With what the world financial markets have done over the course of the last few weeks, how could I possibly resist revisiting my last blog entry? My question is- Eric Knowles, are you still interested in buying stocks in preference to antiques? Frankly, we haven’t been re-pricing our inventory downward in any sort of response to the volatility of the world’s financial markets. We still have the large George III chest on chest that I’ve used to illustrate- what? four of my blog entries in the last few months. It still represents a lot of wood for the money, and, as established as it is in the canon of the decorative arts, will never really be out of fashion. Also- it is functional. Those drawers? Imagine how many pairs of underwear and socks they can hold.
In the last week or so, our domestic markets have been affected by the debacle of the so-called ‘sub-prime’ lenders, coupled with ex-Fed chairman Greenspan’s continued predictions of a recession, something he’s continually hinted at with no supporting rationale. Although he’s not said so until the last week, he now thinks that defaulting sub-prime mortgages and the failure of the lenders that had originated and warehoused these mortgages will be the leading cause of a recession.
Let’s get some facts straight. A sub-prime mortgage loan, in spite of what sounds to be a perjorative term, is not an inherently bad loan. In simple terms, these are loans that cannot be remarketed by the originating lender into the secondary mortgage market. The growth of sub-prime mortgages has been in direct response to the escalation of home values, particularly in the major metropolitan markets, over the course of the last 10 years- and to accommodate the complex income streams of the people who purchase those homes. The mortgage markets have traditionally been targeted to home buyers whose single or double incomes can be verified with W-2’s, allowing then for some simple ratio analysis to determine if the buyer can afford the mortgage payments. This, supported by good credit history, and the down payment for the house, is all that it took. These standard, income verification mortgages are the basic product that can then be resold into the secondary mortgage market.
Have you noticed the huge bonuses paid out to people in the financial services industry the past few years? These people- all of them- are holders of so-called sub-prime mortgages. Why? Because the complexity of the income stream for most highly paid people is far beyond what can be readily analyzed by a traditional mortgage lender. The performance bonuses that compose most of the income for many of the senior officers of banks and brokerage houses have complicated triggers and benchmarks that, while at the end of the year may result in bonuses many times that of their basic salaries, would be impossible for traditional mortgage loan underwriting to understand. As well, the complexities of the income stream are matched by the complexities of the tax planning utilized by most high income individuals. Consequently, what’s developed are so-called ‘no qualifying loans’ and ‘stated income’ loans- loans that require a significant down payment but require minimal supporting data from the mortgage borrower.
So, the irony is that sub-prime mortgages are oftentimes those granted to what one would assume are the most credit worthy borrowers. The problem is, the growth of the sub-prime mortgage market, responding to the dramatic appreciation of the best housing in the best residential markets, has outstripped the ability of the so-called sub-prime lenders to re-market this type of loan. Sub-prime lenders, then, are obliged to keep these types of loans in their own portfolios, or sell them to others with recourse. If the mortgage holder defaults- or even pays late a time or two- the originating lender may have to buy the loan back. What has happened, with all the media concern about the so-called real estate bubble, is that the limited sources for re-selling these mortgages have dried up, and caused some sub-prime lenders to become illiquid. This is exactly what happened to a number of savings and loans in the early 1980’s. How have we all fared since the so-called savings and loan crisis? Did the bottom fall out of the residential housing market? Let me put it like this- if any of my readers would like to sell their home for what it was worth in 1985, please be sure to get in touch with me!