Mortgage market cleanup proceeding

[al_bundy]

what happened was that banks used to originate mortgages so when wall street got into it the government didn't have any regulatory power because all the laws were created with banks in mind

now that wall street is begging for Fed money to bail them out, the story is different. most of the laws don't really have any power unless you use federal money for something which is very easy to do

[nepo]

I'm not sure how fast this industry is cleaning up their act, or if they are, how slow they are going. For example, purely anecdotal, from a blog in NJ:

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A few months ago, my wife and I started looking to buy what would be our first home. I went around to various lenders to research the different loan options and try to get the best deal I could find. I demonstrated that we had good credit, could make a down payment, and could afford the loan amount we were looking for without any kind of gimmicks. Yet almost without exception, despite all this, they almost all tried to sell me on some really bad loans. One of them was called something like the "Flex Pay Plan." The woman showing me the brochure was so excited about it. "You get to choose!" You can make your regular payment, or just the interest payment, or heck - if you don't even want to pay that - you can pay less than the interest amount. Reverse amortization never sounded so liberating. After putting all the numbers into her computer, the woman told me how much they would be willing to loan us. My eyes looked up and jaw dropped open. I knew there was no way I could afford a loan that large. She explained the percentage the bank used to calculate the amount they're willing to loan. I remember thinking that after taxes, there might only be just barely enough to pay the loan - and only if we literally gave up eating, wearing clothes and basically everything else. At this point, the subprime mortgage crisis was already big news and hearing the woman tell me this made me kind of angry, so I told her how irresponsible I thought they were being by offering these loans to their customers. "I know," she admitted. "I feel kind of guilty, but that's what our policy is." At another bank, they tried to sell me on some really bizarre plan. So weird I don't even remember the details. But I do remember telling the loan person that I couldn't even think of anyone that kind of loan would actually be a good idea for. Apparently, he didn't either. He stopped to think for a while and eventually came up with the answer: Wall Street investment bankers who consistently make the vast majority of their money from one-time, year-end bonuses and who don't have the discipline to save their money to last the whole year. I asked why he was offering me that plan. "It's just another option," he said. Amazing. It takes two to make a loan go bad. Irresponsible lenders wouldn't be in trouble without people taking out those loans. But the lenders aren't just being irresponsible -- they're preying on the underinformed with aggressive, deceptive marketing while ignoring fundamental good lending practices and risk profiles. They should know better and yet they're the ones getting a bail-out from the government.

[RockOn]

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Originally Posted by innova Except that the 'bank' is not lending its own money, so as long as there is a spread between the rates it pays on deposits and what it takes in it doesn't really matter to the bank. IE - in a high rate environment, the bank must pay higher rates on savings, etc.. so the trick is maintaining a certain spread rather than worrying about the absolute rates. I'd think that rate volatility is of more importance than what the absolute number is.

I think that is the point, the banks cannot maintain a spread when short term rates rise and their payments go up to savers at the same time they are locked into long term refi'd down mortgages. If rates were much more stable, the problems would be less. Who's fault it that? The overreacting FED? Quit trying to manipulate financial markets. Let the business cycle function, a recession and a bear market once in awhile is not the end of the world. It's better than the boom bust bubble economy of the last 10 years in which T-Bills outpeformed the SP500.

[Notmuchlonger]

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Originally Posted by RockOn I think that is the point, the banks cannot maintain a spread when short term rates rise and their payments go up to savers at the same time they are locked into long term refi'd down mortgages. If rates were much more stable, the problems would be less. Who's fault it that? The overreacting FED? Quit trying to manipulate financial markets. Let the business cycle function, a recession and a bear market once in awhile is not the end of the world. It's better than the boom bust bubble economy of the last 10 years in which T-Bills outpeformed the SP500.

Hmm Ive made lots of money with a well diversified portfolio that took on less risk than the SP 500 alone. The FED is doing their job.

[RockOn]

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Originally Posted by Notmuchlonger Hmm Ive made lots of money with a well diversified portfolio that took on less risk than the SP 500 alone. The FED is doing their job.

My opinion....I'm leery when I see making money as a justification. Sure it was possible to make money in a very diversified portfolio, we had.....a stock bubble, a bond bubble, a real estate bubble, a commodity bubble...doubles, triples, quadruples....but the speculation seems to be unwinding. Where are those oversized gains going to come from now? Just like we all know from studies that market timing doesn't work, there are a lot of studies showing the returns of the past years in some asset classes were quite extaordinary, and there are studies showing that if you buy at high valuations it is possible to be disappointed.

Returns are likely to revert to the mean, which "could" mean your portfolio will underperform to makeup for the recent overperformance as compared to T- Bills and the SP 500. In the next 10 years, the SP 500 could go up 10% annualized but your diversified portfolio could underperform T-Bills. As an example, real estate, commodity, and bonds loses could be negative drags wiping out your stock gains and giving you a 0% return annualized over the next 10 years. I suppose you do not think that is possible? A diversified portfolio may be logically very well thought out, but it is not a 100% sure money maker. Every method of investing has risk.

Of course there might be another FED induced bubble.......

I think it has to end.

[innova]

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Where are those oversized gains going to come from now?

Well.. stocks are not terribly expensive now, nor real cheap either. Perhaps we're due for some more 'normal' returns after the mess. A few years of steady unimpressive growth would be just fine with me.

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In the next 10 years, the SP 500 could go up 10% annualized but your diversified portfolio could underperform T-Bills. As an example, real estate, commodity, and bonds loses could be negative drags wiping out your stock gains and giving you a 0% return annualized over the next 10 years. I suppose you do not think that is possible? A diversified portfolio may be logically very well thought out, but it is not a 100% sure money maker. Every method of investing has risk.

What you are saying is certainly possible, but unlikely. A review of the Callan table of investment returns and correlations data show that scenario is very unlikely. Correlations between different types of equities vary, but generally aren't negative... I guess what I'm saying is if US stocks do well, I would expect REITS to do well also, but not always move in tandem. Bonds generally do not lose money when stocks are up. Commodities are negatively correlated to stocks, so a strong bull market may result in weak commodity returns.

For all the asset classes you mentioned, they all have a positive expected return with varying correlations to the other ones.. so I'd expect a well-contructed portfolio to continue to be the best bet going forward - bubbles or no bubbles.

One last thing.. stocks MUST underperform bonds from time to time for there to support the existence of the equity risk premium over bonds. If stocks always returned more than bonds without downside risk, they would be safer and nobody would buy bonds. So consider times like this a necessary evil.

Bear Markets A Necessary Evil - Research

[RockOn]

[quote=innova;636490]

For all the asset classes you mentioned, they all have a positive expected return with varying correlations to the other ones.. so I'd expect a well-contructed portfolio to continue to be the best bet going forward - bubbles or no bubbles. [quote]

... they all have a positive expected return.....

That is an interesting concept, based upon what? Historic pricing alone?

I can see how a stock has a positive expected real return due to growth of the economy and the company.

Why would you expect bonds to have a postive expected real return?; commodities? ;the family house? ; Real Estate in general?

Other than temporary, as compared to permanent, and sometimes localized supply/demand issues, why would you expect a positive return above the inflation rate on these assets?

[Notmuchlonger]

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Originally Posted by RockOn My opinion....I'm leery when I see making money as a justification. Sure it was possible to make money in a very diversified portfolio, we had.....a stock bubble, a bond bubble, a real estate bubble, a commodity bubble...doubles, triples, quadruples....but the speculation seems to be unwinding. Where are those oversized gains going to come from now? Just like we all know from studies that market timing doesn't work, there are a lot of studies showing the returns of the past years in some asset classes were quite extaordinary, and there are studies showing that if you buy at high valuations it is possible to be disappointed. Returns are likely to revert to the mean, which "could" mean your portfolio will underperform to makeup for the recent overperformance as compared to T- Bills and the SP 500. In the next 10 years, the SP 500 could go up 10% annualized but your diversified portfolio could underperform T-Bills. As an example, real estate, commodity, and bonds loses could be negative drags wiping out your stock gains and giving you a 0% return annualized over the next 10 years. I suppose you do not think that is possible? A diversified portfolio may be logically very well thought out, but it is not a 100% sure money maker. Every method of investing has risk. Of course there might be another FED induced bubble....... I think it has to end.

"Where are those oversized gains going to come from now?"

I cant predict the future. They why I own a well diversified portfolio. Sure it can tank and I could lose everything. I am not intelligent enough to time the market or know where the next big thing to invest is.

[RockOn]

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Originally Posted by Notmuchlonger "Where are those oversized gains going to come from now?" I cant predict the future. They why I own a well diversified portfolio. Sure it can tank and I could lose everything. I am not intelligent enough to time the market or know where the next big thing to invest is.

Well said. I wish you well and cannot say I would advise you to do anything else.

This is just my opinion again, I'm interested in your comments on it.....ignoring past history as justification...... in a totally diversified non-correlated portfolio, if there are no oversized gains (I'll call them bubble markets), wouldn't the likely outcome tend to vary slightly above the inflation rate? Would you not expect a loss in one asset to cancel the gain in another?

Isn't too much non-correlation and diversification actually reducing risk to the point one would expect a limited return outcome? It seems the only way to win with this type of portfolio is to pray for at least one dramatic price move upward.

[Notmuchlonger]

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Originally Posted by RockOn Well said. I wish you well and cannot say I would advise you to do anything else. This is just my opinion again, I'm interested in your comments on it.....ignoring past history as justification...... in a totally diversified non-correlated portfolio, if there are no oversized gains (I'll call them bubble markets), wouldn't the likely outcome tend to vary slightly above the inflation rate? Would you not expect a loss in one asset to cancel the gain in another? Isn't too much non-correlation and diversification actually reducing risk to the point one would expect a limited return outcome? It seems the only way to win with this type of portfolio is to pray for at least one dramatic price move upward.

I believe the world will continue growing. Some assets without a doubt will do better than others. Win? Its almost like you think the world is done growing and this is whats left. If their wasn't any growth commodities would not do well. Businesses would sell less product. People would not need as many houses. I dont need huge tremendous swings upwards. I needed to save enough money during my career to not run out in x amount of years.

I have no clue what black swan awaits. That very well may tank my retirement who knows?

[RockOn]

By win, I just mean get a 5-8% annualized return. Not more than that, to me that's a win. I think the world will keep growing, that's why I said I'd expect a return slightly above inflation, even if assets cancel out.

[Notmuchlonger]

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Originally Posted by RockOn By win, I just mean get a 5-8% annualized return. Not more than that, to me that's a win. I think the world will keep growing, that's why I said I'd expect a return slightly above inflation, even if assets cancel out.

I figure 3 to 4 % real.

[innova]

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I figure 3 to 4 % real.

Same for me.

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That is an interesting concept, based upon what? Historic pricing alone?

I'm thinking more in terms of risk and reward. If you use 28-day Tbills as the 'riskless' investment for a baseline, you can gauge the risk of an instrument by measuring what premium investors will typically place on it.

So.. if cash is expected to keep pace with inflation or not quite so, stocks had better return more - or no sane person would invest in stocks.

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I can see how a stock has a positive expected real return due to growth of the economy and the company. Why would you expect bonds to have a postive expected real return?; commodities? ;the family house? ; Real Estate in general?

Bonds have a real return for the same reason stocks do. With stocks, you are buying future earnings, with bonds, current earnings. If the economy in general grows, so should stock AND bond returns (over long periods of time, anyway).

Commodities themselves - no expected return. Commodities futures - yes. The way I've justified it is this.. Consider PCRIX, PIMCO's CCF fund. It holds TIPS as collateral on futures contracts - so the expected return is at minimum the TIPS return, plus in uncertain times commodities move opposite bonds and stocks (negative correlation to both).

Housing(personal).. I'm still not sure. In MN where I live, the oft-quoted stat was that housing values grew at 6.4% per year average from 1940-2005 without any negative years. Well, look what just happened. I think a reasonable person can do the math and say if wages inflate 3% per year and housing inflates 6% per year that is unsustainable.

REITS on the other hand.. due to their struture which has them paying out 90% of earnings as a dividend - you should expect these to have a real return. Rents have a long-term upward trajectory, and as the economy grows more buildings are constructed and leased.

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This is just my opinion again, I'm interested in your comments on it.....ignoring past history as justification...... in a totally diversified non-correlated portfolio, if there are no oversized gains (I'll call them bubble markets), wouldn't the likely outcome tend to vary slightly above the inflation rate? Would you not expect a loss in one asset to cancel the gain in another?

I'm not sure you can really ignore the past - if you did you may be tempted to avoid the markets entirely in times like these. One thing you should ask yourself is why do you expect that in non-bubble times you would need to have losses in your portfolio at all? There have been many years since 1930 that all major asset classes have posted gains. I think when you consider that it is possible to 'win' over the long run.

Other thing is, its not really possible to build a completely non-correlated portfolio. All equities move together to varying degrees over rolling periods, even though the correlations may be as low as 0.4. I think the point you were making is if you held something with positive correlation and something with strong negative correlation, they would cancel out since they always move opposite each other. I don't think in the real world you could construct a combination that works like that. However - even if you could, as long as both components still EACH have a positive expected return (based on history, sorry!), the combination would also have a positive return.

This has been a good thread - made me really consider my reasons for holding some of the things I do.

[tryan]

Look for the hardest hit areas (FL, CA, NV) to lead the way ....

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Only a handful of the properties would be selling absolute, where any bid would be accepted. The rest carried a non-disclosed reserve, or minimum bid. "When there aren't many absolutes, it makes it hard to get things going," DeCaro said. "And this is a tough market." The auction, which was anticipated to take four to five hours, wound up clocking in at barely two. Two-thirds of the property on the block failed to garner a single bid.

HeraldTribune.com - Real Estate - Real estate and homes news stories about Sarasota, Manatee and Charlotte counties in Florida, from the newspapers of record. - HeraldTribune.com

Once the mortgage holders realize thier reserve pricing is meaningless, everything will be sold absolute. They'll realize it is far better to get "something" than to wait for the market to improve while the asset rots on its foundation.

The absolute auctions are alot of fun. It'll take some time, but it's coming ... save your pennies!

[innova]

Builders have been selling their inventory 'absolute' at auctions here. Just got started recently.

[RockOn]

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Originally Posted by innova So.. if cash is expected to keep pace with inflation or not quite so, stocks had better return more - or no sane person would invest in stocks. Bonds have a real return for the same reason stocks do. With stocks, you are buying future earnings, with bonds, current earnings. If the economy in general grows, so should stock AND bond returns (over long periods of time, anyway). Commodities themselves - no expected return. Commodities futures - yes. The way I've justified it is this.. Consider PCRIX, PIMCO's CCF fund. It holds TIPS as collateral on futures contracts - so the expected return is at minimum the TIPS return, plus in uncertain times commodities move opposite bonds and stocks (negative correlation to both). Husing(personal).. I'm still not sure. In MN where I live, the oft-quoted stat was that housing values grew at 6.4% per year average from 1940-2005 without any negative years. Well, look what just happened. I think a reasonable person can do the math and say if wages inflate 3% per year and housing inflates 6% per year that is unsustainable. REITS on the other hand.. due to their struture which has them paying out 90% of earnings as a dividend - you should expect these to have a real return. Rents have a long-term upward trajectory, and as the economy grows more buildings are constructed and leased. I'm not sure you can really ignore the past - if you did you may be tempted to avoid the markets entirely in times like these. One thing you should ask yourself is why do you expect that in non-bubble times you would need to have losses in your portfolio at all? There have been many years since 1930 that all major asset classes have posted gains. I think when you consider that it is possible to 'win' over the long run. Other thing is, its not really possible to build a completely non-correlated portfolio. All equities move together to varying degrees over rolling periods, even though the correlations may be as low as 0.4. I think the point you were making is if you held something with positive correlation and something with strong negative correlation, they would cancel out since they always move opposite each other. I don't think in the real world you could construct a combination that works like that. However - even if you could, as long as both components still EACH have a positive expected return (based on history, sorry!), the combination would also have a positive return. This has been a good thread - made me really consider my reasons for holding some of the things I do.

A few comments, IMO....I think stocks have a real return because companies grow faster than the inflation rate. That is the reason to expect a real return. Stock earnings grow at about 7% a year, if that exceeds inflation on average, you get a real return. Saying they must have a real return or nobody would invest, doesn't seem like enough for me.

Bonds...since you are locking in current rates and growth, it's hard to understand a real return. The only reason I see for exceeding inflation is that you are paid for taking default risk. As long as the premium you lock in exceeds the actual default rate you can make a real return. Default rates vary with the business cycle. It's hard to justify much of a long term real return.

Commodities....there is really no easy explanation for a real return except for supply/demand in specific situations which tends to balance out over long periods. It's hard to justify a long term real return.

A house....a house should actually depreciate as the materials it was built with age and need to be replaced. The exception would be a supply/demand situation such as waterfront property or Manhattan. It's hard to justify a real long term return overall in the US as land to build is still plentiful in most of this country.

REITs...if they grow as rents increases you should expect REITS to match inflation because rents are in the CPI. Supply/demand is a factor in specific situations. I wouldn't expect much of a real return.

To me the only solid case for expecting a significant real return is in the stock market. IMO speculation is the reason why prices of many assets have jumped. Are we investors or speculators?

I wonder, is a diversified, non-correlated, portfolio really the way to go? Sure it does reduce risk and smooth out returns but is also is likely to reduce returns in the long run. This is true because of reasons listed above for various asset classes, but also because with less risk should come lower returns. A better investment plan may be to just put as in much in stocks as you can stand because with stocks there is a significant exectation for a real return.

Comments?

[tryan]

... and with a growing population, the demand side is growing long term - pushing the return up. Seems to me, population growth is a pretty safe bet.

[Independent]

Rockon -

This is one way to think of bonds:

Suppose I think I have a way of generating a good return on capital in my business. I've got my own money in the business, but I want some additional capital. I could do that by selling shares or by borrowing.

People who might supply the captital understand the tradeoffs. With equity, they participate in all the upside, but they take downside risk. If they lend, their upside is fixed, but they greatly reduce the risk.

If I want to keep the upside for myself (borrow instead of selling shares), then I have to make an offer to the lenders that they percieve as a good deal vs. stock (because they could always buy stock in some other business). Since stock is likely to generate real returns, they will insist on bonds that are "as good, considering the different guarantees" as stock.

i.e. The actual yields on bonds will be whatever it takes to get a mix of equity and debt financing which appears "most attractive" to the stockholders (since they are owners), given the fact that the potential bond buyers could also buy stock somewhere.
I don't see any mechanism that would make the yields equal to the CPI (or whatever you mean by "inflation").

Historically, we see that bonds in the US really have had yields in excess of the CPI, so my theory isn't contradicted by experience.

I could also talk about "bonds" that finance consumer spending instead of business capital, but that would make for a long post.

[lazygood4nothinbum]

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Originally Posted by tryan Look for the hardest hit areas (FL, CA, NV) to lead the way .... HeraldTribune.com - Real Estate - Real estate and homes news stories about Sarasota, Manatee and Charlotte counties in Florida, from the newspapers of record. - HeraldTribune.com Once the mortgage holders realize thier reserve pricing is meaningless, everything will be sold absolute. They'll realize it is far better to get "something" than to wait for the market to improve while the asset rots on its foundation. The absolute auctions are alot of fun. It'll take some time, but it's coming ... save your pennies!

thanx for the post. was curious to what happened there as that is the very auction i opted out of. at first when they tried to get me to participate they said there would be a 10% commission which i thought high but what the heck. turns out the 10% is payed by the buyer (as if) so of course i would have had to factor that into the price. plus the auctioneer wanted $15k from me up front just to participate.

when i refused to pay their cost of doing business (what's up with that?), they said they'd work with me. someone would call me back. i told them to tell the person who was to call me back that i'd only consider the auction on condition that they only get their fee upon closing and not before. needless to say, i never got a return call. what a scam.

[CCdaCE]

What a scam, no kidding.

$15k + 10% ? If I understand correctly. Nice fee structure to have if you're the auctioneer/seller.

-CC