Rob's Rant

There has been a lot of activity this week.  Here is my perspective on some of it.

The $8,000 First Time Home Buyer tax credit has been subject to rampant fraud. (Source: http://www.marketwatch.com/story/fraud-found-in-home-buyer-tax-credit-claims-2009-10-22 ).  DUH.  Throw a bunch of money at something and con men will come out.

Home Sales up 9.5% for September.  (Source: http://www.realtor.org/press_room/news_releases/2009/10/rebound_shows?lid=ronav0021 ).  Throw a bunch of money at something and everyone (not just con men) will respond.  This is an effect of the $8,000 credit, and an effect of Fed buying Mortgage-Backed Securities to drive down yields (aka interest rates) on mortgages.  What remains to be seen is if this will be a short-term or long-term effect.  It is possible the Consumer will be reassured by the halt in price declines and look to buy again in 2010.  It is also possible that people will stop buying in 2010 because those who would have purchased in 2010 moved their purchase forward to 2009 to take advantage of the FTHB tax credit.  Auto sales fell off a cliff after Cash for Clunkers expired: watch for for home sales to do the same early 2010 before underlying market forces bolster the price.  Long-term, Real Estate makes sense as an investment (see previous posts about inflation, etc.).  Short-term is less certain.

TARP program has 1-year anniversary.  How much Toxic Assets did the TARP actually buy?  $0.  Ah well, I'm sure that money went somewhere.  In unrelated news, because Goldman Sachs paid back its TARP money, its Executives will not have their income capped like GM, Chrysler, B of A, etc.  Whew!  Those boys dodged a bullet there!

I read that $3 out of every $10 on deposit in the United States is at B of A, Chase, and Wells Fargo.  Small banks being pushed out and big ones benefiting.  I'm sure that's just a coincidence.

Congress today is working on creating another Federal Agency to oversee the banking industry to prevent future economic crises.  I'm sure that'll work.  Remember how the FBI prevented 9/11, the SEC prevented the Bernard Madoff ponzi scheme, and the Department of Energy was able to eliminate US dependence on foreign oil?

There's a Microsoft Store that opened yesterday right here in Scottsdale.  People waited outside the mall for 20 hours just to be the first to get inside.  It said on the radio it was opened to directly compete with Apple Stores.  Apple has stores?

FHA will now be suing FHA Underwriters directly in cases of losses.  This odd turn of events will make Underwriters more cautious then they have been already.  Times like these are when "the men get separated from the boys".  Sounds like fun to me!  Never before in my mortgage career has it been more critical to have experience, contacts, and a good reputation.  The harder things become, the easier it is for me to differentiate myself from the pack.

Thanks for playing.  Be good to each other and enjoy your weekend!

The world of Finance can be a confusing and scary place.  For this reason many people avoid the topic altogether, until the time comes to make a move: at which time they are often unable or unwilling (or both) to wade through the information available to make sense of it.

Once of the most confusing and contentious terms out there is "Yield Spread Premium" (YSP).  YSP is also one of the most misunderstood terms.  There is even a current proposal at the Federal Reserve to eliminate the practice altogether.

So what is YSP and how does it affect you?

In a nutshell, YSP is how Banks are able to pay Brokers for mortgage loans. 

Here is a simplified example:

1) Let's assume the current market rate for a 30-year fixed loan is 5.5% + 1% Origination and 0% Discount.  You call Bank "A", Bank "C", and Bank "W" and they all are approximately this rate.  Then you call a Broker & s/he quotes you 5.5% + 1% Origination and 0% Discount.  (On a $100,000 loan, 1% = $1,000.)

2) You later learn that the Broker's quote of 5.5% + 1% Origination and 0% Discount includes a 1% YSP.  So to deliver the loan to one of the Banks you called, or possibly to another Bank you didn't, the Broker will be paid 1% by you (Origination), and another 1% by the Bank (YSP).  Your price, however, is the same: 5.5% + 1% Origination. 

So are you being overcharged?  Not because the Bank is paying YSP, you're not.  After all, you're getting the same price (rate and fees) as the fellow who walked into the Bank directly.  Remember, your payment, closing costs, etc. are the same.  So where does the YSP money go in his case?  The Bank just keeps it, & it goes to the Bank's bottom line.

Can borrowers be overcharged?  Yes, they can.  Understand this is a function of rate and fees, not YSP.  Borrowers can be overcharged by both Brokers and Banks (ever heard of Washington Mutual or Countrywide? they were Banks not Brokers).  This is where doing your homework and being educated comes in.

Understand what you are signing.  Ask questions.  Find someone you trust.  Get a Second Opinion on what you are considering, whether it is a Purchase or Refinance.  If you count on the fact that a company is big to protect you, remind yourself of the horror stories of the Bailout.  Investors at Merrill weren't protected, but the Executives were.  The same holds true for AIG and all the rest.

So the net effect of YSP is: more competition in the marketplace.  Brokers can compete with Banks on price, service, or a combination of the two.  Remember, more competition = lower prices.  (Remember your Monopoly game from when you were a kid?  You only can really make the BIG BUCKS when you control a market, represented in the game by a color group.)  This idea is also expressed by the Laws of Supply and Demand.

Remember it is the little guy who can protect you from the "Too Big to Fail" companies.  If they're "Too Big to Fail" what the heck do they care if you get shafted?  I live in the neighborhood in which I work.  Think I care if my neighbors hate me?  You better believe I do!  Think some suit in NYC cares if you're unhappy?  Not likely.  It is the mechanism of YSP that allows me to compete with him for your business.

With whom would you rather work?

(PS--If you would like further explanation, or would like other terms explained, please "comment" or shoot me a private email.  Thanks!)

Foreclosures continue to rise.  The US Government is in obvious panic-mode about housing. People are selling at any price just to get out from under their properties, or are walking away from them.

Is this a good time to purchase real estate?  It seems like if you believe Baron Rothschild (who nobody would really call a "nice fellow" but who was immensely wealthy) you should consider this option for your investments.

There are 2 factors I believe are important to consider right now: people are dumping properties (dropping prices) and ultra-low interest rates (further dropping payments).  Even if prices go down further, rates can't drop and will certainly go up, if only because nothing stays at historic highs or lows forever.

Consider: a $200,000 loan at 5% has a Principal and Interest (PI) payment of $1073.  At 6%, that same $1073 results in a loan of $179,000.

So if rates rise only 1%, home prices would need to drop 10.5% to keep pace, over and above the drop that has already taken place.

On the flipside, when home prices do rebound, you have locked into this lower price and lower rate.  When Rents rise, your PI payment remains the same, and the overage is your profit.  Should values go up 10%, even if rates remain flat (which is highly unlikely), the loan at $220,000 at 5% interest is $1181.  This is $108 that another landlord would have to charge just to break even, putting you at a competitive advantage.

And if the home prices go up 10% and rates go to 6% the loan at $220,000 at 6% would be $1319 per month.  This is a $246 competitive advantage to you.

There is always risk of loss.  You MUST educate yourself about any investment before buying.  Enlist experts to advise and assist you.  But if you sit on the sidelines and just WAIT, you'll miss what seems to me like a party.

Remember the examples I give apply to Primary Residences as well.  If you know someone who is still Renting, this may be the ideal time to change that.  Fixed-Rate mortgages are better than Rent Control!

Open up any official history of our country and you will find reference to the fact that the Federal Reserve, under the wise tutelage of Chairman Paul Volcker, raised interest rates to record levels and broke the back of Inflation.  Since that time, we are told, we have experienced moderate to low levels of Inflation, and the horrors of the 1970s have been averted.

How true is this version of events?

Here is a chart, published by the Federal Reserve, showing the Consumer Price Index, seasonally adjusted:

Take close notice of the period from 1970 - 1980, when we experienced "high" Inflation, vs. the period from 1982 - present, when we have been experiencing "moderate to low" Inflation.  Notice any difference?  Neither do I.

This tells us Inflation is here to stay, until/unless the United States gets serious about its currency and backs it with something.  That could happen soon, or it may be many years from now.  Either way, you need to consider protecting yourself and your family from this loss of purchasing power in the meantime.

Traditional Inflation hedges include: commodities (oil, natural gas, food, precious metals) and real estate.  We are currently watching the unwinding of some folks' heavy bets into real estate.  It will be a long time before people who purchased real property during the "boom" will come out ahead. 

There are some factors going on in the current housing market that tell me it may be time to take another look at diving into real estate as an investment:

(1) It now costs more to build a home (at least here in Metro Phoenix) than it does to buy one.  So buying now will get you the thing below what Adam Smith called the "natural price".

(2) There has been a wave of Foreclosures, and more are to come.  While that could further depress the sales prices, there is a point where we cannot go much lower.  See #1.  All these people who used to own homes will have to live somewhere.  I can tell you they will not be getting another mortgage for a minimum of 3 years.  Therefore they will have to rent.  Watch for Demand for rentals go up, therefore driving rents up (when Demand rises, so do prices).

(3) The Federal Reserve is currently doing all it can to keep mortgage rates low and incent people to buy.  Eventually those rates will have to go up--possibly very significantly.  (In 1981, 30-Year Fixed rate was 18.45%.  Source: http://research.stlouisfed.org/fred2/data/MORTG.txt).  If you own real estate at 5% or 6%, and your neighbors are at 12% or 13%, you can either (a) charge lower rents or (b) make bigger profits.

Should you sink all your money into real estate?  Of course not.  But it may be time to consider adding rental real estate to your mix of investments.  And the lesson from the crash?  If it doesn't cashflow, don't buy it.  The mistake the majority of rookie landlords was buying properties on which they were taking a monthly LOSS, and speculating on being able to "flip" the property later.  Like anything else, in real estate, "bears get fed, bulls get fed, pigs get slaughtered".  This may very well be an excellent time to get into this market, so long as you avoid the temptation to be greedy.