Wednesday, February 16, 2011

The Banking Mess

The Banking Mess
(in very generalized laymen’s terms – and I am NOT AN EXPERT OR AUTORITY ON THE MATTER)
Several years back, the Federal Government did a study and they discovered that when banks were giving loans they were giving/approving loans preferentially.  That is to say, if you lived in ‘a bad part of town’ it was much more difficult to get financing because of location.
As I understand it, the Feds told banks that was being prejudice and they needed to offer better opportunities for the under qualified borrowers.
In response to this, the banks began to develop financing for @ risk borrowers, one of these plans was called an ARM Loan.
ARM stands for Adjustable Rate Mortgage.  So you would get a loan that was typically a two or three year ARM.  After the first two or three years, your interest rate would adjust automatically dictated by the current LIBOR (the standard international interest rate amount, look up LIBOR if you want to know more).
After your ARM period your loans interest rate could adjust to the current LIBOR +3%.  This adjustment would be revalued every 6 months and your interest rate would change.
INTENDED BENEFIT – Provide @ risk borrowers with the financing to prove that they could afford the payment and then have them refinance their loan before the first interest rate adjustment happened.  They would have an established payment history and could refinance to a fixed rate with an affordable loan.
WHAT REALLY HAPPENED – People got greedy, brokers, loan officers, buyers and even appraisers.  If you give good values to properties with these low interest rates (because they were ARMS) you get more money.  Good Appraisers get more business, loan officers make bigger commissions, and banks have excellent payment histories on loans that are performing perfectly.
WHAT BROUGHT IT DOWN – Many of the borrowers were very ignorant of the type of loan they were getting.  The DID NOT understand how it worked and how important it was to refinance before the interest rate adjustment occurred.  Suddenly their payments went up easily by 300 dollars a month and that’s on the low end.
Loans were defaulting across the board and everyone started scrambling not really understanding what was going on.
I will use myself as an example:  My house was probably worth between 55 to 65k.  My appraisal came back at almost 100k.  I took the loan, got cash out (like 30,000 which I ignorantly blew) and my payment was around 650 / month.  I fully intended to refinance before my ARM kicked in.
I forgot.  My house payment went up to nearly 1000 bucks a month; it took almost 4 months for me to manage to get a refinance.  In the end I had to walk away from my home.
The simplest nutshell I can put this in is this.
My home was over appraised; the bank gave me 30,000 dollars that never really existed.  I defaulted on it and the finance company had to eat that loss.  All of the investors that invested in that bank shared the loss, the investors that invest in those investors had to eat some of that loss and the hedge funds had to eat the loss AND the REALLY REALLY REALLY BIG INVESTORS who invest in the Hedge Funds had to eat the loss.
The top layer of investors have not even seen the losses hit their books yet, it could take a couple more years for the BIG MONEY investors to actually see the loss because they do investments in bundles of things that they don’t even know what their investment money is being put into.
So at the end of the day, each and every loan across the nation and in several countries was financed on over appraised properties.  The financial people gave loans against equity that didn’t exist and by the time the borrowers (all the millions of people at the very bottom of this chain) began to realize and understand the mess they were in, it was too late and millions of people couldn’t afford their adjusted mortgage payment.  Home gets foreclosed; borrower got the excess cash so it’s gone.  Banks have to eat the losses and it trickles up through several layers of investors.
This also happened on commercial properties (hotels, malls, city developments, etc., etc., etc.). 
So the government had to intervene.  The financial institutions ‘created and gave out money that never existed’ that money still doesn’t exist, but it has been spent.  It is gone and they are trying to stave off a meltdown of unimaginable proportions
This explanation is incomplete, it isn’t anywhere near perfect and it’s not meant to be, I’m just a pee-on and this is an EXTREMELY SIMPLE EXPLANATION of A TERRIBLY COMPLEX SERIES OF EVENTS.
I hope it at least answered some questions for you.
So who wants to play Monopoly?

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