Thursday, January 10, 2008

US Homeowners vs. Current Housing Slump (Continued)

It just doesn’t seem right if we leave this issue without delving with some seriousness into the all too human factors that helped this all along, which are the human proclivity or predisposition for greed, and maybe, fraud. Yes, because SEC and state-initiated investigations are still ongoing as we speak. Which by the way made this not only a grave domestic issue, but eventually reverberated globally in summer, when a world-wide nail-biter of a credit crunch gripped the global economy necessitating gargantuan infusion of capital funds from various sources to bail out the strapped players involved. Even world's largest bank Citigroup as I recall had to sell away a good chunk of itself to a group in Dubai.

And for some basic understanding we have to dive into the shadowy world of “derivatives”, particularly sub-prime derivatives which a group of Wall Street bankers made available to investors in 2005.

Now these particular derivatives consisted of sub-prime mortgages, which became very prevalent during the peak of the housing boom. Mortgages almost indiscriminately granted to risks that normally would not merit credit-worthiness. Thus we had mortgages where the tests for income and capacity and ability to pay were summarily dismissed and set aside. Mortgages where normally necessary documentations and processes were shunted aside, and even where no or only very minimal down payments were required in granting the loans. And remember this was during the frenzied peak of the housing boom when house values soared high and fast.

So these derivatives were packaged by security firms and marketed as collateralized debt obligations, cleverly hidden and mixed with investment-grade securities as to merit appropriate ratings. But in reality were not only more risky, but their real values could not easily be ascertained.

With very lucratively high rates of return, they easily got lapped up not only domestically but across the globe by investors only too eager to make extra money, counting our now glum friends from Norway as mentioned in the first blog entry. Inventoried by a large numbers of big and renowned banks across the breadth of the economic universe. Even school districts and hospital management companies based in the US went for shares of the large rich pie. Old father greed made sure those interested got their rightful shares.

But poor sub-prime borrower, written of as bad by any logical standard right from the get-go, suddenly started defaulting, unable to pay higher than teaser rate monthly mortgage amortizations. Does he walk away from his precious and newly-acquired palace? With no other viable option available, and realizing too late that the re-finance window had never really been open to his not credit-worthy record to start with, he walked away.

With no other recourse for themselves, security firms who sold those mortgages started plugging the leaks incurring great losses, and understandably they started getting jittery. And the careening ball went for the investors from near and afar who had pocketed those nice and neat investment packages with contented thoughts of great returns.

In due time, by July about 14% of sub-prime mortgages ceased paying. Now that represented only about 5% of total US borrowers.

But it was enough to freeze the world’s credit markets. Suddenly, sub-prime mortgages were toxic to all to them and their marketability fell to zero.

But 2008 finds us in a somewhat appeased mode, with the financial institutions writing off their losses and licking their wounds; and as a result, easing the credit crunch somewhat. And those awash with capital, maybe like surplus-rich China or those wallowing in escalating petro-dollars, go into bail-out mode where needed.

And it may be ironic to mention that there is an unheralded group that actually made the right choices and thus minimized losses. Those who bet against the mortgage market, those who predicted that the mortgage market would go into a tailspin and invested correspondingly.