Friday, August 17, 2007

Bad Money After Good

There is still talk in the financial press about liquidity concerns, mortgage defaults and lack of remaining capital. American Home Mortgage has folded like a house of cards. For may of us, this situation will mean a blip in the stock market and perhaps a slight change in our 401K accounts in the short term. It is not a huge cause for panic - certainly not a reason to run out and sell all your stocks and mutual funds and bury your life's savings in a coffee can. This mortgage lending issue has been on the horizon for a very long time. Those in the know have known this to be a problem for a long while.

The question on alot of people's minds I think it what does lack of liquidity actually mean and how did this all come to pass?

What this means is right now, those companies, who have lent money to folks who perhaps for a variety of reasons have less than sparkling credit histories are now realizing that in their haste to keep pace with the exploding market place, made some bad business choices. The desire to keep selling mortgage products, to take more and more risk, hoping for larger returns, has not come to pass. What has happened is that those folks who have borrowed money have failed to pay it back or are not paying it back on time, every month. While it is true that mortgages are secured loans, that is the bank can take your house if you do not pay, that is a costly process for the bank. Then they have to sell the house and in certain parts of the country, that currently is easier said than done. Banks hate to foreclose, they try to work it out, it is less costly and some money repaid is better than none.

If the above were the only downside, we would not even be having this discussion. Here is the biggest problem of all - the mortgage companies who have made these loans, also now own investors monthly payments. No company carries all the debt on their own. The repackage the debt and sell it to investors - in the form of mortgage pools and other notes. The borrows pay the mortgage company and the mortgage company pays the investors. If repayment fails to happen - investors cannot be paid - or at least not for very long.

What does this all mean for us? Well I think in the coming years we will find it a bit harder to borrow money - even if our credit is really good. I think those people, who for a varieties of reasons have credit issues - may not be able to borrow money at all. Which for those who have recently divorced or had some medical problems - will be a hardship.

I also think we still have not learned our lesson from the internet boom. Capitalism and business are really as old as time. I have something you want and I want to make money selling it. It boils down to that. Commerce is pretty basic - really. I have said this before - there is nothing lie bad business. It will bite you in the but. I am all for calculated risk taking - I get that you have to stretch a little, push yourself. But at a certain point, we have to satisfied with reasonable growth and not exponential. There is too much riding on these decisions. In the case of American Home Mortgage - over 5750 peole are now out of a job. Who wins there?

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