Monday, September 29, 2008

Credit Crisis

What's going on with financial markets? What is a $700 billion bailout? Is my bank safe?

These are questions that I'm hearing all the time now. Having worked in the banking industry for over 20 years I know a little about what is going on. So, let me try and cut through the politics and soundbites of fear and lay out some of the facts along with my opinion.

Mortgage Greed
This is probably the genesis of the current situation. Too many risky loans were made in order to make lots of money. Money was flowing into banks from 1) low Federal Reserve Rates, 2) Foreign depositors, 3) investors. Banks used this money to loan to home buyers and home investors. The huge demand for housing drove up home prices and home values.

Home owners took advantage of double digit home value increases to borrow against the equity and use that cash for consumer spending and investing. This stoked the entire U.S. economy as workers rushed to build houses, suppliers worked to provide home building supplies, land owners sold land for huge profits, and consumer good manufacturers built and sold all kinds of consumer goods.

But I'm getting ahead of myself. Back to the mortgage industry. I said too many risky loans were made. This resulted from a couple of market pressures. 1) The government and pseudo-government entities (Fannie Mae and Freddie Mac) pressured lenders into making home loans available to lower income borrowers by offering to buy up these mortgages thus removing the risk from banks. 2) Lenders coming up with creative financing options to qualify more borrowers. The economics are simple: more loans equals more money.

How a bank makes money
Banks don't make all their money from loan interest. Shocking, I know. Nowadays they make almost as much from fees with an enormous amount coming from selling mortgage loans. Banks will package (bundle together) mortgage loans and sell them to investors. These bundled loans are referred to as Mortgage Backed Securities or MBS. The investors pay the face value of the loans plus a premium for the interest that will be earned on the loans over the expected life of the loans. This "service release" premium is generally between 50 and 150 basis points (100 basis points is 1 percent.) This amounts to hundreds of dollars per loan. For example, a $200,000 mortgage sold for par plus 80 pb would net the seller $1,600 on top of the fees collected for doing the loan (appraisal fee, documentation fees, etc.) It's not hard for a lender to make $3,000 to $5,000 per mortgage loan. These loans are generally done with a buyer already committed to buy the loan so there is very little risk to the lender.

A bank will also make money by investing deposits which are not loaned out. Banks invest in MBS. But so do insurance companies, retirement funds, institutional investors and the average mutual fund investor. Historically,they have been good, conservative investments because the last thing a person wants to give up is their home.

What is a sub-prime mortgage?
It's really just what is sounds like: a mortgage loan that is underwritten to standards below those of a prime borrower. In other words, a more risky loan. But lenders tried to hedge on these loans by finding creative ways for the borrower to pay. Since consumers almost always shop payment (not rate) lenders developed programs to lower the payment. Interest only loans, variable rate loans with a starting rate well below market, 40 year mortgages, zero down. The list was virtually endless. But this wasn't all. Lenders began lending on stated income, meaning they didn't actually verify that the borrower earned what they said they earned. This was all par for our "get now, pay later" mentality.

So what happened?
With lenders cranking out loans by the thousands and investors buying them up, it's no wonder that normal oversite was soon trampled under foot. Politicians are trying to blame this on deregulation and lack of oversite, but that is a scapegoat. The industry is still very regulated. In my institution, for example, we undergo two independant financial audits per year. One by our regulatory agency and one by an independant auditing firm.

The buyer of the mortgage sets the underwriting standards. In other words, they provide the terms of the contract. If the lender doesn't meet those standards the investor won't buy the loan. Therefore, part of the blame goes to the large mortgage investors for loosening their standards. Fannie Mae and Freddie Mac happen to be two of the largest.

Of course, banks, especially large banks, still hold millions of dollars in mortgage loans on their books. And, to stay competitive they began lowering their own standards in order to write more loans. They may have done this with the idea of selling these loans at some future point in time or they may have planned on keeping them for the life of the loan.

The liquidity crisis
So this brings us to the crisis. As these loans started to default, the demand for them from investors dropped and eventually dried up. Banks and investment firms were left holding billions of dollars in subprime mortgage loans. Forclosures increased. Financial institutions had to put more money into loan loss reserves. Additionally, one of the requirements of the Sarbanes-Oxley Act is for companies to mark there investments to market value. As MBS investments lost value banks and other holders had to mark down these investments to market value diminishing their assets resulting in lower equity amounts.

So, the crisis is two fold. 1) Banks are unwilling to lend there diminished money (if they have any) to anyone but the very best borrowers. 2) Banks and investment companies are strapped with billions of dollars of potentially worthless loans/investments.

Now, I keep using the word potentially because not all of these loans have gone bad. Many have, but the majority have not.

What is the "bailout"?
What the government wants to do is borrow against future tax revenues to purchase these loans from banks. This will clear the bad loans off their books and allow them to begin lending money again. They also want to purchase these MBS from investment firms that will allow them to use the proceeds to purchase better investments thus protecting their investors.

The estimate is that the bad loans could equal $700 billion. The government would "protect" tax payers by taking stock warrants in the companies from which they purchase the loans. Of course, the government also hopes that as home values go back up they will be able to sell the homes and make a profit for taxpayers (I doubt that will ever happen, but that's a different rant.)

One of the sticking points has to do with executive compensation packages. Most executives have a terms written into their contracts that earn them hefty bonuses based on profits. But they also protect themselves by requiring a "buyout" of their contract if they are let go. By purchasing bad loans and investments the government can potentially create a windfall profit for Wall Street companies allowing executives to earn a big bonus from the bailout. Or, these executives could be paid to leave. Either way, the average consumer and their legislative representative thinks this is unfair.

What's will happen if a bailout is not passed?
It's hard to tell. We don't live in 1930 America. Economies are global. Despite what the politicians are saying there are a lot of regulations and controls in place. Trillions of U.S. dollars are held in foreign countries (but can only be used, ultimately, in the U.S.) But, the U.S. economy is also heavily dependant on credit. A lack of credit will certainly put the brakes on. To what extent, it's hard to say.

We are still well below the number of bank failures that happened during the Savings and Loan crisis of the 80's and that bailout wasn't even close to the one being talked about right now.

I would put my money in an insured account and wait to see what happens. If I am upside down in investments and have the time to wait it out, I'll leave them for the time knowing that they will eventually go back up. I'll decrease my spending and purchase only those things that are necessary to sustain me and my family. I'll pay off debts.

Bottom line: I'll do everything the prophets have been telling us to do for years.

Friday, September 26, 2008

The Joys of Home Ownership

Ah, the joy of being woken from a blissful sleep at 6 a.m. to the wonderful phrase, "we're flooded!"

Last night I was informed that our kitchen sink was backed up. Well, I was working on something else at the time and soon forgot about that little project.

The dishwasher started at 2 a.m. and, with no place for the water to drain, overflowed into the kitchen.

The kitchen floor was covered in water and a steady drip was coming from the basement ceiling to the carpet below.

Now, I'm getting pretty good at ripping up carpet after our basement flood two months ago. So, up came the carpet (luckly not as bad as last time.)

The ceiling's not looking so good, however. The drywall will probably have to be replaced or at the very least retaped and painted. Likewise, the slats of wood of the kitchen floor all have a nice up-curve on the sides and ends and so the floor will need to be refinished.

The interesting part about all this that in my board meeting last night at work we were discussing companies that have very high Net Promoter Scores or NPS. An NPS is determined by asking customers to rank, on a scale of 0-10, how likely they are to refer the company to family and friends. 10's and 9's are promoters, 0-6 are detractors, and 7's and 8's are passives. NPS is calculated by subtracting detractors from promoters (P-D=NPS). The theory is that word of mouth advertising is the best type of advertising. Customers who are enthusiastic about your company will sell it to others. Therefore, the more enthusiastic customers you have, the more successful your company will be. Thus high NPS=success.

USAA, a company that provides insurance and financial services to military personnel and their families, consistently has one of the highest scores of all U.S. companies. And, it just so happens that we have USAA home owner's insurance. So now is my big chance to test how good they really are (we've had one other claim for a car accident a few years ago and they did a great job.)

Regardless, with one more flood I may consider replacing the carpet in the basement with linolium.

Tuesday, September 23, 2008

Who Moved my Cheese?!

I can always tell the change of season -- not by temperature change, the shortening or lengthening of the days nor the changing colors or new leaves. Not even by the calendar. No, it's something much easier in my household: Lisa begins to reorganize.
I should be happy that I have a wife that can't stand clutter. Honestly, if it weren't for her our house would look like a swap meet. She's often threatened to not clean anything and see how the rest of us like it. Well, since we created the mess it's kind of a silly threat.
And so when I came home last night and saw Lisa hauling filing cabinet drawers down to the basement I knew it was the first day of Autumn.
It was with great sadness that I walked into my closet to find everything re-arranged and organized. I felt the twinge of pain, anger, regret -- you know, that feeling you get when you didn't get to tell someone goodbye.
Lisa likes things out of sight. I like things where I can easily find them. Now, the two should be very compatable. A filing system comes to mind. Labels on drawers and boxes. A pile on the floor or night stand. You get the picture.
Unfortunately, organizing, like loading the dishwasher, is something that we just haven't been able to come to some agreement on. So, I'll continue to reload the dishwasher after Lisa has loaded it and she'll continue to put my things "away".
Now, has anyone seen my favorite t-shirt? It was laying on the closet floor.

Monday, September 22, 2008

Missed it by That Much!

Okay, not so much. The official designation of Iron Butt is to ride a motorcycle 500 miles or more in a single day. So, 450 miles in a day doesn't get it. 900 miles in two days? Nope. 1500 miles in four days? Not even close.
According to the official Iron Butt Association (truly, I'm not making this up) website (, these are some of the sanctioned rides of the IBA:
  • 1000 miles in under 24 hours/1500 miles in under 36 hours
  • Coast to coast in under 50 hours
  • Ride all 48 states in under 10 days
  • 100,000 miles in one year

So, my four day ride through Utah, Nevada, and Arizona wouldn't even qualify as a warm up for this group.

But it was never about accolades or designations. Heck, it wasn't even about the destination. It was about adventure, the beauty of the west, and solitude. It was about visiting national monuments that every american should see.

And so it was. My little escapade took me across monolythic Hoover Dam, listed as one of seven modern civil engineeering wonders. Down historic Route 66, up to the Grand Canyon South Rim, Across Lake Powell at Glenn Canyon Dam, and through Zion's National Park.

I can't begin to describe the beauty of these places. And that's why every american should visit them.

The vastness of the west. The rugged country. The desert solitude. The tapestry of colors. The loneliness of the open road. The deep green water of lake Mead stopped up against Hoover dam while the image of a High Scaler, the tough itinerant dam worker, captured in a larger than life bronze statue invokes images of a true american work ethic. Table top plateau vistas and enormous thunder clouds with black tendrils of falling rain reaching toward the parched earth. Black skies pocked with millions of brilliant stars. A rising moon so large and bright it reflects off the desert sand. Soaring raptors. Golden sunflowers lining an endless ribbon of asphalt. Twisty mountain roads freshly cleaned by an afternoon shower. Scraggly pinyons and desert flowers clinging to red cliffs. Smooth sandstone walls thousands of feet high. The provocative smell of thick forest pines. The heat of the sun and coldness of rushing wind forced down by thunderstorms. The smallness of man against the vastness of the Grand Canyon. A string of water winding it's way through a thousand twists and turns of canyon walls. The pleasure of kicking back in a small-town cafe, listening to the local drawl while washing down a dripping roasted-pepper, turkey and bacon on toasted sour dough with a mason jar of diet coke and thick fries. The waitress calling me "hon". Falling onto the bed of a cheap hotel too tired to even take off my boots. Thinking every moment that the only thing better than experiencing this beauty on my own would be to experience it with the ones I love.

And so, I may not have an iron butt, but think that slowing down and taking in the beauty that is all around is something that I can live with and am all the better for.

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Friday, September 12, 2008

Emotional Vomit

Have you every had one of those out-of-body moments when you are completely aware that you are speaking and acting in a way that you know you shouldn't but you just can't stop yourself? I seem to have those moments a lot. Not in any perverse manner. Mostly when I'm interacting with family members. Now why is it that we can be so kind and mature to complete strangers but when it comes to our own family we behave like two-year-olds?
I had one of those moments just this evening when I went to offer up some fatherly advice to my 17-year old daughter. Well, she wasn't really asking for advice. But, I had committed myself to give it and I wasn't going to settle for anything but complete and utter victory. Mission accomplished.
I soon watched myself saying everything that I shouldn't..."you should be more grateful"...."you don't appreciate how well you have it"...."I work my fingers to the bone for you". It was like I was caught in a bizarre twilight zone of cliches!
Now, I think I know what it takes to be a kind and compassionate father. I see them every day. I read books about them. I even recognize when I'm not one and know what I should do differently. And yet I still find myself dry-heaving the simple and cutting emotions of a cave dweller.
But I hold out hope. Some day, starting tomorrow, I will catch myself in the first burp of emotional debate and plug the dike. It won't taste all that great to me but I'll spare others the mess.