What Can We Say About This Stock Market? Going no where fast comes to mind. As of today's date, March 26, the market is less than 1% above where it began on the first trading day of 2007. It looked like we were in for a good year for awhile. The market was up 3% by February 20, only to fall back to the current level, over the next month. None of us really know the reason why the market reversed course but the current hot topic is the sub-prime mortgage market.
The Sub-Prime Mortgage Market Is a Great Example of Stupid Lenders and Stupid Consumers. Years ago, a number of lenders decided that it was more profitable to make loans to non-creditworthy borrowers at high rates, construct a diversified loan portfolio, and be willing to accept a higher foreclosure rate than it was to compete for borrowers with good credit histories who had numerous sources for rock-bottom interest rates. This worked well for awhile as suppliers of sub-prime mortgages were protected by higher down payments and rising home prices. Life was good. There were plenty of home buyers with credit problems anxious to be homeowners and plenty of investors hungry for higher yields willing to buy sub-prime paper. Real estate prices escalated as more people were able to buy homes now that they had the financing to do so. It even reached the point where increasing numbers of families were no longer satisfied with one residence, they had to own two. They weren't happy with 900 square foot homes like the average 1950's home, they had to own houses two and a half times that size, the average house size today. So where did it all go wrong.
Success Breeds Competition. There is an old economic axiom that says when one provider of goods and services begins to do very well, others will enter the marketplace and provide similar products which compete with the original provider. As more lenders entered the marketplace to compete for the existing borrowers, it became harder to originate enough loans to satisfy the investors, eager for higher yields. In other words, too much money chasing too few deals. To keep from lowering rates to attract more borrowers, lenders lowered their standards to the point that, instead of offering sub-prime loans, they were offering sub-sub-sub prime loans to borrowers who couldn't possibly afford the home they were buying. As home prices leveled off, these borrowers were trapped in homes they could no longer afford and couldn't sell. Delinquencies rose and the resulting increase in foreclosures were the natural consequence.
You Hate To Say That They Deserved It. Some lenders certainly did. Many borrowers, have the excuse of being financially unsophisticated. Lenders may not be all that sophisticated either since many loan officers entered the business with no experience in personal finance and no ability to advise borrowers of the risks of these loans. No one trained these loan officers to explain risk because their job was to sell loans not counsel borrowers. If they didn't sell loans they didn't get paid. In a sense, the entire industry was one in which there was a lack of business ethics and the consequences they are experiencing today were entirely predictable. A number of medium and relatively large sized sub-prime lenders are no longer economically viable and bankruptcy is only a matter of time. Shareholders in public companies have already seen most of their investment evaporate and the rest will soon follow.
It Will Take Awhile to Work Our Way Out of This Mess. A lot of homeowners are hanging onto homes hoping for some miracle to allow them to continue. Most will fail. This will keep a lid on prices, especially in areas where markets overheated. Areas like Denver, while not all that healthy, may not do as badly because they began to deal with these problems several months ago. Overall, the markets will probably weather these effects; however, tax increases being considered the newly elected majority in congress could add to the problems created in the housing market.
I am Reminded of How Little All This Matters. This week-end a local real estate investor accidentally killed himself while trying to fix a jammed firearm. No longer will he be bothered by leaky faucets, complaining tenants, and fluctuating real estate prices and mortgage rates. He was only 41. As I attempted to find words to console his grieving family members, I was again reminded of similar situations where I spent hours trying to help clients solve what we thought were serious problems only to find out they weren't serious at all compared to what happened next. Each day is a gift. Appreciate it.
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