Saturday, September 27, 2008

Burning Down The House: What Caused Our Economic Crisis?

My husband showed me this video this morning. He used it in a little debate that he is having with a friend. I'm not going to go into what the debate was, but I liked the video and it is thought provoking. Of course the material will come as no shock to anyone who has worked in real estate for the last decade. All of this is old news in my business. It is only now that the general population is finding out about the "sudden" financial crisis because it is now affecting the entire economy.

This is a hard topic to pass judgment on. Everyone wants the American Dream. House in the suburbs, white picket fence, 2.1 kids. Truth be told though, not everyone had the financial resources to meet the burdens that they were taking on with subprime ARM. The people that "qualified" (and I use the term very loosely) for these mortgages were the easy targets. When you are feeling low on the totem pole, the idea that you can buy your own house is fiendishly tempting whether or not you understand exactly what an ARM can do to you and your family in a few years.


A low income family's dream come true right? These mortgages should have come with a warning label:

Surgeon General's Warning: Obtaining an ARM is dangerous to your economic health.

Surgeon General's Warning: Subprime financing by Freddie/Fannie may result in Financial Injury, Premature Bankruptcy and Low Dollar Value.

I mean, they have to do it for cigarettes right? Who is going to suffer more this year? People who smoke or the everyman dealing with this economic fallout? As a landlord, people are often confused by the enthusiasm that my husband and I have for our tenants to go and buy their own homes. "Why do you want to lose your tenants to a house purchase?????" Well, quite frankly, we like seeing our tenants do well for themselves. However, we have never ever ever supported the idea of one of our tenants buying a house that they really could not afford and we have, on more than one occasion, taken the time to advise a tenant before getting themselves into a bad deal. We have been there ourselves, but fortunately could see the forest through the trees.

A million years ago when we were trying for our first commercial mortgage on our big property, we had absolutely nothing to recommend us. Really, we were just kids who suddenly found themselves having to play in the big game and we didn't know what the hell we were doing. We did need a mortgage however. It was our first encounter with Predatory Lending or, as a friend preferred to call them "whore lenders". These lenders are unbelieveable in their tactics. Commercial lenders require 3 years of financial records from the corporation they are lending too. It's fair enough, except when you need a mortgage and have not been in business for three years (like we were at the time). Then it gets a little more tricky. The whore lenders will stop at nothing to get your business, especially one like ours. At the time we were looking for financing with an LVR (Loan to Value Ratio) of 20%. Basically, what this means is that we were asking for a mortgage that was 20% of what our real estate was worth. It is a very good investment on a bank's part since they would theoretically make up to 80% profit if we defaulted on our loan and they had to sell the asset. Most commercial real estate loans are more likely around an LVR of 75 -80%. Predatory lenders in the housing market were willing to consider LVRs of 125%. So technically, a borrower under these loans not only had no equity in their property, but were already deep in the hole from day one of the loan. Throw in an adjustable rate in 5 years and BAM! Credit crisis, defaults, bankruptcy.

Predatory lenders can be smelled a mile away. One tried to get us to take a loan that was full recourse (meaning we were personally responsible for the fallout of a default, including our personal assets not relating to the property being mortgaged) along with signed undated letters of resignation from our corporation. What this meant was, they could at any time fire us from our own corporation, decide not to pay the mortgage and then still hold US liable for a default. In the words of my girl Sarah, we said "thanks, but no thanks". Fortunately for us, we were able to get a loan in the tradition manner with a decent fixed rate from our own bank. Others are not so lucky and they are the ones who fell for the sweet talk. When we told the predatory lender we were not interested in his BS proposal he said, no joke, "But I thought we were friends". Trust me. With friends like that, who needs enemies? Now we will all pay the price of these friendships.

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