Housing Cross Contamination: Subprime Infecting Prime Lenders.

Bear Sterns seems to be having some problems with their subprime portfolio fund. Since the March subprime firework show, we had many Wall Street pundits telling us that subprime was contained in a silo and would not impact other lenders who managed funds prudently and hedged for risk. Well guess what? They didn’t. The news coming out this week is that two Bear Sterns funds are close to being shut down after Merrill Lynch decided to seize about $850 million in assets and began selling assets off almost immediately (aka highly motivated seller). Merrill is smart in trying to liquidate whatever it can before the market hits full speed implosion. The major signal here and what sent Wall Street tumbling is that solid funds are not immune to the risky loan implosion, a chant many in the industry were preaching after notables such as New Century Financial bit the dust. Refinancing and mortgage equity withdrawals are dropping at high rates. These mortgage goliaths claimed that they had systematically filtered out risk from their portfolios and all would be well since housing, rent, and credit never went away. But when you have $1 trillion in loans resetting and a housing market in the shamble, there is no way you can engineer your way out of this one. Thank Alan Greenspan for recommending adjustable rate mortgages to the American public.

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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Real Homes of Genius: Today we Salute you Monterey Park. 800 Square Feet for $479,000.

You would expect in a declining housing market sellers would have the wherewithal to adjust prices to meet market expectations. You would also expect sellers to put some effort in marketing their home by sprucing it up with new paint or staged photos to entice prospective clients. Well you are wrong! Welcome to Southern California, home of overpriced Wonderland housing followed by the stubborn seller mantra of “you can take it or leave it.” Today we salute Monterey Park with our Real Homes of Genius Award.

This marvelous 800 square foot villa is a looker. Enjoy 2 bedrooms and 1 large bathroom as you entertain your finicky friends. Make sure you tell your pals to watch out for the cracked driveway. Let them know that the cracks represent every major river in the world from the Nile to the Mississippi. Aside from impressing peers with geography, what home wouldn’t be complete without a custom installation of a modern television antenna?




Professionally installed, you’ll create healthy sibling rivalry as mom and dad race over to your place for some UHF/VHF channel surfing. No need for American Express payments to DirectTV when you can surf the free airwaves. If you stare at the home picture long enough, it starts bending in the middle as if partaking in a Matrix simulator. Alan Greenspan had it right when he stated that adjustable rate antennas where the wave of the future (or was it adjustable mortgages?). Either way, you’ll be making so much appreciation that in a few years, you can refinance and add a fresh coat of paint. But why ruin a good thing right? So let us take a look at sales history for this breathtaking place:

Sale History
06/01/1978: $52,000

Now we’re talking. A healthy 8% annual growth rate for 29 years! Since typical housing growth is at the rate of inflation, we are nearly twice that. After running a few numbers, the median rent in the area is $1,200. Keep in mind that this home is selling for half a million dollars and you can rent it for $1,200. Do we really need to run the numbers to find out what the prudent thing is? I know you're itching to catch this falling knife so go ahead and give your broker a call.

Today we Salute you Monterey Park with our Real Homes of Genius Award.

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Living Under the Shady Tree of Mortgage Advertising: 6 Advertisements That’ll Convert you to the Housing Bubble Camp.

I’ve been getting a lot of solicitations in the mail from mortgage companies. And apparently desperate times call for desperate measures. Some of the ads are good. And some are downright misleading, like a tobacco company telling you nicotine isn’t addictive and you are more likely to get hooked on drinking tap water. I wanted to show 6 advertisements all from mortgage companies or brokers that not only show the extent of the credit bubble we are living in, but the subtle implications each ad conveys of the American psyche. We will analyze each ad. So let us get to it.

Ad #1 – You Got a Pulse, we Got a Mortgage Ad



Where to begin with this ad. Well first, you don’t need to verify your income. Second, who cares if you have every infraction on your credit record. Foreclosure(s)? Who cares. Bankruptcies? No problem. Mortgage lates? Call now! This last one really makes me laugh. So you are willing to give a mortgage to someone that already is chronically not going to pay a mortgage? One would think this ad is the pinnacle of common financial sense. Do you have an educated guess as to why we are in this mortgage mess? After reading this ad, I sure as hell don’t. Another thing you’ll notice is the “ask about our liar loan and referral paid program” in case the subtleties eluded you up until that point. And I love the sentence structure at the top of “mortgage payments around as low as 1%.” Brilliant.

Ad #2 – You’ll Never Own Your Home




This ad strikes at an underlying message of American homeownership that is rather new. You will never own one property for a long period of time. You will carpetbag your way to the top. Each property is a subsequent step for your next and larger McMansion. Why not keep your previous home and rent it out? Why not stay in one place and invest in other areas? Of course anyone can do whatever they want but this ad speaks to the public’s desire for bigger and more expensive places at the behest of bigger mortgages. “Chances are, you’ll sell your home before we sell your mortgage.” They may be right since Wall Street’s appetite for mortgages is drastically declining.


Ad #3 – Why Read Your Mortgage Plan? Its Only Your Largest Purchase Ever!



I love the implication of this ad. You’re too busy to care about your largest financial obligation, so we’ll handle it for you. Let us worry about it and milk you to death with fees and coax you to refinance so we can get continuous payments. You’ll have time to worry about other things, like getting a second job because you were too lazy to read the fine print and didn’t realize the teaser rate was only good for 2 years. Don’t worry, you can trust us.

Ad #4 – I Can Finance while Driving!



Not only can we finance you for 125% of the value of your home, we’ll also drive you to get your dry cleaning. I’m not sure about you, but I get a better sense of security getting a $400,000 mortgage through a traditional brick and mortar operation. Mobile operations always scream transient to me but I may be old fashioned. Car ads are a mixed blessing. You increase your visibility but at what cost? Maybe we should have bumper stickers that say, “I financed my home through a mobile operation and all I got was this lousy license plate frame.”

Ad #5 – Time to Bolt to the Caribbean with $5,000,000



I love this ad. First we have the comfort of getting remarkable service. And then in the next line we have loans up to $20,000,000. But the amazing part is the next line, “no income or asset verification.” Okay, $20,000,000 and no income verification shouldn’t appear on the same document ever but here we have them appear in the next sentence. This is a perfect example for breeding fraud. Why don’t we find a $20,000,000 home and do a 125% cash-out refinance? Since that’ll give us $5,000,000 in the pocket, we can fly off to the beautiful blue beaches of the Caribbean or South America and never be heard from again. The dollar goes far in many places and this money will keep us going for a very long time. You can write that novel kicking up in your head. Maybe explore ancient ruins and take up your love of archeology. This sounds great! Am I forgetting something? Oh yeah, the $20,000,000 home and mortgage note accompanying it. So much for unrestricted dreams. And we wonder why we have so many first payment defaults.

Ad #6 – Try and not Get this Loan! We Dare you!



And finally we have the try and fail to get this loan. I totally dig the line of “it’s almost impossible not to qualify!” They are dropping the gauntlet and challenging you to fail to get this loan. No income, job, money, life, food, or heart but we will find a way to get you into a loan. If we were to take score of restrictions for getting this loan like a baseball game, this would be a shut out. 125% loan to value? Yes! $400,000 for $1,280 a month? You got it boss! The public should be furious at the contempt these people have for your financial intelligence. They treat your home like an American Express card. Refinance to prosperity! Why rent when you can own…and rent from us with your home equity line of credit. These ads are so dysfunctional you’d think we were living in Bobby and Whitney’s relationship. I’m not sure what kind of finance calculator these people are using because 5.44% at 100% financing is $2,256 simply for P and I. But who cares! It’ll only take 5 minutes and then we can buy a Real Home of Genius.

There you have it folks. A sample of 6 ads from the mortgage industry demonstrating a disdain for financial prudence. I am amazed at the lack of risk management in the industry. Many companies have sealed their fate for instant gratification. The companies that are staying afloat kept more conservative mortgage portfolios in lieu of high rates on subprime or Alt-A risky loans. As you sift through your mail, don’t fall for the irrational exuberance of refinancing into risky teaser loans. I know we are all tempted to buy those bouncing-bobble-head-colorful-animal mortgage ads that sell us crazy mortgages because the animal is so freaking funny! Who can resist a talking cat trying to sell you a mortgage? Or the countless spam you get telling you about a $400,000 mortgage for $800 a month. Housing has tipped into a different dimension. I would show you more ads but I’m going to refinance my house at .0125% for 200 years.

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Putting Home Sellers on the Couch: The Psychology of why Sellers Refuse to Lower Prices.

Driving to a meeting today, I tuned into a show called House Calls on a local FM talk radio station. The show centers on real estate investing and taking calls (massively prescreened) from the public. Whenever I’m in the car on a Saturday morning driving with the gorgeous California sun, I usually tune into this station to see what the media and the public are saying about the housing market. I’ve listened to this show for a very long time. And I can tell you that last year they were cheerleading Southern California housing like you wouldn’t believe. Any caller mentioning the word “bubble” was painted as a tinfoil hat wearing bubblelista. Fast forward one year to summer 2007 and they are giving the advice of investing out of state for cash flow properties. Sounds like the strategy I’ve been purporting since the beginning but why mince words, these are the experts.

One call however summed up the psychology of current sellers. A woman called up and the conversation went as follows:

“We purchased a wonderful condo in Orange County in 2001. Last year, homes in the same area were selling for $749,000 and quickly. These were horrible condos in bad condition. We have our place on the market for $779,000 since November and we’ve had no visitors. What gives? We have granite countertops and removed the popcorn on the ceiling. We were wondering what we could do. It seems the days on market (DOM) is hurting our negotiations and giving buyers the upper-hand. We were thinking of taking the home off the market for a few months and relisting it. What do you suggest?”

I’ll get to the advice offered to this women later but let us analyze what is going on here. First, we have the belief that peak prices will come back. Her belief that somehow her home is worth what a buyer was willing to pay last year is massively incorrect. The actual value of the home is whatever a buyer is willing to pay, today. And buyers aren’t willing to pay Pollyanna prices simply because she removed remnant 70s popcorn from her ceiling. You would think that this Trump wannabe would quickly take a survey of the market and ask herself the following questions:

1. Am I not marketing the property correctly?
2. Could it be that the price is too high for the current market?
3. What can I do to make it sell given the current market sentiment?

These questions don’t matter because the ultimate answer is something she does not want to hear. Lower the damn price! It isn’t the granite tops or the green Behr paint you added, it is the fact that the market has drastically changed. Sellers are no longer in the bargaining chair. In addition, many sellers last year were able to squeeze into the party by buying with risky subprime loans. The subprime market is now toast. Banks are becoming stricter on their lending standards. Need we point out that inventory is growing therefore giving buyers more choice?

The second point of contention is overvaluing basic remodeling jobs. It is the case in other states that sellers actually need to replace a roof/carpet, install ceramic tiling, and work on the garden simply to move the home. Not only that, the seller usually under prices these updates so the house can sell. In California, as demonstrated by this seller, they believe that adding granite countertops and doing a basic cosmetic update has made their home worth hundreds of thousand more. Can we say delusional? The great thing about the market once fraudulent credit is removed, no one will buy this place and that will be her outcome. The home will not sell until she reconciles her cognitive dissonance regarding missing the bus in selling the home. Sorry, the lights are out on this party.

Then we get shady tactics that once worked before. She is obviously on the up about relisting her home. Somehow, these yesteryear tactics are pointless in a market brimming with REOs and soon to be added foreclosures. The bank won’t hesitate to cut prices. To them the home is a liability on their accounting books. They will drop prices until market interest is stirred up. This seller? Well they are pining for the days of 2006 as if it were a lost high school love interest. Keep in mind for the last 7 years, sellers only competed with themselves. They had a monopoly on the market. Now REOs and foreclosures are rapidly growing and their market share is increasing. Result? A competitive market driving prices down.

Equity Out of Your Bubble Home to Other States

So what was the advice given to this aspiring seller? Get this. Tap out your equity and invest elsewhere! So let me get this straight, we are in a national housing bubble and you want this person to lock in her overpriced asset and invest elsewhere? In effect, this will make her the buyer of her own home. Say she taps out $100,000 in equity from her house, she has essentially created a pseudo American Express agreement with her home for 10 years. And get this, she will need to pay that $100,000 completely back. It amazes me how so many people in the mainstream media see HELOC or home loans as your money. All you are doing is creating a relatively affordable loan against your biggest asset. Financially retarded in a declining real estate market.

I’m all for investing in real estate. But not at the cost of locking you into an overpriced asset and pulling a 2nd for leverage. Doesn’t make sense. Equity is only yours when escrow closes and you have a cashier’s check in your hand. Maybe they should wait for a year and save up to see how things are in 2008 and try to sell their home again. At that point, they’ll realize that they should have cut and sold in 2007 because some greater fool is still out there. I’m not sure about next year.

The advice is typical for those in the real estate industry. Keep doing things that churn commission cuts. You refinance, the broker gets a cut. You sell, an agent makes money. You buy out of state, you make a loan executive and an agent money. But wait out the market. Ahhh, the silver lining. If you wait, which in investing is prudent at times, you will make yourself money but others may suffer. If you want to buy, go ahead. No one is stopping you. Heck we have enablers everywhere. Give this seller a call for her $779,000 condo. You might be able to get her to chip in a few bucks for closing cost.

Horrible financial advice under the guise of investing. Sorry folks, if you want true investing knowledge purchase a few books and educate yourself. It’ll cost you $30 bucks on Amazon or even free at your local library but you’ll save tens of thousands in the long run. Don’t fall for the mainstream debt trap. Debt is not wealth. Slavery is not freedom. And removing popcorn does not cost $779,000.

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