For Your Consideration

This is great quote. Read it and just let it sink in for a moment….

“The entire real estate debacle is the fault of everybody that was involved. And it was all about greed and speed,” said Rachel Dollar, a Santa Rosa attorney who represents lenders in fraud and other cases. “The brokers wanted their commission. The lenders wanted their premiums. The borrowers wanted their homes.”

(Emphasis added by me). The direct source of the quote.

I love the way Ms. Dollar (sometimes this stuff just writes itself!) uses the word “everybody”…. Let me add some more people who need to be included in the “everybody” category…

• Real estate attorneys received payment for their closings;
• Newspapers received increased real estate advertising revenue;
• Home appraisers received payment for their (ahem) valuation reports;
• Home inspectors received payment for their services;
• Homeowners insurance companies received premiums (and still continue to get paid) based on inflated real estate values (which were required by the lender to fund the loan);
• We can add insurance agents/brokers to the line above as commissions in large part are based on the gross premium paid by the homeowner;
• Many local and state governments benefited (and continue to benefit) from inflated real estate values;

I could go on, but you get the point. In short, it’s turned out to be a big turd sandwich in which we will all now have to take a bite.

Double click on the chart above (it’ll open up a new window) and you’ll understand that home prices have a long way to fall before bottoming out. Ouch.

Almost every investor has a money market account (MMA) or a bond fund. Almost everyone knows these accounts are not ordinary bank accounts and thus are not insured by the FDIC. Of course, FDIC “insurance” is a bit of a canard, as there is nowhere near enough money in reserves to pay everyone who has an FDIC insured account in the event of a sufficiently large enough U.S. banking crisis.

What most people are blissfully unaware of is that a MMA is essentially a very short term bond fund. A bond is essentially a “promise to pay” a certain sum tomorrow (over time) for a certain sum today. There are many websites that explain bond funds in hyper detail (go here for a great primer) - this is the most stripped down explanation I could think of! Bonds can be offered by many entities (corporations/governments, etc.) and are used for many purposes (capital expenditures/cash flow/reserves, etc). “Short term” refers to what is essentially a bond’s duration (which is essentially it’s “repayment period”). The duration of a MMA is usually less than 1 year. Short term bond fund duration as of this writing is about 2 years. Intermediate term bond fund duration is about 5-7 years and long term bond fund duration is 7+ to 3o years.

Let’s consider ABC Company, which needs money to manufacture a new plant. It decides to sell bonds (backed by its ability to repay) to meet its needs. It becomes the bond’s “issuer”. It will pay the bond owner interest for the use of the bond owner’s money today over the duration of the bond. But consider that ABC Company is not in the best of financial shape and would have to pay an interest rate much higher to attract an investor (who is concerned with ABC Co’s ability repay its debt, which is commonly referred to as “default risk”).

So ABC Company decides to pay to have its bonds insured with a monoline bond insurer for a fee, essentially “lending” its own credit rating to ABC Company’s bonds. Without the bond insurance, ABC would (in this hypothetical example) have to pay 8% interest on its bonds, but now that the bonds are “insured”, an investor might only be able to get 5% interest from ABC Co. since the risk of default is (allegedly) far less. ABC Company “pockets” the 3% difference, less the cost of the fee to the bond insurer.

So far, everybody’s happy, right?

• ABC Company is happy, it’s paying 5% interest instead of 8%;
• The investor is happy because the bond is “guaranteed” by a triple AAA rated bond insurer; and
• The bond insurer is happy because it charged and collected the bond insurance premium.

So what happens when the bond insurer goes belly-up? It’s a reasonable question these days and while it hasn’t happened (yet) don’t mistake the improbable for the impossible.

You see, the bond insurers have taken a bite of the sub-prime mortgage mess and the losses in this market segment may cause these insurers to lose their AAA rated credit status and even worse, may bankrupt them.

So in answer to my own question, very bad things would happen. Existing bonds would lose their insured status. New bonds would not be able to become insured, increasing borrowing costs for issuers.  Investors would, in many cases, lose money (principal)  on existing bonds that go into default. The shockwaves are so vast that it’s difficult to get your head around it. Our economy relies so heavily on credit that almost every industry will be effected by this in one way shape or form. Of course, as businesses are negatively impacted, employment will be as well.

The best primer I’ve found to help explain this potential meltdown can be found here. You can’t put your head in the sand on this one.

From wikipedia, “The yield spread premium (YSP) is the cash rebate paid to a mortgage broker based on selling an interest rate above the wholesale par rate that the borrower qualifies for”. What that means in plain language: YSP is a mark-up on the interest rate charged to you over and above the rate a lender would be willing to receive.

Lenders provide rate sheets to mortgage originators (including mortgage brokers). If the originator closes your loan at a rate higher than shown on lender’s rate sheet, the lender pays a percentage of that amount (overage) back to the originator. This is over and above any other fees the originator may charge such as appraisal fees, underwriting fees, etc.

In a prepared statement to Congress in 2002, Professor Howell E. Jackson of Harvard Law School noted in relevant part that the “study indicates that the vast majority of borrowers pay yield spread premiums - on the order of 85 to 90 percent of all transactions” and that “the average amount of yield spread premiums is quite substantial, on the order of $1,850 per transaction, making these payments the most important single source of revenue for mortgage brokers.”

It’s reasonable to suspect the “substantial” YSP amount of $1,850 in the Professor’s study is woefully antiquated. Since this testimony was prepared before the housing bubble, let me give you an updated example for your review, using some reasonable NY/NJ real estate values.

• Hypothetical loan amount: $400,000
• Lender’s par rate per their rate sheet (the rate the lender would accept): 5.50%
• The rate you closed at: 6.25%
• YSP paid to originator: $12,000
• Difference in the total amount of interest paid by borrower on 30 year loan: $69,016.61.

The rule of thumb is for every 25 basis points (0.25) paid by the borrower over the par rate, 1% of YSP is created. So in the example above, about 3% YSP is created. Following the math, $400,000 X .03 = $12,000 would be paid to the loan originator.

As I understand it, there currently is no legal obligation to disclose the loan YSP to borrowers except on the final settlement statement at closing, when it is often too late to do anything about. I believe it is a moral and ethical duty to disclose prior to closing, but since greed trumps morality almost every time, I would urge you request this information before the closing date on your next mortgage.

Further, with many borrowers who bought homes in the bubble years 2003 - late 2007 looking for someone to blame, I wonder what would happen if they looked at the mortgage originator and lender as a prospective target? Perhaps an argument could be made that the lender/originator was “unjustly enriched” for failing to disclose YSP prior to closing. I have to believe that insurers writing mortgage brokers and lenders professional liability (malpractice) coverage are concerned with this. It wouldn’t take many of these actions to start an avalanche of litigation, especially for those in the most “bubbly” real estate markets of California, Nevada, Florida and New York. I’m certain there are litigators who wouldn’t mind trying.

Of course, where the YSP was disclosed and agreed to by the borrower prior to closing, I have no issue. I wonder just “how many” disclosures occurred prior to closing…

I do have one final question, but it is admittedly rhetorical: How can we objectively review borrowers’ legal counsel’s role here? While the closing documents are in preparation, this information is available. What action(s) did borrower’s counsel undertake to explain YSP to their clients? Yes, I know. This line of questioning is a slippery slope with no answer.

Think this post is over the top?  Check out this link.

About once every decade or so (as the economy dictates) the scam artists come out to prey upon people who’ve fallen into the very bad situation of possibly losing their home in a foreclosure event. Well, it’s that time again…

The web is replete with companies that promise to be able to “save” the home from foreclosure. Some even promise they’ll be able to keep the foreclosure off your credit report. In essence, they’ll say anything to have you buy one of their “kits” for anywhere from $995 (cheap!) to over $2500.

It’s snake oil.

Don’t trust this situation to anyone but yourself. Accept responsibility. Talk to your lender - they do not want your home. In most cases they will try to work with you to avoid taking back your home. If this doesn’t work, speak with a licensed attorney to protect your legal rights.

A quick video from Freddie Mac for your viewing pleasure.

Many people, myself included, like hybrid technology in theory. We like the idea of saving money every time we fill up and there’s a bit of thumbing our noses to the oil industry as well. I’ve been considering a new car purchase (my current vehicle is “only” 13 model years old - my wife chuckles every time I say that) and I’ve been thinking maybe it’s just getting time for a change.

So, with the lure of saving money at the fuel pump, I’ve started to consider vehicles with hybrid technology. Aesthetics aside, the Prius is the fuel economy champ, no surprise there. But my current interest is more in how much more is this technology going to cost me up-front and when will it (if ever) start paying for itself?

We need a few data points to calculate a good guess. With that in mind, consider the following:

The average person drives 15,000 per year. Yes, I know many people drive much more than that but let’s use it as a starting point, shall we? Many new cars average (including some of the ones I’m considering) about 20 miles per gallon. The current cost of gasoline (where I am in NJ) is about $3.00 / gallon. So you can calculate your annual total cost of fuel to be about: $2,250. The math is: Total miles / Miles per gallon (15,000 / 20 = 750 gallons consumed) * Cost per gallon ($3) = $2,250.

Now, let’s say that the hybrid vehicle you’re considering averages 30 mpg but costs $3,500 more than the non-hybrid alternative. When do we break even? Well, plugging in 30 mpg into the calculation above lowers our total annual fuel cost to $1,500 because we’re only consuming 500 gallons per year instead of 750 (15,000 / 30). That’s a savings of $750 / year at current gas prices. Our break-even period is about 4 1/2 years at this rate. Of course, that’s assuming that the cost of fuel will stay the same and not increase over that time period. Yeah right, how likely is that?

So let’s try increasing the cost of fuel to $4.00/gallon, shall we? Annual fuel cost, non-hybrid: (@ 20 mpg/$4) = $3,00o. Annual fuel cost, hybrid: (@ 30 mpg / $4) = $2,000. Annual fuel savings - $1,000. So, looks like the hybrid will pay for itself in about 3 1/2 years under this scenario. (Yes, I am ignoring the time value of money calculations to keep this relatively simple!) At $5.00/gallon gas, the annual savings is about $1,250 - but let’s hope we don’t see that too soon. The one thing, however, I think we can all agree on is that the cost of fuel will continue to increase over the next 5-10 years.

For outside sales people who spend their lives in their car, the savings can be dramatic. Consider: 30,000 miles per year, 20 mpg, $3/gallon represents a $4,500 annual fuel cost. Substitute a hybrid alternative (30,000 miles,30 mpg, $3): $3,000 annual fuel cost, savings of $1,500 per year. If the hybrid alternative is $3,500 additional up-front, it will pay for itself in fuel savings in a little over 2 years. If you update the cost of fuel to $4/gallon, the annual savings is: $2,000 and the hybrid break-even point is essentially 18 months. If you like to keep your cars a long time, the annual savings are almost staggering. Happy car shopping!

Looking to refinance your current note or mortgage? Here’s an interesting tool to estimate FICO credit scores.