BEWARE THIS MORTGAGE MELTDOWN

From: Carl Worden wolfeyes@hisurfer.net

BEWARE THIS MORTGAGE MELTDOWN
Carl F. Worden

For several years now I have been warning my San Francisco Bay Area clients as forcefully as possible without totally alienating them, to stop refinancing their home equity out unless they were planning to use the money for relatively short-term investments. Maybe that wasn’t such a good idea, since many of them used their equity to make short term, “flip” purchases of other homes, hoping to take a nice $50,000.00 profit two months later by selling to another “flip” investor.

Home values in the San Francisco Bay Area and Monterey Bay Area were increasing at a phenomenal rate, and incredibly, these “investors” (read gamblers) insisted the market would just keep going up and up. But it is a game of musical chairs with extremely high inherent risk when the music stops, and those who thought the music would never end saw all or most of their profits vanish when they were stuck with a $700,000.00 home they purchased with an adjustable rate mortgage. Now they can’t sell the house for what they paid for it. Many have opted to just “walk away” and let the bank foreclose, and last time I checked the figures, 180,000 homes are going into foreclosure in the United States each month right now.

You can readily see evidence of the foolishness right here in the Rogue Valley of Oregon where I make my primary home. You’ll see relatively modest homes surrounded by expensive motor homes, six ATVs for the whole family, a fancy boat, etc. All toys, purchased with the proceeds from refinancing the equity out of homes that increased in value 50% or more before the music stopped.

I recently read a report that estimated 30% of all money refinanced on the increased equity of these homes was spent on such luxuries, but based on what I see it appears that figure is more like 50% or more.

The Stock Market is reeling right now. Yesterday, 8/9/07, the Dow dropped 387 points, preceded by days that saw an increase of 280+ points preceded by a day that saw a 280+ point drop. At this writing the Market is about two hours from closing and the Dow is up and down all over the place. Mortgage companies are failing right and left due to the fact they can’t resell their mortgages to investors.

The circumstances of this debacle are eerily reminiscent of the Stock Market crash of 1929, when people who thought the Stock Market would just keep going up and up, borrowed against the value of their homes to purchase stocks on the margin.

As we all know, the real impact on the population didn’t sink in until about 1933, when people en masse lost their homes and were living in their cars. Those who lived through those dire times were noted to never again, under almost any circumstances, hang paper on the homes they lived in. But that was many years ago, and as the generations of Americans emerged into years of prosperity, those hard lessons have been largely forgotten.

But those lessons were not lost on me. When my friends were out goofing off in the 1960s, I spent hours upon hours listening to my elders and their friends tell the stories of the 1930s, and it stuck.

You know the old saying about those who fail to learn from history are condemned to repeat it? Based upon my years of observation, I have a different take: No enough people ever learn from history to keep from repeating it.

Six months before the attack on Iraq on March 19, 2003, I wrote an article titled, “If I were Saddam”, in which I detailed exactly how the war would unfold into a quagmire of guerilla warfare that would result in yet another military defeat for the United States.

Although I was never in the military, I did go to Vietnam during the war six times, two weeks each time in the 1970s, and I learned everything I needed to know from that experience to join the relatively few, like former Marine and United Nations Weapons Inspector Scott Ritter, in begging and crying from the rooftops not to go into Iraq. It was like watching a horror movie unfold, and I just couldn’t stop the actor from going through that door no matter how hard I tried.

A recession or depression that is energy-driven can be overcome in a relatively short period of time. But a housing-driven depression is a whole different kind of problem that eventually affects just about everyone. If consumers are not buying new or existing homes, they are not buying lumber, drywall, concrete, windows, doors, cabinets, etc. They are not buying appliances, furniture, carpeting, burglar alarm systems or any of the other items a modern home includes. Very few people are qualifying for loans because credit becomes increasingly difficult to secure, and what mortgages are secured are generally for homes in the medium-priced range. If consumer goods are not being purchased by Americans, people who manufacture and sell those goods start losing jobs left and right.

Even foreign markets are affected when the United States hits the housing skids. Just as the foreign markets were shattered after the 1929 crash, we are seeing foreign investors begin to pull their money out of otherwise robust foreign markets. Right now, the European stocks have suffered their biggest loss in four years, and the tumble has only just begun.

At this writing, the Federal Reserve just authorized an infusion of $38 billion dollars to improve the liquidity situation (money that is available to be loaned as credit) but with 180,000 homes falling into foreclosure each month, $38 billion dollars is just “show money” to lure foolish investors back into the market.

As I predicted in an earlier article, credit card debt is once again on the rise. As home values inflated, many home owners refinanced to pay off their credit card debt, buying into the sales pitch that since credit card interest is no longer tax deductible, the smart move would be to convert the debt into tax deductible mortgage interest. But that also means the home itself has been put further into hock, making the home owners vulnerable to outright homelessness in the event they lose their jobs, become disabled or suffer an uninsured medical loss.

So now that credit has been tightened and home values have dropped to the extent there is no more refinancing available, American consumers who have been reportedly living on 110% of their actual, take-home income are beginning to once again run up the debt on their credit cards.

Two things will make this recession/depression even more untenable as compared to the circumstances of the 1930s. First, as much as I liked President Ronald Reagan, he wasn’t perfect, and he repealed the Usury Laws for the credit card corporations. As I recall, the highest interest on credit cards allowed was two points over the Prime Rate. Now the sky is the limit, and the abuses are just horrifying.

For example, I was just talking to a nice young lady who had perfect credit and was very proud of it, but recent misfortune had hurt her credit score. To make things even worse, her payment to her credit card had arrived just two days late, and the card company abruptly jacked up her interest rate from 12% to 31%. That is happening to people nationwide right now.

The second catastrophe that awaits indebted Americans is Bush’s Bankruptcy Reform Bill that was heavily lobbied for by the credit card corporations. They were the largest contributors to both Bush presidential campaigns. It really wasn’t bankruptcy reform at all; it was virtual bankruptcy elimination for anyone with any assets to speak of. There was no provision or exception in that bill for people who experienced uninsured or under-insured, massive medical losses, which happened to be the leading cause of bankruptcy filings.

Unlike the average American consumer, the credit card corporations clearly saw the writing on the wall. They saw this housing and credit crunch coming from a long distance, and they literally bought the Bush presidency to make certain they would be insulated from it. Unless this Democrat Congress takes steps to amend or overhaul that Bankruptcy Reform Bill, and reinstate a sane form of Usury Laws, millions of Americans are quite literally going to be wiped out financially.

I have listened to a number of presidential debates, both Democrat and Republican, and so far I have not heard a word about reinstating Usury Laws or amending the Bankruptcy Reform Bill, yet I can predict with certainty that those two issues will negatively effect more Americans than just about any others. As far as I know, they are issues no candidate has addressed or even wants to, because most Americans are totally ignorant of what is about to befall them.

But for you “Old School” believers who paid off their home, put money into savings or other secure, low-risk investments and didn’t borrow against their home, the coming years are going to present “a buying opportunity of a lifetime”, as was recently quoted by a representative of the Carlisle Group, an investment group the Bush family is heavily involved in. Most people cannot participate in the investment opportunities of the Carlisle Group, because the minimum you must invest is $5 million dollars – and you must be invited to join.

But savvy, individual investors might consider forming their own investment clubs now and pool their resources in order to compete effectively for the coming buying opportunity. I foresee residential real estate being sold at auction for 25 cents on the dollar – or less – but you must be prepared in advance and in a position to make these purchases for cash when the opportunity comes. Just as in the 1930s, the coming recession/depression will once again make cash king.

For those of you who went without and saved every penny while your neighbors played their fiddles and sucked every dime of equity from their homes, you stand to become the new wealthy in America. But you must put a plan into place now if you are going to compete with the Big Boys in the next five years.

Okay, the Market just closed on Friday, 8/10/07, and the Dow still lost over 30 points even after the Federal Reserve printed up $38 billion dollars in a vain attempt to stabilize it. The idea was to show at least a modest gain, but since it wasn’t successful, this does not bode well for what happens Monday.

Good luck, and may God richly bless you.

Carl F. Worden