sub-prime mortgages

IndyMac to Cut Work Force, Halt Most Loans Applications By JAMES R. HAGERTY and DAMIAN PALETTA Wall Street Journal, July 8, 2008
"IndyMac Bancorp Inc. said it has stopped taking most types of loan
applications and will cut more than half of its work force as it struggles with losses from home-mortgage defaults.
The Pasadena, Calif., mortgage company and savings-bank operator is one of the largest lenders yet to be forced by the credit crunch to ditch the bulk of its business. IndyMac specialized during the housing boom in Alt-A loans, a category between prime and subprime that typically involves borrowers who don't fully document their incomes or assets."
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I don't understand why such loans were ever made. Giving a lender a few W-2 forms, tax returns, and bank/brokerage statements is not difficult. The IRS offers free tax transcripts. A person who cannot document income or assets should not be getting a loan.
There is no "magic" ratio of mortgage, home insurance, and property tax payments to income above which a delinquency is impossible -- the lower the better. In a free country, lenders ought to be able to make riskier loans at higher interest rates and absorb the occasional losses, as in the credit card industry. But why wouldn't lenders gather information before handing over hundreds of thousands of dollars?
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I honestly feel that even the upper ranks of lenders' staff are abysmally educated. Thus they got caught up in the housing bubble (you can't lose when houses only go up and by lots! [not]). Then they fooled themselves into trusting that high risk loans could be re-packaged into lower risk vehicles. I think when one is making money hand over fist, one gets blinded. (And but for the grace of god, there go I. I got a tad too caught up in banks' high dividends.)
I know many here consider this a sound theory. Just reiterating so maybe this will become a lesson to be recorded in the annals of history. Like the causes of the Great Depression.
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snipped-for-privacy@aol.com wrote:

Because they could. The mortgage brokers got paid for making loans. As long as they met the standards to sell the loan, they didn't care. The buyers of the loans didn't care. They packaged them up, got some ratings agency to rate them "AAA" and sold the CDO's to investors, who believed the "AAA" ratings.
It all worked as long as housing prices kept going up. If the homeowner defaulted, the lender took the house and sold it for enough to be made whole.
-- Doug
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On Jul 8, 7:35 am, snipped-for-privacy@aol.com wrote:

This is not a question about financial planning, but since the moderator approved it, I suppose it deserves an answer that also doesn't involve financial planning.
The subprime problem occurred because neither the mortgage brokers nor the bankers had any "skin" in the game. The brokers were lending money supplied by the bankers, securitized by investment bankers, and rated by securities rating companies. The brokers made money on every loan, but had no risk of loss if the loan failed. The bankers were selling the mortgages as soon as they were written to replenish their money supply. They were making money every loan they made, but were taking no risk, either. The investment bankers packaged the loans, obtained favorable ratings, and sold them to investors. They made money on every loan, but also had no risk of loss. The rating companies were paid by the investment bankers, who wanted high ratings to ease sales to investors, and satisfied their customers. They made money on every loan, but they also took no risk by overrating the packaged loans.
Loan qualification rules merely were impediments to the brokers, bankers, investment bankers, and rating companies making more money, so they found ways to relax the rules and finally to eliminate them completely.
Dave
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A Ponzi scheme?
Elizabeth Richardson
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Dave Dodson wrote:

Securitizing itself became part of the problem. In the 'old' days, even a 90% loan to value mortgage was something one could understand. If the house dropped 20%, the mortgage holder stood to lose 1/9 of their funds (plus costs, of course). Securitization brought in more liquidity, of course, but also created instruments that were incomprehensible, slicing and dicing pools of loans so some pieces had no underlying value from day one. Even in normal times, one can slice up the expected payment streams to create tranches which would be impacted by even a low default rate. This time, those tranches all bubbled up too soon and too many at once as rates rose. Joe www.blog.joetaxpayer.com
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I finally understand how banks made risk short of "disappearing" when lending to sub-prime borrowers. Of course, the massive defaults were written on the wall when many of such contracts were ARMs at all-time low interest rates.
Thanks for the explanation.
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Dave Dodson wrote:

Thank you, that is the clearest explanation of this mess I've heard yet. The greedheads keep pointing at each other so you can't figure out who to blame. Greed is good until you bring the whole house down on everybody.
I wonder if this is going to end like the Savings and Loan scandal of the Keating era (John McCain was one of his Five). Massive gov bail-outs for the greedheads and screw the middle guy.
That affects financial planning, brother!
Chip
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Don't the many bank writedowns of recent months show that the banks gambled, took risks, and lost? Also, when a bank requires minimal-to-no downpayment on a home mortgage, and then the house price goes upside-down and many folks default, the risk is clear.
I agree there were underlings who made money on transaction costs of home sales, but this money was relatively meager. Also, these underlings do not control things like the integrity of re-packaged mortgages and how much downpayment is required.
Aside: I think this does go towards financial planning for ordinary folks. We are seeing history here, insofar as another bubble has burst. Noting what caused the bubble is important. Ordinary folks must never look at an investment such as a house, stock, or mutual fund as an ATM machine.
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Ordinary folks ought not to look at their house as an investment.
Elizabeth Richardson
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Agreed, but for some, the downsize after retirement can certainly help. No matter the economy, the person who sells their Boston or LA home and moves to a smaller home further away from a city is going to pocket some difference there. It would certainly be wise to underestimate that sum. Joe
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joetaxpayer wrote:

How about as insurance? We have ~$250,000 in equity, according to a re-finance 6 months ago. We are both retired and love the house. But when either of us goes to the great pie in the sky, the other plans to sell the house and get out of Dodge. Surely the quarter $Mil is worth considering in a financial plan.
Chip
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Elizabeth Richardson wrote:

They must understand the difference between liquid and illiquid assets, and the typically higher transaction costs associated with the latter.

If that were true, then why would anyone buy a house?
From investopedia:
"Investment [definition]: An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth."
"Determining Assets [for net worth determination] -Liquid assets are simply those that can be turned into cash quickly. Bank accounts, certificates of deposit, stocks, bonds, mutual funds and similar investments fall into this category. Illiquid assets, such as your primary residence and other real estate holdings, also count, as do assets in your 401(k) plan and partnerships in businesses. All of these items should be included in your calculations."
-Mark Bole
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Because I prefer not to sleep on a park bench. I own a house, but do not consider it an investment, as I've said many times here. I own it free and clear of any mortgage. If I had either a mortgage or had to pay rent, I would have had to squirrel enough money away to generate additional income to pay for my shelter. So in my accumulation years, I prepaid my retirement shelter.
Elizabeth Richardson
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Mark Bole wrote:

For the same reason that you buy a car, to use it as you see fit. In more numerical terms, there are times when owning becomes more economical that renting. That's when I bought a house.

So the house you live in fails this definition, at least the second sentence, since you live in it today.
-Will
william dot trice at ngc dot com
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Mark Bole wrote:

Sheez, dude, I'm not trying to tick you off. I thought we were having a fun conversation here. That's the problem with text, it's difficult to assess mood and intent. So let's start over - go crack a beer before you read this, though...
You consider the house that you own and live in to be an investment. I don't (under most circumstances), but I can certainly understand why you do. A portion of the definition you quoted read, "In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth." I understand that this is not the end-all be-all definition of an investment, but I was pointing out that the house you're living in fails this part of your definition. A house you're living in is not saved until the future as implied by this sentence. I would assert, as other do here, that you are consuming your primary house by living in it. And just like the consumption of other durable goods, that consumption is evidenced by the wear you put on your house. Obviously there are components of the house that do not experience wear, or at least no additional wear, due to the fact that you are occupying the house, like the frame and foundation, barring catastrophic events like burning the place down. But once the house is built, the frame and foundation are not usually separable from the rest of the house in terms of value. In other words, when you buy a house to live in, you usually buy all the subcomponents as well - the land, the interior, the frame, the foundation, the driveway. This is usually sold as a unit as well.
If it wasn't so early, I'd go crack a beer myself. It must be 5pm somewhere, right?
-Will
william dot trice at ngc dot com
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I am still on the fence about this issue, but I will say that I think the definition in question is "broken".
The statement "an investment is the purchase of goods that are not consumed today BUT are used in the future to create wealth" omits provably existing alternatives. The word "but" creates an "either/or" situation. In this case, you either consume it (not an investment) or save it (an investment). However, in reality those are not the only options. You can partially consume, yet still save some. The definition seems to deny that possibility.
ISTM that a house falls under the "some of each" scenario. At any given time a house can be a consumption good or an investment and, more importantly, the same house can freely switch between the two. One could hypothetically buy a house, and live in it, all the while intending to later sell it, move into a smaller house (or rent), and pocket the profit. I don't see how a reasonable person wouldn't consider that an investment. Or the same person could buy the same house with the intention of never selling it, never making a penny off of it, not caring if it ever appreciates, and living in it until death. That, I don't feel, is an investment.
My $0.02: the definition to which the argument is being applied is flawed and thus a source of conflict. Whether it should or not, intent plays a role in investing (especially with real and personal property). I, for instance, collect wine. I have some wines that are worth 10x what I paid for them, but it does not matter because I will never sell them and someday I will consume them. However, I have others that I purchased simply because I felt the wine to be undervalued and I have every intention of selling them when the time is right.
My only source of conflict with the above is thus: even if I have no intention of selling a bottle, does the fact that I COULD still make it an investment?
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kastnna wrote:
[comments snipped in accordance with posting guidelines, and apologies to the moderators for the length of this posting]

First, I'll try to make one reply do the work of two -- Will, I wasn't ticked, no problems there. I do appreciate a good conversation, frankly I was worried about me being too argumentative.
Will, I can only repeat, when you buy a house, a significant portion of what you buy, namely the land and/or the intangible benefits of living in a certain location, are not consumed no matter how long you live there, and everyone *does* expect the value of those things to increase over time (how else to explain why owning a closet in Manhattan can cost a million dollars?)
For both you and kastnna and others -- maybe it wasn't really clear, but I was also trying to bring in the concept of "opportunity cost". Since I started down this path, let me quote again from an Investopedia definition: "The difference in return between a chosen investment and one that is necessarily passed up."
Consider a house owned "free and clear" and occupied by someone who dies. The fact that they never sold nor intended to sell in their lifetime has no bearing on whether it is investment. Think of a Roth IRA that someone never plans to, and never does, make withdrawals from during their life -- still an investment, right? Just one they plan to leave to their heirs.
Now, suppose the heirs are trying to sell the empty house. Let's say they could easily get $300K net after sales expense, but are holding out for more. Suppose they could also park $300K cash in a "safe" bank account and earn 4% simple interest (to keep the math easy -- $1K/month). It's pretty clear to me that every month they hold out for a higher asking price is costing them $1K. If they wait six months and finally get $306K for the house, they have only just broken even (even though probate judges don't seem to get this concept).
Bring this back to the living homeowner: if you *don't* consider the house an investment, or if it is in fact not gaining any value as an investment, then that $1k/month needs to be added in to their total cost of shelter (in the first case), or considered as negative return on investment (the second case). It has to be accounted for somewhere.
Kastnaa, the valuable wine is a collectible, just like stamps, coins, artwork, and so on. There is an opportunity cost to hanging on to it, and if you end up drinking it, you've basically cashed in your investment and spent it on yourself. How is this different from starting a "wine fund" with some cash, letting it grow for a few decades, and the using the proceeds of the investment to buy and then immediately drink an expensive bottle of wine?
To summarize: I fully understand why it's wise to not treat a temporary bubble in housing prices as a reason to stop saving for retirement or to borrow more, but to me that's a different issue from understanding the investment decision you're making when choosing between renting (unbundled shelter) and owning (bundled shelter plus investment).
Which once again brings me back to the original subject of this thread: there is so much propaganda that says "buy a home instead of rent if at all possible", that many who should have carefully evaluated whether such an investment fit their situation and goals, instead jumped desperately at what they thought was their last best chance to buy into the "American dream". So much attention is given to warning investors in securities what they are getting into, but there should be the same warnings when it comes to buying houses. Of course the realtors and mortgage brokers and home builders wouldn't like that.
-Mark Bole
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Mark Bole wrote:

You've made some very valid points, and I can definitely understand your point of view on considering a house an investment. But since you've brought up opportunity cost, let me try a different tack.
Given opportunity cost, under some circumstances (that I would argue are not all that uncommon) the net present value of the cost of renting can be lower than that of buying a house. As an example, let's say that I'm in a situation where the two choices are economically the same. I can buy or rent an identical house for a cost that has the same net present value. You would say that the purchased house is an investment. Can I then say that renting the same house is an equivalent investment opportunity?
-Will
william dot trice at ngc dot com
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Since this seems to have turned, once again, into a buy/rent debate, I offer a NYT article that I've not seen referenced in this NG. It allows the user to offer the assumptions regarding certain variables and then gives a break-even on the decision. The original URL was huge, this is the Tiny version; http://tinyurl.com/62p7mk
NYT may require a log-in for this page, no charge, just an online setup.
Joe www.blog.joetaxpayer.com
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