A Game of Mortgage Monopoly

Once upon a time, in a land far, far away…. banks made loans to people and people made their payments to banks.  Perhaps it wasn’t that long ago; maybe it was back in the days when our grandparents used to walk uphill to school in the snow – both ways, mind you.  Things weren’t all that great in those days when banks were the exclusive source of mortgage money.  It came with its own set of problems – namely, the problem of liquidity.  Have we made that trip around the Monopoly board and now things have come full circle?  Stopping on Park Place was nice (if you owned it), or any property with Hotels for that matter.  Some of the players may have preferred the Railroads and finally, some I see, may be going to jail.

Right idea.  Wrong execution.  Wall Street says, Mr. Banker, we’ll take these loans off your hands and you can go out and make some more loans.  A virtual never ending supply of money.  Hey, wait a second.  Are you telling me that it doesn’t matter if I apply with the bank or a mortgage broker – either way, my loan will be securitized and my payments will be to another company yet to be named?  Well, OK then.  The lowest rate and best service wins.  I’ll find me an honest mortgage broker.  Have fun kissing all the frogs.  To those of you who have found a trustworthy mortgage broker – keep that business card and refer your friends, co-workers, and relatives to that someone.  To those of you who have not found a trustworthy mortgage broker – ask a friend, co-worker, or relative for a referral to one.  Now, back to our Monopoly game.

Housing goes up!  It’s a boom!  I cringed when I heard people say: “real estate never goes down in value”.  The trouble is that Wall Street believed it.  No, scratch that.  The trouble is that Wall Street sold it.  It goes like this.  Wall Street says let’s buy these loans from these mortgage originators (banks, mortgage brokers, etc.) that meet this lending criteria (credit score, down payment, debt-to-income ratio, etc.).  Hey, WS likes it!  The property values went up and the loans performed well.  Somewhere in a boardroom this fellow with suspenders stood up and said: “very, very few foreclosures. Let’s reduce the qualifying criteria.  No need to verify the debt-to-income ratio.  No need for a down payment.  Plus, we can raise the interest rate in two years!” 

More loans are made.  On a macroeconomic scale it seemed to be working.  True, the payments were made on time, but that’s not because consumers could afford the payments.  Those who fell behind simply sold their home to a real estate investor and pocketed $40k themselves.  That was fun, says the consumer!  I’ll buy another house I can’t afford.  I’ll buy one bigger and when I fall behind on my payments, I’ll refinance the home to pay off my credit cards!  You know who you are.  It takes two to tango.  Consumers aren’t all that innocent themselves.  Now, back again to Monopoly.

It’s Economic Cycles roll of the dice.  Oh no, no one likes EC.  He always walks into the game like a big bear with bad news and bankrupts all the happy go lucky crowd.  Sorry, it’s that time.  His die is in paw.  Time to find out who holds those mortgage loans. 

What is a Hedge Fund?  Investorwords.com defines hedge fund:

“A fund, usually used by wealthy individuals and institutions, which is allowed to use aggressive strategies that are unavailable to mutual funds, including selling short, leverage, program trading, swaps, arbitrage, and derivatives. Hedge funds are exempt from many of the rules and regulations governing other mutual funds, which allows them to accomplish aggressive investing goals. They are restricted by law to no more than 100 investors per fund, and as a result most hedge funds set extremely high minimum investment amounts, ranging anywhere from $250,000 to over $1 million. As with traditional mutual funds, investors in hedge funds pay a management fee; however, hedge funds also collect a percentage of the profits (usually 20%)”.

Hidden in the hedge fund are the holders of the failed-to-document-properly-mortgage-loans that are going into foreclosure at increasing rates.  The Hedgies secrets are being revealed as we speak. HedgeFund.net reports July 6, 2007: 

Braddock Financial Corp. is closing a hedge fund that has been stung by subprime mortgage exposure.

Braddock Financial said the losses the fund has endured in the first half of 2007 led to the decision to liquidate the $300 million vehicle.

The fund suffered outflow amid investor worry over the subprime mortgage crisis.

The rising interest rate has triggered widespread default throughout the subprime mortgage sector—whose main function is to loan to people with poor credit. The sector had been a popular niche investment within the hedge fund industry.

The closure came a day after Florida-based United Capital said it nixed investor redemption on a fund with subprime mortgage exposure. In June, Bear Stearns saw its hedge fund program rocked by its subprime mortgage exposure.

Once upon a time, in a land far, far away…. banks made loans to people and people made their payments to banks.  To the mortgage industry: “do not pass Go”; namely, the problem of liquidity.

(source=investorwords.com/2296/hedge_fund.html)

(source= hedgefund.net/publicnews/default.aspx?story=7468)