Understanding the Bailout

One important part of the Fannie and Freddie takeover is that is can be distilled down for the masses to understand exactly what is happening. Not everyone has a finance or legal background to read through all of the technical information, but those that do can decipher it for us. The Philadelphia Inquirer does a good job with this in the article titled What will happen in the wake of bailout. Lets take a look -

If you were hoping to retire on your Fannie Mae/Freddie Mac stock portfolio, you'll need another plan quickly.

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The takeover was designed primarily to turn Fannie and Freddie debt into government debt, which global capital markets would be more willing to buy. That will increase the amount of funds available to the primary mortgage market.

In addition to promising $200 billion in capital if necessary, the government now holds about $1 billion of senior preferred stock in each company, and it pledges to buy $5 billion in mortgage-backed securities.

Now holding all the cards, Uncle Sam will be first in line to get its 10 percent dividend.

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There will be more mortgage credit available, and that will reduce concern about getting enough money to buy a house, meaning price declines will slow.

Good synopsis for the layman. The article also predicts that the bailout may slow down the slump in housing prices.

More of the old "capitalist" issue of socializing the losses but privatizing the profits. It appears that this may be tweaked a bit, but it will be a wait and see if taxpayers actually get any part of the dividend.

Someone else describes the bailout is kicking the can down the road - just putting of the problem for a few years. Hoping the patch holds up and everything is OK as we move ahead. One big aspect appears to be "wait and see".

Fannie and Freddie Issues

Some things are just are a bit out of our area of expertise so it can be difficult to really grasp the complexities involved - so instead we rely on people with significantly more knowledge in the department. Here are our recommended blogs for a deeper understanding of the Frannie and Freddie takeover/rescue/bailout -

• Calculated Risk

• The Big Picture

• Naked Capitalism

• Mish's Global Economic Trends Analysis

Difficulties in obtaining credit

Credit will be get harder and harder to obtain as the credit crisis spirals downwards. Between old credit lines getting reduced or shut down completely and new credit almost impossible to get things are going to get even tighter. This issues is discussed in the article titled It's a hard time to get new credit from the San Francisco Chronicle. Lets take a look -

With lenders reeling from the housing collapse and loan losses mounting, the crunch is intensifying, economists say. That foreshadows a long and difficult stretch for households and businesses, as loan markets struggle to regain footing.

What started out more than a year ago as a lender panic over mortgages has worked its way through the gamut of business and consumer finance. The result is that all kinds of loans, from mortgages to student loans to credit card debt, have become scarcer and more expensive.

"Credit is just plain hard to get. There's not much availability, and it comes at a very high price," said Jim Wilcox, an economist at the Haas School of Business at UC Berkeley. "Consumers are less able to buy new cars or go on expensive vacations. This is hurting employment and hurting the economy very broadly."

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Mortgages, of course, have become more expensive because it's harder for lenders to sell them to investors. The huge loan losses posted by Fannie Mae and Freddie Mac, which buy mortgages and repackage them for sale to investors, have forced the two mortgage giants to cut back their role as middlemen, putting upward pressure on rates. Thirty-year fixed-rate mortgages average 6.2 percent, up from about 5.8 percent at the end of March, according to Bankrate.com.

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Credit lines on home-equity loans and credit cards are being slashed. A survey of more than 1,000 people nationwide conducted by the San Francisco group Consumer Action found that almost 10 percent had had credit card limits lowered in 2008. And rates on credit card balances are getting boosted even for customers who follow the rules.

So much of consumer spending during the bubble was based on credit. People simply do not have the available cash and savings to make up for the loss of credit and equity. Rather than building a savings account the bubble brought us the illusion that equity would be the emergency money to fall back on. Now the emergency cushion has deflated and many have nothing to fall back on. Instead of making drastic changes it is easier to look for credit lines elsewhere. But those are not easy to find either. This is affecting the economic feedback loop.

Grabbing the Equity in Kinnelon

Commonly when we look at owners who refinance and lose their homes it is because they repeat the process over and over again - which we call serial refinancing. However there are those that only refinance once or twice and lose everything. Perhaps there were difficult circumstances that caused the equity withdrawal like health or employment issues. Or the one-time large equity withdrawal was for some type of investment - retirement property, real estate investment or business venture.

During the bubble financing was commonly given on the value of the property not the ability for the owner to repay. Whatever the reason for grabbing their equity today's example was not able to keep up on the payments. Lets take a look -

Here is the property -



Here is the property info -

Property Features
Single Family Property Status: Active County: Morris Year Built: 1962 5 total bedroom(s) 3 total bath(s) 3 total full bath(s) 11 total rooms	Style: Colonial Living room Kitchen Basement Bedroom(s) on main floor Basement is Finished Parking space(s): 2 2 car garage	Attached parking Heating features: Gas-Natural Interior features: Eat-In Kitchen,Ground Level Rooms: 2 Bedrooms, First Level Rooms: 2 Bedrooms, Dining Room, Kitchen, Living Room Exterior construction: Aluminum Siding Roofing: Asphalt Shingle Approximately 0.21 acre(s) Lot size is less than 1/2 acre

Here are the financials -

• The property was purchased in October 1993 for $164,500.

• There are no mortgages available on the database until April 2005 for a mortgage for $500,000 with New Century Corp.

• In January 2006 a new mortgage was taken for $128,000 with WMC Mortgage.

• Another mortgage was also obtained in January 2006 for $512,000 using an ARM with WMC Mortgage.

• The foreclosure process started with Lis Pendens filed in April 2007.

• The property is currently an REO listed through a realtor with a listing price of $485,000.
  

The Morris County database has information available online from about 2000 to present. This was at the start of the Great Housing Bubble when property was inflating in double digit gains and equity withdrawal was easy. Pre-bubble borrowing was no where close to bubble levels. Most likely other than a lowering the rate refinance or a conservative HELOC money was not withdrawn during the years before the database was online.

Assuming that the 2006 refinance payed off the 2005 refi - the total cash out was $640,000. The lenders stand to lose at least $184,100 if the property sells for the full asking price through a realtor.

The huge equity withdrawal 0f $640,000 with all of the purchase money pulled out plus $475,500. This happened late in the ownership timeline and gave the owner averaged a second income of $42,667 for each of the 15 years of ownership. Nice when the house pays you, especially a second income that is better than most first ones.

Maybe the large withdrawal was for a new place or a nice financial cushion for the owner. Is the trade of a hit to ones credit worth just over half a million dollars? Most of us would think it is. The featured homeowner had great timing at pulling out all the money at the peak of the market.

Some Sound Advice

We hear so much bad advice - usually from those that stand to make a profit off an investors decision. So many decisions only help the advisor - not the investor. Just look to any reserve mortgage sight sponsored by a broker and it tells how wonderful the tool is - it is the right decision for you, it is the right decision for anyone - since the broker makes his commission in his position he is right.

With the complex investment world around us sometimes turning to a financial planner is a great idea. But how to make sure you are going to one that is looking out for your best interests, not theirs. Suze Orman provides an excellent guideline in this article titled How to find a financial planner. Suze provides five questions to use when selecting a Financial Planner. Lets take a look -

1. What's your background? Did he do the work to become a certified financial planner (CFP)? What other formal training does he have? And how long has he been in business -- 10 months or 10 years? Experience matters.

2. Do you recommend term life or cash value policies for most of your clients? You better hear "term." If someone starts extolling the virtues of cash value life insurance, you should stop the interview right there and politely leave.

3. Do you use index mutual funds and exchange-traded funds? You want to hear yes. He doesn't need to use index funds or ETFs exclusively, but you want to know that indexing is part of the mix. The bottom line is that very few actively managed mutual funds consistently beat the indexes. A big part of the reason is that good no-load index funds have super-low costs, and the less you spend on fees, the more you will have left in your account.

4. Do you recommend most of your clients have just a will, or do you suggest a will and a living revocable trust? A living revocable trust is such an important document that I would be wary about any planner who doesn't think it is useful.

5. Do you recommend using a home equity loan or line of credit to pay off credit card debt? A responsible planner will say no to this. When you borrow against the equity you have in your home, the home becomes the collateral for the loan. Miss too many payments, and you run the risk of losing the home. Your credit card debt, on the other hand, is what is known as unsecured debt: There is no collateral that the card company can take if you fall behind on your payments. It therefore makes no sense to put your house on the line to pay off a debt that is unsecured.

We are highlighting number 5 - because even if you are not hiring a financial planner this is excellent advice. This was strongly recommended for years - trade your unsecured debt for secured debt. Good for the lender, looks good for you since your payments and interests are usually significantly lower, but not necessarily good for you. Maybe now you have no credit card debt - but you still have the debt. The article is chock full of more good advice.

Another Record -

9% mortgages behind in payments. Today must be bad news day. This is really bad. Wave after wave of problematic housing issues. This article from Yahoo titled Home loan troubles break records again: Delinquencies, foreclosures rise to more than 9 percent of US home loans in second quarter says it all. Lets take a look -

A record 9 percent of American homeowners with a mortgage were either behind on their payments or in foreclosure at the end of June, as damage from the housing crisis continues to mount, the Mortgage Bankers Association said Friday.

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New foreclosures were concentrated in eight states: Nevada, Florida, California, Arizona, Michigan, Rhode Island, Indiana and Ohio.

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What's driving the delinquency rate up now is the number of homeowners with risky, adjustable-rate prime loans made with little or no proof of the borrowers' income or assets.

Many of these loans allowed the borrower to pay only the interest on the loan for a fixed period of time. Others gave borrower the option to "pick-a-payment," adding any unpaid interest to the principal balance.

More than one out of 10 borrowers with a prime adjustable-rate loan is now delinquent or in foreclosure. That portion, 11.3 percent, was up from 9.7 percent in the first quarter and is expected to continue to rise as more homeowners see their monthly payments spike.

Option ARMs and Liar Loans are going to drag everyone down. Just wait until the ride down hill really starts. We are in for a bumpy ride - downhill.