Wednesday, February 10, 2016


The Big Short: Inside the Doomsday MachineThe Big Short: Inside the Doomsday Machine by Michael Lewis
My rating: 4 of 5 stars

”The ability of Wall Street traders to see themselves in their success and their management in their failure would later be echoed, when their firms, which disdained the need for government regulation in good times, insisted on being rescued by government in bad times. Success was an individual achievement; failure was a social problem.”

The real estate market in the United States after several years of frantic growth peaked in 2004, which was the year I decided to start buying properties. I was able to secure 6% interest on about any property I wanted to buy with no money down. I had an 800+ credit score, which had bankers salivating when I walked in the door. I put everything on 30 year notes to give me more cash flow.

The first time I bought a property, the banker wrote it up as an ARM (adjustable rate mortgage). He showed me how much lower my payment would be. Of course, what he didn’t explain was what the payment would look like when the interest rate went up. (I’m the offspring of a farmer and had the opportunity to watch my father negotiate several mortgage notes. My father always said to never trust a banker and, furthermore, never trust that a banker knows what he is doing.) When I told the banker I wanted a fixed mortgage, he looked shocked for a moment. He said, “I haven’t written a fixed note in so long that I’ll have to look up how to do it.”

Warning bells were going off in my head.

My friends and acquaintances from all over the country were buying properties. Many were buying properties they could not afford and knew it, but they were hoping to ride the positive wave of escalating property values which would allow them to keep tapping their equity to pay their bills. Many of them fell into the category of subprime mortgages. ”A subprime mortgage is a type of loan granted to individuals with poor credit histories (often below 600), who, as a result of their deficient credit ratings, would not be able to qualify for conventional mortgages.”

Michael Lewis talks about ”thin file FICO scores,” which are people with short credit histories, but have good credit. One example that Lewis uses is a Mexican strawberry picker making $14,000, who qualified for a loan for $750,000 all because he hadn’t proved he couldn’t pay.

Anyone with any sense, you don’t need business acumen for this one, can look at that situation and KNOW with certainty that strawberry picker will not be able to make his payments. The whole lending system, from the big boys on Wall Street down to the loan officer in your local bank, was making and encouraging too many loans destined to fail. It was ok though because they were going to bundle them together with a bunch of other notes and sell them to someone else.

Unfortunately, and I blame the car industry for this, Americans are much more interested in a lower payment than they are in how long it will take to pay off a note or how much interest they will end up paying. What is the first thing a car salesman asks a car buying prospect? How big a monthly payment can you pay? It doesn’t matter what type of car or how expensive that vehicle is; what is important is what they are capable of paying per month. Car loans used to be three years in length. Now, most people take seven years to pay off their car. They have no idea how much they will have paid for that vehicle at the end of seven years. I recently bought a new Jeep Cherokee, and when they brought the paperwork, I realized that they hadn’t even asked me if I wanted a five year or a seven year note. They automatically wrote it up for seven. I had them change it to five.

So that same mentality transferred over to mortgages. It was easy to talk Americans into ARMs because of the lower payment offer (interest only) compared to a fixed rate. In most cases, I can guarantee they were never offered or shown a fixed rate. ”Interest only ARM mortgages were only 5.85% of the pool in early 2004, but by late 2004 they were 17.48% of the pool, and by late summer 2005 25.34% of the pool. To say that everything was getting out of balance was an understatement. We were being set up for a disaster. If the real estate dipped or remained flat, the whole, forgive the pun, house of cards, was going to come down. Home owners had to keep gaining equity to stay afloat.

2009 was the year that I decided to refinance all my properties. The interest rate was unbelievably low, and one of my fears was that the paradigm would shift and interest rates would begin to climb. I was on a fixed rate of 6%, which historically that was a great rate for home mortgages, but the interest rate I was about to get was going to blow my mind.

4.25% (now you can probably write a primary loan for less).

Not only did they give me that rate on my primary home, but also across the board on all my rental properties. My main goal for refinancing was to lower the interest, but also to take my 30 year mortgages and put them on 15 years.

The banker said some interesting things to me. One was that they were willing to waive the fees if I’d write new 30 year mortgage notes. He showed me how much lower my monthly payments (ahh yes that old stratagem) would be compared to the 15 year notes. He said that if I wanted to pay them off in fifteen years, all I would have to do is make bigger principle payments. This is extremely bad advice. Most people never make an extra payment on their car or house or with some, totally insane consumers, even their credit cards. They pay the minimum they have to pay.

One of the problems with most loan officers is that they really don’t understand the loans they are writing. I had one property that had a house with a trailer house on the same lot. I could almost hear the pop in the banker’s head when he realized there was a trailer house involved. They don’t finance trailer houses. I explained that the trailer house needed to be considered personal property; I had plenty of equity in the house to meet the criteria for the loan. I had to go up the chain of the bank until finally I was talking to some guy in Milwaukee who got what I was saying and approved the loan. I don’t like the fact that the person who makes the decision about any loan I make is not the person sitting in front of me, but that is the banking system we work with now.

The crises of 2008 should have never happened. Regulations on banks and Wall Street had been relaxed. Without regulations they went crazy. They lost their minds. ”There were more morons than crooks, but the crooks were higher up.”

This book focuses on the handful of brokers who could see the crash coming and decided to bet against homeowners being able to make their payments. It was dicey because if the government stepped in and shored up those home loans, they would lose their bet.

They won, and they won big.

At the time, I supported President Bush’s administration stepping in with a bailout for Wall Street. I was wrong to do so. I was afraid of a further collapse that would bring even those of us who were solvent down with the ones already under water. (I do believe that the bailout of the auto industry was an astute decision that ended up saving that industry and thousands of blue collar jobs.)

I have only a few thousand in the stock market these days. I took my money out and bought a business. I wish more Americans would invest in something tangible, like a business or real estate. I’d rather that when Wall Street goes crazy with greed again, and they will, that they don’t have the retirements of middle class Americans to lose on some greedy short term gain venture.

My advice to everyone is to really KNOW your finances. Don’t assume that a banker or accountant knows what is best for you. Don’t put your future in someone else’s hands. Use their expertise to educate yourself. Don’t over leverage yourself under the assumption that you will make more money in the future. Buy at a price you can afford now, not what you think you will be able to afford later. If you are thinking about buying a home, the concept of buy low and sell high should apply. If possible, wait for a buyer’s market. Buy below market if you can so that you have some ready made equity already in your home. (The quicker you can get enough equity, usually 20%, in your home to avoid PMI payments the better. Private Mortgage Insurance protects the lender if you default on your loan though THEY benefit you pay the premium.) Don’t fall in love with a house until you own it. Don’t ever risk money you can’t afford to lose.

This is a painful book to read from the standpoint of the recklessness, the greed, the foolishness that all contributed to the 2008 subprime mortgage crises. I wasn’t shocked to learn that the “experts” didn’t even know what they were selling or buying most of the time. They didn’t understand their own acronyms. Like, what the fxxk is a CDO (collateralized debt obligation), and what the hell are tranches? It’s okay for me not to know, but these people at Bear Stearns, Merrill Lynch, Lehman Brothers, UBS, Goldman Sachs, and Morgan Stanley didn’t really understand what they were either. These supposedly best and brightest were blinded by greed. They couldn’t see that the track in front of their roaring train loaded with subprime mortgages...had disappeared and the gorge they fell into was... deep.

I’m really looking forward to seeing the movie.

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