Thursday, October 18, 2007

How to Get Foreclosed On

The last couple of days have seen a lot of articles about the plight of the homeowner in trouble and the irresponsible lenders who got us there. Yesterday's Wall Street Journal had a pretty good article about the paper trail of one guy's mortgage as it was sold from company to company and then repackaged into trusts and whatnot. The article was called "Behind Subprime Woes, A Cascade of Bad Bets". Today's WSJ had an article about real estate speculators walking away from mortgages and losing their primary home in the process.

So let me give a bit of advice to homeowners who think they might be foreclosed on sometime soon: never have any equity.

You see, the bank just wants their money back and they have the right to get paid first in a foreclosure. So if you owe $200K on an $800K home, foreclosing on you is more likely to get back all the loaned money than someone who owes $700K on an $800K home. Now if these two homeowners live in an area where that $800K home has dropped to $600K, you can bet your ass the bank is going after the guy who only owes $200K one first. Otherwise they'd be selling the home of the guy who owes $700K at a loss, and that's $100K they can never recover after the house is sold.

So if you have an interest only ARM right now with zero equity and you can't make your payments, congratulations! You will lose nothing except a home you don't actually own. You're smarter than most people who were silly enough to get any equity through a down payment.

Maybe I'm the only idiot who doesn't see why borrowing to buy into an inflated market is a good thing, because basically every financial crisis goes something like this:
  1. Something (call it a Widget) appears to be valuable
  2. Widgets become a hotly traded item, raising the price
  3. People start borrowing additional money to buy Widgets
  4. Widgets keep going up
  5. Lenders then allow people to borrow money in structures that assume the price of Widgets will never drop
  6. Surprise, the Widget price drops a little
  7. Borrowed money gets called in, economy goes south, or people just stop buying Widgets
  8. Panic selling begins. Widget price plummets and becomes illiquid.

That's every panic in a nutshell:

  • Stock Market Crash of 1929: extreme buying on margin, small drop triggers margin calls.
  • 1987: "Portfolio insurance" combined with computer trading trigger step #7.
  • Bubble 1.0
  • Beanie Babies
  • Tulip Mania

The collapse of Enron is very similar to what's happening with mortgages. The quarterly earnings of Enron were pushed around into structured investments called "Raptors". Raptors were dependent on Enron stock to continue going up to function. When Enron stock dropped, the whole thing came crashing down.

So the next time you wonder, "How can I avoid ever losing money?" The answer is to never have any. The government, the banks ... they'll just take it from you if you ever falter, and borrowing gives you leverage to have the cool things you've always wanted. It's best to never really own anything.

If you have equity, borrow against it to buy more gadgets*.

You'd think I'm being sarcastic, but unfortunately that seems to be the way it works.

* - Actually, did you know that something like 30% of new US debt the past few years was money loaned by China? So we manufacture our MacBooks and gadgets in their country, then they loan the money back to us so we can buy those toys. What a racket.

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