Ode To Chicken Little By:Jonathan Waite

I came across this post by Jonathan Waite the other day and thought I'd add it to my blog. It makes a lot of sense, and is easy to read. Here it is, and here's the link tho their blog: http://adailyscoop.blogspot.com/

By Jonathan Waite

OK, I have had plenty of family and a few friends call to talk, ask questions and discuss this current financial mess we find ourselves in. I thought I’d add my 2 cents and provide a quick overview to the financial novice.

How did we find ourselves in this mess??

I think most people know the answer to this one. Just like the stock market in the late 90s, the extreme price appreciation of real estate over the last 5-10 years has been stratospheric. It didn’t take an economist to sense a bubble. What blew this bubble up WAY big was the reckless way mortgages were doled out so freely. Speculation was rampant; loans were taken out without verification of income or assets. You could just say – “Sure I make $1 million a year and can afford this $5 million home”. I think we have all heard egregious stories of people getting in WAY over their heads in mortgage debt either looking for a quick buck or living beyond their means.

Now, here comes the tricky part, which explains some of the problems we are seeing today. Historically, you took out a loan with a bank and the bank might hold/own that loan until the end. A process called securitization really started to take off on Wall Street over the past l0-20 years. You can read the nitty, gritty on securitization here. First off, before we explain what securitization means, remember that a mortgage loan is DEBT for you the homeowner but an ASSET for the bank or whoever owns the mortgage.

For simplicity’s sake, here’s how securitization works: a bank takes 10 loans and pools them together. These can then be split up into groups (or tranches in Wall Street parlance) based on the credit worthiness of the homeowner. Good credit loans are prime, inbetween are Alt-A and the poor credit loans are subprime. The prime group would pay a lower interest rate but be theoretically safer, while subprime would pay a higher interest rate but be riskier. OK, got that? Now, Wall Street would take this pool of ten loans, buy it from the bank (usually at a discount to make money) and then sell the tranches to investors (banks, mutual funds, insurance companies, hedge funds, individuals, etc.). It was a way for banks to make money from originating the loan and then take the risk off their balance sheet by transferring it to others. Investors were able to earn a sometimes higher rate of return with perceived lower risk because real estate never goes down right?? I guess you can see where this is heading. The subprime is the first to start cracking and we see the bankruptcy of New Century and other problems with subprime loan originators. The problems, however, then spread to ALL loans (including the prime loans) as real estate really dropped over the last 2 years. But wait, isn’t the prime tranche supposed to be safe??? As it turns out, they all went in the trash can. There were literally NO buyers (does that sound vaguely familier to people trying to sale their home right now??) Unfortunately, many investors who thought they had a more conservative investment found out otherwise. So how does that affect these big companies I keep reading about in the newspaper?

Now, it’s important to see how these big financial companies work. There were incentives in place to own/be involved in this market. First off, investment banks made big fees on putting these deals together. In addition, by investing directly in the mortgages they could earn a high yield. While I talked about banks originating these loans, then handing them off to be securitized, many banks still own a lot of loans. For the homeowner crowd out there, you might notice perhaps within the first year of your loan that there’s a new “servicer” to your loan. You probably just thought – OK, I just make the check out to a different bank. That might be where the securitization of YOUR loan took place. However, the bank still owned your loan for that first, let’s call it year. So they still have plenty of mortgages on their books. At this point, it’s also important to note that banks and investment banks make money from leverage – yes that’s right good old fashioned debt. So while they are doling out debt themselves, they take on more debt to make debt. For example, Bank A might have $100 in capital and then borrow $500 more, costing 3% and then loan out $500 at 6%. In that case, they have 5 to 1 leverage. Investment banks, on the other hand, are less regulated and in many cases use leverage of up to 30 to one. Yes, you read that right. As a point of reference commercial banks leverage ratios are about HALF of investment banks’. Just think if one of you took a $3 million loan out against your $100,000 home to fund your new start up – you would be taken out back and shot for being so reckless. But hey, that’s how the business has been run.That brings us to Lehman Brothers, Bear Stearns, AIG and others. They were caught holding the bad paper. The bad mortgage investments. Not only that, they were using leverage to buy those investments. So as we think of bankruptcy as one’s liabilities greater than assets, and as those assets are trading at 80 cents on the dollar, then 70, then 50, then 30… Well you get the picture.

What’s up with this bailout?? Should I be angry at this??

Well, we are on the line: who holds the ugly, unwanted mortgage investments now?? You and me, if the proposed $700 billion bailout goes through. We already own AIG, Fanny Mae and Freddy Mac. I personally believe the preceding three were too big to let fail. However, Bear Stearns and some banks that will get a reprieve by this bailout should have been allowed to fail. Don’t get me wrong – I don’t like seeing people lose their jobs. But we risk moral hazard by constantly bailing out companies. That being said, what is the alternative?? The mortgage industry is grinding to a halt and lending was not getting done. The more you learn about global economies, the more you appreciate debt and its power. While it cuts both ways (as we’ve discussed already), it is how highways, schools and hospitals get built. It’s how business and economies work. All you have to do is travel to any third world country that has an underdeveloped credit system and you see how important lending money is to building up a society. Now, IMO the democrats in congress will likely push for the relief to go the way of taxpayers to prevent foreclosures. Legitimate argument, I’d think. It’s important to note that both proposals are going to battle the same problem – the stagnant mortgage industry. It’s just that Treasury Secretary Paulson wants to help the demand side (more loans, means more buyers), while democrats might want to help out the supply side (financially healthy homeowners means less supply of homes for sale). I really don’t know which one would be better – I haven’t seen the details yet. So bottom line, we should be disappointed. But any outcome will be disappointing. There is no happy ending to this mess.

I personally believe, we should let the market play out with these businesses (kind of like the Savings & Loan Crisis of the 1980s), let the risky businesses fail and then bailout the mortgage industry and homeowners. So what does this mean going forward, are we going into the great depression???As much as the media would like to play the role of chicken little, I don’t believe the sky is falling. We are in for some hurt as an economy though. While the data I look at doesn’t point to a technical recession currently, EVERY piece of data I look at that has to do with U.S. consumers DOES point to a recession. Manufacturing, exports, etc. are doing just fine. However, the U.S. consumer makes up 2/3rds of the economy. And it’s the American citizen that can’t seem to make enough money to catch up with inflation. And the job situation is moving in the wrong direction. NOW, in order to make McNuggets out of chicken little, this bailout could help out in restarting the moribund credit markets, leading to more debt to businesses, to more money in the system, to more jobs, etc.etc. So there are glimmers of hope. However, when a large chunk of the assets that make up an economy are a house of cards, it makes trudging through the rebuilding process a longer process.

Sorry this is so long. It’s hard to condense the technical information without leaving out important details to tell the whole story. I did leave out a lot of information but I think this is enough to get a full picture. I am no bank expert (my expertise is more consumer companies), but I thought I’d try and help people understand what is going on out there so you don’t get caught up by the talking heads on TV. I welcome any comments.

Help Us All!

Last week was the start of a historic time for us here in the good ole USA. I shouldn't say it was the start, but rather the start of the visible consequences to the actions the government has been taking the past few years. This time will be studied by students 100 years from now, if we're still around as a country. It's truly a time of fear, and turmoil. Fear that the economy won't hold, fear of food shortages, fear of inflation, fear for our republic. I wish there wasn't so much fear and a little more strong leadership. That's all I ask! The government is talking about a $700 BILLION bailout for banks that are going down here in the USA. What ever happened to Capitalism? Let them fail. Let the mom & pop banks have a chance to flourish. Let WE THE PEOPLE get back to neighborhood communities where the drycleaner knows you by name, and the teller at the bank doesn't charge you $5 per visit. I'm just so dissappointed in it all. But, really, who is to blame? We ALL are, we let this happen by turning our backs on Government and letting it get too big. We did this by not paying attention and not holding Government accountable. We did this to ourselves. WE need to fix it. Hold your representatives accountable. Write them, call them, hound them let them know your name! And then cross your fingers, stock up on food and hold your breath!

Visit http://www.house.gov/ and http://www.senate.gov/ to find your representatives. Click on the contact link to send them a short note - it doesn't have to be fancy, just from the heart. SAY NO TO THE BAILOUT!

If you'd like to do some research, a great site is http://www.camapignforliberty.com/

Something from the past...

I found this picture online and thought I'd post it, maybe it'll give me inspiration for the Wed night classes I go to!

What a Busy Visit!

Whew! Margaret and Rita left our house this morning at 6am after a week long visit. I think a week is the longest we've ever persuaded them to stay, so although I would have liked them to stay another 10 days, I'm pretty happy we got the time we did. Where do I begin telling you about the impact they have had no our lives? These two are really super women! The first and biggest thing (and they won't like that this is first....) is that my kids didn't watch any TV for a whole week! No favorite shows, no cartoons, none of it! I'm sooo happy about that. The best aprt is that I don't even think that the kids are aware that they went a week without that crap. I'm this close to disconnecting cable, but I'll admit, sometimes it's nice to sit at the end of a long day and watch something like "Biggest Loser".

The next thing they did was to get rid of all our (mostly my) junk. We had a big garage sale and sold quite a bit, anything that was left we took to goodwill. The last frontier to conquer at my house is my clothing. I'm now completely inspired.

After all the "stuff" was gone they fung shuied the whole house. They have to stop taking these "vacations"! They're probably exhausted! The house feels completely different. I love it. The basement is clean, and organized. The kids love to play down there now. I can actually see the treadmill! Maybe I'll have to use it. The kitchen looks so clean and I feel like I can breathe so much better in my own home. Thank you! Thank you! Thank you!

The last thing I noticed was when they left. I usually feel sad, I miss my mom! I still felt sad this morning, but the thing I felt that I'd never felt before in my life is that I can carry on what my Mom and Rita started in my home. I think before I was just so completely overwhelmed I didn't know where or how to start on de-cluttering my house. I really think I can do it from here. And most importantly, I feel like I can give my kids more of the quality time and attention they deserve. I think that's the kicker in the whole deal. I usually feel so sad when Margaret leaves because she's able to give the kids so much attention that I'm never able to. It just seems like I'm always preoccupied with cleaning or some project. I literally think it was sucking energy from our home. I am so thankful for what they did. They didn't just clean my house, they gave us a better life! It sounds dramatic, but it's so true! Thank you a million times over. You two are the real Wonder Women!

PS - Thank you to Matt too for taking all the stuff to Goodwill, and for so much of the hard work while I was at work! I love you!

What's Important

Last night we did our usual dinner with the neighbors. Sometimes we barbecue, sometimes it's pizza. Last night it was Chinese at our house. Some Sundays it's 9 of us (like last night), and other Sundays it's 17 of us. (like a few of the barbecues) It's become a regular thing, or at least 2 or 3 Sundays a month. I absolutely love it. All the kids playing until dark in the back yard, or riding bikes in the neighborhood. Grown ups talking in the kitchen, eating desert, or putting dishes away. Sometimes we play cards, sometimes we just talk. I know my children will grow up to remember these nights more than almost anything.
I remember my mother having her friends over to play cards once a month. I can remember trying to listen in on the grown ups conversations, and playing with the other kids. I remember the snacks, the brownies, the loud voices. It's funny the things we remember from our childhood.
I remember long walks after dinner with my parents. We'd go for hours sometimes and just walk around the neighborhoods and talk.
I remember the Sunday drives looking at houses for sale, and stopping at every open house. We weren't buying, but my sister and I would rush into the homes and frantically stake out our bedrooms. Then we'd tell the realtor this house is way overpriced!
I remember the roasts and rolls my mom would make, and her famous brownies.
I remember the first day of school each year, and the night before. My mom would lay out the outfits she was making for us. We'd pick the one we wanted to wear and she'd rush off to finish sewing it before morning.
I remember walking to school with my mom, and having snacks waiting for me after school.
I remember every Christmas Emily and I would search the tree for an odd piece of tinsel. It would be our special necklace for that year. (a silver delicate chain, almost indistinguishable from the real tinsel!)
I remember Holidays with all our crazy relatives. (and we had our share!) The best part was listening to all the conversations.
I remember listening to our radio programs on Tuesday nights. Mom would make graham crackers with homemade chocolate frosting, sometimes mint chocolate, the night before. That way they would be soft for the show. We'd sit on the floor next to the waterbed, or sometimes lie on the waterbed and listen to Fibber Mcgee and Molly, or The Shadow, or The Green Hornet.

I don't remember any of the toys I had growing up, except one. I wanted this pinball machine so much! I was about 10 years old, and it cost about $15. My mom and dad made me save to buy it, and I did. I finally had enough in nickles, dimes and quarters to buy it. It was one of those plastic flat pinball things where you have to pull the plastic knob back to send the steel ball flying, and it'd go around this plastic spiral frought with dangerous holes. If you missed them all you could get a bulls eye and score a ton of points. (which you had to keep a running tally in your head for - there were no bright lights on this thing!) Anyway, that's the only toy I really remember, and I had a lot of toys.

I wrote about my memories because of a blog I read today. The things you do to make memories are the most important gifts you can give your family.

I was reading a blog today written by Courtney, the sister of a mother of four. Courtney's sister's name is Nie. Nie and her husband were learning to fly this summer. They took off one day in August and something went wrong. The plane went down on takeoff. The instructor was killed. Nie and her husband were severely burned and injured, Nie over 80% of her body, her husband 30%. The families of these people instantly went into action, taking care of the children (the children all went with the sister who is now doing the updates on the Blog, and who has her own newborn), and starting fundraising to help with medical costs. You can see the blog here: http://blog.cjanerun.com/

What struck me was something Courtney said in her blogging. She said she never thought she had put in enough time and effort to have such great people around her to help with all the things that needed to be done. The Relief Society came to clean her kitchen, neighbors donated food and meals, friends watched children so she and her husband could have date nights, others donated money or items to be auctioned off to help her sisters fund for medical costs.
I think this is a question everyone should ask every day. Have I contributed enough that others would want to help in a time of need? Have I created memories for my family? Or have I been so self absorbed that no one would notice if I was missing? It really brought it home for me, what's important. Family is everything.

I think the time and energy you put into your life and those lives around you will directly define you as a person. Nothing else. It is a good lesson for us all.