Michigan Loan Experts

Why the Fed Was Going To Disappoint Today No Matter What It Did

It was all eyes on the Fed today; the market anxiously awaited the central bank's 2:15 P.M. ET press release. 

Some of the market bias towards a 0.50% rate cut had decreased in favor of a 0.25% cut.  That shift was largely psychological. 

Markets were trying to "get inside the head" of Fed chief Ben Bernanke, speculating about how he was going react in the first Federal Open Market Committee meeting since the credit crunch reached a head in mid-August.

The speculation and guessing tells us that there was tremendous uncertainty about the FOMC vote today.

Uncertainty in markets leads to volatility. 

No matter what the Fed decided to do (it ended up being a half point cut) a lot of traders, having bet they would do something else, were scrambling to reposition their portfolio because of "bad bets"

Have Americans Turned to Credit Cards Instead of Home Equity To Stay Afloat?

For most of the last seven years, Americans have been happily pulling money out of there homes in 'cash-out' refinancing of their 1st mortgage or acquiring home equity loans.  To a large part, people did put that money back into their homes in various home improvement projects, but another large part of that money was used for purchases.

Now mortgage lenders are pulling back on what they allow to be lent on a home and they require better credit then they did before.  So if the home equity ATM machine is closed, what's a consumer to do?

Credit card balances increased 12% and 8% during May and June.

Well if one form of credit is unavailable, then let's just move on to another.  Since overall spending was flat, but credit card balances increased, it's reasonable to assume that people are still using credit to live beyond their income means.  Gradually the collective balances on these credit cards will reach their maximum and then borrowing on cards will end.

When credit card borrowing stops then spending being supported by those cards will stop too.  Either people will find another form to debt to get into or spending will begin to fall.

When spending falls you run the risk of a recession, which in turn usually leads to interest rates to fall, which leads to more borrowing.  A relatively simplistic explanation of what economists and the Fed refer to as an economic cycle.

The problem is, once you've racked up huge amounts of debt, are you able to borrow again to keep the cycle going?  If mortgage debt and the housing market were trouble, what happens if Americans lose the ability to spend like they have because they're so deep in debt?

Source: "Consumer Credit Usage Spikes in June", Markham Lee.  9 August 2007

Why Banks Are So Fixated on 20% Downpayments. Is It Enough?

Why do banks like to see a home buyer make a downpayment of at least 20%?  Basically it's Two reasons.

1. Statistically speaking people who put down 20%, or who have 20% of equity in the property, were highly unlikely to go into foreclosure.  Banks don't like to foreclose so that seemed the safe amount to require people to put down when buying.
2. If the bank does foreclose then a 20% discount from the 'market value' was what the home usually ended up selling for.  If the owner had 20% equity then the bank typically didn't lose much, if anything on the subsequent sale.

Well now were awash in a tidal wave of foreclosures.   There is significant anecdotal evidence that the 20% rule isn't helping banks right now.

Looking at some recent bank sales the prices are going anywhere from 30-70% of the past sale.  So even if the buyer did put down 20% and the property sold at the high end the bank is still at a 10% loss on the property.  Having PMI would still put the bank at the same loss since PMI typically only insures the lender to the equivalent of a 20% downpayment.

In other words, banks in Michigan are taking losses on loans and on the underlying collateral, too.  This trend is part of the reason that several lenders have over the past year simply decided to pull out and not lend anymore in Michigan.  The lenders who have stayed are doing more rigorous reviews of appraisals.