I think I’m just starting to get my mind wrapped around this credit crisis. I have two questions:
What harm will come to me if we let all the companies with bad mortgages/CDOs go bankrupt? Is it that they won’t be able to pay back their loans to banks and my bank will run out of money?
Why is no one giving out loans right now? I’m hearing a lot about a lack of confidence, but what does that really mean? Why don’t lenders just give money to people with really good credit ratings?
To be very brief, many of the large companies holding toxic debt are the lynch pins of the world financial system. Letting just one of them go under (Lehman) apparently almost caused the meltdown to begin (though this possibility of a Lehman-led near-meltdown last fall is now being pooh-poohed). The idea of letting AIG, Citi, BoA and other huge financial titans disappear fills everyone with dread. One of the bad side effects of letting big companies like this fail is that everyone gets to pick over the rotting corpose, see just how bad it looks, and then begin to speculate about the condition of other still-standing institutions. It’s a grand old mess we’ve cooked up for ourselves. Too expensive to prop up, too big to fail.
Institutions are giving out loans to qualified borrowers, as always. I could get a mortgage today if I wanted. The thing is, I don’t want. And neither does anyone else who’s got a great credit rating. Banks won’t lend to losers they way they did over the past years, and people and institutions like me ain’t borrowing, so very little lending is going on. Our society has morphed in the blink of an eye from vicious borrow-and-spend mania to vicious save-and-wait frugality that has got the financial high priests utterly stumped. They’re urging borrowing and lending with every fibre of their being, lowering the cost of money to the point where the next step will literally see Bernanke in his helicopter with his shovel, but everyone’s listening to their gut and sayin’ ‘Nope, I’m crawling into my hole. See ya in few years!’
I recommend watching the recent FRONTLINE episode called Inside the Meltdown.
the best explanation of the credit crunch that I got that put it in perspective was right here on the Dope: Rysto’s post #11 in this thread: How did the credit crunch start?
For someone without any understanding of economics, it all started to make sense…
I’ve seen both of these. I highly recommend them to anyone trying to understand the crisis. I know why the big companies are failing. I just don’t see the connection between AIG/Lehman Brothers/Bear Sterns and myself.
Is it purely as simple as big companies fail, people get scared and sell stocks, the stock market goes down, everyone loses money?
Why does no one want to get loans? I thought the problem with the credit market was that banks were not giving out loans. Why is it so bad if no one wants to borrow money?
Yes, people with strong credit can still get mortgages. People with so/so credit can get mortgages (over 620)…however, there are some new guidelines for loans…
Every mortgage lender has a schedule of “hits” that they apply to any loan. Let’s say the base rate for a loan today at 5.125% is 100.423. That means that a broker who writes a loan at that rate gets the loan funded, and gets to keep the .423 on the back end in additional fees. However, there are “hits” associated with each loan, and you must consult a table of qualifiers and make adjustments to the initial 100.423. A person with a beacon score of 745, and taking out a loan with a LTV of 55% means that you may get an additional .250, to put in the broker’s pocket, or to buy down the rate perhaps to 5% flat. The schedule of hits is such now that it is unbelievably ridiculous for someone with less than God’s credit to get much of a loan.
Someone with a beacon of 660 (which is actually decent credit), wanting to refinance a house and perhaps consolidate some credit card bills and take a loan with a LTV of 78% may find themselves having to pay an additional 2-3 points on the rate they can get for the mortgage (that 5.125 just became 8,00%)
Ive checked rate sheets for multiple companies, and basically anyone wanting more than 60% LTV (sometimes 70), and anyone with UNDER 700 beacon score, is going to take hits, and usually substantial hits, which are going to make the loan basically undoable.
So yes, the loans are there, as long as you are rich, and are only asking for about 1/2 of your property’s value, if you want a decent rate
Two more great things to check out, from This American Life:
The Giant Pool of Money
Another Frightening Show About the Economy
Should also add that most people in the industry have told me that these things go in cycles,and that the hits will lighten up and the banks will start lending money again maybe once the market stabilizes and we know for sure what real estate in this country is worth.
The last thing Bank of America wants to do is give you a loan of 180,000 on a 200K home that is going to be worth $150,000 in 6 months
The financial well-being of others is tied to these big companies. When such a company fails, employees are laid off. Stockholders and debt-holders realize losses. This is true when any company fails but the impact is particularly severe when a larger company fails because so many more people depend on the company. These folks now have less wealth with which to purchase goods and services, and to invest. This hurts suppliers and the folks that they employ. And so on down the line. Presumably, you have some sort of income stream tied your employer. It’s in your interest that your employer maintain a sufficiently high revenue stream to keep you on payroll.
The fact that some of these large companies are key components of the financial system only creates additional headaches. Additionally, there is an emotional aspect; when a large, well-known, and previously stable company goes under, it erodes confidence.
The future is too uncertain to take out a loan. If you are worried about losing your job because you see rising unemployment, you will be less willing to take out a loan that you may not be able to repay.
If no one takes out a loan, demand for goods, services, and investments will fall relative to prior levels. This forces suppliers to cut back on production, leading to lost jobs. You can perhaps argue that people shouldn’t have been taking out all these loans to begin with, that it wasn’t financially healthy. Nevertheless, there is a constant need for job creation as more people join the workforce relative to those that are leaving it. Stagnation or contraction of the overall economy soon causes employment problems.
RE: Collapse of Big Companies: isn’t capitalism about allowing bad companies to fail? Why keep corpses alive? Clearly Lehman Brothers deserved to fail-its officers destroyed the firm , through their reckless actions (investing in derivatives that they did NOT understand). so why should the taxpaters reward incompetence?
Bankruptcy accomplishes two things:
Only too true. Borrowing and spending lead to job creation, more spending, wealth accumulation, expansion, etc. Which is why Bernanke, Obama, Geithner and Company are desperate to see institutions and individuals borrowing again. But I just don’t see it happening anytime soon. An instinctive desire to batten down the hatches has very suddenly flourished. It’s flight, not fight. The whole situation is utterly perverse: over-borrowing and over-spending got us into this mess, and the instinctive and ostensibly logical thing to do – pull back and save for a while – is going to make the mess even worse, pushing the financial sector to the point of needing to be nationalized. Your every instinct is screaming Save! but what you should be doing for the good of the nation is taking out a $250K loan and spending like there’s no tomorrow.
In essence, because everyone is so interrelated, especially to large finance companies, that allowing one to fail will lead to the failure of three others, which will lead to the failure of six who are too heavily tied into them, which will lead to…
It causes substantially less pain to the peripherally involved to make sure that that contagion doesn’t spread to someone who’s likely to be viable once things settle down.
Not to mention all the smaller companies who depend on the availability of credit to get them through the cash cycle (your small car mechanic - might he rely on bridging finance to match up his parts purchases with his receivables? Does it really make sense to put him out of business and lay off his three staff because all of a sudden he can’t use his overdraft any more?) and the households who do the same (we’re cutting off your credit card this afternoon. No more credit, 'K?)
It causes much less pain for that not to be brought to an head, but that’s not to say that the equity holders in the failed banks shouldn’t lose their investments in totality. Bailouts are necessary - the concept that the bailees should be rewarded by being allowed to profit from the bailout is the absurdity.
They can’t even be sure about many of them. Lots of people who seemed in good shape a year ago don’t seem so good today. A lender looks into the future and figures that some people who are in good shape today might not be so good tomorrow. Layoffs, foreclosures… even people with good credit ratings are more likely to have financial troubles tomorrow. So the lender tightens up their terms to limit their loans to people with really really good ratings.
As others have said, those with truly good credit and finance still have no troubles. It’s the average ones who suddenly can’t get loans because average doesn’t look as good as it used to.
This is true, but it doesn’t quite go as far as it might. If you’ve got great credit, you might be looked at in the same way as someone who had average credit a year ago.
Banks are looking to get debt off their books, especially as ballooning risk premia are giving a pretty good indication that they’d (a) had all their risk assessments priced wrongly and (b) maybe the risk assessments themselves weren’t fundamentally all that sound.
Banks have to make sure that they’re not going to get caught in a bad debt spiral (Lehman’s goes under, so they can’t pay Morgan who goes under and therefore can’t pay Citi who goes under, so they can’t pay…) and the way they do that is by having a whole lot of risk-free, liquid assets lying around. In order to do that, if someone gives you some cash you don’t want to be lending it out any time soon.
Preach it!
We just refinanced our mortgage. We were fortunate that though we bought during the run-up in prices, we did so early enough that our house is still worth more than when we bought it. We also have very good credit (over 800 - I ponied up the 9.95 for a FICO score just before we decided to go for it). The amount we wanted to mortgage (our current mortgage principal) plus the total credit limit on the home equity line of credit (which we wanted to keep open) was well less than 80% of the home’s value.
Yet - the mortgage company (same company we already were with) took over 2 months to close and they were VERY strict about validating stuff, asked for extra documentation we’d never been asked for before, AND they insisted that the HELOC’s limit be modified to be the current balance - i.e. we couldn’t use the HELOC for any further expenditures. This all despite the fact that the refinance theoretically makes it less likely that we’d have trouble making the mortgage payment.
As a thought exercise, I used the company’s website and plugged in the figures, and they’re now restricting primary + home equity to 70% of value.
Basically mortgage companies are very jittery now.
Yes, if you’ve got good credit and are right-side up (or buying a new place with a large down payment), the money is still there. But it’s not as easy to access as it used to be!
Which of course makes it that much tougher to buy a home (though the decrease in housing prices may offset that - if you were saving for a 20% down payment on a 500K house and it’s now worth 400K, you now need that much less in down payment).
I’m no financial wizard and I don’t understand economics much, but this seems like the crux of the problem. Were you buying the home simply because you wanted to sell it and make a profit? To me, it seems that if you’re going to live in the house you bought, it shouldnt matter if it depreciates in value. Wouldn’t a lower value reduce the amount of taxes you pay for it too? Why aren’t all homeowners who plan on living in their house not praying that their house drops in value?
To a certain extent, it’s because people don’t think of buying houses that way any more. They’re not a consumer durable like a fridge or a toaster that you’ll keep until it wears out.
People saw (inflated) house prices as an enormous store of cash, and wanted access to that money so they’ve borrowed heavily against the “equity” that they’d built in their homes (equity in this case being defined as the value of the house less the value of any borrowing against it).
Furthermore, people bought houses that they couldn’t really afford on the grounds that house prices never go down. If you buy a place for $200,000 and tread water on a mortgage for a year, it’ll be worth $250,000 and you’ve just made a $50,000 profit of free money, right? You can then sell the house and find a new one or go back to renting.
But what if it’s now worth $100,000 and you’re still treading water on a $200,000 loan? Especially if it’s not a loan you can just walk away from, or where you borrowed $150,000 and put in $50,000 of your own money which is now completely gone?
People over the last number of years were making relatively sophisticated financial decisions without really understanding them - or often without realising that they were making a financial decision at all - in many areas, housing being just one.
The other point is that many people treated their home as an assured store of value, often using it as a savings plan for their retirement (at which point they’d sell and buy somewhere cheaper and have a lazy hundred thousand or so profit).
I don’t have much sympathy for any of these people - if you make a decision I feel it’s your obligation to realise what you’re doing first - but the craze around American housing led to a lot of profit-driven short-sightedness in the financial arena, and the failures there have a tendency to spread, because of the Fundamental Interconnectedness of All Things™. We’re now looking at the point where dodgy American housing loans are the butterfly’s wings that are triggering the hurricanes that are the bankruptcy of Iceland, the collapse of the Ukranian state and an unwillingness for the more of the governments of the planet to deal with global warming.
It’s a beautiful exercise in chaos theory, actually.
We bought it to live in - and plan to stay put for quite a few more years. Therefore, a drop in value in general is a good thing (our taxes were 400 bucks less last year, for instance).
However, if you’re refinancing, the value matters very much indeed.
I would say we’re not the mainstream of people who are in trouble and causing the failing loans, however. We bought at a price we were pretty sure we could afford in the long term with an acceptable level of belt-tightening, and we weren’t counting on price increases, raises that might or might not materialize, or the ability to refinance after a few years.
We didn’t have to refinance, but with rates lower it made sense for us to do so (we’re saving over 300 a month - closing costs will be paid-for in roughly a year). This’ll benefit us - AND the mortgage lender - if one of us should lose our job in these uncertain economic times.
People who bought their house - to live in - who HAVE to refinance because of less-sound purchases (predatory loans, poor lending choices etc.) are in deep doodoo if the value drops. Ditto people who have to move for whatever reason (job loss etc.).
Basically it all became a house of cards. If your ability to make a financing change worked out down the line (the house value stood up), or you were able to sell (again depending on the house’s value), or you could afford adjusted payments due to variable loans, or due to interest-only switching to amortized… you wound up being OK. That was the gamble that FAR too many people took. Then a few prices dropped, a few people lost jobs, fewer people could afford to buy the house at least year’s price, and it all went on from there. “A few” turned into a very scary snowball.
I’m sorry, that would make so much more sense if you explained to me what “refinancing” means. I keep hearing this everywhere but I have no clue what it entails
Also, something else I’ve always been wondering, why do people go get a loan for a house or a car? To me, it looks like simply changing the payment from the house/car seller to the bank, who charges you interest. Why not just write a check each month to the seller instead of the bank? Seems like an unnecessary extra step.