Below is a blog post by Donna Mitchell, a Home Loan Consultant with Countrywide Home Loans in Tennessee. I am re-posting here with Donna's permission. Donna is talking about how we got into the mess we are in and why a bail out plan is even on the table.

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Here's my take on the issues (its long but everyone needs to read this):

First everyone needs to know and should be communicating to their buyers and sellers that FORECLOSURES are not the problem that is creating the financial "crisis".  (I hesitate to use the word "crisis" because it is not a crisis yet, but will quickly become one if things don't change).  I'll give you a dramatic over simplification of how the mortgage industry works so you'll know why there are issues that are newsworthy. 

Lenders will often borrow money on short term commercial lines of credit to fund loans.  Lenders then make loans to borrowers.  Companies like FNMAE and FHLMC (Fannie Mae and Freddie Mac) invest in those loans and they are packaged for sale as "mortgage backed securities", also called "collateralized debt" or any number of other names.  Companies like Bear Stearns and others sell those bonds of "scrutinized debt" to investors, many of those are foreign investors.  Companies like AIG insured some of those investors against loss from those investments (they insured a lot of sub-prime bonds which is why they got in financial trouble).  Some of the money from the sale of the loans (sale of the investment bonds from the loan packages), goes back to the lenders who then pay their commercial lines of credit off (also called "Commercial Paper"), and then start that whole cycle of lending, selling off loans, and taking that money to fund more loans all over again.  You can think of this as the water cycle for money.  In the same way water evaporates and then rains back down, mortgage money moves in a similar circle.

Foreclosures are normally about 1.5% of mortgage loans.  Do the math and you'll see that 98% of all mortgage loans are not in default and are not going to default barring a catastrophic event such as loss of a job or life threatening illness or disability (those events are in the 1.5%).

In today's market foreclosuresare only up about on half of one percent.  That's right.  Foreclosures are only about 2%of all loans.  That still means 98% of loans are being paid as agreed.

While a half percent increase in foreclosures is certainly not a desirable thing, it is not enough to create the market chaos the media is blowing way out of proportion.  So what's the problem?

The real problem in the marketplace is investor dollars.  Some investors, many of them foreign, apparently did not know they were investing in sub-prime loans.  Foreign investors previously thought investing in the U.S. mortgage market, especially Fannie Mae and Freddie Mac, was almost as safe as investing in U.S. Treasuries.  The U.S. has never defaulted on a bond, so it has been considered the safest of all investments.  U.S. mortgage debt was previously considered second in safety to Treasuries by many foreign investors.

 Enter greedy investment bankers.  It appears, investment bankers, like those at Bear Stearns (some of whom have now been indicted in criminal cases), either did not explain to investors the nature of the risk of investing in sub-prime loan debt, or they were mixing sub-prime mortgage loans up in the same packages of loans that also contained "A" paper loans to hide the true nature of the risk from those investors and keep the money flowing.  It was hard to tell how they sold the junk vs. the good loans.  I think we'll all learn more about this as the investigations continue.

Obviously, making loans to people with the multiple risks of bad credit, who can't document their income, and needed to finance all or a high percentage of their purchase price, especially on investment property, was not a good idea.  A large percentage of the sub-prime loans defaulted (is this really a surprise to anyone?), and this shocked the investors who had never seen large default rates from U.S. Mortgage investments.  Keep in mind that sup-prime loans were only a very small percentage of all loans written in the U.S., but it started to look like ALL loans were experiencing high default rates.  That is not the case!

Once investors got wind that there were more losses than expected in mortgages, they started to pull their money out of mortgage investing.  Investors lost confidence in the quality of American mortgage debt so they stopped putting money in the system.  The sub-prime companies like Ameriquest were the first to go...and with good riddance.  No commercial lender wanted to give them money anymore because they could no longer sell their loans to investors, the investment banks couldn't sell their mortgage backed securities, and they had no more money to pay off their commercial lines of credit and then lend again.  The cycle stopped, so they had to go bankrupt and close their doors.  It was the lack of investors providing more money that made them fold.

Things would have been fine if investors had left the only sub-prime mortgage bonds alone.  The problem is that they didn't.  They stopped investing in ALL mortgage companies, even GOOD ones like American Home and Countrywide (the media is DEAD WRONG on Countrywide as only about 1.6% of their portfolio was even sub-prime loans...very, very small percentage.  It is just, flat out, bad information but that's another blog entirely).  Investors stopped buying Fannie and Freddie stock.  It didn't help that the Fannie and Freddie CEO's were using some "creative accounting" to hide the fact that they were experiencing some hard times from the lack of revenue.  It all came to a head when investors nearly stopped buying the mortgage backed securities almost entirely.  That left even the good companies in trouble of funding loans, because once the loans were made, no investors wanted them, so lending nearly ground to a halt.

The lending industry is now scrambling for cash, as without an infusion, they won't have money to give to home buyers.  Commercial lending would have no money to give to mortgage companies and banks, so banks would have no money to give to customers, so there is nothing to be sold to investment institutions who can't then package them and sell them to collateralized bond investors...all because the bond investors don't want to buy those investment instruments until they are sure they won't be losing money.  And we all need their money whether we know it or not.

THUS THE NEED FOR THE BAILOUT.

While may be detestable to use tax dollars to bail out these institutions, it may be the only way to bring investors back into the market.  I don't want to subsidize someone else's losses with my grand-children's future, but if something is not done to reassure investors that they will not lose billions of dollars, we will all lose billions of dollars.  The government will, hopefully, provide some temporary cash to the likes of AIG and the major players in the financial markets, to keep lending funds available in the short term.  In the mean time, lenders are tightening guidelines in the hopes of showing investors that they are only making good loans.  That is what the media is erroneously calling the "Credit Crunch". 

The headlines continually saying things like "Credit Crunch" and "Mortgage Meltdown" make it look like the average American can't get a home loan, causing them to pause as they think about buying a home.  This compounds the problem in that REALTORS need buyers and banks need to make loans to make profits. 

Average Joe, I'm hear to tell you that YES YOU CAN STILL GET HOME FINANCING.  It is readily available to those who qualify.  The government bailout may be necessary to convince investors that the lending industry is not going to fail so they will keep putting money in the system.  If investing in the banking system stops, then we will have a true credit crunch, mortgage meltdown and financial Armageddon will begin.  Something has to be done, and if I have to pay for a part of it then so be it.  I we can't get investors back to the table, we'll all be in a soup line somewhere, because every business in America is affected by commercial credit lines in one way or another.  If they are not using them, they are making them.  Those that use them can't stay in business if they don't have them, and those that make them can't stay in business if they don't have businesses to lend to.  And you and I can't keep jobs if there are no businesses out there to get jobs from.  If we don't have jobs, we can't keep other businesses in business by buying stuff.  That's where the problem is.

You see sad news stories about people getting foreclosed on because it makes for good news copy.  Foreclosures are not the real problem, though.  While no one wants to see someone lose their home, the real crisis for our country is in bringing investors back to the table to fund American commerce.   It appears the only way to do that in the short term is for the government to step in and stabilize investor confidence by providing short term "bailout" money, which these businesses will hopefully pay back when the money cycle begins again and things get back to normal.

Things WILL get back to normal.  It is just a matter of time.

If you are planning on buying a home, go ahead and do it.  Home prices are great and interest rates are great.  Don't wait for prices to rise and rates to rise.  Once the economy kicks in again (which requires investor dollars to happen), home prices will go up and rates will go up.  Investing 101 is buy low and sell high.  Yes you CAN get a home loan because Donna's Got Money to lend to you!

I do lending the right way so you don't get in over your head and you have the right mortgage product for you.  Visit my website at www.donnasgotmoney.com for mortgage calculators and other helpful information. 

Until next time... 

     Got Money?

Donna Mitchell, Home Loan Consultant

www.donnasgotmoney.com