MaineBusiness.com

Your Mortgage Provider Said What?

Recently a client got a wonderful sales pitch on how to finance the home they plan to build. After the loan officer indicated the maximum amount of credit they would be able to borrow, my client said, “If I take out the maximum available credit that I’m approved for, I wouldn’t be able to afford the monthly payment.” The loan officer replied, “You can always stop making deferrals to your 401(k).”

My client knew better. But this is a perfect example of why we are in this so-called sub-prime mess. It is a total disregard for risk. Skyrocketing home prices led consumers to believe that real estate was a “can’t miss” investment. As the asset bubble rose, greed set in as you saw people flipping houses in as little as a day; other consumers were compelled to buy the biggest, most expensive house they were told they could afford. Mortgage lenders accommodated the demand, encouraging people to maximize their credit. When home buyers with good credit records ran dry, exotic new loan types were introduced to those that had suspect credit history; requiring little down, providing teaser rates or paying only interest during the beginning of the loan. I truly feel sorry for the people who really fell into this trap, but I also find it naïve to think that they had no idea that they weren’t taking some sort of risk. Now, stories are now coming out of loan officers who were paid based on sales volume that fudged the numbers to make the loan work as well as some appraisers, fearing they would lose lucrative business, inflated valuations to ensure the loan would go through. Then many of these mortgages were packaged as securities and peddled off from Wall Street to investors. Hedge funds and other institutional/individual investors did little in due diligence to sift through the complexity to see what the true risk of what they bought into. Asset bubbles, conflicts of interest, greed and now suspicion on the true underlying value of some securities; although the storyline is different, it seems eerily similar to what we had back earlier this decade.

As mortgages re-price into unaffordable monthly payments, expect to see more stories about defaults, sagging real estate prices, job cuts in the real estate sectors and an additional hedge fund going under or institutional investor losing a significant amount of money. Certainly this can lead us closer to a potential recession, but I think the sub-prime hype is overblown. In a recent article in Fortune magazine, economist, writer and comedian Ben Stein put the loss potential in excellent perspective:

“The subprime mortgage world is about 15% of all mortgages, or $1.5 trillion worth, very roughly. About 10%--approximately $150 billion--is in arrears. Of that, something like half is in default and will likely be seized in foreclosure and sold. That comes to about $75 billion. Roughly half to two-thirds of that will be realized on liquidation, leaving a loss of maybe $37 billion. Not chump change by any means--but one-thirtieth, more or less, of what has been knocked off the stock market.”

While some people are watching CNBC and worrying about this being the end of everything good, I see this as a positive. Short-term noise such as this gives me the opportunity to buy stocks at much lower prices than three months ago for me and my client’s long-term needs. It also gives the opportunity for younger people to buy homes at prices that are much more affordable today than several years ago. And it has told many others that they SHOULD and BETTER respect risk. Risk isn’t the enemy, but you can bet your bottom dollar it should be recognized.