Savers Are from Mars. Debtors Are from Venus. Episode 5

Turning Gold into Lead:
How To Lose $100k, and Your House, and Your Family

"Wendy's home had appreciated in value by about $100,000, only months after she and her husband bought it. So, they took out a second mortgage for almost $80,000 to enhance their new home. It was at 8% interest. When the housing bubble burst, that $100,000 in equity evaporated. But, the interest on that second adjustable rate mortgage by now had climbed from 8% to almost 16%, creating a monster of a monthly payment they couldn't handle. 'Then, it just gets pulled from right out underneath you.' Wendy says her marriage even broke-up over this. Now the couple faces possible foreclosure on the house" (KVOA).

Debtors often display this unfortunate tendency to turn even a $100k windfall into more debt, to eliminate increases in net worth, to eradicate any trace of even accidental equity.

Remember that the $100k was only a paper profit, not real wealth, because they did not sell the home at the high price (they ignored the basic, old "sell high" truism).

They ignored the chance to increase their income and instead increased their outgo (spending)--the opposite of basic financial advice to increase income and decrease outgo.

Ben Bernanke on South Park?

Gangrene on the Greenback: The Falling US Dollar

If South Park did Ben Bernanke and Federal Reserve monetary policy:

Alan Greenspan: Fun with Financial Armageddon and Famous Movies

Which movie best explains Alan Greenspan's tenure as Chairman of the United States Federal Reserve?

Comment on these and post your own choices.

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Dr. Greenspan: Or How I Learned To Stop Worrying and Love the Bubble

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Greenspan: The Man with the Golden ARM

(ARM=Adjustable Rate Mortgage)

See more Fed spoofs:
Canada Forces US Federal Reserve To Raise Interest Rates?
Ben Bernanke Music Video
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Negative 11% Home-Value "Appreciation" Rate Is Considered Good Now?

Negative 11% is one of the best "appreciation" rates in the nation.

The Real Estate Bloggers posted a list of the top 20 real estate markets over last year.

Look at Detroit (below).

If the "top" 20 home-value "appreciation" rates include double-digit negative rates, what do the worst 20 markets look like?

Top 20 Markets: Real Estate Property-Value Appreciation Rates over Last Year

Seattle 9.10%
Charlotte 7.00%
Portland 5.70%
Dallas 1.80%
Atlanta: 1.70%
Denver -1.40%
New York -2.30%
Chicago -2.80%
Cleveland -2.80%
Los Angeles -3.30%
Miami -3.30%
San Francisco -3.40%
Minneapolis -3.50%
Las Vegas -4.10%
Boston -4.30%
Phoenix -5.50%
Washington, D.C. -6.30%
Tampa -6.70%
San Diego -7.00%
Detroit -11.10%

Destroy Your Retirement Nestegg with Happy Thoughts

Magic Numbers:
Pick One . . . Whichever One Makes You Happy

My recent article about investing vs. paying off your mortgage, Never Prepay Mortgage? Housing Myths Part 1, has a bigger lesson for the subprime mortgage and Collateralized Debt Obligation (CDO) mess.

“Prove” anything by picking the magic number.

My article noted how a 2001 Fool.com article predicted a 12% annual return on investment (ROI) for an S&P500 fund but in early 2007 the 10-year average was only 7.7% (even using "Bull's Math" (optimistic Wall Street math)).

The second mistake is forgetting what an average is.

The problem for your retirement nest-egg is that a return to 12% annually does not fix the predicament. To average 12% after a decade of 8%, you need the next decade to provide over 16%. However, we are coming due for a recession (cycles are inevitable) and a steady 16% for a decade seems unlikely. Moreover, if a coming particular year does “only” 12%, you need another year at 20% to average a 16% decade to make up for the first decade’s 8%. If the S&P500 returns a modest 8% in a future recession, we might need the S&P500 later to return 25% simply to average 12% in the 21st Century.

“Experts” apparently made this mistake in financing the housing bubble.

Experts at an early-2006 conference on home-equity-loan securitization assumed a worst-case scenario of +3% asset (home) appreciation per year. It seems as if they assumed the worst stress-test condition to be the long-term trend rate of residential real estate appreciation, barely treading water with inflation (if we continue 2-3% core inflation).

The bigger they are, the harder they fall.

The glaring error is assuming that the price basement will be the historic average, rather than the lower numbers that created the average. +1 and -1 average to 0. It is mathematically impossible for every year to be either average (0) or above average (+1). Some years must be below average (-1) to make the average. If you then had a few years at +10 (far above average), you cannot assume that your future floor will be 0 (the average) because now you need a few years at -10 (far below average) to return the average to 0.

The big problem ahead

Standard & Poor's (S&P) and Moody's are reducing the ratings of mortgage securities, which is like telling a new owner, after the purchase, that his/her "6-pack" of soda only has 5 cans, his/her "30mpg" car only gets 20mpg, or his/her "3-bedroom" house only has 2 bedrooms.

The valuation errors contributed to the housing bubble by (1) overestimating the profit in home-mortgage sales, (2) thus overselling the financing product, (3) thus causing the inflation of too many dollars chasing too few assets (the home, necessary to cash the profit on the home-mortgage product), (4) thus contributing to the asset bubble, (5) but also underestimating the risk, (6) thus underdiscounting/overpricing securitized debt/CDOs, (7) thus sticking buyers/investors with insolvent lemons, (8) and the double whammy of evaporating home equity and evaporating securities equity creates yet to be seen ripples in pension/retirements funds, consumer spending, employment, Federal Reserve monetary policy, stock market performance (+25% or -10% for the S&P500?), and the economy writ large.

See also: Beware Vanguard 500 Faulty Logic & False Performance Measures for Investments

Wizard of Oz Lesson for Your Personal Finance

Dorothy in The Wizard of Oz finally learned that she always had the power to achieve her goal. The solution to financial freedom always has been and still is available to you or anyone who wants it.

Note: I separated this message from another post: Declare Independence from Housing Slavery: A Famous 4th of July Lesson on Personal Finance.

Savers Are from Mars. Debtors Are from Venus. Episode 2

Mind-Boggling True Story

Like Mother, Like Daughter

Deborah Beatty has no job but took a mortgage for a new New Jersey 3-story home with a view of the Manhattan skyline and Statue of Liberty and then did not pay the payments. Her daughter makes less than $20k/yr as a graduate student but took a $600k mortgage split into 8.75% and 12.5% interest rates and then did not pay the $5k/mo payments—maybe because the payments were more than 3 times (300%) her entire gross income.

“Beatty acknowledged the mortgage was probably too good to be true” (Union-Tribune of SD).

On what planet is $600k debt @ up to 12.5% and payments 3x gross income “good”?

(The quote might only refer to the mother’s unspecified loan but I suspect that she approved of her daughter’s loan and that the mother's loan was little better.)

Take the quiz: Do you find these loan offers attractive or repulsive? Answer in comments.

Avoid Debt “Anti-Scam” Scams

Everyone Wants To Believe in the Tooth Fairy and the Free Lunch

People who get themselves into debt problems often do so by wanting to see the best and ignoring red flags so they can sign on the dotted line and get instant stuff. When considering a contract or loan, there is a temptation to ask the right questions but accept dodgy answers that do not add up, so you rationalize that you “did your part” and any later problem will not be your fault. That is a self-deception because you are the one who will be left holding the bag.

Debt Relief: Out of the Frying Pan, into the Fire

People who get themselves in debt trouble are unfortunately likely to repeat the same mistake for the same reason by desperately wanting to believe that some debt-relief expert can provide a painless way out of a debt problem. Some companies charge up-front fees but offer no success guarantee. Some companies offer to take care of everything (sending the mortgage payments, negotiating with banks) but—as you discover too late—did not do so.

You are ultimately responsible and you suffer the consequences so the sooner that you accept responsibility and stop wishing for the too-good-to-be-true short-cut, the sooner you can establish a solid financial foundation.

Mortgage Foreclosures: Subprime and Job Loss Not the Real Reasons

As usual, the mainstream media manage to be several years late to the housing bubble story—and still get the story wrong.

The better than average Investor’s Business Daily helpfully mentioned that job loss might better explain recent foreclosures but even they missed the main point.

The borrower’s bad behavior is the main reason for the borrower’s bad situation.

Bad loan terms and job loss problems are only symptoms of the borrower’s bad behavior:

• If you chose bad loan terms of 50% interest but you only borrowed $1, it is unwise but not dangerous.
• If you lost your job a year later but only owed $1 and change, it is annoying but not catastrophic.

The true problem is overconsumption, buying a $500k house on a $250k budget.

Buy a $125k house on a $250k budget and adjustable rates or job loss will not mean foreclosure.

Ameriquest Mortgage Refinancing

Crossposted from Inexpensive Home Building

The mainstream media are finally doing many stories on risky mortgages. Ameriquest was one of the first bubble lenders to admit financial trouble.

From Wikipedia:

Ameriquest is one of the United States's leading wholesale sub-prime lenders. It is a private company, owned by Roland Arnall, founded in 1979, in Orange County, California, as a bank, Long Beach Savings & Loan. The bank moved to Orange County in 1991 and was converted to a pure mortgage lender in 1994, renamed Long Beach Mortgage Co. In 1997, the wholesale part of the business (funding loans made by independent brokers) was spun off as a publicly traded company, called Long Beach Mortgage; the retail part of the business was renamed Ameriquest Capital and remained private. (In 1999, Washington Mutual purchased Long Beach Mortgage.)

Ameriquest is best known for its subsidiary, Ameriquest Mortgage Company, which makes direct loans to customers. Its Argent Mortgage Company affiliate works with independent brokers. It has offices nationwide, and more than 12,000 employees. Other subsidiaries are Ameriquest Mortgage Securities, Long Beach Acceptance Corp., and Town & Country Credit.

Ameriquest was among the first mortgage companies to use computers to search for prospective borrowers, and to speed up the loan process.

...

Sub-prime lenders made $587 billion in new mortgages in 2004, up from $390 billion in 2003, according to National Mortgage News. Ameriquest's share of that is estimated at over $50 billion.

In 1996, , the company paid $3 million to settle a Justice Department lawsuit accusing it of gouging older, female and minority borrowers. Prosecutors accused it of allowing mortgage brokers and its employees to add a fee to these customers of as much as 12% of the loan amount.

In 2001, after being investigated by the Federal Trade Commission, the company settled a dispute with ACORN, a national organization of community groups, promising to offer $360 million in low-cost loans.

On 1 August 2005, Ameriquest announced that it would set aside $325 million to settle attorney general investigations in 30 states. In at least five of those states — California, Connecticut, Georgia, Massachusetts, and Florida — Ameriquest has already settled multimillion-dollar suits.

In May, 2006, Ameriquest Mortgage announced it was closing all of its retail offices, and will emphasize in the future its loans through brokers, a channel that is not covered by the predatory lending settlement with the Attorneys General.

The issues confronted by companies like Ameriquest are considered by many industry experts to be the major contributing factor to the rapid rise of Certified Mortgage Planners, certified industry experts that work in concert with Certified Financial Planners in harmonizing the home finance products utilized by consumers with their larger financial portfolios.

Home Equity Loan Buys Sports Car

People continue to borrow home equity loans to buy toys.

Today's Car Talk radio show caller bought a $14,000 used luxury sports car with home equity. The car had a bad transmission, but he was more interested in the Candy Apple Red color.

The big problem with the housing bubble is that not only did new buyers overpay for homes but also that existing home dwellers who had manageable mortgages embarked on spending sprees based on the imagined paper "wealth effect" of higher appreciation. They treated their houses as ATMs by taking out home equity loans or the similar Home Equity Line of Credit called HELOC. So, even people who had bought before the bubble and had good finances have endangered themselves by bubble behavior.

Appreciation can be temporary. Debt is certain.

The big mistake people make with debt is that they assume that present conditions or trends will remain the same ("I make enough for that payment."). Every scientist should know the danger of extrapolating current trends into the future and the uncertainty is why stock disclosures warn that past performance does not guarantee similar performance tomorrow.

Make your life easy by not volunteering to lock yourself into future burdens, especially unnecessary ones.

Yes, a broken $14,000 sports car counts as an unnecessary one.