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Mortgage Musings

October 12th, 2011 1:25 PM

We have a new program available in conjunction with our credit provider to help you understand and strengthen your credit profile. It is particularly effective with anyone that feels they need to take steps to improve their credit to make it more likely that they will qualify for a loan or will qualify for a better loan.

The program is called AVAIL. AVAIL is a web-enabled software that 'proofreads' your credit report and gives suggestions as to steps you can take to make your credit more attractive to lenders. It identifies potential credit errors and gives you the information on how to get any errors corrected.

It also suggests better ways to use your credit cards to strengthen your credit scores. Additionally as you take steps to improve your credit profile AVAIL notifies you of your progress. And while AVAIL is an automated system you also get my advice and guidance any time you need it.

If you would like to know more about AVAIL here is a video you can watch that describes the system in detail. AVAIL Video

Posted by Harlan M. Cooper on October 12th, 2011 1:25 PMPost a Comment (0)

The Credit Crisis and the "Bailout" -- It's a Wonderful Life

October 1st, 2008 12:46 PM

Here is my explanation of the evolution of the credit crisis and what is behind the bailout, rescue plan, or whatever you would like to call it.

Homebuyers that had trouble qualifying for a loan purchased homes with subprime loans expecting to refinance as their credit improved or to sell the house at a profit in a rapidly appreciating market. Homeowners with credit problems or unable to document their income used the homes they owned as ATMs by refinancing with subprime loans to get money to invest or sometimes just to get by. Mortgage brokers and mortgage bankers originated these loans. Mortgage lenders underwrote and approved them.

The loans were then packaged as mortgage backed securities (MBSs) and sold by Wall Street investment firms to investors (banks and other institutions) worldwide as AAA securities as rated by the rating agencies. Mortgage lenders would be paid to service (collect the payments on) the loans they made while passing the principal and interest collected on to the investors that purchased the MBSs. With their supply of money to lend replenished, the mortgage lenders could then make more loans and continue to build their servicing portfolio, their main source of income.

The flaw in the system was that the default rate on the underlying loans that was used in rating the securities did not take into account the almost unprecedented deflation of property values that has occurred. One key to understanding this mess is to understand how these securities are valued. This is where things get tricky. Many factors influence the value of an MBS. For example, the yield which is the amount of interest paid on the principal affects the value of an MBS. If the interest rate on the MBS is greater than current interest rates, that security might sell at a premium. If the rate is lower than current rates the MBS would need to be discounted or sold at less than face value to be attractive to investors. But this presumes that all the loans in the security are repaid. What if some of the MBS's homeowners don't repay their loans? The servicing lender forecloses on the homeowner and sells the property to try to get as much of the loan's principal back as possible. If property values are increasing then more of the principal of the loan is recovered. Additionally the more property values are increasing the less the number of foreclosures, since if a borrower cannot make their payment they might be able to sell the house at a profit instead of letting the mortgage lender foreclose. When the sale of the foreclosed home doesn't pay back all of the principal, that loss comes out of the investors yield, making that security less valuable.

As property values drop the default rate on the securities increase and the value of the security continues to drop. Not every loan in the security may be in default, but using the current deflation rate in property values predicts that many loans in the security might default in the future. Even then, not every loan will default and those that do will have the property sold to mitigate the loss as much as possible. These are the factors, along with the yield, that determine the market value of the security today. As these factors change, for example a stabilization in property values, the value of the security changes. Just like property values can not continue to go up indefinitely, they can't continue down indefinitely either.

The problem lies in what assumption to make about property values. To conservatively estimate their value today requires using today's rate of decrease in property values in the equation. IF property values were stable or increasing, these securities would be worth more than they are currently.

So based on the presumption that property values will stabilize or increase in the future, these securities are worth more if held to maturity than if an investor had to sell them in today's MBS market. But due to the recently instituted accounting rule called "mark-to-market" an investor holding these securities (say a bank) must put the current value of the security on their books as if they had to sell them today, not the held-to-maturity value. Hence the large write-downs that are occurring. These write-downs can make a firm insolvent based on the premise that IF the firm had to sell the security today and not wait and hold them to maturity, then the firm's assets would not be enough to cover the firm's liabilities and therefore they would be bankrupt, even if it isn't necessary for the firm to sell the securities in today's depressed MBS market to continue operating. One possible solution is to change the mark-to-market accounting rule and let banks and investment firms that hold these securities use the "held-to-maturity" value instead of their value if sold today.

The premise of the so called "bail out" or "rescue plan" is that the government will step in and make a market for these securities by purchasing them from the ailing firms. The firm's (bank's) books look better and a market is created for MBSs making for more liquidity and, just by the law of supply and demand, increasing the value of the securities. As this relieves the strain on lender's books they are able to lend money again and the credit market may return to a more normal state.

The government is not bound by the mark-to-market accounting rules and can either hold the securities to maturity or sell them in an orderly manner in the future as property values stabilize and the market value of the securities increase. This presumes that property values stabilize or increase in the future. Of course the devil's in the details. For example, how will the price or value of the MBSs the government purchases be determined?

So what does this have to do with "It's a Wonderful Life?" Remember how George Bailey, played by Jimmy Stewart, responded to the citizens of Bedford Falls when a financial panic created a run on the Bailey Building and Loan?

http://www.youtube.com/watch?v=Ba8id0Q7UkQ&feature=related

While oversimplified and maybe even a little corny it does point out one important thing, we're all in this together.

What are mortgage backed securities? They are American homeowner's promises to pay back money that they borrowed with their homes as collateral. Who receives the interest paid on these debts? Investors.

Who are these investors? Do you have a 401K? Then you are an investor. Do you have a checking account, a savings account, or a money market account? Then you are an investor. Do you have a pension? Then you are an investor. We the American public are the debtors, but we are also the investors. Maybe George Bailey had it right, let's not panic, but pull together as a community to solve this problem.

Posted by Harlan M. Cooper on October 1st, 2008 12:46 PMPost a Comment (1)

Declining Property Values is not all bad!

January 14th, 2008 2:54 PM

Property values have declined in many parts of the country and many homeowners are suffering due to this decline. Fortunately in Texas there are factors keeping us from the worst of the drop in values even though almost all markets have been affected somewhat. But looking at it from a longer perspective it could be worse. Take Portland, Oregon and Seattle. Since 2000 property values in these two cities have almost doubled, appreciating around 8% or 9% a year. They have declined less than 1% from the peak as of Sept 07. So have the brakes been applied to the rapid appreciation in these areas. Yes. Have prices dramatically declined. No.

But there are areas that have seen much more dramatic decreases in value. The cities that have seen around 10% decreases in value from the peak in values are Miami, Washington D.C., San Diego, Tampa, Las Vegas, Phoenix, and Detroit. All of these cities, except Detroit, have seen incredible increases in value since 2000. Miami has seen the most appreciation with almost 180% peak gain since 2000. So following these statistics a Miami condo that sold for $200,000 in 2000 sold for $560,000 at the peak. And with the 12% drop in values from the peak was only worth about $500,000 at the end of last year.

If you are a homeowner in California, Nevada, Arizona or Florida, wanting to use your home equity like an ATM, you're hurting big time. If you are a buyer that wants to purchase a new home and have to sell a home you recently purchased that is certainly a challenge also. But if you don't have a home to sell and are considering purchasing a home it has turned into a buyer's market and is a great time to buy.

But not everyone purchased a home last year or took out all of their equity. Our fictional Miami condo owner that purchased their condo in 2000 may not need to sell today and if they do, they can still pocket some decent change. True they may be feeling a little poorer by $60,000 in equity, but they can console themselves with $300,000 in appreciation over the past few years.

So far what I believe we are seeing is a much needed correction in property values. It had to happen. Think of it this way. If Miami values continued to double every five years, a home valued at $500,000 today would cost $8,000,000 in just 20 years. I don't think we would be making many loans 20 years from now if the houses cost $8,000,000.

So what led to this run-up in values? Loose credit and speculation. A market "crash" (at this point really a correction) tends to take care of the speculators. You don't see people lined up to snap up pre-sales in Miami just to sell the contract as soon as the project is completed like you did just a few years ago. And now a purchaser may have to show some income and have decent credit to borrow a few hundred thousand dollars to buy a home. These aren't necessarily bad things. Unless you're a mortgage or real estate professional in Miami or one of the areas hardest hit with this market correction. Or you are a home owner that purchased at the top of the market and needs to sell. Or a homeowner living beyond your means and needing your home equity to use as an ATM. There is no denying though that, on a personal level, this market correction is devastating to many. It reminds me of that definition of the difference between a depression and a recession. 'If my neighbor loses their job, it's a recession; if I lose my job, it's a depression." But with adversity comes opportunity.

So might we see a recession? Possibly. We are already seeing a slowdown in the economy and it might get worse before it gets better. But unemployment is still low even if the quality of jobs has declined. If people have jobs that can pay for housing then they will still buy houses. People need a place to live. Will real estate growth patterns return to a more sustainable pattern driven by people's need for shelter instead of speculation and loose credit. I hope so.

The $64,000 question is will the property value decline reach a tipping point where the price correction turns in to a real crash where property value declines reach levels that start to snowball. Fortunately this is probably remote. While housing is a huge part of the economy and consumer spending may contract some due to the decline in home values, the economy is probably resilient enough to absorb this correction. So while we are seeing a slowdown, it remains to be seen if it is an actual recession. The chances of a depression though are remote.

Regarding the debt market, it is functioning as it should. It has been dysfunctional for the last few years and is now returning to normalcy. There are plenty of buyers for good paper, but not so for junk. Just look at the rates for conforming . . . low and going lower. If there were no purchasers for this paper the rates would be skyrocketing to attract investors. Not so for loans to people with bad credit and no income. You can't sell this paper at any price. Without the unsustainable increases in property values this paper is worthless, and that fact is reflected in the lack of investors.

Unsustainable increases in property values and loose credit over the past few years have distorted the perception of what is normal. When addicted to the "drug" of easy money, it is literally sobering when things begin to return to normal. But that withdrawal, while difficult, is ultimately healthy for the economy and our children's future. Would you really want your children or grandchildren to have to pay $8,000,000 for a Miami condo, even if they could go stated?

Posted by Harlan M. Cooper on January 14th, 2008 2:54 PMPost a Comment (0)