The Subprime Crisis

My first thought is that the system worked.

The system where hedge funds and certain other things (like toxic waste CDOs) are limited to high net-worth individuals and institutions. For all the market problems, normal investors haven't been affected (unlike people who need mortgages).

It is unbelievable that hedge funds (and European banks) put their futures on things they couldn't really measure or understand. This should put the nail into much of the quant model. Instead of minting money, they're actually collecting insurance, collecting pennies on an annuity basis until every couple years the market collects dollars.

While the jumbo mortgage market has melted down, the normal people mortgage market appears to be going strong.

I do feel sad about the people who were counting on refinancing their ARM and now have that option closed. I am pretty surprised they didn't understand the terms of the loans and the risks they were taking up front.

I did. 4 years ago I was a perfect buyer for a 5 year ARM. My reset will be financially painful but survivable. I made a conscious financial decision which turned out to be a loss. Given the same situation (without knowing the future) I would make the same decision. Plenty of real estate investors took a financial risk and lost big. Hopefully they (like me) had this as part of a diversified financial portfolio.

I'm leaning towards mandatory financial education. Especially for people who can't come up with a "normal" down payment. A no down payment ARM really should be limited to knowledgable investors. Or at least someone who has had to go through an hour or two of basic finance and potential scenarios.

The biggest surprise is that savvy investors haven't jumped into the jumbo resale market. Or subprime/Alt-A with reasonable (20%+) downpayments. If there was a way to participate as an individual investor, I'd be all over it. This should be a down payment crisis, not a general availability crisis.

And for people who have relationships with credit unions or small banks (that hold mortgages and know local areas) the window is still open. The whole brokerage system of national lenders is great until it falls apart.

Comments

[Mike Harmon]

I'm pretty surprised you're pretty surprised that people didn't understand their loans. There are several things at work there: people just looking at the monthly payment, people having the terms change when they sit down to close, and the non-trivial nature of some of the more exotic products. I recently spent the better part of a day trying to determine exactly how a certain pay-option ARM would really operate, for example (and may not have gotten it right, at that).

I don't buy education as the solution, simply because I have no faith at all in its effectiveness. I've seen some of the conclusions that can be drawn from comparisons of borrowers that have been "educated" for a few hours and those that haven't. It's a negligible help, if any. The real solution is just what we're going through now: creating organizational memory for the next twenty or thirty years about what happens when people forget that risk is actually *risky*, not just a euphemism for "large spreads". Possibly something could be done to keep lenders properly appreciative of credit risk when making financial decisions, but nothing occurs to me right now. I *would* like to see the abolition of pre-payment penalties as a consumer protection step.

I couldn't agree more about the hedge funds. Unbelievable. And marking these things to market (which *will* have to be done at some point) may well still cause quite the unwinding, especially as credit tightens.

Also, hey, long time no see.

[John Stafford]

If I'm committing my financial future to a piece of paper, I'm going to understand it.

Part of it is a really sleazy side of the mortgage brokerage market which paid high commissions if nasty traps could be set on unsuspecting subprime borrowers.

I once helped a guy who was looking to refinance. He saw it as a "great interest rate that would save him a lot of money". When I looked, the interest rate was actually higher than his existing mortage -- the savings were all from reamortizing (stretching his mortgage back to 30 years from 24 remaining).

Though he did the right thing and asked someone more financially savvy.

The problem with organizational memory is that something else was learned -- that this was a highly profitable maneuver to pull on financially unsophisticated customers. Mortgage originators (unlike holders) made out like bandits. Some can be solved by regulation (prepayment penalties -- though those were legitimate in the context of zero closing cost loans). Or artificial barriers (education). They'll be back.

[Mike Harmon]

Sure, you are going to understand a mortgage before you sign it. Most people are not you.

Let me tell you about the hardest-working person I ever knew. I worked with him at one of his two full-time jobs (he also worked a third part-time job). He came in to work one day just bubbling over with excitement about the car he had just bought. He had thought there was just no way he could possibly afford a car like that, but he told the salesman how much money he had left over every month after rent and groceries, and the salesman and his manager worked really hard and found a way to make that his payment.

He was so thrilled with the great service the dealer had done him that I couldn't bring myself to explain what had happened, or how much that car was going to cost him over the next 7 years. The *only* thing that mattered to him was that next month, by working 100-hour weeks, he would have exactly enough money to pay every bill he had.

He also owned a house.

That particular organizational memory is not limited to car dealers, and it is as old as the hills. The whole reason for those nasty traps and products that were virtually designed to fail was the irrationality of the secondary markets that were desperate for spreads. Naturally, if someone will overpay for bad mortgages, there will be someone eager to put people in them. Your guy looking to refinance doesn't surprise me at all, you should see some of the loans and products that come across my desk.

[martina]

I' m an italian student... your article is very clear and interesting for me! I'm doing a stage at Realesse tg and I try news on subprime crisis.Take a look at this interesting italian news video that talks about the US subprime mortgages crisis. This important crisis also involved the EU and Italy, so if you are interested, you might want to take a look at our point of view on the subject:
mutui sub prime
banche usa
mutui usa

[Lee Matthews - Financial Concepts West]

"I do feel sad about the people who were counting on refinancing their ARM and now have that option closed."

These folks still have options:

Today’s Real Estate market means that folks can no longer count on appreciation to build home equity. Those who realize that they need to pay down their current mortgage debt are looking for alternate ways to aggressively (yet safely) build equity.

And they've discovered a perfect online system to do that; they can focus on their wealth accumulation goals while accelerating their equity simply by using a Home Equity Line of Credit (HELOC) to ‘power’ this ‘financial solutions’ program.

A typical 30 year loan (of whatever type) can be paid down in 1/3 to 1/2 the time — it's a great way to save *huge* amounts of income by eliminating a mortgage amortization front-end interest load. (On a million-plus dollar home, I've personally seen where this particular program will save the homeowner $750,000 in interest charges!)

And the best thing – homeowners don’t have to refinance their existing mortgage or make (little or no) adjustments to their lifestyle.

I’d be happy to provide further details…

[xnoq asqj]

puecr zvsndlaqg uohag wrbynu logduib qmdsianph pruib

[xnoq asqj]

puecr zvsndlaqg uohag wrbynu logduib qmdsianph pruib