What started with the subprime mortgage crisis has spilled over into the general economy. So the government decided to bail out banks, AIG, Fannie Mae, Freddie Mac...
Of course it was inevitable that any large corporation that was experiencing financial trouble would be lining up at the money trough for a handout. But is that really the best use of taxpayer money. GM has squandered their money, what makes people think they'll do any better with taxpayer money? GM has invested hundreds of billions of dollars with virtually nothing to show for it. They have made bad decision after bad decision. Their market share has dropped from 50% to 20%. They can no longer afford all the commitments they made when they had 50% market share. The only solution is to either have GM declare chapter 11 or allow the market to crush GM into oblivion. I believe most of those employed by GM will find lucrative employment elsewhere in our economy. We'll need to provide training and placement assistance but in the long run it is the best solution.
Monday, November 17, 2008
Monday, November 3, 2008
What next!?
Now banks are afraid that if they don't take bailout money they'll be viewed as uncreditworthy by the market.
Saturday, November 1, 2008
Looking to the future
I think the best mechanism for preventing future disasters like the current
mess is to anticipate problems before they begin.
For a moment put aside the idea that mortgages were given to people who
couldn't afford to repay them and take a giant step back.
Before a financial institution would provide that kind of a loan they would
have to find some way to get rid of the bad loan. Their solution to
divesting themselves of the bad loan was to separate the asset from the
liability through securitization.
While securitization isn't inherently a problem, it is when you're talking
about subprime mortgages. I think securitization of prime mortgages is
fine.
mess is to anticipate problems before they begin.
For a moment put aside the idea that mortgages were given to people who
couldn't afford to repay them and take a giant step back.
Before a financial institution would provide that kind of a loan they would
have to find some way to get rid of the bad loan. Their solution to
divesting themselves of the bad loan was to separate the asset from the
liability through securitization.
While securitization isn't inherently a problem, it is when you're talking
about subprime mortgages. I think securitization of prime mortgages is
fine.
Thursday, October 30, 2008
The Exploding ARM
Why are there so many foreclosures? It isn’t because of massive unemployment or a horrible recession (although the subprime mess has caused a recession). No, the answer is simply because too many people bought more than they could afford.
Before we dive into the details of the current financial crisis, let’s look at the loan that I believe started this mess: the option Adjustable Rate Mortgage (option ARM), also known as the exploding ARM.
This loan has several options that can get a borrower in big financial trouble.
• One option provides for a very low introductory interest rate that adjusts to a higher rate after one to seven years.
• Another option allows the borrower to pay only the interest on the loan for a specified period of time and then the rate adjusts and the borrower must pay interest and start repaying the principal.
• Another option allows the borrower to pay less interest than what is due, with the balance added to the mortgage (negative amortization).
• There are many other variations to the option ARM.
Frequently option ARMs carry a pre-payment penalty. In other words, if you pay off your mortgage early or if you refinance your loan you’ll have to pay a financial penalty. Sometimes these penalties can be very, very large.
Some option ARMs carry balloon payments in which the borrower will have to pay off the loan at the end of a specified period of time. For example, the loan payments may reflect a 40-year amortization but the total amount of the loan will be due in five or seven years. For example, a $185,000 loan with a 40-year amortization schedule would mean a monthly payment of $1,083. But at the end of the 5 or 7-year period you’d have to repay the $185,000 or get a new loan. Not a bad deal if:
• Interest rates don’t go up.
• There isn’t a big pre-payment penalty.
• You can afford a traditional 30-year mortgage payment; say 6.5%, which would mean a payment of around $1,250.
• You can refinance after five or seven years. Some reasons you may not be able to refinance include:
o The bank is no longer loaning money in that particular neighborhood.
o Some of your neighbors’ homes have been foreclosed driving your property value down and now you don’t have enough equity to qualify for a loan.
o Your credit score has declined and you no longer qualify for a loan.
o You’ve lost your job or don’t have the income to qualify for a loan.
Before we dive into the details of the current financial crisis, let’s look at the loan that I believe started this mess: the option Adjustable Rate Mortgage (option ARM), also known as the exploding ARM.
This loan has several options that can get a borrower in big financial trouble.
• One option provides for a very low introductory interest rate that adjusts to a higher rate after one to seven years.
• Another option allows the borrower to pay only the interest on the loan for a specified period of time and then the rate adjusts and the borrower must pay interest and start repaying the principal.
• Another option allows the borrower to pay less interest than what is due, with the balance added to the mortgage (negative amortization).
• There are many other variations to the option ARM.
Frequently option ARMs carry a pre-payment penalty. In other words, if you pay off your mortgage early or if you refinance your loan you’ll have to pay a financial penalty. Sometimes these penalties can be very, very large.
Some option ARMs carry balloon payments in which the borrower will have to pay off the loan at the end of a specified period of time. For example, the loan payments may reflect a 40-year amortization but the total amount of the loan will be due in five or seven years. For example, a $185,000 loan with a 40-year amortization schedule would mean a monthly payment of $1,083. But at the end of the 5 or 7-year period you’d have to repay the $185,000 or get a new loan. Not a bad deal if:
• Interest rates don’t go up.
• There isn’t a big pre-payment penalty.
• You can afford a traditional 30-year mortgage payment; say 6.5%, which would mean a payment of around $1,250.
• You can refinance after five or seven years. Some reasons you may not be able to refinance include:
o The bank is no longer loaning money in that particular neighborhood.
o Some of your neighbors’ homes have been foreclosed driving your property value down and now you don’t have enough equity to qualify for a loan.
o Your credit score has declined and you no longer qualify for a loan.
o You’ve lost your job or don’t have the income to qualify for a loan.
Saturday, July 26, 2008
Subprime Questions
Why would banks, the pillars of fiscal responsibility and risk aversion, lend money to subprime borrowers who couldn't afford to repay their loans?
You'll find the answer to these and other questions in my book, 'Subprime Meltdown: From U.S. Liquidity Crisis to Global Recession', published in July '08. http://www.amazon.com/Subprime-Meltdown-Liquidity-Crisis-Recession/dp/1438236611/ref=ed_oe_p
How did Wall Street manage to hide the risk and sell the subprime mortgages?
How did the subprime mortgage business unravel and evolve into a worldwide liquidity crisis?
What are the frauds and scams, how do they work and what should you look out for?
What's the forecast for the future and what conclusions can be drawn?
Why are there so many foreclosures?
You'll find the answer to these and other questions in my book, 'Subprime Meltdown: From U.S. Liquidity Crisis to Global Recession', published in July '08. http://www.amazon.com/Subprime-Meltdown-Liquidity-Crisis-Recession/dp/1438236611/ref=ed_oe_p
Subscribe to:
Posts (Atom)
Posts
