Should we open the window and go out on the ledge?

You know, those wonderful adjustable rate mortgages? The ones where you start out at a low teaser rate for the first couple of years ... and then the bank "adjusts" the interest rate and your monthly payment sky rockets? When you took the loan, the loan officer told you that people tend to sell their homes every 3 or 5 or 7 years ... so you'd probably sell your house and buy a new one before the adjustment hit. Or, alternatively, you could always refinance the mortgage before you got whacked by the sky rocketing adjustment, right?

Well, that works really well as long as housing prices are going UP. But what happens if, all of a sudden, the market value of your home starts circling the toilet? What happens if, suddenly, you can't sell your home for what you owe on it? What happens if you go to the bank to refinance the mortgage and the bank appraisal says your home isn't worth what you owe ... and to refinance, you have to come up with the difference of say 10% or 20%. On a $250,000 home that means you have to come up with between $25,000 and $50,000 in cash to avoid your monthly mortgage payment going through the roof.

Here's a picture of the amounts of money tied up in adjustable rate mortgages spread out over when those adjustments are scheduled to hit.

The problem with this debt is we have now partially crippled our economy going forward. The U.S. economy relies on the credit markets for a host of necessary economic activities. But those markets are not functioning smoothly right now. And the chart from the IMF indicates they won't function smoothly for some time into the future. As a result, the U.S. economy will limp alone for the foreseeable future as the credit markets work-out their self-imposed problems. And that's not good for anyone.

Hal Stewart, market analyst | Bio | Full article |

Lenders like Countrywide are devaluing their mortgage holdings like there's no tomorrow. The foreclosure rates are at record highs - that means banks and lenders are taking ownership of the homes people can no longer pay for - and that is depressing both the existing home and new construction markets. (Why would you buy a home at retail when you can get one just like it down the street at wholesale?)

Well, one of the things the chart tells me is that it's going to get a lot worse before it starts to get any better.

The lesson in all of this is that the only time leverage works for you is when you have other alternatives. The only time to buy something by leveraging it's future value is when you don't have to. Betting that the value of your home will always increase is a foolish dream. We make the bet because it's been the case since the 1950s - but history goes back a lot further than the last 60 years and there are precedents of values dropping like a rock --- over night.

Lets hear it for market deregulation! The invisible hand of the market will solve everything! Milton Freedman forever!

Well, the invisible hand of the market doesn't solve everything. Corporations don't always act in their own best interests and they certainly don't act in your best interest. This economic hiccup is a prime example of why regulation of an industry is important. For the last 10-15 years the financial markets have been using "hedge funds" as a means to circumnavigate the regulations covering stocks and bonds and other other publicly traded financial instruments. They created a totally free and unrestricted market on the side and then they engaged in a high stakes, "free market" game of Three Card Monte among themselves. They bundled terrible loans and sold them back and forth among themselves at ever increasing prices until, one day, someone asked the forbidden question: "What are these things REALLY worth?"

The answer is now coming to light. "They're not worth what we've been selling them back and forth to each other. Not anywhere NEAR what we've been selling them to each other for."

So much for "free markets", invisible hands and all that bunk.

The problem is that the only people who get hurt in all of this are the people who believed that their home values would continue to increase at unbelievable rates (as they have for the last decade).

I know how it works because I took advantage of the situation. We bought a condo in New Jersey about a decade ago and sold it for a healthy profit in a bidding war between potential buyers. We took the money and bought a fixer-upper house in the mountains of Pennsylvania and flipped it in three years ... for a significant profit. Circumstances pretty much repeated themselves a couple times here in Arizona. We find ourselves in quite a nice home now, leveraged on the backs of the condo, the house in the mountains and a couple of other transactions that too advantage of market escalations. The down side is that I got caught with two houses; buying this one before I unloaded the previous one. The up side is that the leverage worked but only because I'm fortunate enough to have an alternative I can fall back on if things get tight. Oh, by the way, the mortgages aren't adjustable.

Several years ago, in the late 1990s, when the "Dot Com" bubble was spiraling out of control and fortunes were being lost faster than popcorn pops as we watched hyper inflated stock prices flush down the toilet in hours, I passed a paper around to a couple of friends of mine. It was a history of the Holland Tulip Craze (1634-1637). The language may seem a little stilted but, one must keep in mind that the piece was written in 1852. It reads like satire but, it is in fact, simply history. It points out that there is a significant difference between "intrinsic" value and "market" value - something missed in all of the "scientific" economic formulas tauted by Uncle Milty, the Chicago School and many of the so-called fiscal conservatives on the Right. It's worth reading now because history is repeating itself yet again. I guess Uncle Milty missed that reading assignment when he was developing his theories.