Interesting news on Wall Street this morning - Consumer confidence is the lowest on record, Unemployment is expected to reach the highest levels in several years, and Home prices dropped by >16% in the top 20 MSAs in the U.S. Even with this news, the DOW ended up by >800 points!

The market appears to be searching for any bits of good news.

There is money to invest and it appears people believe the risks reported are already priced into the market, and they are beginning to look for bargains. This is good news if it lasts, and could show the beginnings of a recovery (although that is a bit of a long shot)

In my opinion, there are two things that can happen to best speed this along.

1. Lenders can report the performance of their 2008 vintage loans. Assuming the performance on those loans is strong as it should be, this will help the market regain confidence that the UW standards have been tightened as announced, and that the mortgage industry is performing as it should.

2. The government should stop handing out money to shore up problems, and should start purchasing loans on the secondary market. The loans would be more of a non-conforming type, but would be loans that have a long track record of performance and with limited risk. This again would open up a secondary market for these types of loans. This will also give investors a chance to view the performance of these loans and will give them the confidence that the loans do perform.

As with most things, this will take time to work out, the sooner these steps are taken, the sooner we can get back to normal lending conditions. Where banks make loans people can afford and the banks take the risk, and the people who take out the loans pay them back!

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Was the real cause of the economic collapse the “sub-prime” mortgages? No.

Are all sub-prime mortgages bad? No.

Are the mortgage brokers all bad? No.

The definition of a sub-prime loan is still being muddied. Many of the loans causing problems today are loans that a sub-prime lender wouldn’t have even considered, but they were in fact closed by lenders who sold them to Fannie Mae and Freddie Mac!

It seems like the reports that come out today are more concerned in giving us a 30 second soundbite than getting to the root of the problem. Perhaps that is caused by our limited attention spans, or perhaps it is caused by the limited attention spans of those reporting it…..

The real issue as I see it was the ability to spread the risk. In prime lending – where 99% of people pay their bills on time, it isn’t an issue. They will pay because they committed to do so. Prime customers place a priority on paying their bills on time, and typically manage their budgets, and are a low risk.

Sub-prime customers typically have a higher default rate, need a more ‘hands-on’ approach to lending, or they may have a more aggressive borrowing pattern than the prime candidates.

This doesn’t make them ‘unlendable’ by any means, but you do have to lend money differently than you would for a Prime customer.

The issue at hand is, when you lend with your own money and know you have to collect on that loan to make a profit, you will typically lend in a way that is more responsible. However when you lend other people’s money, and you have no stake in the money that was lent, you assume a more aggressive lending stance.

In many cases in the mortgage world, the question asked when making a loan wasn’t “will the customer pay us back?”, it was in fact “can I sell this loan to the market?”

These two questions carry very obvious differences, and are responsible for the housing sector crash.

Barring any governmental prohibition on this….. Sub-prime loans will return, and will serve customers well. People need to keep in mind though that as they carry a higher involvement factor, they need to be priced for the risk.

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It is a word that has almost lost meaning in the past few years… Speculation has become the new ‘watchword’ and investors seem to be focused on ‘trend investments’ instead of investments based on the fundamentals of profitability, stability, and growth.

Years ago in the mortgage secondary market, lenders had to present their track records, underwriting guidelines, quality control measures, etc to show the investors that their loans would perform. They would also present the risks associated with their loans.

The investors would make their decisions based on the the fundamentals, and the track record of performance.

What drove us crazy during the frenzy was investors coming to the banks telling them what types of loans they wanted! I even heard from some that they investors told the banks that the risks were built into the pricing…. Oops.

Track record is another term that needs to be re-defined… A track record is not really a 1 year record of performance. It should be a time tested record of performance which shows how loans (or investments) stand the tests and trials of up and down markets.

The market has been beat up. The ‘trendy’ investments are limited. There are signs though that the timing MAY be right to start a recovery. The time is right to select the companies you feel have strong fundamentals, and invest in them. We are seeing signs of light at the end of the tunnel. We may have more bad news ahead of us, but when you see the smart people buying into good companies right now, it is truly a buying sign!

One thing to keep in mind though. While there are good signs out there, we have been on a downward path for about 2 years now. Even longer if you add in the true Subprime crash that was initially dismissed as being isolated. A recovery has to go uphill before you can level out. It will take some time.

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