The Truth About the Recession

The Truth About the Recession

I do not have to tell you how harsh this recession has become. Jobs have been lost, unemployment is creeping up to 10%, profits have been cut in half, 401k’s have turned into 101k’s. Our baby boomers nearing retirement age may have to work for 5-10 more years to feel comfortable in their fixed income setting. This financial meltdown has had and will continue to have extreme effects on the future of business and markets. Like it or not we are a global economy. The US is not the only one that has been affected. Markets worldwide have been affected by this enormous crisis. I have worked in the financial industry for 12 years and September 2008 was one of the scariest times I can remember in the financial industry. Warren Buffet phrased it “an economic Pearl shelter”. Firms with prior successes such as Bear Sterns and Lehman Brothers were forced to close their doors, Meryl Lynch and Countrywide was forced to sell to Bank of America, Wells Fargo had to buy Wachovia, JP Morgan gobbled up Washington Mutual, and the lists go on and on. And today edges are continuing to fail at an enormous rate. We know what appears to have happened but what REALLY happened? As an insider of the industry, I am exposing the truth behind the recession.

In 1999 President Clinton made the following statement, “For many possible homebuyers, the without of cash obtainable to build up the required downpayment and closing costs is the major impediment to purchasing a home. Other households do not have sufficient income obtainable to make the monthly payments on mortgages financed at market interest rates for standard loan terms. Financing strategies, fueled by the creativity and resources of the private and public sectors, should address both of these financial barriers to homeownership.”The Clinton administration urged financial institutions such as Freddie Mac and Fannie Mac to create plans which would allow anyone interested in purchasing a home to be able to reach their goal. Lenders under the guidance of Freddie Mac and Fannie Mae lightened their requirements of qualification to buy or refinance a home. 100% financing was obtainable to clients that had less than stellar credit. Stated income loans, no income verification loans, and no assets verification loans were produced. The worst lenders were incentivized by selling these loans.

Pricing for a borrower was better for jumbo loans (loans above at that time $333,700) if the lender put them into a no income verification loan (NIV). For the lender, it was an easy transaction with better rates, less work and easy sale to the market place by Freddie Mac. This produced an onslaught of buying which pushed real estate prices soaring and construction was at an all time high. It was not uncommon for someone to buy a character for one price and three months later to sell for $100k profit. This was very shared during the years of 2003-2006. With all the construction in most major cities booming, many construction companies would hire immigrants to help with the work. Immigration surged with people from Mexico, El Salvador, Panama, and other Central and South American countries. They were the buyers of all the inventory and homes being built. It was a true sellers market. I remember frustration from my buyers that could not compete with the need of homes. They would call me and tell me they were losing bids left and right due to the other contracts being offered. People were out bidding each other by $30-$40k at a time. Home values were at a enormous bubble.

The market was at a point where the “Home affordable program” was not affordable. People were giving up on the market place because it was cheaper to rent than to buy. It finally reached a pointer where people who could once provide to buy could no longer provide to buy. This caused construction to slow, workers became unemployed, and immigrants started moving back. All of this led to enormous inventories being left behind. Defaults started to happen first in the subprime market due to mortgage fraud and false documentation being given to lenders. It was easy for people to walk away from home that they were now upside down on. This started to crawl it’s ugly head on October 9, 2007.

Investment edges who held these mortgages as Mortgage backed securities (MBS) were starting to see a rise in defaults in their portfolios. This led to now value cutting these securities which then led to losses and write downs. The accounting practices from the FASB did not help the matter either with the forceful write downs of these securities to what is called Mark to Market accounting. Before long the market for these securities was nonexistent and edges were having to write down their portfolio to zero. This caused enormous panic and a race for capital injections to offset huge balance sheet losses. This when the people began to speak of the government stepping in to save the day.

Federal Chairman Benjamin Bernanke and Treasury Secretary Paulson, were in the middle of a firestorm and had to somehow offset these losses and not cause a financial meltdown. On September 16 and 17th, 2008 Bear Sterns and Lehman Brothers went bankrupt. Lehman Brothers were huge players in the secondary market (this is where the mortgage securities were bought and sold). These investment edges not only had huge portfolios of these instruments, but they were leveraging these investments 30:1. If you or I were leveraged 30:1 we would be bankrupt tomorrow! Rumors around Wall Street were flying around as to who would be next, credit spreads were at all time highs, and LIBOR borrowing rates were getting out of control. In stepped the Federal Government and as people were pulling their money out of edges, they were guaranteeing money markets and were insuring these securities. They had to buy a enormous amount of MBS and 10 yr Fed treasuries to counteract this crisis. TARP and TALF was produced, and we now have the government owning publicly traded companies such as Citigroup and AIG.

Risk tolerance has been neutralized and this has changed the markets forever. We now see this great country established on capitalism being turned into socialism. Wall Street has given up it’s control to Washington DC. Elected officials have become more powerful than the CEO’s of the major companies in America. Mortgages are getting harder and harder to come by and the “easy” everyone can get a mortgage stage has passed. We now have the pendulum swung to very tight regulations. Freddie Mac and Fannie Mae require 20% down for buyers, credit scores above 660, fully proven income for 2 years, a very strict examination if you are self employed, and new laws and regulations are being made everyday.

In my opinion, it’s too little too late. The once government who is casting blame on capitalism and free markets are the very ones who promoted the enormous home crisis in the first place. Washington DC needs to stop being hypocritical, let free markets reign, let failure occur and let reward happen to those who do things right.

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