Monday, March 30, 2009

Beyond Leverage!

I just got back from a talk by David , a man who in the past sixty-five years , made tons of money in real estate. David pointed out how you could leverage real estate using OPM ( other people's money). Even at 20% down, you have a five to one ratio. Eighty per cent is from the bank. Of course, the bank is using OPM, too - yours! Insurance companies, like AIG, use OPM, too - the premiums you pay.

It appears that the "best and the brightest," have been using your money to get rich. It turns out "the best and the brightest" are the "worst and the dumbest." Several years ago, I spoke to an online real estate broker about refinancing. He asked me if I wanted to provide documentation. I said to myself, "Are you crazy? A bank is going to give me a loan without knowing if I have any income or assets?" He had offered me a "liar's loan"! I knew it was the beginning of the end. Then a friend tried to buy a house in San Francisco where the average house seems to cost $1,000,000. He put together all the money he had for a down payment and would have had to pay half his monthly income on mortgage payments. Since he had a good income from an I.T. job this was a prime mortgage. The mortgage broker couldn't care less if he would be able to make his payment or even eat. All the broker wanted was his commission, so he could take his family on a very expensive vacation. Then I spoke to a "recovering" drug addict at Twin Peaks in San Francisco. He told me that thanks to his newly found belief in God, he was now a rich man and that he owned five houses in San Francisco and Sacramento which he bought for no money down apparently with subprime mortgages.

About a year later. the value of an MBIA bond, the biggest name in the Municipal Bond insurance business, dropped ten percent overnight. The reason? MBIA had been insuring CDOs, SIVs and other alphabet soup. Not satisfied with a very lucrative insurance business using OPM, greed led MBIA down the slippery slope along with all the other lemmings. Why were mortgages brokers and bankers so non-chalant about writing bad loans? Because they knew they could unload them. Just bundle them into tranches of CDOs and sell them to everybody else. More OPM. So the "best and the brightest" ended up selling bad loans to each other.

Back to leverage, more OPM. These banks and brokerages, more accurately, investment banks ( What ever happened to Glass -Steagall, Mr. Greenspan?) used leverage with ratios like 36/1., like totally other people's money. So everybody including the "best and the brightest" assumed that housing would continue to go straight up. Any fool knows that things fluctuate - even J. P. Morgan said that. Rapacious greed led the entire financial establishment to build a house of cards on bad loans. Give anybody a mortgage! Now the lemmings have reversed gears, and refuse to lend money to anybody including each other. Get a bailout - more OPM - but fight any regulation that might restrain the failings of rapacious capitalism. Karl Marx and Adam Smith were each right about some things and wrong about others. What they both missed is the role of greed in economic life. Marx's biggest errors - the labor theory of value and a complete miss on human nature - the role of incentive or, in plain English, greed. What Smith missed, is the destructiveness of unrestrained greed. Free markets go to extremes and need to be modulated by regulation. When the stock market approached irrational exuberance, Greenspan, just shrugged, Ayn Rand style, and saved himself in his time by creating the housing bubble. One can hope that a third way will work , but I'm afraid the "best and brightest" will always find vast piles of money "bubblicious." They will probably just continue to get high on OPiuM.

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