A word from Jim Turner and Warren Buffet

While looking for ideas for writing a spooky article for this month’s newsletter I thought I had found something really scary: The Dow Jones Industrial Average. Eeeek! So I stared into the face of this terror, and got into the spooky spirit of this all-hallowed-holiday and started writing a bone chilling article about the end of the economy. Chaos in the streets, martial law, dogs and cats sleeping together! But then a real party-pooper came along and canceled all of the festivities of fright and started turning on the lights. It was Warren Buffet.

It turns out that this wet blanket was cautious about the market when everyone else was
having a celebration. His entire personal portfolio was in Treasury Bonds, not in the stock market at all! Now that everyone is scared out of their wits in the stock market what does he do? He calmly walks in and starts converting almost all of those Treasuries to stocks! Doesn’t he know that the stock market just dropped 36% from its all time high of a year ago? Oh…wait a minute.

"A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful," said Buffett. "And most certainly, fear is now widespread, gripping even seasoned investors."

I suppose he must have seen how disappointed he had made the partygoers who were dressed up as stockbrokers and financial analysts. He then threw them a bone by saying: "In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary." But before the DJ could start playing “The Monster Mash” he sobered up the crowd again by saying: "Fears regarding the long-term prosperity of the nation's many sound companies make no sense. Most major companies will be setting new profit records 5, 10 and 20 years from now."

This article isn’t scary at all! Especially when it comes to real estate! Everyone needs a place to live, so that even when times are tough housing always doubles in value (or more) every decade. That’s including the busts that occur almost every decade like clockwork. Even when I find an article that is really trying to be scary like: “Housing starts hit record low”, I can’t even get a little chill. Even the dimmest economics student knows from their “Supply and Demand 101” class that when you decrease inventory, but increase population, you have a housing shortage. So when the current overstock of inventory has sold, normal demand and reduced supply will drive prices up. This is still good news for the homeowner and real estate investor.

Perhaps I never really got scared on Halloween anyway. Now that I think of it, I come to the party for the fun outfits, the silly games and for the people. I hope I haven’t let you down this year. For those of you who really need the fear and the terror to really enjoy the holiday there’s
always CNN.

Credit market beginning to thaw

Watching the Dow over the last week or two has probably given folks a little motion sickness and whiplash. Mortgage rates over the last week have been similarly volatile. After jumping up a percentage point last week, they have improved dramatically in the last few days. Using the same 30 year fixed loan with a 20% down payment that I have used in previous posts, the rate is now back down to 6.0% after climbing to 6.875% a week ago. Lower rates indicate more willingness to loan, and could give a much needed spark to the real estate and mortgage industry.

There are other signs that the credit market is beginning to thaw. The overnight LIBOR rate has fallen to 1.28%, below the Federal Funds rate of 1.5%, suggesting that credit markets are stabilizing. "Libor is a daily average of what 16 different banks charge other banks to lend money in London and is used to calculate adjustable rate mortgages...Overnight Libor soared to a high of 6.88% earlier this month after the government's $700 billion bailout bill was signed into law."

Other signs of the credit market beginning to thaw:

• Larger companies that were having difficulty getting overnight loans a month ago, are now finding a market for their 30 and 60 day loan paper.

• Shoreline School District sold capital-improvement bonds valued at $25 million for a total interest rate of 4.94 percent, said Trevor Carlson...As recently as last week the interest rate — and the potential cost to the district's taxpayers — would have been substantially higher, he said.

• King County's sale of $48 million in short-term "bond anticipation notes" for jail improvements attracted eight bidders — more than expected, said Ken Guy, the county's finance director.

CNN Money
Seattle Times

While you're waiting, take the time to get prepared

If you are interested in buying a house, but not ready to act on it at this point, it would be wise to prepare yourself to be a strong buyer in the meantime. As 100% loans have all but disappeared, you should be setting aside some money for a down payment.

In addition, you should make sure your credit score is as high as possible. Lenders have become more restrictive and have raised credit score requirements. A higher score also means a lower rate on your loan, which translates to a lower house payment and/or a better house.

While the credit score is calculated on various formulas that aren't published, the following are the general portions that make up your score:

• 35% Your payment history Pay your bills on time. Automating payments online can help. Mortgage or rental lates are particularly damaging to your score.
  
• 30% How much you owe Keep balances on credit cards and other revolving accounts below 50% of your credit limit, preferably below 30% (lower is always better).
• 15% Length of your credit history Rather than let old cards go dormant, charge a latte a month (then pay it off). No activity lowers your score.
• 10% Your new credit Don't open unnecessary new accounts. And if you're rate shopping for a mortgage or an auto loan, do it within two weeks; multiple requests could ding your score.
• 10% Your mix of loans You can't do much to change this (except get a credit card if you don't have one). "No payment for 90 day" type loans are also a ding against your score.
  

You can also get a copy of your credit report at annualcreditreport.com. Check to make sure there are no errors on your report. Correct any errors as soon as possible.

Also, if you have any collections on your report, depending on how old they are, it may be wise to leave them alone. By paying them off, you make them a more recent factor in your score than they were before. If they are sufficiently old, it may make sense to pay them at the same time your mortgage loan closes.

Other helpful information can be found here on my website seanday.net.

Both Dow and rates climb, Fed considers more action

The Dow closed up 976 points today as investors (finally) reacted to worldwide government interventions to ease the crisis. This is the largest single day point gain, and the fourth largest when viewed as a percentage gain (11.1%). This of course follows a historic slide over the last week.

At the same time mortgage rates climbed further, up almost a full point since Thursday to around 6.875%. Though the stock market is now reacting to the Fed's recent moves, credit markets remain somewhat frozen.

The Fed is considering a less talked about provision in the bailout bill that allows it to pump money directly into banks for an equity share. Rather than buy up the mortgage backed securities that have unstable value, the Fed can pump money into the banks and credit market. An article in the Seattle Times does a good job of explaining the different strategies and benefits.

If Paulson pays banks exactly what their mortgages are worth, he will not increase banks' capital (or their lending ability) — he will merely convert one asset (mortgages) into another (cash), making no impact on the credit crisis. If, to protect taxpayers, he buys mortgages at lower prices than banks list them, banks will have to write down their capital and consequently contract lending — and the credit crisis will worsen. If Paulson overpays for mortgages, he may marginally augment bank capital, but also incur massive taxpayer losses when he later resells the mortgages at their real price.

The silver lining is a little-noticed provision in the bailout bill allowing Paulson — if he chooses — to buy ownership stakes in banks. According to Robert Johnson, the Senate Banking Committee's former chief economist, this would cost roughly $375 billion less than the mortgage-buying plan and, better yet, more aggressively attack the credit crisis.

Mortgages may be underpriced today, but they retain some value on banks' books. So rather than purchasing mortgages (a capital-neutral transaction), Paulson could buy bank stock, infusing banks with new capital on top of their mortgages. That would exponentially increase lending capacity, prevent taxpayers from buying toxic assets, give the public a share of future profits, and grant regulators ownership leverage to restructure bank management.

Full Article

Crisis metaphor

Here is an article that was published in the Seattle Times that uses It's a Wonderful Life as a vehicle to explain the current mortgage crisis. It is pretty basic, but introduces the subject of credit-default swaps which is a complicated piece of the crisis puzzle.

Mortgage rates up sharply

The rate on a 30 year fixed mortgage shot up by over half a point overnight following the drop in the Federal Funds Rate.

The Federal Reserve has dropped the rate that banks lend to each other from 4.25% in January to 1.5% yesterday, trying to spur economic growth without increasing inflation. Yet mortgage rates have been (relatively) steady in the high 5% to low 6% range for most of the year.

This latest point drop had an effect opposite to what people may expect. Rates at one of our lenders shot up from 5.875% to 6.5% on the same 30 year fixed loan. The effect of lowering the Federal Funds Rate is more a long term economic fix, as it can take six months to increase borrowing. It is unusual to see such a dramatic jump in mortgage rates as a response. It is possible things may settle down in the next couple of days, but clearly lenders are not any more confident in the market, and credit (at this point) remains tight despite the Fed's actions.

Spooky

Forwarded to me by a friend

Prices down, but activity up

An article in the Seattle Times detailed statistics released by the Northwest Multiple Listing Service for the month of September. While the median price in King County slid by 7.8% compared to September of 2007, it is an improvement over August's numbers, and the number of pending sales is up 15% from a year earlier. These are small, early indications that the market may be beginning to bottom out.

With the recent financial news, the market will continue to change of course. Rates are still very good and could possibly improve with the recent drop in the Federal Funds rate (though the past year's rate drops have had little effect on mortgage rates). Home prices are also back to levels seen in March of 2006. If you are interested in buying a house (and of course have the ability), the buyer's market may be peaking.

The Fed drops the rate again

The Federal Reserve has dropped the Federal Funds rate by a half a point from 2% to 1.5%. This is one more response to the worsening economy and stock market.

As I said, I'm not sure how effective this will be in loosening the credit markets. The rate drop was matched by similar rate drops in the U.K., Canada, Sweden, Switzerland, China, Hong Kong and Australia over the past day, so with this world-wide coordinated effort there may at least be a psychological boost to the market.

Wall Street Journal

CNN Money

Bernanke speaks

Federal Reserve Chairman Ben Bernanke released a statement predicting that the global economy will be down well into 2009 and hinted at a possible future rate cut. The next scheduled meeting is October 28-29, but there is a possibility of an emergency meeting.

CNN story

I don't believe another rate cut is warranted at this point as it is not rates holding people back from borrowing money, but the banks refusal to make the loans in this uncertain climate. There are also less funds to loan with the collapse of the secondary mortgage market, further restricting banks ability to approve loans. Hopefully the Fed's plan to buy up short-term debt (as well as troubled mortgage backed securities) will help unfreeze the credit market.

Rates are still historically low, at least in the mortgage lending market.

More Federal Relief

On the heels of the passing of the $700 billion bailout plan, the Federal Reserve has expanded it's economic rescue plan and is planning on buying massive amounts of short term debt to try to unclog the credit markets.

Commercial paper is a way of borrowing money for short periods, typically ranging from overnight to less than a week.

In more normal times, about $100 billion of these short-term IOUs were outstanding at any given time, sold by companies to buyers that included money market mutual funds, pension funds and other investors. But this market has virtually dried up as investors have become too jittery to buy paper for longer than overnight or a couple of days.

The unstable situation has left many companies vulnerable. The notion under the plan is for the government to provide a "backstop" that would give companies a new place to get cash, the Fed said. The action makes the Fed a crucial source of credit for nonfinancial businesses in addition to commercial banks and investment firms.

Full Seattle Times Story