up in its hyperinflationary whirlwind.

Rothbard provides his usual brilliant insight to explain what happens once the “Havenstein moment’ is reached. There are two alternatives.

“If the government tightens its own belt and stops printing (or otherwise creating) new money, then inflationary expectations will eventually be reversed, and prices will fall once more – thus relieving the money shortage by lowering prices. But if government follows its own inherent inclination to counterfeit and appeases the clamor by printing more money so as to allow the public’s cash balances to ‘catch up’ to prices, then the country is off to the races. Money and prices will follow each other upward in an ever-accelerating spiral, until finally prices ‘run away’…[i.e., hyperinflate]”

Weimar Germany took the second alternative.

The dollar has now reached its ‘Havenstein moment’. Will policymakers follow the prudent advice of Murray Rothbard and ‘tighten its belt’? Or like Herr Havenstein, will Mr. Bernanke continue to ‘print’?

Jim in San Marcos said...

Hi Tyrone

Thank you for the link.

I think we have one thing that is different today that may temporally save us. People are pouring money into 401K's to avoid taxes and the government is spending it like a drunken Senator.

What you suggest is probably going to happen, but only after the baby boomers retire and start to consume.

As a side note, I notice your last post on your blog is Jan 31--you getting writers cramps?

frakrak said...

Being an average Joe (now without the six pack!) my take would be:

The four decades past in your country, has seen quite a bit of short sighted de-regulation of your countries financial markets. Any big player would have to be driving a jack-knifing Mac truck, and even then would be unlucky to “take out” one of the regulatory guide posts, so I wouldn’t hold your breath regarding GS!

My question with regard to this Jim:

Would you trust another government to re-regulate your markets now? Or would you stop all the c@#p on Capitol Hill first? Regarding lobbyists, and some pretty poor governance!! A third political party may be a great idea for a while?


Anonymous said...

Why focus only on the GSEs when secondary market originators like CountryWide wrote the bulk of the bogus paper?

You think only Fannie and Freddie securitized MBS?

HotIrr said...

I started calling it in 2001 to 2007 when I was selling my 198 properties like a CRAZY MAN. SELL SELL SELL! I Sold as much property from my own portfolio as I could. Man, what a WILD FUN RIDE! MILLIONS IN CASH FOR THE NEXT FORECLOSURE CRASH! 2010 TO 2014 WILL BE "blood sucking" investment time! My car License plates say: BIG-IRR AND HOT-IRR, I can brag that I have the HIGHEST IRRs in the World when it comes to REAL ESTATE! 198 sales in the 2000-2009 decade, 1167% avg gross profit, 23.65 months average hold, avg. 49.22% gross monthly profit, and estimated IRR of 29% a month, or about 360% a year for the time period from 2000 to 2008. Yeeee HAAA!!!

JMS said...

Well... At first I was going to write some sort of smart response to you Hotlrr. To me you are part of the problem. Part of the reason we are here today. But I have to be honest with myself. If I were placed in your situation I would have done the same thing. So I can't fault you.

Anonymous said...


Did you have to pay take on all that capital gain? Or did you 1031trade into more real estate?

Just curious

HotIrr said...

JMS, thanks! I did not borrow 1 dime since 1992. So I am part of the solution, not the problem! Good luck!

HotIrr said...

Paid LT capital gains taxes. 1031 only moves your profit to another over priced property! That's the worst "benefit" of 1031.

Jim in San Marcos said...

Hi Frakrak

I think that a lot of the damage has already been done. The effects of it are just becoming obvious.

Fannie Mae, Freddie Mac and FDIC insurance were government programs that got us out of the last depression. Our present mess revolves around the ability of people to abuse those systems for personal profit.

I look for the government to change the rules, but the damage is not going to go away.

As for a third party, Great Britain is about to hold elections in May and there is a third party in contention. Will it steal votes from the other two parties and allow the incumbent to win re-election? We keep on hearing, "it could be different this time." I guess we will have to wait and see.

Jim in San Marcos said...

Hi Anon 6:26

I think you're mixing things up a bit.

Assume that Country Wide only had one Billion in capital to loan. Once it is loaned, they are out of the real estate loan business. They manage the portfolio and collect the interest on the loans for 30 years.

Or they sell the billion dollars worth of loans to Fannie Mae. They get a billion dollars for new home loans and get a 1/2 percent management fee from Fannie Mae for managing the loans. If Country Wide could flip their billion in loans every week to Freddie, that 1/2 percent would be a return of 26% (52x 0.5) on the original billion for management fees.

Once these loans got packaged by Fannie and Freddie, investors came in and tranched them off to private parties. At that point is is hard to figure who bought what and how to figure out what it is worth.

The banks were managing the long term housing paper for investors. Of course if some real good paper came down the pike, they had the option to keep it on the books Second trust deed look like real good paper in a bull market and that can change quickly. The banks probably got caught flat footed in this area.

The commercial real estate construction loans that the banks hold, are now coming on line for maintenance and contractors are going bankrupt. This could be the big wave that cripples the banks.

I look for things to get worse.

HotIrr said...

If you all want 100% of the west coast USA real estate info fed to your email in box for free, log into www.patrick.net and enter your email for a daily "email" of links. My goal is to get on the Forbes 1000 list for USA so you at least know I'm not a flake pushing this good info that's free!

Jim in San Marcos said...


I like to point out to people, it is not about how much you can make, it is how much you can keep once you earn it. William Crapo "Billy" Durant the founder of General Motors died almost penniless. It is a pretty common story for the well-to-do of the 1930's and the 1987 crash. Watch you step.

Thank you for your comments

frakrak said...

Sort of agree Jim, one line ideas really just amount to that, with regard to a 3rd political party! So where do you go as a nation from here? Do any trust government, regulatory bodies, political parties to really clear out the swill, so a “freer market” exists? I read last night that if you earn $50 K or below and have dependants, you probably will not get a tax bill, and American corporations, contributed to 7% of your nations tax revenue last year? So who pays the bills? You must have a very complacent and exceedingly large middle class!

I agree to, that the damage has been done. My point is that bloodlust for the “scape goat” may be a little premature. With all things being equal a little wrist slapping will be the outcome! I have read the SEC is understaffed, outgunned legally, and poorly resourced, and prosecutes in accordance with some very fuzzy legislation? Wouldn’t it be more prudent to empower the wrist slapper with a “bigger stick” first?

Obama is giving the line about reform being needed now so it will never happen again, well it will happen again he aint gonna stop that one! But I am suspicious that the cobberling together of the world economy has a used by date, and it may be more politically expedient to have these investigations now instead of when things really get bad!!

Last point, imagine if you were Greek and you were forced into austerity measures, your economy was relatively in no worse shape than the ones enforcing these measures, who would you blame for this? The majority of the population are saying “let the banks take the bath, they caused it!”

Jim in San Marcos said...

Hi Frakrak

As to who pays the tax with everyone who earn 50k or less paying no taxes, is a little misleading.

Corporations pay no tax, the people who buy the product pay the tax. The rich pay no tax, once you earn your money and pay taxes on it they can't tax you again. The people who pay taxes are the high wage earners.

Also the poor who smoke and drink and play the lotto pay a lot in taxes. The kids get to eat milk toast and candy while mom and dad are at the race track/bar.

Everybody under the age of 62 that contributes to Social Security is paying taxes. They think it is for retirement, but it isn't.

Then you have sales tax (10% here)--god help you if you buy a car, 10% add on is a choker on a 30k car.

We have the taxes, they are just invisible to the average Joe.

As for the SEC, they do a very good job of keeping the stock market honest. That could be debatable, but if we measure our markets to the rest of the world, you want to play here.

Obama isn't really part of the solution. He can't stop this from happening again anymore that FDR did in the 1930's. They fixed it and we undid it at a later date. It will happen again, but not in our life time.

I do think that the Greeks have had it with their government. They are not going to blame the banks, there is going to be an overthrow of the government. The only way to get rid of the bribes and corruption is a clean slate. I look for a military takeover, and if done right will be welcomed by the populace.

I kind of hope I am wrong on Greece, but it almost seems certain to happen.

Take care.