Dumb, Dumber, and Hedge Funds
There was a study conducted showing that those with high IQs usually made the dumbest mistakes in finance. They usually had high incomes due to their educational background, but somehow made idiotic moves in financial markets. Why? Sometimes they mistakenly believe they are immune to economic cycles or the risk of chance. Think Long Term Capital Management (LTCM) and Amaranth. Both highly managed funds with unbelievably intelligent financial engineers running the show. Where are they now? It reminds me of the story of the would be mail bomber who sent out a package with not enough postage; as the package was returned to sender he decided to open it up. Hilarity ensued. These mortgage backed securities funds have been holding up rather strong up until this point. We’ve been seeing boiler room mortgage fund operations running with a bunch of frat guys dropping like flies which is expected. But seeing a major player such as Bear Sterns draws the ire of Wall Street raises some eyebrows and makes us think twice about pulling out that American Express card for vacations. This implosion will impact everyone.
Private Mortgage Insurance
Private Mortgage Insurance (PMI) is insurance paid by the buyer to protect the mortgage holder on loans over 80% loan-to-value. As a buyer this is ridiculous since you can careless if a mortgage company goes down in flames. They should manage their risk accordingly and not push this charge onto the consumer. PMI issues a yearly risk assessment of the market based on a 50 to 1000 point scale. The higher the score, the more likely said market is to fall. Let us take a look at numbers for last year:
San Diego-Carlsbad-San Marcos, Calif., 599
Nassau-Suffolk, N.Y., 589
Boston-Quincy, Mass., 588
Santa Ana-Anaheim-Irvine, Calif., 588
Sacramento-Arden-Arcade-Roseville, Calif., 585
Riverside-San Bernardino-Ontario, Calif., 583
Oakland-Fremont-Hayward, Calif., 582
Los Angeles-Long Beach-Glendale, Calif., 575
Providence-New Bedford-Fall River, RI-Mass., 568
San Francisco-San Mateo-Redwood City, Calif., 560
San Jose-Sunnyvale-Santa Clara, Calif., 559
Cambridge-Newton-Framingham, Mass., 537
Edison, N.J., 536
New York-White Plains-Wayne, N.Y.-N.J., 498
Las Vegas-Paradise, Nev., 481
Newark-Union, N.J.-Penn., 459
Fort Lauderdale-Pompano Beach-Deerfield Beach, Fla., 441
Washington-Arlington-Alexandria, D.C.-Va.-Md.-W.Va., 431
Miami-Miami Beach-Kendall, Fla., 359
To simplify the data, according to the above data San Diego has a 59.9% chance of falling in 2007. The data has been out since early 2006. My question to these financial juggernauts at Wall Street is, if you have multiple metro areas in California blinking red with 50% or higher risk assessments, why in the world did they continue to fund risky mortgages? Doesn’t matter at this point. We are seeing what is happening. Fund holders are getting smoked while assets are being distributed out. Guess what this will do to the overall market? More inventory and more motivated sellers. What does this do to prices? Knocks them down. No financial engineering degree needed to see this stupidity unfold.
Peak-a-Boo I See you Hedge Funds
The problem in this industry is transparency and public apathy. Everyone does whatever they want. Government oversight is a joke. The major political action committees get cash from the National Association of Realtors. So where is their allegiance? But many people were screaming a siren call long ago. Folks like Bill Gross and Robert Shiller. Yet the pundits used their media outlets to marginalize these folks as tinfoil hat wearing bubblelistas. Why ruin the party with these neg-heads? Well now everyone is waking up with a major hangover wondering what happened. When you drive on the freeway, do you ever see those folks that pick their nose behind tinted windows? For some reason, they think the tint is strong enough to hide their facial nugget digging so they go at it with a vengeance. But guess what? The sun shines and illuminates your shadow idiot! We can see your entire exercise in one finger gymnastics.
Think this mortgage mess isn’t prevalent? “A recent sample of 100 stated income loans which were compared to IRS records (which is allowed through IRS forms 4506, but hardly done) found that 90% of the income was exaggerated by 5% or more. MORE DISTURBINGLY, ALMOST 60% OF THE STATED AMOUNTS WERE EXAGGERATED BY MORE THAN 50%." These results suggest that the stated income loans deserves the nickname used by many in the industry, the “liar’s loan.” Good times. Think housing isn’t a big deal? As of 2006, residential housing now makes up 16 percent, or $1.9 trillion, of the gross domestic product and is the economy's largest single sector, slightly bigger than the industries and services that supply health care. Housing is the economy.
So is the case with the mortgage backed securities market and collateralized debt obligations (CDOs). They figure the public is too busy and dumb picking their nose to understand what is going on in Wall Street. What they did is repackage financially irresponsible loans with prime loans and sold them off on the securities market. Like taking a whiz in the sea; no one will notice right? Well what if it wasn’t the sea and your county pool? And everyone simultaneously decided to let go of their liquid wealth? Would you want to swim in that pool? Well we have a dirty mortgage market with horrible debt floating all over the place. Care to take a dive into the housing industry?
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