YOU ASKED ME FOR AN EXPLANATION OF THE LIQUIDITY CRISIS AND COMING CREDIT CRUNCH
“When your loan is in trouble you are not the only one worried about it. Your lender is also worried unless he is trying to steal your property.”
Lesson 19 from the book HOW TO MAKE MILLIONS IN REAL ESTATE AND LOSE IT?
When I wrote that book we had an old fashioned lending system. You borrowed money from the lender and owed it to him. As long as the loan was unpaid, both of you worried about it. It is time for me to explain what happened to this clear and understandable relationship.
Several years ago, with the encouragement of the government, banks began selling the loans they made to other entities. The mortgages were bundled into large portfolios and sold and traded in a large secondary market. The banker was no longer interested in the outcome of the loan because he got rid of it within days or hours. After selling the loan he could make other loans, make more fees, points, etc. The risk was moved to others.
This was such a profitable act that a number of other players got involved to make some money. Mortgage brokers and companies got into the act to pick up fees and commissions. The best part of their job was that they had none of the risk because they moved the paper almost instantly. The strange part of their role was that they had none of the responsibility either although they were the ones who would qualify the borrower for the loan. Now you understand the ads: No Credit Check: Bankruptcy OK, etc.
Soon the bundled loans were purchased by a new kind of buyer – the hedge fund. Most of you have no idea what a hedge fund is and would find it hard to understand how such entities can exist in a normal world. Rich people and large institutions need to invest large sums of money and prefer no government scrutiny into how much and how they invest their funds. The hedge fund is a private investment company, which operates in secrecy and without any government regulation. With interest rates in recent years at a ridiculously low level, hedge funds could go out and invest in more risky investments providing a high yield for their customers, who were more interested in a return on their money rather than of their money.
Sub prime mortgage bundles were extremely attractive to these hedge funds. They provided a good return on investment and had a built in acceleration of yield feature. In addition they were secured by thousands of homes
Let us stop for a moment and see who was worried about these mortgages. The original bankers sold them long time ago, the mortgage brokers made good profit creating and bundling the loans – they were not at risk. The various types of bundlers washed their hands and passed the bundles on to ultimately to the hedge fund. The hedge fund did not quite care either because they could always foreclose or refinance homes in the US market.
This is where greed created an overreach and crisis. The hedge funds used their bundled holdings of sub prime mortgages and borrowed large sums against them from the banks. When the sub prime market started to collapse, the banks realized that the loans made to the hedge funds were no longer secure. Just as in the 1980s the banks started revaluing the assets securing loans and in many instance demanded repayment, or refused to extend the loans to the hedge funds. In many cases the hedge funds could not repay loans because suddenly there was no market for sub prime bundles.
It was the hedge funds inability to sell their sub prime mortgages that cause the liquidity crisis described in my last newsletter. (ON AND OFF THE RECORD VOL XXI #113.) To save the banking system the Federal Reserve and Central Bank throughout the world pumped more liquidity into the system than in the days after 9/11.
This solved the problem of the hedge funds and banks, but it did not solve the problem of the individual borrowers’. Now Uncle Sucker will come in and offer to refinance a house that won’t last 30 years with a 60-year mortgage. It is easy to do. After all who will be around to solve problems 30 years from now. As an old Fossil I surely won’t.
I just found out that Old Fossils never die, they just get stoned. I am already petrified.
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