So there has been a lot of talk that the economic crisis, specifically the housing crising, was a failure of the free market. The housing crisis was definitely a failure but don’t think that what drove it was the free market. In fact a properly functioning free market would have actually prevented it. Also don’t think this is a new problem requiring new theories. There are hundreds of years of economic theory (recognized by no less than 5 Nobel prizes) that predicted and can explain all of this. Allow me to do that in one web page. (SPOILER ALERT: There will be economic terms used but it will be quick, mostly painless but very informative)
Lets first start with the assertion that for any market to work there is the underlying assumption that complete (if not perfect) information is available and that all participants act rationally. According to this article:
Complete information is a term used in economics and game theory to describe an economic situation or game in which knowledge about other market participants or players is available to all participants. Every player knows the payoffs and strategies available to other players.
Complete information is one of the theoretical pre-conditions of an efficient perfectly competitive market. In a sense it is a requirement of the assumption also made in economic theory that market participants act rationally.
Examples of the LACK of complete information in the housing market included:
Buyers didn’t understand housing market risk.
Buyers didn’t understand the true mechanics of the financial commitments they were making.
Banks for giving out “No-doc” mortgages.
Rating agencies provided bad information on ratings (either via ignorance or straight up fraud).
In economics and contract theory, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry.
Examples of information asymmetry during the housing bubble include:
The exotic and esoteric financial contracts that emerged. (asymmetry between the bank and the consumer)
The questionable package of mortgages (loaded up with “no doc” mortgages) that also emerged. (asymmetry between the bank and the investor)
Adverse selection, anti-selection, or negative selection is a term used in economics, insurance, statistics, and risk management. It refers to a market process in which “bad” results occur when buyers and sellers have asymmetric information (i.e. access to different information): the “bad” products or customers are more likely to be selected.
Examples of “adverse selection” almost go without saying but here goes anyway:
People bought houses they couldn’t afford.
Most of those “no doc” customers got loans.
Most of those questionable packages of mortgages were gobbled up by investors.
In short this was NOT a failure of the free market because the free market wasn’t even involved. If a proper free market was involved then there would have NOT been information asymmetry. Without information asymmetry there would have been no adverse selection and hence no bubble.
So what now? Well this is where another term gets misused and misunderstood and that is regulation. It appears to me that most view the term regulation as the way for the government to restrict certain activities so OF COURSE we should be against that (offering certain financial products, limiting speech, telling us what we can do in our bedrooms ,etc..) . I think, however, there is another form of regulation that is far more beneficial and more universally acceptable and that is requiring disclosure/transparency of information (AKA “complete information”). One successful example of this is warning labels on cigarettes. This did NOT restrict usage of cigarettes but allowed consumers to make more informed decisions (and replaced those ads where doctors told you smoking was good for you).
Regulation that provides greater “transparency of information” (e.g. disclosure of true financial costs of mortgages) is clearly a pre-requisite of the free market (see “Complete Information” above) as it prevents information asymmetry and thus adverse-selection.
So in the end the great irony here is that those that are supposedly the proponents of the free-market (fiscal conservatives) also seemed to be the most opposed to regulation (even of the information-transparency kind).
Well they actually do, inadvertently, have one point. Even if you make information readily available, if the general public is not properly educated to consume it, its a waste of paper to print it. So in the end if information transparency is provided it will still be useless without education. If you want to see a good piece on the importance of education then check this out.
Sure tax season is 10 months away but you still can protect yourself now if you live in the state of California.
As you know, California is starting to issue IOUs to those that have lower priority on debt held against the state. The lowest on that totem pole are any taxpayers who are owed a refund. It is very possible that this IOU system will continue for some time, even as late as next calendar year when you are filing your 2009 taxes. Remember. April 15th 2010 is the next calendar year but it is within the current IOU-laden fiscal year for California.
What does this mean for you? If you are expecting any sort of tax return there is a chance that you will, instead, receive an IOU. As a result you should seriously consider (legally) reducing the amount of tax withheld to a point where you at least wind up break-even (or even owing a little bit) when you file your taxes for 2009. If the state owes you anything do not expect to receive it in a timely fashion. Better it be in your pocket than there’s.
Also remember you have paid half of your income taxes for the year so you’ll need to account for that as well.
This is probably extremely critical if fear you may be unemployed in the near future. You may find yourself in a situation where you would wind up with a tax refund but not see the much needed cash in time.
Please note that your situation may vary depending on your specific circumstances so you should ALWAYS contact a professional for the right strategy. I just contacted an accountant and wanted others to at least have the chance to do so as well.
Forewarned is forearmed.
Oh and be forewarned about the next major drop in real estate on the San Francisco Peninsula. Here is an article that shows why prices are due for another 30% drop.
Why are the taxpayers only going to get a few pennies on the dollar for its GM investment? Its very simple math that goes something like this
The government effectively will get 60% of General Motors in exchange for $50 Billion in aid.
This, using standard investor math, means that GM has an implied value of:
50 Billion/.60 = $83.3 Billion
Currently (or as of last Sunday) GM had 610 million shares outstanding.
That means that for the taxpayer to break-even GM shares (in the pre-bankruptcy world) would need to be worth $136.55 PER SHARE (83.3 Billion/610 Million)
The lifetime HIGH for GM is $93.62 back in April 2000 when the going was good. So good luck with that.
Oh and to complicate matters the government will see its holdings diluted if the bondholders take the extra 10% that they were promised as part of setting up the bankruptcy filing. If GM is doing well one would assume they would exercise these options and taxpayer shareholders would get diluted.
In that case the taxpayer stake goes to 54% which means an assumed market cap of $89.3 Billion or a per share price of $146.39
So even if GM were to return to its lifetime high of $93.62 the taxpayer would only get back $34 Billion 0r 68% of its investment if GM got as BIG as it ever was.
This of course is impossible based on the Government’s own admission that they are structuring GM to compete in an economy where car sales are 33% less than they are now.
Sure these numbers are approximations and some of the debt might be repaid like a normal loan (and I hope most of it is) but you can tell that there is no way that the taxpayers will see even HALF of their money returned even if all the right things happened (in a short-period of time as President Obama doesn’t want to hold on for long).
Well look on the bright side. We got rust-protection and under-coating free with the deal and we know how important those are.
With a good run on the stock market and even some good news about housing sales I think its time for an example before anyone gets too cozy that the worst is behind us.
To play it safe you need to think about where we are in the economic cycle the same way as an important scene in the movie Titanic. This is the scene where the ship, which has been slowly sinking for about an hour, suddenly levels off when the submerged part of the boat (partially) breaks away. Everyone is relieved that they are floating level when all of a sudden they get pulled down in a rush to the bottom. The sinking part of the housing market just (partially) broke away and everyone is giving that sign of relief. Strike up the band!
Here is why we are in for that second more hellish ride straight to the bottom. In the short term the credit markets will get a swift kick when we finally have a large bank failure come to light. Give it 3-6 months and my FDIC insured money is on Bank of America (eventhough they passed their “stress” test). There goes the financing revival. Second of all housing will get another kick in the pants in two years when interest rates have to start going up again (to combat eventual inflation). We have seen the recent good news being the result of lower interest rates so what happens when those interest rates go up?
Also as any real estate agent will tell you “location, location, location”. Well while prices have begun to level in the outskirts like Vallejo they haven’t really begun their fall in Silicon Valley and the Peninsula. Right now people here think “whew that wasn’t so bad” (only a 10% drop in value) but in reality what these market movements (dramatically falling median home prices) presage is a large fall coming to the Peninsula this year. Yes everyone is buying homes in the cheaper areas of the “bay area” which is what is driving down the median. That means less buyers on the Peninsula (in which you can’t find any homes close to the current depressed median). Its only a matter of time before it finally hits here.
My prediction (or is that a “sinking feeling”) is that this summer will feel “soft” on the peninsula and that will prick the confidence bubble leading to the same panic here that happened last year in the suburbs. This is when 30-40% price drops (peak-to-trough) become a reality in Palo Alto by summer 2010. Additionally the bank efforts to artificially restricted supply of foreclosures will finally give way as all banks decide they need to get out before its too late.
Impossible you say? Remember it was once said that the housing market could not possible crash the same way the NASDAQ did during our last bubble. Really?? Have a look at this graph which offsets the NASDAQ peak to correspond with the peak in Bay Area housing prices.
Oh and lets not forget that the housing market is permeated by many myths that are proving to be quite untrue (and therefore won’t be there to save this market). For a detailed analysis of these myths please point your browser here.
On December 31st, 2008 I posted a sarcastic (and hopefully not too offensive) post about how GM’s Rick Wagoner could very well have been Jesus. In that I offered this little prediction:
Rick (at least his job) will likely be killed by foreigners (the same ones who have been persecuting “his people” for years)…
…and it will happen in the spring (end of Q1 2009)…
Well the end of Q1 2009 is March 31st and today March 30th Rick Wagoner resigned from GM. DAMN, I missed it by 1 day…
Now I’m ready to double down. GM goes into a pre-arranged bankruptcy by the end of May 2009.
Please make sure to reread some of my other GM commentary:
Its Time to Demote the General (from November 10th, 2008) in which I say (as a casual aside) that the AIG bailout will get larger and yet still fail (WOO-HOO, two-for-two)
An expose (of sorts) showing that many “Japanese” cars are actually more “American” than those made by GM, Ford or that company that begins with a “C”.
A humorous look at how GM can save not just auto industry but also retailers and home owners.
Chrysler is already a Japanese company. Afterall who else but the Japanese would partner first with the Germans (Mercedes-Benz) and then the Italians (Fiat) in what will turn out to be a failed effort for world (economic) domination.
Thanks for listening. Do us all a favor and please buy cars made in America (by Toyota, maybe Ford).
The Bay Area is still a highly desireable place to live so housing prices could never decline and if they did never that dramatically.
Houses take longer to sell and can’t be traded like a stock so prices can’t fall as fast.
Also since you can always live in your house (and you can’t live in your stock) there is no reason for a fire-sale so prices can’t fall as far.
At that same time I saw a chart of house prices in which the curve was shifting to the point where it was almost going straight up. That reminded me of what the NASDAQ looked like in March of 2000 and we all know what happened in April of 2000. So could this happen again? Were all bubbles fundamentally the same (eventhough the assets were dramatically different)?
Well clearly we are in the midst of a price adjustment but evenso it can’t be as bad as the NASDAQ, or can it?
So the other night I decided to do a little data-diving and found two key pieces of information:
Month-end NASDAQ prices from 1981 to the present.
Month-end median housing prices for the Bay Area back to 1987.
I then overlaid the data on top of one another after shifting the NASDAQ data up by 6 years. Why 6 years? Simply put the NASDAQ bubble popped in 2000. The housing bubble, it is currently agreed, popped in 2006. By shifting the NASDAQ data by 6 years we could see how well the curves aligned.
So what you see graphed below are month-ending NASDAQ prices starting in 1981 and month-end median house prices for the Bay Area starting in 1987. See anything interesting?
So there you have it. All three arguments as to why the housing prices wouldn’t collapse like the NASDAQ were COMPLETELY WRONG and now we see that no matter what the asset the dynamics of the bubble are the same. Yes it is true that the run-up in housing prices is not as fast BUT the fall was just about as fast and there is a good chance that it will go as far.
So next time someone says “this time its different” make sure to laugh discretely and sell quickly.
Now the next question is when do you buy? Certainly not now.
I wouldn’t advise using the chart above as a way to peg a specific date and I would go back to fundamentals. The key fundamentals you need to check are:
Is owning now cheaper than renting?
Are prices equal to or less than 3 times the median of incomes in the area?
If you answer “no” to either of these questions then DO NOT BUY.
Now what if the fundamentals do check out but the market is still falling? This is where the trend information in the chart can come in handy. To find a bottom wait until prices move upward for about 3 consecutive months (make sure they are prices for your city and NOT the county or region). If they do and the fundamentals still check out then its time to buy. While its true you will miss the absolute bottom its much better to buy on the upswing than to “catch a falling knife”. Until it turns you have no idea how much more its going to fall so its worth paying a small premium for some certainty. As you can see from the chart waiting a little bit won’t result in you missing a big upswing. It took the NASDAQ about 6 years to reach HALF of what it was worth at the peak. Missing three months of house price gains isn’t going to break the bank.
An article published on March 14th by Joe Nocera of the New York Times finally called it out clearly that homeowners who got in over their head shouldn’t be helped by the government. Take this part from Mr. Nocera’s article:
I suppose you could argue that most … lacked the ability or the financial sophistication of someone like Mr. Hedges. But it shouldn’t have mattered…
“These were people with a fair amount of money, and most of them sought no professional advice,” said Bruce C. Greenwald, who teaches value investing at the Graduate School of Business at Columbia University. “It’s like trying to do your own dentistry.” Mr. Hedges said, “It is a real lesson that people cannot abdicate personal responsibility when it comes to their personal finances.”
And that’s the point. People did abdicate responsibility — and now, rather than face that fact, many of them are blaming the government for not, in effect, saving them from themselves…There is a powerful sense that because the agency was asleep at the switch, they have been doubly victimized. And they want the government to do something about it.
And how about this snippet:
“The government should come and say, ‘We bailed out so many others, we can bail you out, and when you will do better, you can give us back the money,’ ” he (Elie Wiesel) said at the Portfolio event.
But why? What happened … is terrible. But every day in this country, people lose money due to financial fraud or negligence. Innocent investors who bought stock in Enron lost millions when that company turned out to be a fraud; nobody made them whole…People lose it all because they start a company that turns out to be misguided, or because they do something that is risky, hoping to hit the jackpot. Taxpayers don’t bail them out, and they shouldn’t start now. Did the S.E.C. foul up? You bet. But that doesn’t mean the investors themselves are off the hook. Investors blaming the S.E.C. for their decision to give every last penny to Bernie Madoff is like a child blaming his mother for letting him start a fight while she wasn’t looking.
OK, now for a little truth-telling. As you may have been able to surmise this WASN’T and article about housing bailouts but about victims ot Bernie Madoff’s Ponzi scheme but isnt’ the sentment the same? In fact its worse than that with respect to homeloaners. Here Mr. Nocera is saying that vicitms of an outright fraud and theft don’t deserve government help. The victims in the housing industry are, for the most part, NOT vicitms of fraud (yes there was some but seriously its a VERY small part of the market) and therefore should get even less help. I mean if you aren’t going to help vicitms of crime then why would you even help those that are victims of themselves and just plain bad circumstances.
Does it make any difference that the money lost was in investments as opposed to a house? Technically it shouldn’t (you spend less either way) but housing has been given a special, irrational place in society as something different. True you don’t live in your investments but you can always rent, you don’t have to actually own a house (and if you hold a mortgage you don’t “own” your house anyway, you have an option to own in 15-30 years). But renters are the invisible detritus of society but that is a topic better covered here.
HI!, yoo-hoo, over here, we are 100,000,000 men, women and children who rent and we seem to be invisible to you and the media (including NPR, New York Times and the Wall Street Journal) but clearly our numbers make us important. We are wondering why you are helping 9 million people at the expense of me and my 99,999,999 friends, neighbors and fellow countrymen. Not to mention the additional millions of former homeowners who will soon join us because they rationally decided to live within their means and rent.
But how is your plan hurting 100,000,000 renters? It is hurting them in three major ways:
By putting a floor (and debatable how stable or realistic that floor is) under housing prices above what they were before the bubble began you are continuing to price renters out of the market.
By raising the deficit you are going to be putting some of the tax burden on renters (yes some will go to homeowners as well).
Because many former owner-occupied properties have turned into rentals rental prices are actually falling. By keeping people in houses they can’t afford you will, in effect, raise rents again.
The net result is that you are charging renters, through the eventual taxes needed to pay for this, for the privilege of NOT being able to afford a house while also raising their current rents. This reminds me of the former Soviet practice of making soon-to-be-victims of execution pay for their own bullets and then charging their families for their burials.
Point #1: This plan is further eliminating renters ability to buy a home by reducing their income (through higher taxes and raising rents) and through maintaining artificially high prices (through so-called “stabilization”).
To make matter worse renters comprise those who either can’t or have decided not to overextend themselves to have the “American Dream” (which was originally “life, liberty and the pursuit of happiness” until it got co-opted by marketing experts in the real-estate industry in the last century). Renters are STILL disproportionately Hispanic and African-American and lower income. Homeowners are disproportionately white and have higher incomes.
Home Ownership by Race - (US Census Bureau)
Point #2:Helping homeowners at the expense of renters is yet another transfer of wealth from the lower class to the upper class. How Bush-league.
Oh and why would the the vast majority of homeowners (who do, truthfully, outnumber renters) care to help us ? Very simply because the survival of any market (or pyramid scheme which the housing market has proven to be) depends on a continous stream of first-time buyers to fuel growth from the bottom. By attacking renters you are attacking the first-time buyer base and, while you may temporarily save the market, you are draining the pool in the medium to long term.
Point #3: Homeowners need to watch out for renters if they want to truly protect their home values.
How can you help? Well if you can’t bring yourself to let the market work out the right price then at least provide renters with some rental income tax deductionsso they don’t wind up paying (two to three times) for the mistakes of homeowners. Additionally this will help incent those on the edge of home-ownership not to over-stretch to buy a house so they can get the equivalent mortgage income tax deduction. Its the least you can do.
Finally, of those 9 million you are helping, at the expense of 100,000,000, how many got themselves into their situations by cashing out their equity cushion for home-improvements, new cars or family vacations? I guess its comforting to know that the money we saved by renting will go to buy some nice stuff…even if it isn’t ours.
In all the financial press there has been much discussion about the shape of the recovery, always in the form of letters. Would it be a “V-shaped” recession – sharp drop followed rapidly by a sharp recovery? Or possibly “U-shaped” – sharp drop followed by a period of bottom-trawling followed by rapid recovery? Or even a “W” – two sharp drops with recoveries after each? Some have even proposed an “O” as in “O sh#t its never going to recover!”
I have found that letters cannot describe this recession. My belief is it will be a sharp drop (been there, currently doing that) followed by a long and slow climb out for stocks and house prices. Well nothing in the English alphabet can possibly account for this. So what could?
Stumped, I sat staring at my Smart Phone looking for answers and then it hit me. Looking above and to the right of the screen, not where I typcally find answers to my internet queries, I saw my cell phone carrier’s name and logo and VOILA!!!
Welcome to the official shape, logo and motto of The Great Recesssion.
Representative Barney Frank was quoted in the Wall Street Journal today (9/23) as saying:
“I just think it’s inconceivable that people would say that the taxpayers should put some money at risk because of bad decisions made by people who then continue to be rewarded without any restrictions and, in fact, would be rewarded for their mistakes,”
While he was referring to financial executives this logic also applies to the individual homeowners when considering the “bailout” and “mortgage relief”. It is wrong to have taxpayer money going to reward, without any restrictions, the bad financial decisions of corporate executives or our neighbors. We have to remember that a large percentage of loans that are currently going bad were due to voluntary cash-out refinancings and NOT new mortgage originations.
According to RealtyTimesin 2006 (the peak of the bubble) 80% of all refinancings involved taking extra cash out against the growth in home equity to pay down consumer debt. In short many of the people the government is trying to help with the “mortgage relief” plan are those who endangered their homes because of their consumer debt. Without that consumer debt they would not have refinanced and would have had an equity cushion to protect them in this type of market.
The net effect is the currently contemplated home-owner bailout is going in a large part (indirectly) to paying down consumer debt and rewarding consumers for profligate spending. Is that a proper use of taxpayer money? Not according to Mr. Frank
So back to Mr. Frank’s quote. What should those restrictions on homeowners be?
Raise loan standards to pre-bubble norms (e.g. stringent payment/income ratios, down payment minimums, loan documentation)
Limit loans/refinancings/modifications/relief to people that meet those proper standards.
Offer loans based on current house appraisal prices and at standard market (NON-subsidized) mortgage rates.
There is no objective/reliable way to determine who deserves help and who doesn’t (did you lie on your app? were you lied to? blow your equity on a new car?) so why not just use the proper standard consistently as that would be fair, logical, and not reward people for their mistakes. If you cannot meet the standard there is NO REASON why you should keep your house otherwise we are doomed to repeat this over-and-over again.
Its time for everyone to take their medicine (banks, financial executives and, yes Mr. Frank, even individuals). Don’t fear the falling of prices, welcome the reshuffling of assets from those that cannot afford them to those that can. That’s how you build an engine for growth and a stable economy.
Also remember that saving a borrower who can’t meet the proper standards prevents another family who could meet those standards from buying a home and therefore prolongs this societal pain.You are hurting as many people as you help.
Most of the panic going on right now is with the falling value of homes. Should you worry? For the most part you shouldn’t and just need to ride it out.
Lets face it when you buy a new car the minute you drive it off the lot its worth less than you owe on it yet you don’t see people abandoning new cars on the side of the road (although wouldn’t that be cool for the next person to drive past). Additionally, unlike many other investments, that car is never going to go up in value yet people still keep them.
Why do they keep the car? Because it provides ongoing value. No matter how much more your loan is than the value of the car it still transports you to where you need to go (with the exception of most American cars from the 1970s – 1980s)
Similarly savvy investors don’t dump all there stocks during every dip (yes many non-savvy do but any financial expert will tell you you can’t time the market so you diversify and ride it through).
Like the car your house provides ongoing value. Like your investments it will rebound off the lows. Granted it may not rebound all the way and it may not rebound fast but over the long-term the trend is up (unlike your car).
The only time you really need to be concerned is if you have some impending financial event or have your ego tied up in your house price, but in many of those cases you don’t need to worry (or shouldn’t have to worry). Lets look at those non-ego driven events:
Taking out an equity loan (Mostly DO NOT WORRY)
Seriously should you be doing this? Yes if you have a health issue or are recently unemployed you may have to (in which case you should WORRY) but if you wanted to go on that vacation or buy that new TV, or remodel your house then you should be upset but should NOT WORRY. Also remember it was these “cash-out equity refinancings” that got many people into trouble in the first place. To quote a classic Groucho Marx skit:
Patient: “Doctor it hurts when I go like this”
Doctor (Groucho): “Well then don’t go like this”
Selling your home to upgrade to another home (Mostly DO NOT WORRY, in most cases CELEBRATE)
Well there are two situations here:
You owe less than your house is worth: This is good for you if you are like most homeowners and looking to upgrade your home. Although you have “lost” money in the recent downturn on your house the house you are going to buy has lost more. For example lets say the market dropped by 10%. You are selling a house that was worth $300,000 and buying a house worth $450,000. Well your house has lost $30,000 of value but the house you are buying has lost $45,0000 worth of value. You come out AHEAD by $15,000. You should NOT WORRY and even CELEBRATE.
You owe more then your house is worth: Is this really the time to be upgrading? So in that case you should NOT WORRY. You’re just going to have to tough it out. If you have to move (e.g. job transfer) then you should WORRY.
Refiancing your mortgage: (Mostly should WORRY but also RESET YOUR EXPECTATIONS)
Well there are two situations here as well
Refinancing because you can’t afford the current loan. Here you should WORRY but at you may also want to RESET YOUR EXPECTATIONS. If you can’t afford something you can’t afford it.
Refinancing because you want to take advantage of a better rate: Sure this is annoying if you can’t do that but at the same time you still can afford your mortgage so you should NOT WORRY.
So in short there are some reasons to WORRY but for the most part you should NOT WORRY. Granted you can get angry, and feel like you aren’t getting all you deserve but in the end you still have a house and you still have your health.
So I have a very simple question, why don’t we get our bailout ideas from someone who knows how to pick a market as opposed to a former Wall Street CEO, failed President and 535 desperate and economically naive, attention/vote hungry lawyers? Its not elegant but why not just take a page from Warren Buffet?
So he recently gave a cash infusion to Goldman Sachs (see the Wall Street Journal article) in a way meant to maximize his shareholder(s’) value. The plan basically provided money with a fat interest rate that gave him priority over the exisiting shareholders. Simply put he got protection and payout while the normal Goldman shareholders assumed most of the risk. Isn’t that what would make for a very palatable bailout (in the eyes of the taxpayer/investor) for the rest of the banking industry?
True, Goldman is a going concern and the “cream of the crop” in terms of banks. That is different then the cream-of-the-crap that we (the US taxpayer/investor) would be investing in but we would be the preferred shareholders. If anything that is much better than purchasing, by design, self-described “toxic assests”.
This plan has all the benefits of the equity portions of the bailout plan with much less of a downside, namely:
No valuation issues so its quick to accomplish. Here’s $5 billion, give us a check for $500 million every year and we’ll call it square.
First in line for payback so we get the upside
Last in line for risk so we don’t get, for the most part, the downside
Shame on the Wall Street Journal today for advising people, as a way to survive this downturn, to refinance their mortgages without giving them the caveat of “save now, pay later” in this article by Brett Arends . The key point is that while you can lower your current cash flow requirements by refinancing you will pay for it on the back end unless the interest rate drop is severe and also depending on where you are in your loan. Worse yet this article encourages people, without warning, that that would be an excellent source of cash. In other words a cash-out refinancing which is what got most people into the current mess by removing the equity cushion from their homes to protect in a downturn.
Here’s an example. You currently have a $300,000 mortgage at 6.5% on a 30 year fixed. You are 7 years into this mortgage.
Monthly payment is: $1896
You have already spent $159,281 (in interest & principle)
You have a remaining balance of $271,248 on it
Your total payout at the end of the loan will be $682,633
Now you decide at this moment to refinance the remaining $271,248 at 6% on a 30 year fixed:
Monthly payment is: $1626 (a cash-flow improvement of $270 per month – that’s good)
Your total payout on this loan will be the combination of what was paid out before refinancing ($159,281) and what will be paid out on the new mortgage ($585,456).
Your total payout at the end of the loan will be $744,737 (an out-of-pocket INCREASE of $62,104 – that’s BAD)
In short improving cash flow now does have its costs and its not a simple solution and requires “doing the math” first. Unfortunately it is this lack of knowledge on the part of the consumer that got us into this mess in the first place. I hope the Wall Street Journal won’t continue to spread half-truths that will only have us in this situation again, 10 years hence.
In America home ownership (or is that “loanership” as Americans own less than 50% of equity in their houses according too USA Today) and spending make you cool. Renting and saving is un-American and suspect. Its time to realize that home loanership is not the ideal but just one option of being American that is right for some people and wrong for others.
Shame should not fall to those that don’t own a home but to those that don’t properly live within their means. The heroes that we should celebrate aren’t the ones with the most toys but the ones who are happy with their lives no matter their economic level.
Lets look at the middle-class peers of my parents in the Inland Empire in Southern California (yup, ground zero for the housing meltdown) who took out their home equity to buy new cars, large screen TVs, etc and are now foreclosing with abandon. To put matters in perspective if you bought a house in 2000 and sold it in 2006 in that area you would have seen a 250% appreciation in value. If you waited until 2008 you would have seen a 50% appreciation in value because of the collapse of housing values. So its all about perspective. If you didn’t know about the 250% option you would think you were doing pretty good and wouldn’t be upset about your current situation. However no one takes the long view and is now UPSET about only getting a 50% appreciation in that time frame (having spent the other 200% of appreciation on disposable assets)
Lest one thinks I’m heartless I would rather have seen this $1 trillion NOT have to go to a bailout (although as an economic realist I realize its now a necessary evil) but to have gone to a safety net so all could participate in the economy and earn the honor of living happily within their means.
With apologies to Mr T, don’t pity the fool, lionize the smart.
No longer should the 3 most important things in real-estate be “Location, Location, Location”. Instead it should be “Education, Education, Education” and it should be applied to ANY form of investing.
Quick quiz, how many of you believe that one of the disadvantages of renting is you throw your money away? Common answer is “absolutely”. Correct answer is “it depends”. For a full analysis see this article. To do the actual math see this rent vs. buy calculator,
The problem is that for all the proposed solutions to the current financial crisis ABSOLUTELY NO ONE is talking about consumer education. Its all about protecting the consumer with regulations as opposed to education. Well whatever your political view on regulation/deregulation (BTW its not about more or less regulation its about the right type of regulation) I can absolutely guarantee you that it WILL NOT prevent the next financial scandal no matter what we do now. The crooks/financial geniuses/snake-oil salesmen will ALWAYS be ahead of the regulation and if the population is not educated we will have the next crisis (circa 2018-2021).
Want proof look at the previous bubble. Like this one it was driven by the same old mechanisms including good old fashion lying, cheating and, of course, greed (banker, business and, yes, individual). That bubble was based on tech stocks in which easy money was available, valuation estimates were, uhm, inflated and the common consumer could easily invest over his/her head (sound familiar?). The result of that collapse was more regulation like Sarbanes-Oxley and other accounting rules but not so much in the way of education. PHEW, now everyone would be safe…
Now its almost 9 years later and everyone was protected…from another tech stock bubble. But wait, didn’t Joe Six-Pack as well as the economy just get screwed (and screw themselves) again with an entirely different asset class? Yup, but his time it was housing.
So, in short, wherever you stand on regulation (pro or anti) it won’t be sufficient to protect you in the future. You need to complement that with education so you can spot the too good to be true offers. Just ask Greg Brady in The Brady Bunch episode “Wheeler Dealer” (Season 3, Episode 4) in which he buys a $100 car that, OMG, turns out to be a lemon. Mike Brady is there with the fatherly advice ”Caveat Emptor”. Don’t know what it means? Look it up it will be good exercise in doing research.
So get smart and get prepared because the wolves, while being hunted now, will be back (in new sheep’s clothing) and no amount of regulation can completely protect you.
Are you financially responsible and upset that your money is going to BRIBE people to stay in their homes EVEN THOUGH they can make the payments. Well if you are you can write to the new Chief of Homeownership Preservation Donna Gambrell at Donna.Gambrell@do.treas.gov and let her know that the Treasury Department should NOT do this.
She (or at least her office) has already been kind enough to respond to me so she is receiving email.
Let’s face reality. General Motors has had cancer for over 35 years that just reached all the major organs. Back in the early 1970s they first encountered a surprising spike in high-priced gas during a time when they sold fabulously large and gas-guzzling vehicles (deja vu?). At that time Toyota was not even a viable competitor but because they made smaller cars they had a more fuel efficient fleet (and, believe it or not, lower quality) and they were able to grab an increasing share of the market. Dumb luck played into their hands but they seized the opportunity.
At the same time of Toyota’s ascendancy GM, however, took an entirely different tack (I know I worked there from 1988-1992 and yes worked on the Saturn EV-1 doing all the initial market research). They continued to lose market share by ignoring the market or, even when they got it right, building poor quality product, or even when they got that right doing a poor job of pricing or marketing them. They even had the world’s first alternative fuel vehicle (Saturn EV-1) and gave up on it when California law no longer required it. Toyota, on the other hand, stood by the Prius for 11 years and now look at it.
The sad truth is that the weakness of the GM business model means that, at best, GM can survive (no matter how much help they receive) as a much smaller entity. It is fruitless to provide a “bail-out” and any assistance should be in the form of a bail-down. It should be designed to allow a smooth downward transition of GM, maybe not to oblivion but to a much smaller company with AT MOST 3 domestic divisions (I vote for Cadillac, Chevy and Saab) as opposed to the 8 they have today (more than they had when they had 50% market share then as opposed to 25% now). No matter what is done jobs will be lost as GM cannot continue to survive in its present form or present size (and there is 30 years of trend data to back that up).
Looking at any help for GM as a bail-down as opposed to a bail-out also helps to make better decisions that have a longer term positive impact. A bail-out pours money into an archaic “blue” AND “white” collar management structure that cannot operate efficiently and will only continue to decline (throwing good money after bad). A bail-down shifts those funds to the innocent victims, namely the individual employees (in the form of unemployment benefits, retraining, relocation) currently trapped in that archaic structure and provides a transition out and the ability to reorganize for more efficient use of their labor in growing companies. It seems to be an overlooked fact that there is actually an American automotive company that is hiring and even building a new plant. Its called Tesla and its here in Silicon Valley. Lets get some of those employees some plane tickets (to save on additional fees at the gate leave the union baggage behind). Not to mention they could buy some of those foreclosed houses in Gilroy and Vallejo we need to get rid of thereby solving two problems at once.
A lesson to learn from the AIG is that those initial bailouts never work and only get larger as time goes on so that is why a much more metered and purposeful response is in order that benefits the individuals and not the companies.
Oh and President-Elect Obama I have good news for you. You have a vision of one day being able to buy a hybrid or alternative-fuel vehicle made right here in the United States. I applaud that vision and am happy to tell you that two years ago today I traded-in my old gas-guzzling Pontiac for a beautiful mid-sized HYBRID family car made right in Lexington Kentucky that gets 35 MPG OVERALL and has more domestic automobile content than the Ford Mustang. Its called a Toyota Camry.
We keep talking about the bailout of the American auto industry but for years now the domestic content (the amount of American materials and labor used to make that car) of the Big Three has been falling while the domestic content of the “foreign” companies has been growing.
Here’s an interesting stat. The Toyota Camry (one of the most popular cars, by sales volume, in the United States) is produced in Lexington Kentucky and consists of 80% American content, the Honda Accord (another one of the most popular) has 70%. The all-American muscle car, the Ford Mustang, consists of 65% American content. Surprised? Well then check out this study by The Federal Reserve Bank of Chicago (one could argue a “pro-American” organization).
One noteworthy quote from that study is:
“Today the distinction between “American” and “foreign” vehicles is not so clear: Some models produced by the American-owned Detroit Three carmakers have a smaller share of domestic parts than models produced by foreign-owned carmakers.”
So ask yourself is a bailout of the Big Three truly a bailout of the American automobile industry or just a bailout of the worst American auto industry players? Also ask, does Toyota get a bail-out as well so they can retool their American factories to build more fuel-efficient cars? Oh, that’s right they already have, my Camry Hybrid came from that Lexington Kentucky plant OVER TWO YEARS AGO.
In the 1970s when General Motors had 50% US market share they had 5 consumer divisions (we’ll leave GMC as a “business” division).
That meant that each division, could, on average, have 10% market share. That’s an OK-sized business.
Now GM has 7 divisions (again leaving GMC aside) and has 25% market share.
That means that each division could, on average, have less than 4% market share (3.57% to be precise). That is not a very healthy nor sustainable business model (given the marketing and infrastructure costs to keep these divsions alive – as it were)
This division is the heart of GM’s division problem. Before they can ever even hope to get better they need to benefit from a concept that made them successful in the past, namely “economies of scale”. Right now there is no chance to take advantage of that because they have NO SCALE.
This is why there should not be a bail-out of GM and at most a “bail-down”. They should pare down to 3 divisions at most (Cadillac, Chevy, Saab)
Until they scale-down they can never hope to scale-up.
GM has set up a number to have your voice heard. Granted they want you to call and profess support but you can also call this number to say “NO!” to bailing out inefficent companies that have had ample time to fix it themselves (35 years since this problem happened once before).
Simply call 1-866-927-2233, enter your zip code and you will be able to connect with your representatives (Senate and House). When you are connected say:
“I DO NOT support any bailout of General Motors (or Ford or Chrysler) and feel that, in the long run, the country will be better positioned if the current companies are left to make the hard-choices that will make them competitive in the future.”
In addition you can also send a personalized email to the President, Vice President and your members of congress though FreedomWorks.org.
I recently stumbled upon this excellent response to a misguided New York Times editorial that argued that GM needed to be protected from bankruptcy. The response, posted by Mr. Lancelot Fletcher, argued that, in fact, bankruptcy was exactly the remedy that is needed, is not all that bad and is the best course for GM and the economy. While these were the exact points I wanted to make Mr. Fletcher beat me to it and I like to give credit where credit is due. To that end I have reproduced Mr. Fletcher’s comments below:
Isn’t this — the current plight of the big auto makers — exactly what Chapter 11 of the US Bankruptcy Code was designed for? Chapter 11 is not the “drop dead” option. (That would be Chapter 7.) A Chapter 11 debtor normally proposes a plan of reorganization to keep the business alive, pay creditors over time, and ultimately return to profitability. Many large companies have entered Chapter 11 bankruptcy without ceasing operations and some (e.g. Delta Airlines) have subsequently emerged as profitable enterprises.
I don’t think the opponents of a Washington bailout for the auto industry are proposing that the Big Three should be simply liquidated under Chapter 7. Hence talk about the millions of jobs that would be lost if bailout legislation is not enacted is misleading and exaggerated.
If the opposing sides on this issue would listen to each other, they might discover that they are not that far apart. The advocates of the bailout are not proposing to have the government simply lend money to the auto companies with no strings attached. They are proposing to require, as a condition of the loan, that the industry agree to a far-reaching reorganization of the industry. On the other hand, reorganization is precisely what is required in a Chapter 11 bankruptcy. It’s true that in a Chapter 11 bankruptcy the US Congress does not normally get to dictate the terms of the reorganization. But most Americans would probably agree that having the government specify the terms of business organization is not a good idea. So the argument of the opponents of the bailout might be that we should not enact new laws to do what the existing laws are already capable of accomplishing.
On Saturday there was an article in the New York Times entitled “At GM, Innovation Sacrificed to Profits“. The headline of this article should have been “At Congress, Innovation Sacrificed to Profits” and it should have been about the House’s current proposed solution to GM’s “problem” because the parallels are prophetic, ironic and downright scary. According to this article, GM, when faced with a chance to innovate, would eventually take the money for innovation and redirect it to fund the base business.
If the current proposal goes through to reassign the $25 billion fund, which is slated for innovation, because, and I quote the article, “the money was needed elsewhere” then Congress will be following in GM’s footsteps (a set of footsteps it has been criticizing strongly for the past two weeks) and, one can rightfully assume, will be doomed to the same fate – That’s the PROPHETIC.
Are Ms. Pelosi and Mr. Frank aware that they are behaving just like GM in their current actions? That’s the IRONIC.
While GM can go to Congress when it fails who can Congress go to when it makes the same bad decisions? We the taxpayers – That’s the SCARY.
Is anyone else concerned that Congress has shown no ability to learn EITHER from its own mistakes (how’s their last financial bailout plan going?) let alone the mistakes of others? That’s just SAD.
I am proud to announce a new feature of “Watching the Marcitz” called “Letters to the Editor”. I myself have often written letters to the editors or commented on articles on their websites. The problem is the chance of publication in the printed edition is slim-to-none and often the website postings are moderated. In the desire to allow the free-form change of ideas I will be posting articles relevant to the topics covered here and allowing anyone to publish their comment against those articles.
Also I will be accepting nominations for articles to place on this sight so you, your friends or anyone else can comment on them.
To see the articles availale for comment please check out the Letters to the Editor category. If you seen an article you would like to comment on then click on that post and submit a comment at the bottom.
I hope you enjoy the increased freedom of speech this new feature provides.
So today President Bush in his last (we can only hope) in a string of failed crisis management efforts proved that he couldn’t even get being a Republican correct. “Non-binding” was often the strategy used by the Pelosi congress to enact “concessions” from the Bush administration on the war in Iraq. How’s that working?
Well the proposed “non-binding provision” laden loans given to auto-makers, I can only assume , will have the same success. March 30th watch for the headline “over 4000 have died in effort to save the Auto Industry, loan surge proposed to stop the bleeding”. Thank you President Pelosi!
Not long after receiving a federal bailout General Motors announced today their new “Mortgage too heavy? Move to a Chevy!” program to provide a lifeline to victims of foreclosure while turning around failing demand for its line of cars. The new program is designed to allow underwater homeowners to swap out their homes and move into a brand new vehicle from General Motors.
With the price of the average American home hovering around that of a 2008 midsized sedan, General Motors Rick Wagoner thought the time was right for this innovative program. “Remember when you had to be a wealthy Hollywood star to live in Malibu. Well now even the poorest former homeowner can too just by going to their local Chevy dealership, where there are enough Malibus for everyone, at bargain basement prices.” Wagoner then went on to highlight the advantages of living this way, ”…unlike a typical home, with only a front and a back door, this one has four doors. Think of it as a private entrance for each family member. Now that’s luxury!”
Retailers have also applauded the move. Ellen Davis, Vice President of the National Retail Federation, saw an opportunity. “Empty stores have meant empty parking lots”, said Davis. To deal with this problem NRF and GM have partnered to rent those spaces to new GM homeowners. Davis went on “Its a win-win situation, our customers get a home, a place to park it and access to the clean bathrooms in our stores which means we’ll finally be able to generate foot traffic in time for the next holiday season.”
When asked about GM’s past failures to improve fuel efficiency Wagoner responded, “We are now providing a way to reduce green-house gas emissions from homes by 100%. You know how much less fossil fuel it takes to heat a Buick than a 2000 square foot house? Lets see Toyota top that!”
Wagoner expects to capture 20% market-share of the 10 million foreclosures expected next year leading to a net increase in vehicle sales of 2 million in 2009 alone.
Executives and workers at cross-town rival Chrysler have alredy expressed interest in the program not as competitors but as actual buyers. Executives for Cerberus, Chrysler’s owner, could not be reached for comment.
Even with this innovative program GM’s famous marketing strategy “A car for every purse and purpose” has not been forgotten. For those that haven’t been hit as hard by the economic downturn GM offers a a more spacious 2-bedroom Homevee which sleeps both you and your foreclosed neighbors comfortably, although your comfort may vary.
I now have dug up email addresses for Obama’s top two economic advisers Timothy Geithner and Lawrence Summers. See this page to see how you can email them and make sure that irresponsible homeowners are not bailed out.
So fundamentally I am totally against “cram-downs”. This is the idea that one should reduce (cram-down) the amount owed on a house to put it more in line with the new (reduced) value of that house so a person can refinance or won’t just abandon the property.
Unfortunately I fear political winds are going in this direction so I want to propose that we at least have one way of doing this that protects taxpayers, encourages the right kind of behavior going forward and isn’t just a handout to the unfortunate or financially ignorant or profligate. That lesson comes from the way venture capitalists invest in Silicon Valley startups and the answer is “cash for equity.”
Yes cash for equity has already been done with the money going to the banks but the valuation method has all been wrong. For housing cram-downs its very simple and it aligns everyones goals (at least the ones we want to support)
Take for example you have a house that has $600,000 in loans against it but it is now worth $500,000 . The owner is seeking to refinance it but can only do so for $500,000 so they need a $100,000 “cram down”.
If the government (or the bank ) provides it they should get a percentage of equity in the house equal to the cram down amount divided by the new appraised value of the house.
In this case that would be $100,000/$500,000 = 20%
Now when the owner goes to sell the house 20% of the proceeds immediately go to the entity providing the cram-down (government, bank, etc..).
Why is this fair? Well if you are going into foreclosure you have effectively lost the asset. Refinancing is a way to buy it back but to buy it back you need a partner to provide some of the financing. So, in this example, you are effectively asking someone for $100,000 to buy a $500,000 asset (remember $600,000 is irrelevent at this point in the game). They are putting up 20% of the money so effectively they own 20% of the equity.
Here’s why you do it this way:
Supposedly preventing foreclosures will “save the market” so the taxpayer/bank investor should get to partake in the upside (and share the risk on the downside).
If the goal is to keep people in their homes with our money then those people better damn well stay in those homes. This will make that likely because they’ll have to wait it out until either they have paid down the principal on their loan by the equity percent or the home has risen in value enough so they can sell the home and pay off the cram-down equity holder and the mortgage lender.
This should also separate the real homeowner from the “flipper”. The “flipper” won’t want this “long term commitment” and will just give up the house. The real homeowner who is committed to staying will be much more agreeable because they truly plan on riding this thing out.
Administering this program is simply done by the IRS which is informed of all major income events and can act as a collection mechanism for this.
So PLEASE don’t do cram-downs but if we must lets do them right. It works for Silicon Valley to take cash for equity so why not let it work for the rest of the country.
Finally a lower cost way (from a taxpayer perspective) to keep many people in their homes and to prevent foreclosures. Lets start with the only two reasons for foreclosure:
You can’t afford your house.
You can afford your house but choose not to (e.g. because its “under water”).
The thing is that there is a big difference between the two. The first are unlucky or irresponsible. The latter are engaging in common extortion by threatening to help trash the economy if they don’t get paid off through debt restructuring (even though they can afford their homes without help). Simply put they are real estate terrorists and we shouldn’t negotiate with terrorists
So how do you differentiate the between the two? Very simple, instead of using a carrot (restructurings) to keep #2 in their houses use a stick (more severe penalties for leaving). Carrots are expensive and we all have to pay for them, sticks are cheap and don’t cost taxpayers a dime.
Foreclosures look bad on your record but we should make them look worse than if you declare bankruptcy. If you abandon your house we should double the time it stays on your credit report, put a lien on any future tax refunds that then gets paid into a foreclosure fund to pay banks at least part of the debt lost from those who abandoned their houses (that might also help relieve the negative downward pressure on banks’ desire to lend). Even tax, as income, the amount left behind on the loan as if it were a forgiven loan. Oh, I’m open to other punishments from people who know better.
Now what about those that truly can’t afford their homes, should they be punished as severely? Well they can be offered a trade-off. Simply put if you declare bankruptcy (which if you are truly under financial water is a viable option) you don’t suffer the enhanced punishment for those who don’t declare bankruptcy. As stated above this may even be a better option with less severe penalties. Granted there are still penalties but now bankruptcy is the more attractive option.
Why favor bankruptcy as opposed to foreclosure out of bankruptcy? In bankruptcy you have to report to a bankruptcy judge that helps you make the tough decisions to become financially solvent again and the burden is on you. In bankruptcy you learn how to get back on your feet and stay on them. If you just walk away from your house in a standard abandonment you learn nothing, the burden is mostly on others, and may very well find yourself in this situation again (and so will all those around you who pay to bail you out).
So now you have a choice. If you are truly bankrupt you declare bankruptcy. If you aren’t you may have to think twice about walking away because you either face even more severe penalities than you would have in bankruptcy. You certainly won’t declare bankruptcy because well, uh, you’re not really bankrupt. You’ll just have to stay in that house and tough it out at no cost to the taxpayer. Oh and we just prevented a foreclosure.
