Sunday, August 20, 2006

Reckless Real Estate Loans

This note is about the wacky loans being made in the real estate market. But first, we wish to emphasize that the ultimate cause of the real estate slowdown is not wacky loans, but the micro-managing of the economy by Federal Reserve money manipulations. First they pump huge amounts of money into the economy, then they raise rates and cut the money flow. The loans are a byproduct of the Federal Reserve money pumping activity.

But, the types of loans being created for the housing market will result in the real estate crash coming sooner than would otherwise be the case, and also deeper. WaPo reports that loans that are being made "include interest-only mortgages and 'option' mortgages, in which borrowers decide each month how much to repay."

WaPo goes on to state:

Many borrowers are paying as little as possible. About 70 percent of the people who take out an option adjustable-rate mortgage, which lets the buyer avoid paying even the full interest on the loan, end up paying the lowest permissible amount each month, according to the Federal Deposit Insurance Corp... The amount unpaid is added to the mortgage balance, so borrowers end up owing more than when they started. Having no equity in a home increases the risk of foreclosure, especially when housing values fall and houses are hard to sell...

In 2000, just 1 percent of American homeowners who got new loans had these types of loans, but by May 2005, about a third of all borrowers did -- about the same percentage as in May 2006, according to new data from First American LoanPerformance, which tracks the statistics.

It's an open secret these loans are a problem. WaPo again:

"We are deeply concerned about the potential contagion effect from poorly underwritten or unsuitable mortgages and home equity loans," Suzanne C. Hutchinson, executive vice president of the Mortgage Insurance Companies of America, wrote in a recent letter to regulators. ". . . The most recent market trends show alarming signs of undue risk-taking that puts both lenders and consumers at risk."

We have speculated on these pages that the Federal Reserve will at some point open the floodgates and pour enormous amounts of money into the system, when some type of financial or economic panic occurs. We have not speculated as to where in the financial system or the economy such a panic will occur. There are many, many possibilities. But looking at the current structure of the real estate market, one can not rule out a major panic or problem by those holding all these mortgages where foreclosures are almost a foregone conclusion.

One question that remains is who is holding this high-risk mortgage paper. Banks are to a large degree making these loans, but they are then securitizing the mortgages and selling them off. But someone is ultimately holding this wacky paper. Is it pension funds? Hedge funds? Unfortunately, in time, it is likely we will learn when the entire structure collapses.

1 comment:

  1. Although unfortunate in some locations some real estate players are being smart about their investments and adding some value to their property by installing decking in Perth, and having everything looking ready for a grand open house.