Wednesday, December 19, 2007

Credit Markets for Dummies / Bankers

Last week, I was complaining about the idiocy of the CEO's of the major banks in their sub-prime and general end-of-cycle lending practices. Although I thought that these folks should be smart enough to understand cyclical risk in mortgage lending, apparently it has escaped them.

While your servant is just a humble real-estate appraiser in his real life (and a former branch manager for Household Finance), I didn't think understanding changes in real estate values or basic credit lending (and hence, value at risk for a bank) was too complicated.

Apparently, though, I was mistaken. Hence, my new class, Credit Markets and Residential Real Estate Values 101. Now, I want the heads of Citibank, Bank of America, to stop goofing off, and sit at the front desks here.

Prince! Up Front!! What? You've been canned? (oops, "resigned under pressure") Well, all the more reason to sit up front here. Now pay attention!

This is pretty simple.

  1. First of all - don't lend to people who can't afford to repay you - yes, over the long term - not just based on the teaser rates!

  2. Check their references - i.e. confirm their income, debts, payments, etc.

  3. Medium-to-longer term changes in real estate values (which is really what the bank's security is predicated upon) is based almost completely on just three factors. Pay attention to those factors, since they can affect values!

The three factors affecting the medium-term plus value of real estate are:

a. Changes in population in an area;

b. Changes in after-tax income;

c. Changes in interest rates.

Prince, note that unsustainable changes or trends (as an example, interest rates at historic or near historic lows, eg 2001-2005) will have the effect of exagerating short-term property values. Meaning, in the context of real estate values, circa 2002-2007, they are likely to become OVERSTATED due to "c" above. And thus impair balance sheets.

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No one could have predicted this? I pull some narrative commentary from my own appraisals dealing with values in 2003 ...

"... the local housing market continues to set records, fuelled by both low interest rates, and a relative shortage of product."

... in 2004 ...

"Lending rates remain at near-historic lows, and continue to support economic activity of all kinds, but low rates are well-known to provide significant boosts in pricing and activity in the housing sector."

... and in 2006 ...

"Lending rates remain at near-historic lows, and continue to support economic activity of all kinds, but low rates are well-known to provide significant boosts in pricing and activity in the real estate sector."

Prince, Prince!! Pay attention.


The Confused Capitalist

1 comment:

Anonymous said...

The sub-prime mortgage issue has received a lot of attention lately and fears of a slumping economy are emergent in even the most non-attentive members and spenders within our giant growth-mobile. The alarming news that many Americans are financially irresponsible, inattentive or just plain careless seems a sudden and shocking realization to our esteemed financial institutions who find themselves in an real and burdening predicament. I too find myself in a position of burden. As person with little or no real debt, being financially responsible with money and investments, I hold little sympathy for those whose misperception of the housing market, or home-ownership or, business opportunity, has led them into an undesirable financial position. Sorry, these folks deserve no crutches from our monetary establishment and bailing out large lenders to ease self-imposed burdens goes against the ideals of our well-oiled capitalist machine and a Laisse-Faire government.