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We are in the middle of a severe credit crunch, one of the worst in memory. This crunch was caused by two factors: subprime loans and incomprehensive derivatives.
1. The first factor is subprime loans. A few years ago, a lot of unscrupulous brokers and lenders made loans to people who wouldn’t normally qualify for a mortgage. They didn’t have enough savings to make a normal down payment. They didn’t have enough income to make normal monthly mortgage payments. Nonetheless, they got loans because some salespeople got paid for every loan they made, regardless of whether it was a good loan or a bad loan. Often, these so-called subprime borrowers got a low teaser rate for a few years, and then their mortage rate jumped to double-digit levels.
These subprime borrowers cannot afford to make higher mortgage payments unless their income increases dramatically or the value of their home increases dramatically. They were a foreclosure waiting to happen. They couldn’t make their monthly payments. These forced sales are a huge drag on the real estate market.
Plus the lenders who got burned by these bad loans are hurting and they can’t afford to make a lot of new loans.
2. The second factor is incomprehensible derivatives. Bundles of loans were put into packages and then sliced and diced into pieces like baloney. These are called derivatives because the value of this baloney is derived from the values of the mortgages that were used to make the baloney.
The problem is that that no one really understands what is in the baloney. A very good rule is “Don’t invest in anything you don’t understand.” But even sophisticated investors are human and humans are susceptible to wishful thinking and greed. They held their noses and bought this rotten baloney because they hoped they were buying prime rib.
These two factors created a credit crunch.
A credit crunch means that many banks can’t make loans and some banks don’t want to make loans.
So, people with lots of income and assets and impeccable credit scores who’ve paid every bill on time are getting turned down for mortgages simply because lenders are very nervous and are being very cautious.
This credit crunch is awful for home sellers and it is awful for home buyers who have their mortgage applications rejected. But it is a great opportunity for anyone who can get a mortgage. This is a genuine buyer’s market. Mortgage rates are low, and sellers can’t find buyers. This is a great time to be a buyer because mortgage rates are low and you can have the upper hand in negotiations with the seller.
When will the market turn? When banks rebuild their capital and are willing to lend again. The Federal Reserve, Congress, and state and local governments are doing what they can to end the credit crunch. And it will end. If you can get a mortgage now, now may be a great time to buy, before the credit crunch ends and the real estate market turns into a seller’s market again.
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Posted April 22, 2008
