Sub-Prime Meltdown - Round Two

[JohnH]

Interesting article and a possible warning of what may be imminent on the international finance scene. Arnaud gets a little worked up at times and I prefer to read him when he's talking about events in the Middle East, but he may be onto something here with his "Neutron Loans" article.. I especially liked this phrase:

"A symbiotic relationship between banks and mortgage companies erected beautiful monetary sand castles on the world's financial beaches, just out of range of high tide. They hadn't reckoned on a subprime mortgage rip tide that flattened them."

Here's the link:

http://www.washingtontimes.com/apps/pbcs.d.../109130001/1012

[jainen]

>>beautiful monetary sand castles on the world's financial beaches<<

Note that these sand castles are NOT the mortgages that homeowners might default on. Those are bad enough, but at least there is substantial equity to recover. The problem is the derivatives and hedge funds that used the expected stream of payments as security for vast investments backed by only pennies on the dollar. By pennies I mean that a two or three percent adjustment in property values can completely wipe out billions of dollars in pension fund assets. Trillions, actually.

We are going to see lots of blame for homeowners who "buy homes beyond their means." It's a lie.

[JohnH]

I have to agree with you concerning the ultimate result (derivative & hedge fund failures potentially wiping out pension fund investments), but I disagree with the conclusion that the homeowners buying beyond their means is a lie. That is where the problem originated. Everything else which constructed this financial house of cards was built on shaky borrowing.

One can certainly argue that the poor, financially ignorant borrowers would not have taken out the loans unless the lenders were willing to lend them money, but personal responsibility has to enter into the equation at some point. People need to be responsible for their own decisions, and if I'm foolish enough to jeopardize my financial future just because someone else is foolish enough to lend me more than I can reasonably repay, then we both need to accept responsibility for our actions.

[jainen]

>>People need to be responsible for their own decisions<<

Yes, I agree with that. I don't feel sorry for borrowers who thought they could buy obviously high-priced homes with little down payment, ignoring the actual monthly payment that would be required in a few years. And not much more sympathy for homeowners who risked their family's welfare by cashing out and spending short-term paper gains. They didn't lose much that they would have had anyway.

But whatever their own blame or personal loss, they didn't create the crisis that has required hundreds of billions of new "liquidity" to keep the dollar afloat. That honor goes to the financiers who played consumers and investors for suckers.

[JohnH]

After firing from the hip with my last post, I began to migrate towards the idea that this was what you had in mind.

And I agree completely.

I remember attending a real estate continuing ed seminar dealing with home mortgage financing a few years back. (Maybe more than a few years, since it was shortly after FICO scoring became the norm). The presenter discussed various programs which were coming on line to bridge the gap between the sales price and the first mortgage, essentially enabling people to buy with little or no money down. It covered the range from 80-20 loans to grants & gift programs, combined with ARM's or interest-only loans. The presenter focused on first-time buyers and credit rehabilitation cases, but it was made clear that the rules were pretty loose and that many others, including investors, could get in on many of the programs with a little creative thinking. At the time I kept asking myself "Where's the risk that will encourage the borrower to hang on if times get tough?" One attendee asked if this idea of counting on increases in the value of the underlying property or future ability to refinance at similar or lower rates to take them out of a bad decision wasn't just a classic application of the "greater fool" theory but all he got was a non-answer. I thought this was just an aberration that the lenders would quickly put out of its misery. Wow, was I wrong.