Archives For June 2009

Interesting article by David Wessel in today’s WSJ about how he believes (and Greenspan too) that the economy can only rebound if housing prices rebound. From the article:

For the two-thirds of American families who own their homes, a house is their biggest asset. The lower house prices go, the less wealthy they are and the less they can or will spend and borrow. For home builders, the lower home prices go, the fewer new homes they will build and the fewer workers they will hire. And for many American banks and other financial institutions, mortgages, mortgage-backed securities and financial instruments that rest on mortgages remain a huge headache. The lower house prices go, the less these loans and investments are worth and the weaker the foundations of the financial system are.

Although I understand the importance of housing prices, I’m concerned that as a nation we will return to our former ways of using home equity as a piggy bank for consumer spending. From what I have read it’s clear to me that that was what led us to this predicament in the first place.

I guess my real question is…

What’s to stop this from happening all over again?

I mean, we have laws against fraud, but they weren’t enforced when people lied about their income in order to get bigger mortgages. What’s to stop this from happening again? Clearly we can’t rely on homeowners or potential homeowners to not take on too much debt. Nor can we rely the ethics of the mortgage brokers and bankers to not allow customers to take on more debt than they can handle since they [the mortgage brokers and bankers] are worried about the potential customer getting financing from a competitor.

I’m also concerned that so much focus is placed on consumer spending. Yes, we need consumer spending but shouldn’t we be more concerned with the incomes necessary to support that spending? We saw in the last eight years that consumers were simply borrowing money in order to spend.

Maybe we should have some standards in place. Things like…

• No more than 30 – 35% of your income should be spent on housing.

• Your income MUST BE VERIFIED!

• You need at least a 10% down payment when purchasing a house.

• No more than 80% (or maybe even less) of your equity can be withdrawn via a home-equity loan.

I would even like to see new homeowners attending homeownership classes or something of that nature. Purchasing a home is a HUGE decision and people should be getting their education from someone other than those who stand to gain from their decision.

Those are my thoughts? Do you have anything you’d like to add?

During the subprime boom, lenders were using “stated-income” loans, which meant the borrower could state their income but no income verification was used. Basically, this type of loan allowed for the borrower to inflate their income and no one would know the difference. Doing so allowed for the buyer to “qualify” for a larger mortgage.

Here’s the deal:

Overstating your income (lying) on a loan constitutes fraud. Fraud is punishable by law.

I haven’t found any hard numbers on how many stated income loans were used or how many of the stated income loans were overstated. But, it shouldn’t have been that hard to figure out. If you say you make $16,000 a month and in reality only make $3,600 per month (an example in the book), it wouldn’t take long for that overstatement to come to light. All one would have to do is find the paperwork and then compare that to tax returns. And, this could be done by those who are helping people stay in their homes.

Unfortunately, prosecuting the fraudsters would most likely be an expensive process.

I’m not against helping those who LEGITIMATELY need help. I just don’t like the idea of helping those who might have committed fraud.

Just think, this entire crisis probably could have been averted had lenders insisted on income verification!

Read this comment left by AFM reader and commenter, LOL:

The middle class is under a massive squeeze: they can’t afford medical care, college for kids, housing, etc. The only reason we have not been in recession since 2000 is due to availability of cheap debt to absorb the rising costs — while at the same time, having a reduction in wages and offshoring of their jobs.

My crystal ball tells me that we will not have a sustained economic recovery without a middle-class, and the best way to bring the middle-class back is to drastically reduce taxes on them, and increase the taxes on the rich to rates that are at least equal, if not above, the middle-class tax rates.

This means: remove the income cap on Social Security and Medicare taxes, and eliminate the 15% dividend tax [and tax them at regular income tax rates]. The rich get the majority of their income through dividends, yet they are taxed at the 15% poverty level.

LOL comes across as almost hateful towards the rich, the vast majority of which worked their butts off and made great sacrifices to get where they are. I get the feeling that LOL thinks that most rich people woke up rich.

Personally, I think the middle class’ struggle has much more to do with their inability to prioritize. I would suggest that LOL read The Millionaire Next Door* by Thomas Stanley and William Danko. In that book he will find that most millionaires drive old cars. Take a look around at what most “middle class” people drive and you will probably see that they are driving cars and SUVs that they really can’t afford. Imagine how much money could be saved if we didn’t have to drive $50,000 SUVs.

For example, I was dropping my daughter off at daycare one day and this young woman pulled up in a BMW 740. For those of you not familiar with cars, the BMW 740 is around $80,000 brand new (I could have purchased THREE of my cars for the price of her BMW). No, I do not know this woman’s situation—she could be wealthy and can afford a BMW 740 without harming her finances. But, going on the averages, I would have to say that by driving that car she is forsaking some other important area of her finances.

I think the middle class suffers from the “I deserve it” syndrome.

Take a look at the houses being built these days. They are freaking huge (and freaking expensive)! I grew up in a 900 square foot house (plus a basement) and we were a family of five! We had one bathroom. Yes, times have changed but these bigger homes cost more money and they cost more to maintain. All of this means that they are requiring resources that could be allocated elsewhere (like savings, retirement planning, college funding,…).

Instead of removing the cap on Social Security taxes (there is no cap on Medicare taxes), I think we should cut benefits. We are creating a monster in Social Security because we keep promising way more than we can deliver. Social Security is a cancer on our society. Instead of looking for ways to feed the monster, we need to put the monster on a diet.

Finally, I want to gag when I hear people say stuff like, “The rich get the majority of their income through dividends, yet they are taxed at the 15% poverty level.” First off, those dividends have already been taxed at the corporate level. Secondly, 15% is a tax rate, and should not be equated with any economic level. The more you make, the more you pay. It’s pretty easy to understand.

*Affiliate Link

I Was Right!

June 22, 2009

If you want to read a short book that will give you a pretty good idea of what went on with subprime mortgages, check out David Faber’s And Then the Roof Caved In*. It’s a very good read.

As my regular readers know, I have blogged a lot about the subprime mortgage crisis. In one of my posts, I mentioned that brokers were incentivized to put prime borrowers into subprime products. One of my commenters (mortgage broker I believe) argued that brokers were not given incentives to promote one type of mortgage over another. Well, unless David Faber is lying, on page 71 he writes that some brokers WERE given incentives (emphasis mine):

The higher the rate on the mortgage, the more money the originator would be paid in that rebate** by Wall Street. “If you could sell the loan for a highter rate and sell a lot of them at a higher rate, the Wall Street was in love with you. They would bend over backwards for you. They would buy anything you’d give ’em, just about,” gushed [Lou] Pacific. Subprime loans carried a low initial rate, but over the life of the loan a very high rate. It proved to be the perfect product for Wall Street. It also proved tempting for many of the subprime firms to convince consumers to take a subprime loan even if they qualified for a much lower-priced prime loan. “We used to get an awful lot of them [prime borrowers],” say Pacific unapologetically. “They were more concerned with the pseed of getting a loan. And plust the average person doesn’t understand where their credit ranking is, some don’t think they can qualify for a good loan, but they can. So0 they’ll call and if you sell a loan with a higher FICO score, you’re going to make more money on it.” Pacific claims that when he encountered such a person he would refuse his business and tell him to go to his local bank.

Yeah, right. I’m sure Mr. Pacific turned the business away. He may have, I don’t know. Let’s just say I’m skeptical.

Of course, the AFM commenter may not have been given incentives if he worked for a smaller firm that didn’t have a direct relationship with Wall Street. I suppose that is possible.

I encourage you to pick up a copy of David Faber’s And Then the Roof Caved In*. It’s a page-turner as David does an excellent job of explaining the story in a way that most people can understand it. I’ll be mentioning more tidbits from the book in the near future.

*Affilitate Link
**Also known as a yield spread premium.


Wiley’s Little Book series is a wee bit confusing in that there’s The Little Book That Beats the Market*, which is a stock-picking book. Then, in the same series there’s John Bogle’s The Little Book of Common Sense Investing*, a book essentially about indexing or passive investing. So, you read one book and say, “That makes sense,” only to have that opinion challenged by the very next book in the series. If it’s confusing to me I can only imagine how confusing it might be to someone who might be new to investing and financial planning.

That’s why I was pleasantly surprised when received a copy of Jonathan’s The Little Book of Main Street Money*, which is much more of a book on the basics of financial planning and the bigger picture rather than just another book touting a particular investment strategy.

For those of you who may not be familiar with Jonathan. He was the author of the Getting Going column, which ran in the Wall Street Journal for something like 17 years. I interviewed Jonathan a couple of years ago (Part 1 and 2).

I asked Jonathan about his book and he said, “I’m biased, of course, but I think it’s easily my best book. The “Little Book” format really suited my writing style. It was like penning a series of columns, except—because it’s a book—I was able to draw tight connections between the different topics.” He also added, “Most personal-finance books are about money and only money. But as we all know, there’s a whole lot more to life than dollars and cents, and I endeavored to make that clear with my Little Book. Money is just a facilitator, a means to an end, and we need to think long and hard about how we save, spend and invest if we want a truly happy financial life.”

In The Little Book of Main Street Money* you’ll find 21 truths about money expressed in a no-nonsense, easy-to-read manner. Truths like:

• We can’t have it all – a basic law of economics that people tend to forget.

• No investment is risk-free

• Markets may be rational, but we aren’t

• Paying off debts could be our best bond investment.

Because it is a “Little Book,” each chapter is short. The entire book can almost be read in one sitting (unless you’re a slow reader like I am). The concepts in the book aren’t new but have clearly been ignored by lots of people as you can tell by watching the news or reading the newspaper. It’s time to get back to the basics and that is what Jonathan’s book is all about.

I think that’s why this is my favorite of the “Little Book” series so far.

From Yahoo Finance:

Foreign demand for long-term U.S. financial assets fell in April as both China and Japan trimmed their holdings of Treasury securities.

The Treasury Department said Monday that net purchases of stocks, notes and bonds obtained by foreigners fell to $11.2 billion in April, from $55.4 billion in March.

China, the largest holder of U.S. Treasury securities, trimmed its holdings to $763.5 billion in April, from $767.9 billion in March. Japan, the second largest holder of Treasury securities, reduced its holdings to $685.9 billion, from $686.7 billion a month earlier.

We knew this was going to happen.

The question is: How bad will it get?


June 15, 2009

I read this article in Fortune over the weekend and it has me concerned:

WE OWE WHAT? The next crisis: America’s Debt

According to the article, at our current spending rate, each individual’s share of the debt will be $155,000 in 10 years.

Paul Krugman supports Obama’s spending but thinks we need higher taxes to pay for it.

Here’s my thought. Maybe we should cut spending! Go back to the basics of what the government should be providing for its citizens.

Oh, and the article talks about a value-added tax (VAT), which would be IN ADDITION to our income tax. A value-added tax is similar to a sales tax. The end result would mean that consumers would be spending more and inflation would only compound the VAT. I can’t believe that this is going to be good for the economy.