Archive for December, 2007

Date: December 9th, 2007, Filed under Bank bankruptcy, Foreclosure, Mortgages, bailout

Zion, IL
By A.B. Dada
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I can’t seem to wrap my head around any possible situation that can save many of the top tier banks in the U.S. and the rest of the world. There’s a problem that the Old Media is still ignoring, a problem that has the possibility to effect cash flow and the middle class more than the so-called “credit crunch” that we’re facing today. This problem is the absolute illiquidity of the big banks due to the pending litigation and fallout from the mortgage frying pan many have played with over the past few years.

As some of the regular readers know, the mortgage industry was a big game with big profits. The banks would happily loan money to people who had no credibility in their ability to pay that loan back. Because the banks thought that “housing prices always go up,” they felt they could loan money out to anyone, even the credit score poor, and if they had to foreclose, they’d make money on the foreclosure since “property values always go up.”

The banks didn’t have the money to make all these loans, which may number in the tens of millions of individual loans. Because this idea that property values always go up was so rampant for the past 3-4 years, banks took their loans, packaged them together, and sold them to a hungry bond market in the form of CDOs and MBSes. Basically, a bank could take 10 or 100 mortgages, and sell them for a nice commission to investors who also thought their money was safe. Many of these CDOs have fallen in value, some as much as 90-100% (meaning they’re worthless or near that). The investors will lose all or most of their money, is the thought. The banks profited by taking a nice chunk of a commission for producing the mortgage before it was sold off.

Here’s the catch, though, the saving grace for the CDO or MBS buyer-investor: many of these bond issues have contractual wording that protects the investor if the loan origination had any fraudulent activity. If the bank loaned money for a mortgage and the investor can find any fraud within that origination, their purchase is contractually invalid. If that situation comes true, and it seems it may in some cases, the bank would have to refund the investor 100% of their original investment, basically buying back the mortgage onto their own books.

Many loans are coming out as fraudulent. Mortgage brokers and agents accepted “stated-income” statements from borrowers, who inflated their incomes double or triple in value from reality. Some brokers and agents even inflated the borrowers’ incomes without the borrower knowing. Appraisals may also have been fraudulent as some mortgage brokers/agents shopped for appraisers who would give the mortgage lender a number that would maximize their profit. Many in the industry thought the fraud would be overlooked as the housing prices escalated. With the recent downturn in housing expected to continue (severely, still), those frauds are becoming evident.

If a bank has to buy back their loans, they will need cash (liquidity) to reimburse the investor who was defrauded. Many of these investors are fearful of redepositing these refunds back into banks (fearful that the money will be used to bail out other defrauded investors), so the banks can’t rely on their refunds coming back as deposits, to be refunded again. The banks up to now have been able to use some of their mortgages as collateral to borrow short term from the Federal Reserve, but the collateral is declining in value, so their ability to generate new liquidity from the Federal Reserve is becoming more difficult.

As the fraud involved in some (or many?) mortgages comes to light, more and more CDOs will be returned. Banks will be desperate for money, pushing interest rates on CDs and savings accounts up as they need to borrow from millions of small savers versus borrowing from the Federal Reserve. Higher rates on deposit accounts means higher interest rates on loans and credit, which will increase the cycle of foreclosures and home owners feeling the pain: as loan interest rates go up, housing prices tend to fall.

The banking cartel, centered around the fractional-reserve banking system, is in trouble. The money that was created by the Federal Reserve for the past decade is not being redeposited in the banks, so their cash capital is declining. As more people find themselves upside down on their mortgages, more will face foreclosure. As the foreclosures increase, the fraud on the books will come to light, forcing the banks to buy back more mortgages.

No Federal bailout can save the banks without utterly destroying the U.S. dollar. No investor will risk putting their money into banks if the banks may go bankrupt. The FDIC only insures the first $100,000 of a deposit, so those will millions of dollars to save or invest will stay away from the deposit accounts.

I have no idea what to recommend for those without millions. I believe that gold and silver is still the safest form of savings, but in a deflationary economy, which we may experience, the gold-dollar ratio and silver-dollar ratio will fall (although I believe the buying power of gold and silver will rise).

Markets will crash. Banks will shut down. Millions will be hurt financially. The question is: what will the powers that be, the powers that created this problem, do to try to save the system that is built on fraud and monetary value destruction?

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Date: December 7th, 2007, Filed under Foreclosure, Mortgages, bailout, short sales

Zion, IL
By A.B. Dada
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There’s talk of the Federal Congress working for a law that would remove the tax burden from the short sale of a home when the owner can’t make the mortgage, and can’t sell it for the remainder of the mortgage. What is happening now is the option of the mortgage lender to “gift” the difference between the mortgage value and the sale price of the home, with the lender optionally giving the borrower a 1099 for that price difference. If you have US$200,000 remaining on a loan, and the home short sells for US$150,000, the lender is gifting you US$50,000, and issuing you a 1099 since the gift is considered income.

If the bill passes, the lender will be unable to give you that 1099, which would supposedly “help” the short seller by not having the tax burden from such a big gift. While I am vehemently against the IRS and the Federal Income Tax at every level, this new proposal creates a loophole that I believe many wealthy people will use.

Picture this: You’re offered a new job earning US$100,000 per year. The employer is also offering you a US$50,000 bonus to sign on and leave your old job. A move of some sort may be required (not not necessarily). You’d be liable for US$150,000 in income towards your Federal income tax return for that year. If the tax-free short-sale gift proposal passes into law, this picture changes significantly for the intelligent.

Instead of taking the US$50,000 bonus and the US$100,000 income for the year, you could instead take a US$20,000 salary for one year (with a contractually guaranteed raise in year two to US$100,000), and have your boss loan you US$130,000 as a mortgage. Since your income that year is only US$20,000, there is no way for you to pay that mortgage back, so you could ask for forgiveness in the loan. Your employer would forgive the loan, which did put US$130,000 in your pocket, and you’d be tax free on the forgiven loan.

While I do feel the whole idea of being taxed on gifts is ridiculous (it’s not income, it’s a gift, generally paid for out of someone else’s after-tax income), this proposal will create this loophole, and possibly many others like it.

Instead of looking to help homeowners going through hard times with various government proposals, bailouts, and grants, how about ending the Federal income tax, reducing Federal government spending by an equal amount, and letting homeowners keep what they’re normally paying (sometimes as much as 20% of their gross income)? A 20% raise would quickly solve many homeowner mortgage dilemmas, possibly allowing some to pay down their mortgage to the point that they have equity in their home, at least enough to refinance into a fixed rate mortgage.

Nothing will help people who bought homes that their income can’t afford. Freezing rates will only push the problem off for a few years, but not lower prices to be affordable by others. We need a clean-sweep of the homeownership numbers, bringing home prices back down to 3-4X annual income. As is typical of all market bubbles, they’re created by government, and then they’re made worse when government tries to save people from bad investment and purchasing decisions. Also remember that many home loans today were financed by pension funds that invested in the mortgage market. By freezing rates, those pension funds could go from being worth little to being worthless. Who is going to bail those people out?

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