The Crisis of Credit Visualized continued.....

Video - Courtesy crisisofcredit.com

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I came across this video which illustrates the cause of the banking crisis and stock market collapse. I found it very informative and easy to understand with excellent graphics and commentary. Video - Courtesy crisisofcredit.com

As an investor I hope I can always learn from my mistakes and help others. I hope together we can all grow stronger moving forward.

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 For a while now, many can spectulate the trouble started at the tail end of 2006 with the mortgage industry busy, the American economy has been struggling, facing uncertain times.  Many understand the historic significance of last week but the implications of a federal bailout has yet to hit home.  With the annoucement that the Federal Reserve will aid the ailing AIG with an $85 billion rescue package, the details seem murkey as more politicians throw in his or her two cents of how this bailout will work and impact the economy.  While the bailout does not favor AIG, the company must hand over 80 percent control of the organization's future business dealings, this new bailout and the status of future bailouts remains in the balance and hands of the federal government who stepped into save the mortgage giants Fannie Mae and Freddie Mac not too long ago with a $100 billion package.  Where this differs and many fail to see a need to save AIG is that Fannie and Freddie were already government controlled and sponsored by federal dollars.  Why should the federal government step in and save a stockholder owned company?  What I am trying to say is that this bailout of finance giants has been a popular trend, starting with a $30 billion loan to Bear Stearns in February.  It is a trend we will see more of and possibly a part of the Federal Reserve's strategy to save the American economy.  I believe many who are struggling to make ends meet, living pay check to pay check, the working class and even the upper class, when push comes to shove and with a cold winter on the way, wish that the Federal Reserve would give the American people a loan.  That $300 incentive check just did not cut it.

While AIG must pay the Federal government back or risk losing control of its interests, many are concerned with the level of government involvement and bascially, the bottom line, who really will be paying for the bailouts?  Is Washington really to blame for this mess?  What about corporate accountability and the management of these organizations?  Something is rotten in Denmark as Shakespeare wrote in Hamlet.  Really it does not add up.  It is cause to worry of how this can be avoided in the future but also how this will impact the American people over the years to come. Many will argue that this has been a long time coming that part of the issue has been a faillure to tighten lending practices and that the subprime market has lead to the downfall of the whole market.  Truly companies like Countrywide should have known better instead of living high on the hog.  We could have avoided a lot of trouble today with bad loans.

So should the federal government step in and save companies riddled by bad behavior in the market place?  This whole crisis begins and ends with the practice of predatory lending and we've known it since before the mortgage buble burst.  As said above, not only Countrywide but other banks allowed their lending practices to be too flexible allowing many under qualified borrowers to purchase items like homes and cars.  Many brokers pushed such products on people who otherwise should not have been buying in the first place.  Many did not look at the full picture and mainly the issue of repayment.  Now the market is suffering due to underperforming loans or bad loans.  Still the bank is at fault, they should have never allowed such practices to continue but they were leveraging on the risk involved as long as the portfolio was performing well, the bank was making money on subprime products.  Now the current situation prevents this demographic of people with blemished credit from establishing any credit and only the prime customers (A & B paper) will prevail.  Many will have to learn to live without or forget about keeping up with the Jones because there will just not be any loans out there for these customers.  It is unfortnate because this takes aways from sales people's commission salaries and many people of these professional will be out of work.  Truly this is why so many people have never believed in the concept of credit in the first place.  It creates a vicious cycle. 

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The so-called days of the mortgage boom are over causing a certain amount if disbelief among industry professionals.  Like a bad hangover from Saturday night wild party, those who gained from historic low interest rates and flexible lending products that spawned the real estate boom at the turn of the millennium, are now slowly waking to reality.  The once profitable sub-prime market is now close to extinction as many institutions known as great powerhouses are no longer in the business to originate loans.  While Wall Street may have had a say in rating these companies poorly, the ones who catered to a specific clientele should have seen a shift coming especially when the funding is no longer available.

So what is the big deal anyway?  All this hoopla has many asking, what is a subprime loan anyway?  How does this influence the mortgage industry? So okay, a subprime mortgage is a real estate loan given to a consumer with less than perfect credit and little or no down payment available.  One must keep in mind the majority of loans in a financial institution's portfolio does not consist of these types of loans but during the mortgage boom, many consumers took out these types of loans as a means of affording the American Dream of homeownership.  These loans broke down the barriers to home ownership because of their flexible lending parameters.  What this has now lead to be a marketplace upside down in loans not considered "A" paper but B, C, D and F translating into a high-risk venture?  As home values have risen so has the risky nature of these loans still being unpaid or falling behind.

So how did the bubble burst so badly, one is also wondering?  As subprime became a more popular loan product, so did the practice of selling it to the consumer become more flexible.  More and more lenders approved borrowers with not only less than perfect credit (small blemishes) but also those with poor track records including larger debit issues like previous foreclosure and automobile repossessions.  What further compounded the issue is the lenders sales device of enticing the poor credit customer by offering homeownership programs with minimum documentation needed known as "stated-income" or "no doc" loans.

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A new study says a tidal wave of foreclosures-about 1.1 million- will soon flood the nation.

Christopher Cagan, director of research and analytics for First American CoreLogic, explains that the study focused on 8.4 million adjustable-rate mortgages (ARMs) that were obtained in the period of 2004 to 2006. More than a million of those borrowers will lose their homes to foreclosure in less than a decade.

There are ways to tell if you're the type of borrower who is likely to lose your home. For instance, ARMs are a losing bet right now. Homeowners who got one of these mortgages in 2004, 2005 or 2006 have a one-in-three risk of foreclosure. Those who got a subprime ARM during those years have a lower risk, with only one in eight of those homeowners projected to lose their homes.

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The real estate market and the mortgage industry has turned upside down as our economy is spiraling downward which we haven't seen seen in decades.  In this depressed economy, some of our loans on our homes exceed the actual value on the market.  The prices of residential real estate are so depressed, hitting an all time low since 1980 that some experts are forecasting that we are headed into a recession.

 Just this last February, it was noted that the prices were dropping at such an alarming rate that the slump did not look as if it was easing up but instead gaining speed. The Standard & Poors/Case-Shiller housing index for prices using over 20 large cities in the U.S. dropped almost 13% in one month in comparison to last years figures.  A good number of these 20 cities are stating that it is a decline they have not seen in over 30 years.

Developers are filing bankruptcy and homes have been left uncompleted and unoccupied and even those companies that were looked upon as the more established builders have stopped building or slowed down to a survival crawl.

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If you know how to make money on properties which have no equity, you'll be able to do deals most other investors can't. You will have the competitive edge over your colleagues.

In this climate of the real estate market, there are an abundance of sellers who want to sell their home, but they don't have enough equity to cover a real estate agent's commission. Some may barely have enough equity to even cover their closing costs. Most of these sellers are just waiting for someone to come along and provide them with a solution, and that maybe you, if you know what solutions to offer them.

You might be pondering "If the property doesn't have any equity, how am I supposed to make any money?" There are several ways in which you can make money on a property even if you are paying full market value. They are... buying "Subject To", doing an Agreement For Deed or Lease Option, and doing a short sale.

One way to make money on a property which is 100% financed, is to take over the property "subject to" the existing loan. Then, you can Lease Option the property to a tenant/buyer. You could not only make money by getting an upfront deposit, but you can also make money every month by charging a higher monthly payment. You can even tie the sales price to a future appraisal. This way, you are building up equity in the property until your tenant/buyer exercises their option to buy. That equity would be your third payday down the road.  There's more you can do with "subject to". Say take over the property on "subject to" and find a buyer who's going to live in the property. Many people who wish to own a home are ready to pay five to ten thousand dollars above market rate, if they didn't qualify for the loan.

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Investing of any kind involves some form of risk.  Real Estate in particular, it is wise to have some cushion in your Loan to Value and not to exhaust all your equity in a "cash-out refinancing".  It is risky for investors to finance or refinance their properties at a higher percentage of value than normal, with the advent of 90%-100% LAV loans on investment properties.  Eager investors are taking cash out at the closing, and others are choosing to pay close to retail for properties that qualify for this financing, on the notion that a no money down deal is a good deal, even if it only cash flows a little.

Some mortgage brokers will try to sell the investor the "opportunity" to finance or re-finance their properties at a higher percentage of value.  Sadly, the investor could be paying close to retail for the qualifying property.  Some investors have been duped into believing that this "no money down" or "cash at closing" deal is a sweet one.

The smart investor has been able to resist the advances of the mortgage broker.   It is "OK" with having no money in a property.  The point is not to owe more on the property than 80% of the property's retail value.

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