Reap What You Sow

Warning: I am only writing this for my own memory’s sake. I wanted to include this in my blog so I can remember it. And it’s about the financial world for anyone reading. So if you want to stop here, great. I can’t guarantee there will be any interesting or new information as I’m sure everything I’ve read recently I’ve ripped off a little bit from multiple sources. I am only including it so that when I read through this again, years down the road I can remember what I was thinking at the time. Just like how my dad always says to me about how those “rotisserie chickens at the grocery store used to be a dime”.

Just like that.

Sub prime. AKA, Sub slime. AKA housing bubble. AKA this post. Reap what you sow.

Thinking back over the past 12 years, it’s been kind of creepy. We’ve been building ourselves up - our economy on very little. In 1995 it was tech. Everything was tech. Sure, some value was added, but the stock market went shooting up like a sky rocket in dot coms that were worth nothing with ridiculous valuations in to the thousands. And people who were smart enough got out before it all when to shit. Others that didn’t got hurt. Bad.

And by the end of 2001 and in to 2002, things were looking terrible. Which is when the Fed decided to cut rates to “their lowest point in SO many years”. What did a lower rate mean? It meant borrowing cash became cheap. Suddenly those that couldn’t afford a 30 year fixed at 8.5% were magically able to afford it at 5.5%. Look at all the interest they were saving!

So all that money that wasn’t being made in the market had to move somewhere. How dare we expect people to earn less than 10% a year on their money. Is part of your American dream being wealthy beyond your wildest dreams? Mine’s about halfway there.

So people borrowed. And borrowed. And borrowed until they were so heavily leveraged that paying principal became a thing of the past. Because now everyone could afford a home. In fact, the housing market got so hot that new products were popping up everywhere. Balloon mortgages, 1 month ARMs and negative amortization loans. All for $0 down! Can you imagine that? Oh, and what’s that? You and your wife don’t have a job either? Well, we’ll put you on a stated loan that says that you’re a doctor and she’s a lawyer and together you make upwards of two hundred and fifty thousand dollars a year.

Sure, I got caught up in it. And I still am. My wife got in to a condo at the right time, in 2004 just as the housing market was peaking. I threatened leaving her because Issaquah was “too far” for me. Little did I know I’d love it out there, and it’d be one of the best investments of our entire lives thus far. But she put a little amount down, on a stated loan and paid PMI on a 80/20 split loan. Luckily we were able to get out of there while things were still hot.

Because builders saw it. They saw the wild buying. People outbidding the asking price just to get in to a property as soon as possible. Because a 20% return on even a $300K property is a lot of money in a year.

So they built more. And more. And buyers kept scooping them up. Because “property isn’t as risky as the stock market – you actually own something FEASIBLE – that you can touch – when you own property”. It’s amazing how hearing this now, 3 years later makes me cringe after it was pounded in to my head so much…

But now, there’s more homes than there are buyers. Back in 2002 was when that first 5/1 ARM at 5% or whatever ridiculous rate was out. And everybody saving hundreds of dollars a month by just paying their interest every month is having a hard time either refinancing in to another loan – because they’re not going to give you “interesting financing” on your property now. No. Too many people out there over the past few years have screwed the lenders over and vice versa.

5 years ago you moved in to a property you had no right affording. Expecting that your home value would appreciate enough that you’d have a good return on investment as soon as your ARM/balloon/negative amortization loan was up. And you were broke the entire time, but it was OK, because as soon as you sold the house, you’d make back everything you put in. Right?

Well, little did you know that the builders kept building. And as soon as inventory started piling up, suddenly 5 blocks down the street they were selling a brand new house that was bigger and had more upgrades than yours and they were selling for the same price. Who was going to buy your house?

So you had to reduce your price. And reduce it further. And maybe you were going to rent it out…but it was crunch time and the lender was breathing down your back. Maybe putting nothing down and not getting a fixed rate wasn’t the best idea in the first place. It seemed like a good idea at the time…such a small monthly payment…

But at the same time there were those out there (just like me in the past month) who realized that the market has been on a tear since 2005. It seems like at that same moment in 2002 someone realized that they could take a second mortgage out on their home, or leverage something they had to invest it in the stock market. In another property. In something. Wouldn’t that make sense? If you were paying 6% on your 2^nd mortgage and you were earning an average of 12% on your S&P 500 fund, why in the heck wouldn’t you bet the house to earn a little extra cash? If another property was going to earn you a 20% return on your money, why wouldn’t you do it?

So I made it a little bit late to the party. So what. I’m still going to fight and struggle and do my best to succeed.

But for the rest of the people out there in a lot shakier positions, I’m sure there is guy X out there who just did the same thing as me. Except they pulled out more. And over this little stock market correction we’re experiencing over the past 2 weeks they’ve lost everything they’ve made. Or there are the people that bought 3 more properties. And suddenly that value in those homes they were holding onto has just dropped out of the bottom. The sure thing didn’t seem like it anymore…

And now the only out for them is bankruptcy. You couldn’t afford it in 2002, what makes you think you can afford it 5 years later when the rates have gone up and unfortunately wages haven’t really followed.

So here we stand. One of the slowest “shit hitting the fan” sequences I’ve ever seen. I saw my first sub prime lender go bankrupt in February of this year. And that was the red flag for me. Debt was cheap, so we threw it around to whomever felt they could handle it. Americans love debt. Unfortunately not all of them have the right mind about them to control it properly. In fact, to the tune of about 7 million home owners.

7 million. Can you imagine that? 7 million families, people, friends, neighbors literally just walking off of their property and claiming bankruptcy because no one will provide them with a loan to which they can afford their property any longer? I can’t. My neighbors actually seemed proud that they put nothing down on their property. Like they were almost getting some sort of deal.

It is the perfect storm at it’s finest. And unfortunately everyone that bit off way too much are going to reap what they sow. And they’ll bring the rest of us with them. I just hope it hurts a lot less than I think it will. I’ll keep my fingers crossed, but it’ll require a lot more than that to fix what’s coming down the pipeline.

The Fed meets tomorrow. I can’t wait to hear what they’re going to say. Either they’ll go along the lines of my blog post. Everyone can just tank because none of you read the fine print or expected less than 28% year over year growth in the value of your properties.

Or, the Fed can bail everyone out by cutting rates and possibly restarting the whole cycle again.

For the short term, I like the idea of a rate cut. Or at least the acknowledgement that something has gone terribly wrong when a person making $28K a year can suddenly afford a $300K house with nothing down.

For the long term though, I’d love to see us suck it up. Just like the ridiculous valuations in 2000 of high flying stocks with worthless underlying companies, we’ve got people who gambled with the worst possession they could…their own homes.

At the least, it’ll be interesting to see what happens between now and 2009. That’s when the big lenders say most of the “interesting loans” will either be refinanced or defaulted by.

One of the best rules I’ve continued to follow is, “If it sounds too good to be true, it probably is”. Unfortunately so many people are going to get burned by not remembering this rule. We’re on shaky ground right now, and end of this seems so far away…

Until this whole mess is over, I’m praying that the bad apples don’t spoil it for the rest of us.