Banks Turn to Odds Makers
In the past, banks have depended on companies like Moodys, Standard & Poor and Fitch to rate the credit worthiness on a borrower and their assets. But the recent financial crisis has eroded their confidence in that system to provide accurate credit scores. The crisis has forced banks to take a critical look at how they assess their corporate borrower's credit worthiness. Some of them have decided to use the price of credit default swaps to rate the companies that they lend money to.
One form of Credit Default Swap is like an insurance policy, or a bet, that a particular company will or will not go broke. As you might imagine, no one wants to be the insurance company that pays out the claims when the insured company goes belly-up. So the price of a CDS is directly related to how likely it is that the insured company might go broke. If the chance of default is small, then the cost for the CDS, (insurance policy) is small. But if the company looks financially weak, the CDS is going to cost more. It's kind of like the difference in automobile insurance rates between a 35-year-old driver with no history of accidents compared with a 20-year-old with a couple of accidents and two recent speeding tickets. There's gonna be a difference!
So Citigroup and Credit Suisse are planning on linking the interest rate they charge their corporate borrowers to the price of Credit Default Swaps on those companies. They no longer trust the traditional rating services and are going straight to the people betting on the possibility of the company going broke. It's like you and I looking to the Las Vegas odds makers instead of the national polls to see which US presidential candidate is ahead.
60 Minutes on Credit Default Swaps
Bloomberg News
The Deal.com
A Floatplane Tour of Wasilla
Derivatives and the Financial Crisis
So, out of curiosity, I did a little research to find out what all the talk was about. What I found out shocked and surprised me. I think you’ll be amazed too.
Simply stated, a derivative is a contract between two parties in which one party agrees to pay money to the other if a particular event occurs. The event that triggers the payment usually has to do with a specific financial instrument, like a bond or a note defaulting. The Buyer of the derivative pays the Seller an agreed-to fee with the understanding that the Seller will pay the Buyer for losses they incur if the bad event takes place. Sort of like a wager or an insurance policy.
One kind of derivative is called a “Credit Default Swap,” or CDS for short, and they are very much like insurance policies. You might want to buy one if you held a bond and were afraid the issuer might default and not repay you at maturity. If that happened, the seller of the CDS would reimburse you for the loss. The financial folks refer to this as “hedging” an investment. Unlike insurance dealings, swaps are not regulated. Originally the practice made a lot of sense. But as time passed it morphed into a risky gambling activity and a way to legally cook the books.
The sellers of CDSs made a nice profit, and since they are unregulated they didn’t have to prove that they had reserves to pay for future claims. The buyers could show their stockholders that the risky investments they were holding were OK because the CDSs protected them. There were also special accounting rules that allowed companies to distort the values for CDSs and inflate reported assets. That’s real important to a CEO that is paid based on the company’s bottom line!
Then there were the speculators. They didn’t hold the bond that was insured by the CDSs. They just wanted to bet on the possibility that the bond issuer would default or go bankrupt, and since the whole thing was unregulated, they bought as many as they wanted!
This led to our current situation where the total CDS market is estimated to be between $34.8 trillion and $62 trillion. That’s more than twice our national debt AND gross national product combined! Back in 2002, Warren Buffet called the speculative CDS the financial weapon of mass destruction.
Meanwhile, a lot of people were buying homes for inflated prices and getting mortgages they couldn’t afford. Many bought homes based on the assumption they would increase in value so they could re-sell or refinance after two or three years.
The resulting mortgages were packaged and sold to investors. The investors then bought CDSs from companies like AIG and Lehman Brothers to hedge against the risk of the mortgages defaulting.
Then, when the mortgages started to default, AIG and Lehman Brothers couldn’t pay the claims. Lehman went under and AIG was bailed out by the feds. These events triggered claims on still more CDSs that were based on other bonds that AIG and Lehman had out and... well, you start to get the picture.
It’s hard to believe that the leaders of Wall Street didn’t see the current crisis coming. It’s also surprising that our federal regulators allowed credit insurance to be sold without any rules in place.
More on Credit Default Swaps in the news:
60 Minutes Show "Wall Street's Shadow Market"
NYT Graphic "A Primer on Credit Default Swaps"
Latest News on the Financial Crisis
Homes For Sale vs Homes That Sell
I just finished looking at the sales stats for the last couple of months. A trend that I first noticed maybe eight or nine months ago has really begun to play a major role in our market. Here’s what’s happening:
The homes that are selling are coming on the market at a competitive price and are selling relatively quickly.
Homes that sold in August were on the market for an average of 62 days. The average days on market for homes not selling is 106 days. The median days on market for sold homes was 39 days and for active listings, not sold, it’s 79 days.
Homes built before 1999 that sold in August 2008 had an average asking price of $208,557 and sold for an average of $207,842. In the same age group the average asking price for unsold homes is $293,000 and they have been on the market for 127 days!
While some of the gap between the prices of sold and active listings might be due to the lack of demand for high-end homes, most of it isn’t.
When I first wrote about this trend I made the statement that it looked as though we had two MLS listing groups. One group of homes was listed and just sat there while another group of homes was listed and sold. If you’re selling, you want to be in that group that sells. That means you have to get aggressive about pricing your home to sell quickly.
If you’re buying, you need to watch the market closely and act quickly when the home you want pops up with a good price. You won’t get it if you offer less than a competing buyer who sees the value.
And whether you’re buying or selling, this is not a good time to get stuck on little things in negotiating. Focus on the objective!
Questions? Comments? give us a call, we love to talk Real Estate!
Politics and Valley Real Estate
The news that Sarah Palin had been chosen to become the Republican nominee for VP was the biggest thing to hit Wasilla for the last 100 years! For most of us it was a surreal experience for a few days.
No matter what your personal political leanings are you’ll have to admit we will benefit economically, and that equates to good times for real estate. Here are some things that I’ve heard over the past couple of days:
Business & tourism... Alaska will be brought to the attention of many people who would otherwise never even thought about our state. We’ll have leaders of many different industries focus on the Last Frontier with a fresh perspective.
Energy... both candidates promise a comprehensive energy plan. Both are for developing more domestic oil. Alaska has lots of oil.
People... if the oil is going to be developed it will take people. We have lots of room for people, and the Valley is a perfect place to live if you don’t have to commute but every two or three weeks.
Development... I think the Valley is ready for some local industry. The Pt. McKenzie port is poised to handle just about any expected volume of traffic that comes our way.
It’s way too early to determine whether the economic wave will be a tsunami or a ripple, but no matter which candidate wins this year’s election the exposure will do Alaska and the Valley a lot of good.
At least a lot more people know how to pronounce "Wasilla" correctly!
The Federal Bailout
1. Federal financial backing for loan giants Fannie Mae and Freddie Mac
2. A refinancing alternative for homeowners that are in danger of foreclosure
3. A tax-free, risk-free $7,500 loan for first-time home buyers called a “tax credit”
Fannie Mae and Freddie Mac are in the business of providing the money to pay for the houses that folks buy. They do this by purchasing the mortgages that banks create when they originate a loan. They make a profit on the interest the mortgage earns. This all works out just fine until the payments stop on some of the loans.
Right now, the number of mortgages going sour that are held or guaranteed by Fannie and Freddie is getting to the point where they are losing a lot of money. They own or guarantee almost half the mortgages in the US. That’s over $5 trillion!
So this law says that in the event Fannie and/or Freddie start to go under, the Feds will bail them out by buying their stock or lending them money. The price that Fannie and Freddie will pay for this government largesse is more federal oversight in their future operations and management.
Item #2 is designed to help borrowers that are about to default on loans that they cannot afford. FHA will guarantee a new mortgage if the banks will make concessions to get the loan amount down to 90% of the home’s value. They figure this will help about one-third of the at-risk mortgages.
It’s estimated that about one-third of the mortgages that FHA takes over will default. The tab comes to around $300 million.
Sub-Prime Crisis Explanation
The Sweet Smell of Success
Dealing with odor is part of getting your home ready to sell.
Our noses give us a lot of information, and information is what Buyers are seeking when they look at your home. If it doesn’t smell right, they won’t buy it!
Almost every home has some kind of odor. To most people, the smell of baking bread, pie or cookies is a good thing. A citrus smell is almost universally associated with cleanliness and freshness.
Chances are, if you have pets inside your house, you have pet odor. You probably can’t smell it but others can.
It’s next to impossible to get rid of all the smells in your home. But you can get them under control. Here are a few tips;
1. Borrow a nose you can trust. Have someone that doesn’t live in your home give it the sniff test. Ask them to be brutally honest!
2. Try and diminish the bad odors. Get the source out of the house...Yes, that means Rover’s blanket and the litter box! Try products like Fabreeze or enzyme cleaners to reduce the odor. Some carpet-cleaning companies specialize in odor mitigation. Wash drapes as well as mats and throw rugs.
3. Accentuate the positive. Having fresh flowers, a bowl of lemons or baking bread or apple pie works well. Scented candles and air fresheners are popular but be careful not to overdo it. Buyers may think you’re trying to cover something up if you have more than one.
Raised Bed Gardens
We have a garden made up of 15 four-by-four foot raised beds. The fifteen beds are separated by three-foot pathways that are laid out in neat rows and covered with rock chips . You have room to roll a wheelbarrow between
the beds.Since the beds are four-by-four you can easily reach anything in them without having to stretch too far or step onto the garden soil. The rock chips serve two purposes. They discourage weed growth and slugs can’t navigate across them!
To make the raised beds I use 8”X2” cedar stacked two high assembled with deck screws. That gives you a bed that is about 14” high or so. We get about 10 or 12 years use out of the cedar before it rots and has to be replaced. I prefer plain cedar over treated because of the poisonous chemicals in the treated lumber.
We fill the boxes with garden soil which is a mixture of peat, sand and topsoil. Regular topsoil tends to clump up and the vegetables don’t do as well in it.
For fertilizer we like to use a liquid and flood the boxes with a 5-gal bucket mixed for direct application. In the fall we mix in leaves and in the spring we add some manure to the soil.
We have the best luck with carrots, broccoli, cabbage, lettuce, peas and, in the drier summers, squash.
Good Luck and Good Growing!