Tuesday, November 3, 2009

Putting Foreclosures in Perspective

Putting Foreclosures in Perspective

By George W. Mantor

RISMEDIA, November 3, 2009—When considering the implications of the current foreclosure situation, I believe we are being misinformed about the forces behind the high rate of mortgage defaults.

I also believe there is more to learn about the lack of success in getting mortgages modified.
Or, as recently published reports on certain court cases have shown, why foreclosing entities either cannot or will not produce a valid chain of title in foreclosure proceedings even though it may cost them the case or sanctions by the courts.

Just as baffling, why would a lender make a loan and then lose the means by which to repossess the asset? There are, as it turns out, other ways for financial institutions to make money and when they can, they do.

That goes to the very heart of what happened to our prosperity. By reclassifying liabilities as assets, Wall Street was able to sell debt as an investment. Any kind of debt will do because the debt doesn’t matter. No risk is too great because there is no risk. They sell the loan and then make a bet that it will default. It’s called a Credit Default Swap (CDS).

A CDS is the most widely traded type of derivative, and these investments represent the biggest financial market in the world. CDS resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to increase profits by gambling on market changes

According, to the Bank of International Settlements [BIS], the aggregate derivative positions of banks grew from $100 trillion in 2002 to — believe it — $516 trillions in 2007; that is over 500 per cent in five years.

The BIS recently reported that total derivatives trades exceeded one quadrillion dollars – that’s 1,000 trillion dollars. This is curious when you realize that the gross domestic product of all the countries in the world is only about 60 trillion dollars.

The answer is that gamblers can bet as much as they want. They can bet money they don’t have, and that is where the huge increase in risk comes in. There is no regulation of these instruments and they do not show as liabilities on the balance sheets of the institutions.
A Derivative is a financial instrument whose value is not its own, but derived from something else, on some underlying asset or transaction, such as commodities, equities (stocks) bonds, interest rates, exchange rates, stock market indexes, why, even inflation indexes, index of weather. Basically, they are just bets. You can “hedge your bet” that something you own will go up by placing a side bet that it will go down. “Hedge funds” hedge bets in the derivatives market.

Nor, did mortgage defaults cause the crisis. Mortgage securities made up only $7 trillion of the huge derivative market.

To the extent that any information is available on what brought us to this point, it is mostly bloggers.

Most of the blogging perceives the foreclosure problem as the result of sub-prime loans, irresponsible borrowers, and mortgage resets.

Such a superficial view reveals a complete lack of understanding of how the securitization of mortgages makes Wall Street all of that money out of nothing at all. You have to follow the money.

An important distinction is that the consumer was not the driving force behind this money binge, but the profits Wall Streets was making on Derivatives.

When you break it all down, it looks to me like Wall Street possibly took a lesson from Broadway. The Producers is about a Broadway producer and his accountant who realize they can make more money with a musical that was guaranteed to fail than one that would succeed. But, the musical’s sure-to-fail hit song, “Springtime for Hitler” surprisingly turned out to be an astonishing success. When the investors came for their profits, there were too many investors to pay back.

Wall Street, where life imitates art.

George W. Mantor is known as “The Real Estate Professor” for his wealth building formula, Lx2+(U²)xTFP=$? and consumer education efforts. During a career that has spanned more than three decades, he has amassed experience in new home and resale residential real estate, resort marketing, and commercial and investment property. He is currently the founder and president of The Associates Financial Group, a real estate consulting firm.

Mantor can be reached at GWMantor@aol.com.

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The Difference Between Loan and Appraisal Contingencies

This question was asked by a Trulia Blogger. Here was the question.

I am trying to understand the difference between both. If there is an agreement to put 20% on a home with no appraisal contingency and if the bank estimates the home to be of much lower value would the situation not be covered by loan contingency (since bank may refuse to give the loan asked for)? What is the use of the appraisal contingency in cases where buyer only puts 20% down?

Here was my response.

The two are interrelated but there is a sharp difference between them. What is implied by your post, I would characterize as loan contingency consideration. In other words it strength of buyer in regards to financing.

(Lets start by discussing) the financing. Lets say we have a 400k loan and a buyer with 20% down payment of 100k on a 500k purchase. I use this beacuse I can do the math in my head easily. So buyer is in contract and the home appraises for 450k. Now like you descibe there is no problem with the loan approval. The buyer puts 90k down instead of 100k and you go to close right? Well no. A an appraisal contingency states that the contract is valid only if the property appraises for price on the contract. The buyer can now walk away. Right? Well no.

This is one way realtors make their money. Realtors make money by getting contracts to close. Our contracts state that the buyer just cant walk away. Buyers have to give the sellers a chance to reduce the sale price to the appriasal or get another appraisal (or lately go through an administrative appeals process which I wont get into here.) Clearly the buyer isn't going to balk, they loved the house at 500k at 450k it would be assumed they are now ecstatic.

Lets now say that the sellers pay for a 2nd appraisal and they lose the administraitve appeal. The value of the home is $450 per appriasal and there is an appraisal contingency and the contract says 20% down. The seller says, "I don't care, but I'll take 475k and I won't take a penny less." Now, we know the buyer can offer the seller the additonal 10k (The difference between 20% of 500k vs 20% of 450k) without a problem. The loan contingency though says that the buyer can only put down 20%. There is a 15k gap.

This is why there is a separate contingency for loan and appriasal.

Web Reference: http://bob2sell.com