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October 22, 2008
The System of the World (Part Two)By Greyhawk
Our house is a very, very, very fine house...
But what is it worth?
Back in part one we mentioned that Fred sold his house to Ernie. Fred had an asking price, but Ernie offered him a little less. The went back and forth a couple times, but eventually agreed on $35,000. (Remember, this was the 1970's). It's a small house in a nice neighborhood. It was Fred's first house, but he's had it for several years and his family is growing and he's making more money now and he's ready for something bigger. But it's just right for Ernie.
So anyhow, there's the simplest explanation for what anything is worth - it's worth what the buyer is willing to pay the seller. In the real estate market if the buyers outnumber the sellers it's a "seller's market" - he can get a higher price than when the sellers outnumber the buyers (a "buyer's market"). But here in Yortown supply pretty much equals demand, and Bob the Builder keeps it that way.
Now Ernie doesn't have $35,000 in his pocket - or even in the bank. So he asked for a loan from the bank. After they determined he was likely to pay the loan back (he had a good job working at Joe's Widget Mill and a history of paying his debts) the bankers wanted to know what the house was worth. So they had an appraiser check it out. She looked at the house inside and outside and measured the rooms and looked at the type and quality of construction and material and compared it to other houses that had sold in the area and determined it was worth the agreed upon price. Since Joe was also using some of his savings as a down payment this meant the bank was fairly safe in making the loan - so they did.
After the deal was complete, Fred paid off his loan to another bank and used most of his profit (he only owed $16,000) as a down payment on a bigger $50,000 house Bob was building over in the nice new Avon Park subdivision.
So everyone was happy.
Now, we already know from part one that the bank is going to send that mortgage off to Fannie Mae and get money to offer more mortgage loans. Fannie Mae, in turn, is going to offer that mortgage on the "secondary market".
But that begs a question: "What is the mortgage worth? And if you think about it for a minute, you'll know that's a very different question than "what is the house worth?" Here are a few reasons why:
Ernie's mortgage is designed to be paid off over 30 years. If he makes the scheduled payments on time whoever gets those payments will get a large sum of money - their profit will be the interest Ernie pays. (However, those payments will look pretty small in 20 years time compared to new mortgages if housing values keep going up...)
But if Ernie makes larger payments he might pay the loan off sooner with less interest accrued.
But he might also do what Fred did and sell the house to someone else and pay off the entire loan after only a few years.
Or he might fall on hard times and not be able to make his payments at all. If his loan was guaranteed or insured then once again the principal would be covered, but there would be no more interest received and whoever guaranteed or insured it gets the house. If not, whoever Ernie owed the money to gets a house. And what is that house worth? How long has it been since Ernie bought it? How much did he still owe? What will it cost the company to sell the house? How long will that take?
So the best answer to "what is the mortgage worth" is "something". That uncertainty means there's quite a bit of risk involved in buying a mortgage, making it more difficult for buyer and seller to agree on a price . If you deal in a high volume of mortgages to qualified borrowers you reduce that risk, but frankly anyone willing to assume that risk is probably better off originating mortgages (what the bank did for Ernie) in the first place.
But we already explained in part one why a secondary market for mortgages is desirable. So how do you go about creating one?
Here's a simplified explanation of how it was done in America. The Emergency Home Finance Act of 1970 established new standards for mortgages, and reduced or eliminated regional and local variations. This allowed Fannie Mae (and other Government Sponsored Enterprises) to "pool" several similar mortgages. Then, instead of trying to sell one mortgage worth "something" they had a large block of mortgages that had a more definable value.
While you can't predict with great certainty what one mortgage will be worth over time, you can statistically predict what a thousand will (especially if they were generated using the same applied standards). Some percentage will be paid off on time, another percentage will default, another will be paid off early, etc. etc. This doesn't eliminate uncertainty (risk), but it does reduce it.
And to further lower risk, instead of trying to sell that large pool to one investor, Fannie Mae (or anyone else in the business) could get multiple investors to purchase a portion of the pool. Those "portions" are called "mortgage backed securities". There are numerous complex variations, but the bottom line is that these securities facilitated the growth of the secondary mortgage market - and a way for investment firms that weren't in the industry to cycle money through it, keep mortgage generation possible, and make a profit. With the system "backed" by property (collateral), insurance, guarantees, (and in many cases the United States government); along with a widely accepted premise that real estate would gradually increase in value over time (albeit with fluctuations), an assumption of generally accepted "safe" lending practices in loan origination, and assumed fiscal responsibility throughout all levels of the process it seemed like a safe bet. Lots of pension funds, insurance companies, and other financial institutions "bought in".
In fact, it was a safe bet. "The system" even facilitated that gradual increase in property values that it needed to thrive.
But the key word, as we all know now, is "was".
More to follow...
Posted by Greyhawk / October 22, 2008 10:11 AM | Permalink
November 26, 2010
I think anyone who's ever pondered the "comment" option - once only available on blogs and bulletin boards, now ubiquitous on almost any web site - will appreciate this:
The so-called faculty of writing is not so much a faculty of writing as it is a faculty of thinking. When a man says, "I have an idea but I can't express it"; that man hasn't an idea but merely a vague feeling. If a man has a feeling of that kind, and will sit down for a half an hour and persistently try to put into writing what he feels, the probabilities are at least 90 percent that he will either be able to record it, or else realize that he has no idea at all. In either case, he will do himself a benefit.
That's wisdom from the past, captured for posterity at the US Naval Institute, shared via the web on the institute's 137th anniversary.
From their about page:
"The Naval Institute has three core activities," among them, History and Preservation:
The Naval Institute also has recently introduced Americans at War, a living history of Americans at war in their own words and from their own experiences. These 90-second vignettes convey powerful stories of inspiration, pride, and patriotism.
Take a look at the collection, and you'll see it's not limited to accounts from those who served on ships at sea, members of the other branches are well-represented.
I'm fortunate to have met USNI's Mary Ripley, she's responsible for the institute's oral history program (and she's the daughter of the late John Ripley, whose story is told here). She also deserves much credit for their blog. ("We're not the Navy nor any government agency. Blog and comment freely.") We met at a milblog conference - Mary knew (and I would come to realize) that milbloggers are the 21st-century version of exactly what the US Naval Institute is all about. Once that light bulb came on in my head, I mentioned a vague idea for a project to her - milblogs as the 21st century oral history that they are.
"Put that in writing," she said (of course - see first paragraph above!) - and here's part of the result.
Shortly after the first tent was pitched by the American military in Iraq a wire was connected to a computer therein, and the internet was available to a generation of Americans at war - many of whom had grown up online. From that point on, at any given moment, somewhere in Iraq a Soldier, Sailor, Airman or Marine was at a keyboard sharing the events of his or her day with the folks back home. While most would simply fire off an email, others took advantage of the (then) relatively new online blogging platforms to post their thoughts and experiences for the entire world to see. The milblog was born - and from that moment to this stories detailing everything from the most mundane aspects of camp life to intense combat action (often described within hours of the event) have been available on the web...
And et cetera - but since you're reading this on a milblog, you probably knew that. And you know that milblogs aren't just blogs written by troops at war, that many friends, family members, and supporters likewise documented their story of America at war online in near-real time, as those stories developed.
The diversity in membership of that group is broad, the one thing we all have in common is the impulse to make sense of the seemingly senseless, and communicate the tale - for each of us that impulse was strong enough to overcome whatever barriers prevent the vast majority of people from doing the same. Everyone at some point has some vague idea they believe should be shared - we were the people who, from some combination of internal and external urging, found and spent those many half hours persistently trying to write it down.
But where will all that be in another 137 years? Or five or ten, for that matter. That's something I've asked myself since at least 2004 - when I wrote this:
Membership in the ghost battalion has grown in the years since, and an ever growing majority of those abandoned-but-still-standing sites are vanishing. Have you checked out Lt Smash's site lately? How about Sgt Hook's? If you're a long-time milblog reader you know the first widely-read milblog from Operation Iraq Freedom and the first widely-read milblog from Afghanistan are both gone from the web. If you're a relative newcomer to this world you may never even have heard of them - or the dozens upon dozens of others who carried forth the standard they set down.
If you have a vague notion that something should be done about that, (a notion I've heard expressed more than once...) then you and I and the good folks at the US Naval Institute are in agreement. Preserving the history documented by the milbloggers is just one of the goals of the milblog project, the once-vague idea that we're now making real.
And it's a big idea, if I say so myself - too big to explain in one simple blog post, so stand by for more. Likewise, it's too big a task to be accomplished by just one person. So if you're a milblogger (and exactly what is a milblogger? is a topic for much further discussion on its own) I'm asking for your help. All I'll really need is just a little bit (maybe just one or two of those half hours...) of your time, and your willingness to tell the tale.
We've already made history, it's time to save it.
(More to follow...)
The Mudville Gazette is the on-line voice of an American warrior and his wife who stands by him. They prefer to see peaceful change render force of arms unnecessary. Until that day they stand fast with those who struggle for freedom, strike for reason, and pray for a better tomorrow.
Furthermore, I will occasionally use satire or parody herein. The bottom line: it's my house.
I like having visitors to my house. I hope you are entertained. I fight for your right to free speech, and am thrilled when you exercise said rights here. Comments and e-mails are welcome, but all such communication is to be assumed to be 1)the original work of any who initiate said communication and 2)the property of the Mudville Gazette, with free use granted thereto for publication in electronic or written form. If you do NOT wish to have your message posted, write "CONFIDENTIAL" in the subject line of your email.
Original content copyright © 2003 - 2011 by Greyhawk. Fair, not-for-profit use of said material by others is encouraged, as long as acknowledgement and credit is given, to include the url of the original source post. Other arrangements can be made as needed.
Contact: greyhawk at mudvillegazette dot com