Questions .. and an attempt at answers.

The Harris Poll group surveyed 2225 adult USians the week of July 6-13 to learn that about 2/3 of them knew little about world politics, and, seemingly, from the way the results were reported on Breitbart.com, about the same percentage don't know what is going on in USian politics, either. That is a scary set of statistics, and one can only hope that the ignorant stay home at election time. Of course, they could get off their soap opera channel and do some work reading what candidates have to say, what the issues are really about, and study a bit of US and world history. Just as likely, the height-challenged emergency substitute childhood careperson (We do need to maintain our political correctness, do we not? I wonder how they say that in Spanish?) could drop about $100 million in my checking account, tax free, also.

I am throwing out an unsubstantiated guess that roughly the same percentage of USians have no working understanding of economics. An even smaller proportion have any clue as to why there is turmoil on Wall Street over interest rates. I fielded two questions today that no one had asked me before.

The first had to do with the reason home values for insurance purposes have continued to rise when market values for the same homes are in decline. This is addressed by looking at the fact that there are several kinds of value. The market value of a home, as defined on the FNMA appraisal forms, has to do with the most probable price a willing seller and willing buyer, neither acting under duress, can agree upon for the home. When there is a lot of unsold inventory, for whatever reason (high interest rates keeping people from borrowing, overbuilding by developers, etc.), the seller must reduce his price to get the buyer to choose the seller's home over a competitor's home.

Insurance values, on the other hand, have less to do with the resale value of a home and are almost enirely concerned with the replacement value. As inflation increases (which can be done through lowered interest rates, by the way), the cost of rebuilding goes up with the cost of the materials and labor. The costs can also be artificially manipulated, as happened when the US restricted the import of Canadian softwood lumber in an attempt to protect US lumber workers, or in the case when a competitor begins buying up all of the surplus lumber (As happened when the Canadians turned to the Japanese as an alternative market, and the Japanese continued to buy even after the US lifted the import restrictions. Keep a sharp eye on the Chinese, who are competing with us for petroleum.). Also, insurance values have to include the cost of cleaning up the damage and hauling away the debris. Most insurance companies will only replace up to 80% of the value, figuring that they won't have to replace a foundation if the house burns to the ground. On a new construction, at 80% replacement, the insurance company is near a break-even point when market value and insurable value are compared.

The second question had to do with why so many mortgage lenders were downsizing or closing down their operations. Most people think they go to the bank for a loan, and Jimmy Stewart is on the job. What they do not realize is that Congress and the regulators changed the rules of the game a quarter century ago when they had to bail out the savings and loan companies. When the rules changed, mortgage brokerage came into its own.

Let's say you want to be a mortgage broker (OK, don't shoot me, I'm going to simplify this a great deal). You get a license (now required most places, but only in the past few years) and round up 100 people (Investor A) to provide seed capital. They are your shareholders, and at $10,000 per share, put up a million dollars. You find five customers who want to borrow $200,000 each, and loan out the million dollars at 7% for ten years. Over the 10 years, they will pay $393,308 in interest. You package the loans as securities, and by the end of the second week sell the package to Investor B. You have to discount the package so Investor B will pay you right now, so you charge him only 6% ($60,000) simple interest. You pay a loan servicing company 2.5% ($25,000) for collecting the monthly payment and passing it on to Investor B. You get a 1% commission ($10,000) for your two weeks' work. The $1,000,000 has earned $25,000, or $250 per share. You do this 25 times in a year. At the end of the year (simple math) your shareholders have dividends of $6,250 each. You have made $250,000. The borrowers are happy to have 7% mortgages. But...

What if some of those borrowers default? Both the servicing company and Investor B will lose money. If the loans were not insured (which most sub-prime loans are not), they may come to you to make good on the default. What's that? You bought a big house, a new Lexus, and took several cruises and spent the money?

Suddenly Investor B no longer wants to buy your loan packages. With little prospect of quick gains, Investor(s) A rush out to sell their shares. With some bad publicity, suddenly no one wants to buy the shares. Wall Street notices. You have no more money to loan. You are out of business.

You will have to Pass GO without collecting $100. If you were careful, you may be able to avoid having to look for the Get Out Of Jail Free card. If you were putting pressure on appraisers to hit inflated numbers in their appraisals, both you and they MAY go to jail for bank fraud. If you were careless in qualifying borrowers and sold them loans they could not reasonably pay back, you MAY end up under the bright lights of a Senate hearing. You MAY end up in consumer lawsuits.

It was a good thing (from one perspective) while it lasted. To every thing there is a season...