The Real Bear Sterns Debacle

I always like to think of those times when we come to integral decisions in our day when we are faced with two equal choices, each with its own respective reward and consequence, and must pick between one effect or another. Many times its a matter of social responsibility, sometimes its based on inadequacy of information, and others its the preference of a lesser evil.

The Federal Reserve seems to be at one of these pivotal junctions, caught between a rock – a struggling housing market – and a hard place – price inflation. If it lowers rates for housing inflation levels may surge. If it raises rates, housing will falter.

We are seeing a similar affair developing in the mortgage market. We all know how the mortgage lending business operates. Prospective buyers seek the home of their liking. They then file for a mortgage loan from the bank. The bank will usually offer the loan, following a down payment, give the funds to the seller and document the property as collateral. The buyers agrees to pay the specified increments plus interest. The bank secures its profits off this interest. In the event the owner defaults on his payments and specific actions have been taken and time given, the bank reserves the right to foreclose on the property.

What has happened recently is that many buyers have been unable to make the necessarily payments and have given up their homes. Thus mortgage lenders, such as Bear Sterns, are now left with numerous houses on their books for which they are receiving no income. The ideal option would be to sell these homes at the market price.

But herein lies the problem. The amount of homes are enormous. Just to give you an idea,

Bear Stearns and its affiliates are listed as buyers of at least 53 homes so far this year in San Diego County, California, 48 in Maricopa County, Arizona, and 40 in Cuyahoga County, Ohio, according to a search of property records.

JPMorgan, the third-largest U.S. bank, and its subsidiary Chase Home Lending acquired at least 194 homes this year through foreclosure in Wayne County, Michigan.

Merrill, the third-biggest securities firm by market value, and its mortgage unit, First Franklin, took possession of at least 87 homes this year in San Diego County, California.

Citigroup and affiliates are the new owners of at least 47 homes in Clark County, Nevada.

“Our expertise is in lending money to people to buy homes, it’s not in owning homes” said Chase Home Lending spokesman Thomas Kelly.

Now, if these banks keep these homes then they will risk lower prices in the future that may injure tehir bottom line. However, if they sell at the market it will have a decimating effect on the mortgage-backed securities market when lenders start facing the music and letting property go at whatever price people will pay.

The same can be seen in the CDO market. Being that these bond-arrangements were priced by model of complex mathematical accounting as oppose to market of what investors would pay for them they, in a sense, held onto an asset which they hoped would eventually be priced at a greater value sometime in the future and obviously before they were found to be worth-less (all pun intended).

But, hope is a dangerous thing ladies and gentlemen. It sits in the minds of the complacent and eats away at the future returns of an otherwise potentially profitable portfolio.

Time will tell.

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