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Bank failures - the next Stage of the Housing Downturn
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Former Owner
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PostPosted: Mon Jul 14, 2008 1:59 pm GMT    Post subject: Bank failures - the next Stage of the Housing Downturn Reply with quote

Now things are really beginning to get interesting.

Friday we had a double dose of bad Real Estate News.

1. Fannie Mae and Freddie Mac need a bail out. Most home owners that I know don't even know what Fannie and Freddie do. This is a clear sign that the secondary mortgage markets are in CRISIS. If the secondary mortgage market is in Crisis then your local banker will have less-and-less interest in selling Mortgages to potential home owners.

2. Indy Bank - in California is seized by the FDIC - the Bank is insolvent.
Most don't understand that the cornerstone of our Banking system is debt (specifically Real Estate Mortgages). As the value of real estate falls - the collateral supporting the Banks falls in value and the Banks have less wealth - this makes the Banks more conservative and less likely to lend money.
This cycle leads to the continueing fall in value for the Collateral that supports Banking system - and ultimately leads to a Bank not having enough money to cover withdrawls from folks who have stored their Wealth in the Banks Saving Accounts or Checking Accounts.

Be very selective of the Bank you use and the savest place to keep saving is US Treasuries. You don't want to be one of the poor folks waiting 3-9 months for the FDIC to send you a check.

The Bank failures will be a major catalyst in the next down leg for Real Estate. Sadly, most home owner are unaware whats happening!
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john p



Joined: 10 Mar 2006
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PostPosted: Mon Jul 14, 2008 3:19 pm GMT    Post subject: Reply with quote

Ok, I think you're dialed into this clearly more than most.

What I'm having trouble understanding is the magnitude and number of homeowners that this will affect.

For instance, what percentage of homeowners are in ARMS, or are having trouble meeting their mortgage obligations who are forced to sell?

My feeling is that if less credit is available, only the people upside down and have solvency problems will sell, and others who can pay their mortgages will just sit tight.

I have trouble finding data to help me with the order of magnitude to help me asses the impact of these events.

What makes this correction unlike the 90's is that we had massive job losses that affected solvency. Do you think that we'll eventually have these massive job losses, things aren't looking great right now, but keep in mind, part of the basis of the argument is that the FED FLOODED THE MARKET WITH MONEY.
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john p



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PostPosted: Mon Jul 14, 2008 3:20 pm GMT    Post subject: Reply with quote

I didn't finish the paragraph...

The FED flooded the market with money so wouldn't inflation due to too many dollars eventually put upward pressures on wages and devalue people's debt, actually making their debt hurdles lower?
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PostPosted: Mon Jul 14, 2008 3:48 pm GMT    Post subject: Impact of Bank crisis Reply with quote

John,

The hard part with this topic is getting your head around how the Banking system works. Its too long of a topic to go into here - but, remember if you have $10,000 in a Savings account at your bank - the Bank only as $900 of your money on hand. The rest of your savings is invested in Real Estate related investments - think the Movie "It's a wonderful life".

I believe we are entering a period similar to the period of time of the S&L Crisis only worse.

Remember, Banks actually credit Money in our Fraction Reserve Banking system. Yes- the Fed will provide liquidity to keep the system going and cause inflation. But, the Banking system will be mired in problems and will lend with caution. This means small businesses will have a very hard time getting Bridge loans or loans to expand their business. Less Money in the economy from the Banking system will make for a sluggish economy.

Wage increases were a result of Stag flation in the 1970s. But, the USA had a much bigger manufaturing base in the 1970s (manufacturing jobs had collective bargaining contracts that provided for Cost of living adjustments in their pay). How many people do you know that are Union workers today?

So, look for Gas, Oil, food, and most commodities to increase in Cost as the Federal Reserve works their magic. Expect to see sever Budget challenges for States, Cities, and Towns as revenue drop and costs sky rocket. Towns will attempt to raise taxes, the towns people will finally say no, and service cuts will begin.

Next shoe to drop is when we hear that the State and local pension funds are under funded. Yes- The pension funds were major participant in the Real Estate mania. There was a great article in Forbes Magazine about this very topic - well worth reading.

The money from the Real Estate Mania invaded every area of the economy. The extraction of the cash will have an equally negative effect!
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john p



Joined: 10 Mar 2006
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PostPosted: Mon Jul 14, 2008 4:18 pm GMT    Post subject: Reply with quote

So, basically, the capital which is like the fuel for the capitalistic engine will run out. The result would be a serious slowdown in the economy. I know it is too hard to fully get into it in this sort of thing, but if the M3 supply of money has skyrocketted, where is all of that money? It seems to me that by allowing banks to lend more, people were able to charge more for things like housing, creating asset bubbles. Being able to borrow less and less means that people can only pay less and less, is that what you're saying? I wonder about the amount of people who did buy in the past six years that ARE capable of making their payments, there is a lot of money making it's way to banks. I believe that the majority of people who did buy in that era actually can make their payments and when you step back and weigh things, banks lent out a ton of money because they knew the majority COULD pay the amounts due to affordability and for the percentages that couldn't, they could write them off. Further, buy being able to package them and sell them off, it was like having a toxic waste dump of bad debt that the Government would bail out anyway.

I look at it like how I see the Boston Bruin's business philosphy. They didn't care that every seat was filled or the team was winning, they knew that if enough corporations were paying $80, it was better to have every third seat missing than to have them all full and only charge $20 a seat. The people that can only afford $20 are shut out economically.

The part of this I can't understand is how banks are so good at determining risk could let this collapse happen. I think that what the rest of us are forgetting about is that the people that are paying bubble prices to the banks are creating the REWARDS that are making Old Man Potter rich.
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PostPosted: Mon Jul 14, 2008 4:49 pm GMT    Post subject: Reply with quote

john p wrote:

The part of this I can't understand is how banks are so good at determining risk could let this collapse happen.


They aren't as good at it as they think. Their securitization processes, including risk models, were based on historical data drawn from loans to people with good credit and substantial down payments for homes that they could generally afford. The recent "innovation" was that they extended the process to people with lesser credit (subprime borrowers) with less collateral and I think that they extended the risk models mainly based on historical FICO data. That's problematic for at least a few reasons. First, an individual's mortgage debt will be larger than credit card debt by at least an order of magnitude, which in and of itself makes the FICO score a questionable proxy for the probability of mortgage repayment. Second, allowing people to effectively bid up the price of housing unconstrained by their actual income changes the very nature of the system itself, invalidating the use of historical data from a fundamentally different environment.

You may also be seeing a survivorship bias. Those lenders who did appropriately account for the risk probably had no choice but to stop doing business during the heyday of the bubble. To compete would have required taking on excessive risk. So the prudent lenders were winnowed out by a survival of the riskiest, a perverse sort of natural selection.

- admin
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john p



Joined: 10 Mar 2006
Posts: 1820

PostPosted: Mon Jul 14, 2008 5:34 pm GMT    Post subject: Reply with quote

Admin said:

Quote:
To compete would have required taking on excessive risk. So the prudent lenders were winnowed out by a survival of the riskiest, a perverse sort of natural selection.


"Winnowed" is a great word for starters. Take the same sentence and plug in "prudent buyers" for "prudent lenders".

As far as "herd behavior", I am thinking about how a herd can deform fundamentals and change the elastic properties for things to snap back to their fundamental repose. At a certain point, even responsible people will jaywalk if the traffic stops due to everyone ignoring a do not walk light.

Part of me thinks that by adding liquid to the market, the FED can dillute the concentration of fundamental problems. I doing so, they amplified some of the trouble and created a whole new set of issues.

As long as the vast majority of people can make their mortgage payments, I think we can avoid a major collapse. What concerns me that I don't have much data on is how many people refinanced and how much our economy is based on people using their homes as ATM's and how much our society is dependent on all that money.

I think a big, big issue that nobody seems to talk much about, at least what I read, is how people were able to get a tax shelter in their mortgages by refinancing and adding to their mortgages boats and luxuries. I mean debt to pay for a shelter is one thing for a society to shelter taxes from, but to include luxuries in that debt was very irresponsible in my view. I really wish I knew of sources that identified the order of magnitudes for these. I can only imagine.
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PostPosted: Mon Jul 14, 2008 5:36 pm GMT    Post subject: History is littered with failed Banks Reply with quote

While in the Boston Area - my wife and I like an Arlington restaurant called Fiora- it was a former Bank. Banks go out of Business!
Banks have failed through out the history of the United States. Sadly no one ever teaches their children how to manage their money, the history of money, and NEVER-EVER-TRUST a Banker.

In the USA there were lots of Bank failures in the 1880-90s, there was a Bank Panic in 1905 or 1906 (I think), then the 1930s, the early 1970s, the late 1980s/early 1990s (The Bank of New England- run on the Bank).

The interesting part is the Bank crisis corresponds to challengeing times for Real Estate.
1. Symphony Hall Boston- Did you see the recent live sculpture at symphony Hall in Boston. Symphony Hall was completed in the Midst of a Banking/economic melt down and there was not way to fund the sculptures for the outside of the building.

2. In the early 1930s - the Empire State building was brand new and it was nicknamed the Empty State Building.

3. In the early 1970s, the World Trade Center in NYCity was completed and there was no one interested in renting space

You see Banking and Real Estate are intimately intertwined. When Banking booms Real Estate booms and when Real Estate is crashing - so are the Banks.

So what we are experiencing is not new and will likely be one of the more painful periods in Banking.

The moral is - Learn Everything you can about Money and then pass it on to your children!
Moral number 2 - Put your long term saving in Treasury only Mutual Fund or buy Treasuries direct from Treasurydirect.gov or put your Wealth in some other Asset!
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PostPosted: Mon Jul 14, 2008 8:33 pm GMT    Post subject: Reply with quote

a few other factors that will directly impact housing:

- Bailout will cause the dollar further fall in value as a international currency greatly increasing inflation (relative term)
- Inflation will cause a increase in interest rates
- inflation will reduce borrowing power
- Fred and Fan bail-out will make all current lenders very hesitant of issuing mortgates (and make it increasingly hard for people to refinance or get new mortgages)

Alll key indexes down nearly 25% this year

There are brightspots in the economy but to be honest I do not see any that can repair this ginormous hole. We are in a economic perfect storm and it is hard to tell where we will end up.

The world is flat and we have seen our once enormous wealth starting to transfer all over the world.

Hey buddy can you spare a dime>
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PostPosted: Mon Jul 14, 2008 8:57 pm GMT    Post subject: Reply with quote

Also do not forget about consumer credit-- the economic stimuls package might have been nice for a short time but will mounting forclosure and job losses i am sure the consumer credit markets and auto loans are going to get ugly as well.

Would you rather lose your house or your car.....
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CJ
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PostPosted: Tue Jul 15, 2008 10:07 am GMT    Post subject: Reply with quote

john p wrote:

What makes this correction unlike the 90's is that we had massive job losses that affected solvency. Do you think that we'll eventually have these massive job losses, things aren't looking great right now, but keep in mind, part of the basis of the argument is that the FED FLOODED THE MARKET WITH MONEY.

Massive job losses? We may see that soon, probably from construction companies, banks first and followed by auto makers, airlines, and computer and consumer electronic companies....etc.
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krishnarama
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PostPosted: Sun Jul 20, 2008 2:29 pm GMT    Post subject: Reply with quote

The moral is - Learn Everything you can about Money and then pass it on to your children!
Moral number 2 - Put your long term saving in Treasury only Mutual Fund or buy Treasuries direct from Treasurydirect.gov or put your Wealth in some other Asset!

Totally agree with first one. I would add that "What Has Government Done to Our Money" by Murray N. Rothbard is a great one to start with.

http://www.amazon.com/What-Has-Government-Done-Money/dp/0945466102/ref=pd_bbs_sr_2?ie=UTF8&s=books&qid=1216563640&sr=8-2

But I am not sure about your Moral Number 2. As Jim Rogers said last week, It took US Government over 200+ years to accumulate $5T since the republic was founded . It just took one weekend to add another $5T.This is outrageous. I can understand the rationale for being in liquidity and all,but they are so many things in the world that we can buy with these fiat dollars. [/b]
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Boston ITer
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PostPosted: Sun Jul 20, 2008 7:03 pm GMT    Post subject: Reply with quote

john p said:

Quote:
What concerns me that I don't have much data on is how many people refinanced and how much our economy is based on people using their homes as ATM's and how much our society is dependent on all that money.


Well, from what I see around me, that's about 70% of homeowners I know of. And that exclusive 30%, of $0 cash back, are generally at or near retirement age. Those are the ones who see a loan for what it is, borrowed money with which one pays interest on.

For the most part, whenever I hear of a floor a/o roof-ceiling improvement, it's always conjoined with adding a 'line of credit' so I think this housing ATM was alive and well up until this year. I'm a little confused by what I see around me as the number of babies hit an all time high this year but at the same time, no one I know of can afford to have them unless they decide to raise them in a developing nation (FYI, I have a few Asian and South American friends who're doing that by sending their kids to private schools in their parents' hometowns). All and all, it's pointing to a future decade of dwindling opportunities for the average person.
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PostPosted: Tue Jul 29, 2008 12:36 pm GMT    Post subject: Scams continue Reply with quote

The rescue of Fannie and Freddie will allow scams like the following to continue, because banks can continue to pass off questionable loans to the taxpayer now. The raising of the mortgage limit to 729K has made this possible. This scam took place early this year, regardless of the hysteria about "sub-prime". Please check the following link:

www.ocregister.com/bus...

The scam works like this:
1. Find someone with good credit and not much knowledge of English or with poor reading comprehension. Tell them they will be able to buy a house and make 50K in cash.
2. Buy the house at auction for 300K after foreclosure, probably close to fair value at this price.
3. Mark up the house to 600K, and loan the buyer 125K to satisfy the 20% down requirement. Cut an appraiser and a loan agent in on the deal.
4. Wells Fargo approves the 500K mortgage since the buyer paid 20% down, and he/she has good credit, and they do not want to seem anti-minority or get sued!
5. The "buyer" pays the scammer 500K - 50K = 450K.
6. The scammer makes a cool 150K profit.
7. Wells Fargo does not care since they are going to bundle up the loan and sell it to Fannie Mae or Freddie Mac, ince their conforming mortgage loan limits went up to 729K for jumbo mortgages.
8. "buyer" goes out and buys a nice 50 inch LCD TV and sends some money home to Guatemala.
9. The "buyer" suffers a job loss/divorce/deportati... problem and the house goes into foreclosure
10. The foreclosed house now ends up on Fannie Mae's balance sheet, and is sold for 325K at auction, and the remaining 275K is added to the US taxpayer account.

Chinese and Vietnamese language newspapers are full of these ads where a "buyer" is solicited and a cash offer is made. Now if Fannie and Freddie Mac were private entities, they would not ask for an independent appraisal and reject the loan. Still wonder why you pay taxes?
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PostPosted: Wed Jul 30, 2008 3:50 pm GMT    Post subject: Think deflation, not inflation Reply with quote

Sorry, the link above to the Scam story got cut off, the full link is:

http://www.ocregister.com/business/house-on-a-2104411-street-wrecked

Anyway, I think many people are making a mistake thinking we are going to enter a period of stagflation. It is more likely deflation. M3 is growing by about 20% lately, however, this is not likely to lead to inflation. Inflation is by definition, a net expansion in the supply of money and credit. The Federal Reserve can print money and jack up M3, but banks have to be willing to lend. Credit cannot expand, if banks do not lend to consumers, commercial entities, and each other. Also, the complicity of the rating agencies, and the monoline insurers (for credit default swaps) in the whole financial mess means few investors trust financial instruments anymore.

This is the real problem. Trust is central to having a smoothly functioning financial system. The US financial system at this point is fundamentally insolvent. If house prices go down nationally by another 20%, then Fannie Mae and Freddie Mac, who have 5Trillion dollars worth of mortgages on their books, will be insolvent. Their losses will exceed 1Trillion dollars, and given that their assets are worth only a fraction of that, they would be bankrupt if they were a private entity. China alone has hundreds of billions of dollars of agency bonds. If all foreign investors try to redeem their investments, then it is a run on the Fannie and Freddic Mac entities.

The Fed only has 800 billion dollars as reserve, and has already lent 360 billion to the JP Morgans, Lehman, Wamu, Wachovia, and other banks. It cannot take on 1Trillion in losses that Fannie and Freddie can suffer. FDIC only has 50 billion dollars of reserves, of which 8 billion have already been spent on taking over IndyMac. If more and more banks go under, then FDIC in effect will be insolvent. If the monoline insurers go under, then trillions of credit default swaps and other derivatives will vanish, causing a worldwide financial system shock. Nobody really knows who holds those derivatives. Even banks in Australia, Hong-Kong and other places are putting in 100s of millions of dollars each in shoring up loss provisions if derivative contracts vaporize. This bad paper has been spread worldwide.

If the US Govt assumes control of insolvent entities, then it will have to print money to bail out everyone. The US Govt will not default on its obligations, but its AAA rating will be toast. Also, the dollar will be devalued. A flight to gold is not wise either, because Central banks can manipulate the price of gold by selling their substantial holdings into the market driving down prices and making fiat currencies like the dollar more attractive. The US alone has 30,000 tons of gold. Each ounce is approx 1000 dollars today. That is over 2Trillion dollars worth. Other central banks also will liquidate gold to support their fiat currencies.

So what is left, gold is a form of currency, but it cannot be eaten or used in any way since it can be manipulated. Thus commodities, like oil, corn, wheat and others become the new gold. And hence the run into those commodities, which is pushing up prices. However, if there is a global deflation, which I think more likely, then demand for commodities will also fall since industries and consumers will cut back since they will not be able to get credit to expand because banks are too scared to take on risk by lending.

As George Soros put it, the coming few years will represent the greatest period of wealth destruction since the Depression. Equities, bonds, Real Estate, nothing will be safe. Even cash may not be safe if the dollar plummets. The Euro may also be overvalued, while the Chinese Yuan and Indian Rupee are not convertible on the open market. Now does everyone understand why the US govt will do anything to shore up the US housing market?

The US govt, in the best case scenario, would like for the housing prices to stop falling, and maintain nominal prices while they slowly fall in inflation adjusted terms. There is a massive effort underway in the US Govt and worldwide, and lots of positive spin worldwide, because a run on the US might lead to a global unwinding of derivatives and an acute systemic shock. Global depression is then assured.
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