Rich Dad Conspiracy of the Rich

Mark To Market Valuation

With the new market-to-market valuation set to take place, you are going to see a drastic change in the way banks approach lending, appraisals and risk valuations. The reason is simple, with accountability come conservativeness and change. If the banks are going to have to value there portfolio and then adjust capital reserves to account for losses or devaluation of the asset essentially the entire banking system is going to be dependent on a credible upfront valuation and collateral assessment to determining a lending decision. Your going to see banks now be much more conservative when it comes to lending due to ratios having to be met throughout the life of the loan and a constant upkeep of capital reserve to maintain a adequate spread on the assets underlying value.

This will help ensure investor, regulators and consumers that the financial stability of the financial institution is not overstated.

Example:

ABC Bank makes 100 loans for $80,000(risk) with LTV of 80%(20%spread). All of these homes appraised for $100,000 (underlying value).

Based on these numbers a bank would have to keep at least 10% of cash in reserves based on the $8,000,000 in loans with a 20% spread and a total valuation of $10,000,000.

Now 2 years later the market takes a down turn (yes that can happen) and now after AVM's, BPO's or Appraisals are ordered a portfolio receives a value of $7,000,000 meaning now the risk or spread went from 80% to 110%. The new mark - to market laws would require an increase in capital reserves to cover the increased risk and maintain an adequate risk spread on the collateral.

Banks love this when the market is going up as it doest the exact opposite. Now with the market set to take another hit, banks are shaking as there 10% typical reserve ratio would almost double just to be on the safe side and prevent any fuzz from the FDIC and regulators.

The Challenge in the Real Estate Market

As everyone is well aware there is a great challenge we face as a nation. No challenge or recovery is greater than the recovery of the financial markets. From the stock market to real estate the entire financial system has turned upside down. Right now one of the biggest challenges is finding sustainable regulations that allow an efficient market between conducts and markets. The solution would go beyond the traditional patchwork done by regulations as there is an underlying fundamental problem that must be solved. The problem solving becomes especially challenging as intuitions are constantly being forced to implement government regulations almost overnight with no clear picture as to why and for how long the law or regulation will be in place. You are seeing major players on the side line waiting for the dust to settle before they begin commerce again.

I guess the question that should be asked is, What should or mortgage market look like?

We at least know it shouldn't look like it currently does. The rate of bank failures is astonishing and still growing. In 2000 there was a total of 2 bank failures, 2002 -11, 2007 - 7, and as of 8/26/09 there have been 92. So a total of 20 over the past 8 years and we have already had almost 100 in less than a year.

The reason for up evil has been simple. Too much weight has been placed on housing and the warranties placed on risk. Essentially the matrix's that were used were wrong. This fault has come from a lack of education on housing, the markets and how they work. Underwriting the risk of real estate is more than just housing but what aspect of housing and the expectation and market shifts expected to take place. On top of the misunderstanding there was an array of fraud, inflated appraisals, predatory lending prices and lose underwriting practices.

Due to this the government has not choice but to get involved. With FHA, Fannie and Freddie in control the government is currently involved in over 90% of all mortgage transactions. The treasury has purchased over 100 billion in Mortgage backed Securities, the Fed 1.25 trillion. Simply put without the government there would be no mortgage market.

The market has gotten so bad banks face ruthless defaults where the homeowners makes regular payments and then justs walks away. This causes huge frustrations for hedging risk as you are stuck guessing what payment increase or LTV is the walk away number.

So the question is how do we fix this?
Is the HVCC going to help or hurt?
Is the new RESPA laws going to help or hurt?
How should the appraiser and broker relationship be structured?
What should our mortgage market look like long term?

To be honest I don't know, however we will shortly find out.