Banks Tank As Concerns Over Housing Bailout Mount

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Bank stocks continued to be under significant pressure today, with Citigroup dropping below $1 for the first time, plunging 14% to .98. But the company doesn't need to worry about being delisted (which happens if you can't maintain $1 per share), as the exchange modified its rules requiring the $1 minimum. Bank of America slid 10% to $3.21 and Wells Fargo dropped 17% to $8.
President Barack Obama announced more details of his mortgage bailout plan yesterday, which his administration tout may keep as many as 1 in 9 U.S. homeowners in their homes.

Obama's point man, Treasury Secretary Timothy Giethner, stated: "It is imperative that we continue to move with speed to help make housing more affordable and help arrest the damaging spiral in our housing markets, just as we work to stabilize our financial system, create jobs and help businesses thrive."

So let's review the plan, now that a few more details are available. Let's first talk about loan refinancing.
They are saying that the plan will enable "up to 4 to 5 million responsible homeowners to refinance." That's true ... and a great boom for loan officers and title companies, but let's look a little more at these claims that they will stop foreclosures. It helps folks who right now aren't the ones really struggling ... and ignores the folks under water on their mortgage beyond 5%.

Let's read directly from the White Houses' summary:

"Consider a family that took out a 30-year fixed rate mortgage of $207,000 with an interest rate of 6.50% on a house worth $260,000 at the time. Today, that family has about $200,000 remaining on their mortgage, but the value of that home has fallen 15 percent to $221,000 - making them ineligible for today's low interest rates that now generally require the borrower to have 20 percent home equity. Under this refinancing plan, that family could refinance to a rate near 5.16% - reducing their annual payments by over $2,300."

Yep, they sure can do that ... but guess what? Most of the folks who will take advantage of this are not the folks that are in foreclosure or currently facing foreclosure! If they have a conventional mortgage with Fannie and Freddie, they aren't the issue right now ... for the most part, the subprime garbage is.
But there's a magic number out there ... 105%. Yes, that's what we're talking about. If the loan is less than than 105% of its current market value, they might be eligible for refinance. But come on! Most of the people in foreclosure purchased with 100% financing ... you know, the 80/20 loan. Most homes lost at least 15% of value last year, and in California, Nevada, Arizona and Florida, just double that to at least 30%. This plan does nothing for these homeowners.

Now let's think about this further. In order to refinance with Fannie and Freddie, you have to not only have equity in your home (or in this case you can't be under water more than 5%), but you also have the meet the guidelines for a loan refinance. That means you have be employed. You must have a job. NINJA (no income, no job, no assets) loans aren't around anymore. So everyone who just lost their job doesn't qualify for this help.

Unfortunately, with 80% of distressed properties having a first and second mortgage, modifications for those who were over leveraged is going to be next to impossible unless they've been paying extra payments to bring down their loan balance.
What about the modification for those who are in foreclosure? What is that all about?

First, the lender reduces the interest rate on the mortgage to no more than 38% of the borrower's income. (Note: what if they don't have a job...kinda hard to do, huh?) Income is defined to include wages, salary, overtime, fees, commissions, tips, Social Security, and pensions.

Second, the government will match dollar for dollar the reduction from 38% to 31% debt to income ratio (government is buying down interest rates, not a bad idea, but the investor has to take the hit getting to 38% which many of them won't do).

Third, lenders must keep the modification in place for 5 years.

In order to incentivize lenders, the government will pay the $1,000 for the initial modification and then will give a $1,000 payment for the next three years if the loan is current.
Then the government will give a carrot to the homeowner of a $1,000 principal reduction for up to $1,000 each year for the next 5 years.

So does this do anything to really stem the foreclosure tide? Unfortunately not really ... because lenders know the nasty statistics that most folks don't want to talk about.
But the New York Times told us the real story a few weeks ago: "The nation's 14 largest banks reported that more than half of the loans they modified last year were delinquent again after just six months, according to the federal bank regulator, the comptroller of the currency."

Yes, after just six months over half of the modifications that were done went back into foreclosure. Why? First of all, a lot of people that never should have been homeowners became homeowners with 100% financing. They aren't ready for the responsibility of owning a home and aren't able to manage their finances accordingly. Second, the economy has a lot of folks wiped out and they've lost their job. And third, after paying for a property that they know is $75,000+ underwater, at some point they just walk from it because it frankly doesn't make economic sense to keep it, especially since their credit is shot already because they've missed so many payments. They can bail out now, rebuild their credit, and buy something again in a few more years (with a short sale they only have to wait 2 years).

Now on to our real estate investor education section...

"Only Buy Something You Would be Perfectly Happy to Hold if the Market Shut Down for 10 years" ---Warren Buffett

Although Buffett probably had financial instruments in mind when issuing this insightful quote, the wisdom behind the mindset remains just as pertinent today as when it was first uttered. During periods of prosperity there are those that rush in where even fools don't dare to tread. They believe the good times will last forever and buy as though there is no tomorrow. Unfortunately, the price must be paid for such rash behaviors with the resulting loss of confidence in stocks, bonds and every other piece of paper that supposedly represents wealth.

Former generations and those from other nations know that a piece of paper is only as good as the trust bestowed upon it by the general public. Once trust is gone each and every "asset" reverts back to its intrinsic value. For most of America, those pieces of paper and other financial instruments face the very real prospect of becoming worthless. Like the demise of the Confederate dollar, financial instruments of all types provide little in the form of shelter, food, clothing or other essentials once a crisis of confidence is underway.

After the end of the Civil War, Confederate dollars were reportedly more valuable as fire kindle than currency. While we hope this nation never again faces such dire prospects, it drives home the idea of buying something you would be perfectly happy to hold if the market shut down for ten years. Ask yourself if you would be willing to hold any of the following if the market was indeed depressed or shut down for the next three, five, ten or even twenty years:

Short sale real estate that provides shelter, recreation, food, raw materials, supplies, rental income or other necessities or amenities. Notice, it cannot be stolen and land still remains even if destroyed by fire.

Stocks and bonds at risk of dropping to zero

Gold, Silver or other precious metals that can be stolen or require expensive storage

Treasury bills or notes backed by the good faith of the indebted US government

Dollar bills or blips on a computer screen secured by failing or faltering banks

Antiques, paintings or collectibles that can be ruined in storms, fires, theft or vandalism

Foreign currencies from emerging markets or other nations that have internal strife, corruption, lack of clear regulations (even less than those of the USA) and other challenges.

Municipal or corporate bonds by bankrupt states, local government and over-extended corporations

Finally, ask yourself which is likely to restore wealth and help you regain financial independence once the markets and economy are restored? Buy what you would like to hold...chances are it is the same assets others will seek during tough economic times.

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