In this country, we treat our houses as more than just a place to live. It is that, but it is also an investment, a tax shelter of sorts, a tangible asset which can be borrowed against as well as a source of pride.

I have been reading (and listening) with interest about the sub-prime mortgage problems, the effect it is having on the stock market and the potential economic problems for the rest of us. I am no economist but it seems that there is just too much money floating around out there that needs to be invested in something. No longer are people content with CD’s, bonds or other safe investments, likely because the return is too small compared to riskier mutual funds and stocks. Stashing money away in the savings account? That is so 50’s of you.

As they say, hind sight is 20/20. Here is the way the road lead to our current financial issues:

1. Back in the late 1990’s the stock market super heated with tech stocks. Remember the whole dot com debacle in early 2000? People bought into the tech stocks hook, line and sinker. Companies that had yet to make a single penny had their values double then double again because their stocks where highly sought after. Then, as in many things, what goes up, must come down. People began cashing out, prices fell, The Company that was the Wall Street darling a yesterday went bankrupt and out of business today. Such is life.
2. In order to create a “soft landing” The Federal Reserve began lowering interest rates, down, down, way down to levels that had not been seen since WWII. Since the stock market was still under performing, many people began to look for other investment opportunities. Real estate became attractive because of the very low mortgage rates available and it is something tangible, you can walk around on land, go inside a house whereas a stock is a value attached to something that can change drastically.
3. The housing market slowly began to heat up in 2001 and 2002. By 2003 and 2004 things were really happening. People were buying unbuilt houses on speculation and reselling them for a hefty profit. Housing prices were appreciating at 10-20 percent per year in many real estate markets. It was a seller’s market.
4. The Fed, which has always been preoccupied with inflation concerns, raised the interest rates repeatedly until the housing market began to cool off. Then, contrary to what everyone expected them to do, left them a little higher than the historical average.
5. Housing values began to slowly go down in most places, not to anything close to the pre-2000 levels, but a few percent here and there. Many people are now stuck owning homes that are worth less than what they paid for them and many of those people owe more on the mortgage than what the house is worth. This is known as being upside down and is nothing new. What was new was the sub prime mortgage loan. These are ARM with a short two year initial period at an interest rate below that of prime rate. After two years, the interest rates are then adjusted upward, in most cases way upward. This has left borrowers with a choice, albeit, not a very good one. Either pay the ever increasing mortgage payments, or walk away from the house and default on the mortgage. Many are choosing the latter.
6. This in turn has left the those lenders, especially those who were lending to the high risk investors, holding the bag. As mortgages default, banks foreclose on properties that are worth less than the mortgage principle. Again, much to the chagrin of the lending institutions in question, the Fed is not doing much of anything about it.
7. This is sending shock waves through the rest of the investors on Wall Street, causing a ripple effect in the economy.

Even though I am taking a hit on my investments because of the stock market, I think the Fed should not bail out the failed sub prime mortgage market. There has to be some risk/reward relationship involved in speculative investing. If it were not risky, then everyone would invest in it and the returns would be much lower; for example US savings bonds. The fact that an investment is high risk means that the investor can loose value but at the same time, the payoffs are higher. I do feel badly for those who were swept up in the buying craze and now own a house with an upside down mortgage.

Part of that is impulsive purchasing and not negotiating hard enough with the seller. Part of it is other market forces driven by speculation and part of it is the belief in the mythical ever rising market. Just like the dot com bust before it, super heated markets generally do not last and make adjustments downward to more realistic levels. Hopefully this lesson will be remembered by those future home buyers.

How to avoid the sub prime mortgage pitfalls:

1. Don’t finance more than you can afford. Carefully consider your housing budget, it should be not more than 35 percent of your gross earnings.
2. Negotiate aggressively when buying a home. Some owners will not tolerate this and get angry. No matter, walk away from the deal and look somewhere else. Research the neighborhood and see what other houses have sold for recently. Do not over pay. Do not get emotionally involved or attached to a house before you own it. Emotions are strange, sometimes irrational things. They have no place in a business deal.
3. Be very careful when refinancing. Many people refinanced to sub prime loans thinking they would be saving lots of money on there payments. That held true for the first year or two, but then not so much. Read the fine print, ask questions, or better yet, only deal with a bank that you know. If it seems to good to be true, it probably is.
4. Finally, hire a good attorney. Ask questions, after all, you are paying him or her to look out for your best interests. They should earn that money.

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