The mortgage crisis continues to worsen.
As an indication of how bad it's gotten, the largest mortgage lender in the US, Countrywide Financial has accepted a so-called `White Knight' offer from the Bank of America for $4.1 billion to purchase them at well below market price, after Countrywide reportedly explored filing bankruptcy. One indcation of how anxious Countrywide was for someone to step in and how far below th ecompany's book value the selling price was is the stock tradeoff: for every share of Countrywide stock owned, shareholders will only receive .187 share of Bank Of America stock in exchange.
Of course, that won't effect well connected insiders like Countrywide's CEO Angelo Mozilo,who reportedly sold his personal stock for over $150 million before the shares tanked.
In reality, this wasn't so much a rescue as the B of A looking out for it's own interests.
The Bank had invested two billion in Countrywide last August, buying 16% of Countrywide for only $18 dollars a share.But as the real estate market tanked, that investment fell by nearly half in just a few months, foreclosures had doubled and the company had $15.5 billion in debt maturing this year.The stock was in free fall and Countrywide laid off or planned to lay off a substantial number of their 51,000 employees...which could have seriously hurt the Bank of America's investment.So instead of taking a write down, they bought Countrywide at a fire sale price, and will be positioned as a major player when the housing market turns around again. (personal prediction: the upturn will start in the spring of 2010)
Why this matters in the grand scheme of things is because of the global investment in mortgage backed securites and investment funds in whatthe industry refers to as the secondary market..secondary because it's a resale market on a negotiable vehicle, which is why many of you end up writing checks for your home loan to a different company than the one you originally got your loan from.
It also matters a great deal to state and local governments, who have been relying on property taxes based on the inflated values and things like taxes on gasoline to fund their budgets.And the trickle down factor affects the entire economy.
During the boom, homeowners lucky enough to buy before the surge hit ended up with hundreds of thousands of dollars in unearned paper equity. These people were encouraged to use their homes like ATMs not by a bunch of unscrupulous subprime bottom feeders, but by virtually every bank, credit union and lending company in America.
And consumers loved it. If the interest rates on the two loans got too out of whack, they'd just refinance and roll the two loans into one...usually along with a few four or five figure credit card bills and some cash out on the side. As any mortgage broker will tell you, there were homeowners that did this four or five times in the space of a year or two...and why not? Prices on homes kept going up up up, and people were still clamoring to buy.
What ended the party was a combination of factors.
First of all, what I call Ricardo's Law, a simple but accurate aid to real estate investing first formulated by a British Jewish economist named David Ricardo back in the 18th Century. His Utile Theory of Land Management says, simply, that when the cost of owning property is greater than the cost of renting or leasing, people rent or lease and the price of property drops.
Because of the high prices, more and more people were simply unable to purchase homes in many markets. In Los Angeles County, it's estimated that only 14% of the potential homeowners are able to afford a median priced home, especially if you factor in expenses like property taxes, insurance and/or association dues. They're renting, because it's what they can afford, and it's cheaper than buying.
Second, because of the high prices and the average working person's inability to save up even a five percent down payment on a `modest' $500,000 home, let alone the monthly payments, the market created tools to keep the properties moving... no money down 100% financing based almost entirely on numerical credit scoring(FICO), something developed to automate loan underwriting and make it easier to securitize the paper for the bond boys to sell on Wall Street.
Now that the crunch has come, both consumer and government spending have been affected. California, without the huge sums coming in from inflated home sales and faced with one of the highest foreclosure rates in the country is in what Governor Schwartznegger decribes as a `budget emergency'as the Gubanator goes mano a mano with the Democrat legislature in an effort impose a 10% spending cut across the board and keep the Golden State financially afloat.
Meanwhile, on the consumer end American Express announced it will take a $440 million hit on its books because of a higher rate of deliquencies from it's relatively affluent base of cardholders. Capital One and Discover also reported sharply higher than usual delinquencies from their card holders.
I'm not planning on jumping on the gloom and doom train just yet. The economy tends to expand and increase the size of the overall pie and decrease deficits over time..provided taxes are kept low and the government keeps it's big mitts off things and allows to market to adjust.
Nevertheless, if I were you, I'd keep your personal debt low and put off buying that home for a year or so...just a sign of the times.
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