jlweathers
Beach Lover
the fed's move to cut the rate at the discount window is more bark than bite. the move gives the capital markets the perception that the fed is there for you if you begin to feel too much pain. but i for one say these folks should suffer the consequences of their actions.
additionally, I do not necessarily think that liquidity is the issue. a cut in the interest rates should not be in response to the current mortgage situation alone. if they decide to lower rates it should be in response to the economic outlook & growth. if it is determined that the current situation is going to have a significant impact on economic growth, then perhaps we should look at cutting rates.
the problem appears to me to not be liquidity but rather an inability to price assets - many of the instruments that are being traded today are relatively new & very complex (CDOs, CLOs, CMBs, etc). this inability to determine the price of an asset leads to the liquidity issues - its much like the housing market here - if you want to sell something you have to make your market, i.e. discount the price heavily; which may in effect causes the seller to receive much less $ than originally anticipated (if they can get any). so, if you are relying on these financial instruments as collateral for short term borrowing you are in a bind - b/c nobody wants to lend on them since they are unsure as to the risk, pricing, & thus required rate of return.
trouble with the collateralized instruments is information asymmetry. the investors in these obligations are so far removed from the actual loan origination that they cannot be sure exactly what they have & consequently find it difficult to define probability of default &/or risk.
so here we are today with a terribly opaque financial instrument which no one seems to have the ability to determine an appropriate price. as a consequence of an opaque financial instrument you now find it difficult to create a new CDO and borrow against it - which means you can't make more loans, which means that your revenues & cash flow needed to sustain operations takes a huge hit. this is why the rumors of bankruptcy for countrywide and other lenders exist. not from a lack of liquidity in the capital markets. plenty of $ exists in the markets - they simply don't want this type of investment anymore & have taken a "flight to quality".
corrollary to this and touching on the comments about the fed lowering rates and the impact on adjustable rate mortgages. First, many of the ARMs are not, or are only marginally, impacted by the discount rate. These mortgages are often tied to the LIBOR (London inter-bank offering rate) index or CMT (constant maturity treasury) - these rates have already been impacted by market forces. The turmoil in the CDO market has forced investors to seek quality & safety, i.e. treasury notes & bills. This effectively reduces interest rates as with all fixed income investments an inverse relationship exists between price and yield. As demand has soared for high quality, treasuries prices have risen and yields (think interest rate) have fallen. So your ARM may end up getting some help after all (not much as this point, but perhaps some).
But i have digressed far from the real underlying issue. The entire mortgage mess whether it be subprime, alt-a, or prime mortgages was largely a result of greed and a lack of accountability. A financial institution's ability to sell mortgages on the secondary market means they do not have to worry about defaults & is willing to take increased risk. Additionally, the loan officer who originates the loan is compensated by commission only and is incredibly motivated to make a loan. Finally, investors helped facilitate by providing the opportunity via the exotic and reduced doc mortgages.
the only way to determine how to rectify the situation is to see what the fallout is. Where, why, & how did we go wrong? So, I say let this happen.
For the lenders i implore them to change the compensation schemes which exist today. While in an ideal world; payment for performance (commissions) is the most appropriate and effective form of compensation. Obviously, we are not in an ideal world. If we would like to keep the secondary mortgage market as it is (or close to it) we must maintain accountability at the point of loan origination. The secondary mortgage market and collaterilized instruments provide immense benefits to homeowners, so it would be in our best interest to make them work effectively.
For the consumer - I can only stress that you know what your are getting into; read your documents, do not sign anything you are uncomfortable with or do not fully understand, be reasonably conservative in your estimations (don't assume you will be able to sell the property, or that your income will continue to rise, or that prices will always go up) & recognize that whomever is offering the "lowest rate" may not always have the best product for you. as a former mortgage banker i always despised the rate shopper - people can quote you any rate! When you shop for a mortgage do not shop for the lowest rate - shop for the loan officer which is trustworthy, honest, helpful, forthcoming, and will deliver what you expected.
so, there is my shpill for the morning. terribly sorry for the length, but I suppose I had a little too much coffee this morning & as a former mortgage banker & current banker this subject hits close to home.
please see the attached article from the wsj for a great article on this.
"be well & do good work"
additionally, I do not necessarily think that liquidity is the issue. a cut in the interest rates should not be in response to the current mortgage situation alone. if they decide to lower rates it should be in response to the economic outlook & growth. if it is determined that the current situation is going to have a significant impact on economic growth, then perhaps we should look at cutting rates.
the problem appears to me to not be liquidity but rather an inability to price assets - many of the instruments that are being traded today are relatively new & very complex (CDOs, CLOs, CMBs, etc). this inability to determine the price of an asset leads to the liquidity issues - its much like the housing market here - if you want to sell something you have to make your market, i.e. discount the price heavily; which may in effect causes the seller to receive much less $ than originally anticipated (if they can get any). so, if you are relying on these financial instruments as collateral for short term borrowing you are in a bind - b/c nobody wants to lend on them since they are unsure as to the risk, pricing, & thus required rate of return.
trouble with the collateralized instruments is information asymmetry. the investors in these obligations are so far removed from the actual loan origination that they cannot be sure exactly what they have & consequently find it difficult to define probability of default &/or risk.
so here we are today with a terribly opaque financial instrument which no one seems to have the ability to determine an appropriate price. as a consequence of an opaque financial instrument you now find it difficult to create a new CDO and borrow against it - which means you can't make more loans, which means that your revenues & cash flow needed to sustain operations takes a huge hit. this is why the rumors of bankruptcy for countrywide and other lenders exist. not from a lack of liquidity in the capital markets. plenty of $ exists in the markets - they simply don't want this type of investment anymore & have taken a "flight to quality".
corrollary to this and touching on the comments about the fed lowering rates and the impact on adjustable rate mortgages. First, many of the ARMs are not, or are only marginally, impacted by the discount rate. These mortgages are often tied to the LIBOR (London inter-bank offering rate) index or CMT (constant maturity treasury) - these rates have already been impacted by market forces. The turmoil in the CDO market has forced investors to seek quality & safety, i.e. treasury notes & bills. This effectively reduces interest rates as with all fixed income investments an inverse relationship exists between price and yield. As demand has soared for high quality, treasuries prices have risen and yields (think interest rate) have fallen. So your ARM may end up getting some help after all (not much as this point, but perhaps some).
But i have digressed far from the real underlying issue. The entire mortgage mess whether it be subprime, alt-a, or prime mortgages was largely a result of greed and a lack of accountability. A financial institution's ability to sell mortgages on the secondary market means they do not have to worry about defaults & is willing to take increased risk. Additionally, the loan officer who originates the loan is compensated by commission only and is incredibly motivated to make a loan. Finally, investors helped facilitate by providing the opportunity via the exotic and reduced doc mortgages.
the only way to determine how to rectify the situation is to see what the fallout is. Where, why, & how did we go wrong? So, I say let this happen.
For the lenders i implore them to change the compensation schemes which exist today. While in an ideal world; payment for performance (commissions) is the most appropriate and effective form of compensation. Obviously, we are not in an ideal world. If we would like to keep the secondary mortgage market as it is (or close to it) we must maintain accountability at the point of loan origination. The secondary mortgage market and collaterilized instruments provide immense benefits to homeowners, so it would be in our best interest to make them work effectively.
For the consumer - I can only stress that you know what your are getting into; read your documents, do not sign anything you are uncomfortable with or do not fully understand, be reasonably conservative in your estimations (don't assume you will be able to sell the property, or that your income will continue to rise, or that prices will always go up) & recognize that whomever is offering the "lowest rate" may not always have the best product for you. as a former mortgage banker i always despised the rate shopper - people can quote you any rate! When you shop for a mortgage do not shop for the lowest rate - shop for the loan officer which is trustworthy, honest, helpful, forthcoming, and will deliver what you expected.
so, there is my shpill for the morning. terribly sorry for the length, but I suppose I had a little too much coffee this morning & as a former mortgage banker & current banker this subject hits close to home.
please see the attached article from the wsj for a great article on this.
"be well & do good work"
.
