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Dr. Kalinda Rose Stevenson
Does A $700 Billion Bailout For Banks Prevent Foreclosures For Homeowners?
Welcome back!
The top item in the news in the last week has been the financial crisis facing the banks. Yesterday, Washington Mutual was seized by the FDIC. This is the largest bank failure in United States history. WaMu was then sold to JP Morgan Chase, to further consolidate the banking industry into a handful of giant banks.
“As the debate over a $700 billion bank bailout rages on in Washington, one of the nation’s largest banks – Washington Mutual Inc. – has collapsed under the weight of its enormous bad bets on the mortgage market.”
“The Federal Deposit Insurance Corp. seized WaMu on Thursday, and then sold the thrift’s banking assets to JPMorgan Chase & Co. for $1.9 billion.”
“Seattle-based WaMu, which was founded in 1889, is the largest bank to fail by far in the country’s history. Its $307 billion in assets eclipse the $40 billion of Continental Illinois National Bank, which failed in 1984, and the $32 billion of IndyMac, which the government seized in July.” Government seizes WaMu
Meanwhile, the debate continues in Washington about a $700 billion bailout for the banking industry to buy up bad mortgages. One of the issues at debate is whether homeowners who are facing foreclosure because of bad mortgages will receive any part of the $700 billion.
In an outstanding article, “It’s The Empty Houses, Stupid,” Bob Sullivan asks the question why the government bailout is focusing on the banks that hold the bad mortgages and not the homeowners who cannot pay the bad mortgages.
“In case anyone has forgotten the core of the current economic crisis, here’s a reminder: empty homes, both present and future. Empty homes are behind all the supposedly worthless mortgage-backed securities that no one wants to buy on Wall Street. Fear of the coming avalanche of empty homes — what the Center for Responsible Lending calls the “tsunami of foreclosures” — has made Wall Street’s mortgage-related paper nearly worthless.”
“It seems that filling those empty homes by dealing with foreclosures and stoking demand to buy homes should be the first order of business. So why — as we discuss the most dramatic government intervention in nearly a century — is there only passing mention of all these vacancies?” It’s the empty houses, stupid
Sullivan makes the point that there are two interlinked crises. The liquidity crisis affecting the banks and the housing crisis affecting homeowners. At this point, it seems as if the bailout will benefit the banks, but homeowners are on their own. He cites bankruptcy experts and consumer advocates who make the case that the simplest and fairest solution would be to amend bankruptcy law, to allow bankruptcy judges authority to modify mortgages, as they can modify payments for other types of loans.
“‘This was kind of a game of chicken and I’m afraid it looks like the consumer advocates in Congress are the ones who blinked,’ said Adam J. Levitin, a bankruptcy expert at the Georgetown University Law Center.”
“Details of the not-quite-completed-bailout-plan are still emerging, but by all accounts it will not include the most obvious and direct tool to stem the empty house problem: adjustments to bankruptcy law that would allow judges to modify the mortgages of at-risk homeowners.” It’s the empty houses, stupid
But as the current negotiations stand, there is no provision for homeowners facing foreclosure to receive any direct help from the massive government bailout for the big banks.
The simplest way to prevent the coming avalanche of additional empty homes — and thereby make those asset-backed-securities have some real value — is to prevent people from getting kicked out. It’s stunning that $700 billion is about to change hands with no direct plan for keeping them in their homes. It’s the empty houses, stupid
Dr. Kalinda Rose Stevenson
Find out how the current mortgage crisis is a direct result of a banking system that allows banks to make money out of thin air in No Money Limits For Real Estate Investors at www.NoMoneyLimits.com.
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Using Leverage To Create Weapons Of Financial Mass Destruction
Leverage creates wealth. This has been the promise behind the real estate boom. Now that the boom has gone bust, what is the role of leverage in the current financial crisis?
Greed is blamed for much of the economic crisis currently facing us. But blaming greed misses the real point. Greed needs a mechanism—a tool—to put greed to work. This tool has been touted as the magic money-making tool. What is the tool? It is leverage.
Underneath all of the complicated terms, such as “derivatives,” “leveraged buyouts,” “financial instruments,” the fundamental tool that has led us to this point of crisis is misused leverage.
What is leverage anyway? Leverage is the result of the action of a lever. When properly positioned, a lever allows you to move something you could not move with your own strength.
“A simple machine consisting of a rigid bar pivoted on a fixed point and used to transmit force, as in raising or moving a weight at one end by pushing down on the other.” “Lever” http://www.answers.com/topic/lever
In finance, leverage is primarily the use of borrowed money to buy what you could not afford to buy with your own money.
The real estate boom has been fueled by leverage. This has been the great selling point for real estate investing. You can use leverage to buy real estate with little or none of your own money. In other words, you finance your real estate purchases with debt.
Leverage is the tool that rewards greed. With leverage—whatever form that leverage takes—you can buy more than you would be able to buy using your own money.
Leverage is a tool that can and does create profit. The real estate boom is a testimony to the effectiveness of leverage as a wealth creating tool.
“People used to build wealth through building equity in their homes. Today, people prefer to speculate on the price of their house by using historically high levels of leverage.” Richard Bernstein
So why are we in the current financial crisis? Underneath the crisis is a shared belief that values will keep going up. Robert Schiller makes this point in his book, Subprime Solution.
“In Shiller’s view, the biggest dangers in financial markets come from unanimity. In Subprime Solution, he argues that what united the missteps by the Federal Reserve, mortgage brokers, Wall Street bankers and home buyers that together brought on the current financial mess was a shared belief that house prices never go down.” “Crash Master” http://www.time.com/time/magazine/article/0,9171,1838756,00.html
This is the true irrational belief behind the financial mess. In reality, real estate prices are subject to cycles, and ups-and-downs. The old adage states: What goes up must come down. Nothing continues on a continual upward path indefinitely.
Yet, from the greatest investment banks on Wall Street, to novice real estate investors, many of us operated with the belief that real estate values would continue to go up, and that leveraging borrowed money was the smart way to make money fast.
As a result of this shared belief, many real estate investors and the bankers who financed their transactions, never saw the downside of using leverage as a tool to create wealth.
Think again of using a lever to move something. Leverage is inherently risky. Think of changing your tire. As long as your car is resting on four tires, it is stable. As soon as you lift up your car with a jack, you have created a potential danger. A car on a tire jack is no longer stable. The car can slip off the jack, and you can get hurt.
This is the downside of leverage. When you use leverage, you create a potentially dangerous object that can slip off the bar. Leverage lets you go higher than you could on your own, but it also means that you can come crashing down faster and lower than you would without the lever.
“In finance, leverage (or gearing) is using given resources in such a way that the potential positive or negative outcome is magnified and/or enhanced. It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity.” “Leverage” http://en.wikipedia.org/wiki/Leverage_(finance)
The fundamental reason that the big investment banks have failed is because they threw caution out of the window and relied on ever-increasing amounts of risky leverage. in simple terms, they used large amounts of borrowed money.
“Lehman’s fall shows the downside of using borrowed money. Even though Lehman has a 158-year-old name, it’s actually a 14-year-old company that was spun off by American Express in 1994. AmEx had gobbled it up 10 years earlier, and it wasn’t in prime shape when AmEx spat it out. To compensate for its relatively small size and skinny capital base, Lehman took risks that proved too large. To keep profits growing, Lehman borrowed huge sums relative to its size. Its debts were about 35 times its capital, far higher than its peer group’s ratio. And it plunged heavily into real estate ventures that cratered.”
“Here’s how leverage works in reverse. When things go well, as they did until last year, Lehman is immensely profitable. If you borrow 35 times your capital and those investments rise only 1%, you’ve made 35% on your money. If, however, things move against you – as they did with Lehman – a 1% or 2% drop in the value of your assets puts your future in doubt” in “How Financial Madness Overtook Wall Street” http://www.time.com/time/business/article/0,8599,1842123,00.html
The current economic mess is tremendously complicated, but the basic mechanism behind the crisis is leverage created by arcane financial instruments that few of us have any hope of understanding. The particular form of the leverage ranges from subprime mortgages, to derivatives with fancy names, such as “collateralized debt obligations” (CDOs) or “credit-default swaps” (CDSs)
In 2003, Warren Buffet called these derivatives “weapons of financial mass destruction.”
The reason that all of these leveraging tools worked so well for so long was because property values were going up. But when property values started to go down, these leveraging tools turned into the weapons of financial mass destruction that Buffet foresaw.
Dr. Kalinda Rose Stevenson
Do you know how banks make money out of thin air? Find out in No Money Limits For Real Estate Investors. And be sure to sign up for your Free “52 Heart Of Money Insights” at NoMoneyLimits.com.
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Greenspan’s Folly: Why Lack of Regulation By The Federal Reserve Is The Root Cause Of The Current Financial Mess
John McCain claims that Wall Street greed is responsible for the current financial mess behind the bank failures and the subprime mortgage debacle. Michael Hirsh has written a significant article that places the blame squarely on the refusal of the Federal Reserve under Alan Greenspan to use its regulatory authority.
“Who is mostly to blame for the biggest upheaval on Wall Street since the Great Crash? The disaster appears to have many fathers. “In a way, it’s the perfect crime: Who do you go after?” asks Jim Rokakis, the treasurer of Cuyahoga County in Ohio, one of a slew of state-level officials who saw the mess coming years ago but were ignored by the Feds. “If you arrest the mortgage brokers, how can you in good conscience not arrest the officers of the mortgage banks and the rating agencies?” Rokakis wonders. Ultimately, a big share of the blame lies with Wall Street CEOs who encouraged all this bad lending by packaging it into ever more complex securities, and then invested in it themselves by the billions. Indeed, the myth surrounding the subprime fallout is that no single player along the pipeline could have prevented what happened, including the giant investment banks that loaded their balance sheets with this dreck only to have it drag them into oblivion. “Everyone’s to blame, and no one’s to blame,” says financial expert Joseph Mason of Drexel University, summing up a common view of academia and in Washington.
I don’t buy it. Especially the idea that somehow the blame lies mainly with Wall Street’s greed, as John McCain reiterated the other day, saying we have to “fix” it. How do you fix greed? And let’s face it, left to its own devices, Wall Street has always operated on pure adrenalized greed, which is why financial manias and bubbles come and go and always will.”
“This mess is mostly a titanic failure of regulation. And the largest share of blame goes back to one man: Alan Greenspan. People mainly fault the former Fed chief, who once enjoyed a near-saintly reputation because of his reputed “feel” for market conditions, for ushering in an era of easy credit that accelerated the mortgage mania. But the much bigger problem was Greenspan’s Ayn Randian passion for regulatory minimalism.” Read the rest of “Greenspan’s Folly” here.
Dr. Kalinda Rose Stevenson
Discover how Federal Reserve interest rates determine how much money banks have available to fund your business and real estate projects in No Money Limits For Real Estate Investors. Visit NoMoneyLimits.com for your Free ”52 Heart of Money Insights.”
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