Let's get to the heart of the matter. Everyone is talking about the credit crunch, yet how many of you really know why this is happening? Everyone says is goes back to the subprime market. But do any of you know why this is?
When a lender has to take back a property they must meet reserve requirements to cover the loss and they lose lending power on every home on their books. For example:
Bank takes back a $100,000 home. They must have 7-10 times this amount in cash reserves to cover the loss. The bank needs to pony up $770k-$1 million in cash reserves to offset this take back. Think of all the homes at different price ranges the banks are taking back and how much cash reserves they must have to match this. This is the tip of the iceberg. Let's look at the loss of loaning power.
The $770k-$1 million is only 10% of their loss in loaning ability. For this example, the bank taking back this home and needing to have the $770k-$1 million in cash reserves also lost the lending ability of $7.7-$10 million dollars. This is one transaction...ONE! As these banks take back more and more homes their cash reserves are drying up and they are losing their ability to loan any money. Do the math. The numbers are significant in terms of loss.
The smaller banks can't handle this kind of loss. They may not have as many foreclosures but as the bigger banks cut off the supply of money to them they go under. Businesses are not receiving funding to pay wages and operating expenses because they rely on short-term loans from banks to cover these expenses. It is a trickle down effect that strains the entire market.
The banks are desperately trying to get these homes off their books. This is why they are pushing the federal government to buy their toxic loans so they can start lending again. The subprime loans were good for short term lending only. They were designed for the home owner to get financing and clean up their credit and refinance out to a better loan product. However various factors impeded this possibility for these people. Divorce, loss of job, mismanagement of finances, and not having the ability to stay in a loan like this long term if needed.
At first these loans helped boost the economy now it is hampering the economy. There are opportunities to gain from all of this. Learn how to invest, educate yourself constantly, don't be a victim, move forward and grow.
Learn how to invest in this market. Assist others and grow yourself. Take your life on and create success!
Happy Investing!
Tony
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