Monday, September 10, 2012

Home Loans - Too Risky? Don't Ask, Don't Tell!

Should Banks be making mortgage loans? We take the answer for granted. Yet, I have been involved in an on-line discussion that started about gold’s value and price, that became about the wisdom of banks making loans for homes. And, if so, the circumstances under which loans are made. Financial and economic modeling does not take into account all of the variables, nor can any model accomplish that feat. My position is that, the contributors to the conversation should have the actual experience to deal with the issues, and even then they will end up with as many opinions as there are participants

The Philosophical debate of home ownership is one that has so many moving parts, IBM's “Jeopardy!” winning super-computer, WATSON, would have difficulty arriving at "an answer".Oh, and that assumes that we can identify all of those factors which should/must be considered. Part of the problem here is that lending for home purchase is tied to our (U.S.) culture and societal expectations. Further, politically, we have tied ourselves to a tax and income structure that counts on home ownership.

How to make successful loans? Easy - (1.) Take only Borrowers with perfect credit and lifetime employment with Life and Disability insurance naming the lender (2.) Variable rate (3.) changing DAILY (4.) at a rate fixed to the Fed Funds rate (5.) Plus whatever margin the institution needs to satisfy stockholders. (Oops! Nothing will satisfy stockholders so let's just call it a reasonable “ROI”-Return on Investment)

The issue is simply Home Ownership for the “99%” or Not! The mutual financial institutions, including credit uions, have an advantage, that they have squandered, as they have no stockholders and pay lower/no taxes. Mutual holding companies allow community banking to survive the onslaught of mega-banks. But as mutuality disappears, we will be left with the Savings & Loan “S&L” model. That worked real well. I ran several failed S&Ls for the State of MD with the FSLIC (now part of FDIC) right next to me. Commercial banks? How about Bank of New England - $32B "failure" in 1990 (translate that to 2012 dollars!). I know it well, because I "worked-out" a small part of the organization, me having moved from MD, where I was President of a new Federal Savings Bank, in January 1989 to run the Berkshire, MA region of BNE.

Lending is RISK. That is what banks are supposed to do: Take Risk! However, it is supposed to be managed. Shareholders, by demanding higher dividends and share prices, force unwarranted risk-taking. The two demands are somewhat diametrically opposed, yet sophisticated models will demonstrate that they follow one another, and lower the risk taking as the Board over-sees the "lending activities". GOOD LUCK!

Spend 10 or 20 years in banks and mortgage companies. thrifts and commercial banks. Then spend 10 years looking at changing regulations, but not just "real" banking, but so-called shadow-banking (Morgan Stanley, Goldman Sachs et al) as well. See what the SEC (Securities & Exchange Commission) has planned, versus what was on the books in 2006. Then look at enforcement or the lack thereof.

My long and drawn out point is that without field experience one cannot "model" the issue of "to lend or not to lend" and how much to charge if the decision is "YES". Then again, we are at the juncture of epistemology, philosophy, and economics. Answering the question of whether there is A God, many Gods, an Intelligent Designer" (ha ha - think about it), or just Chance, would be easier.

The price and value of gold - I guess that debate is over. It's worth something because we say so and because my grandson liked shiny stuff when he was little.

Author's Copyright by Richard I. Isacoff, Esq, September, 2012

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