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[Fee Simplistic] Getting Primed On Sub-prime

Fee Simplistic is a regular post by Martin Tessler, whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. This week, Marty explains the smoke and mirror lending process.
…Jonathan Miller


My original commitment to authoring Fee Simplistic was that it would only be written when commentary would be warranted by current events in the real estate market. And so the imploding of the sub-prime mortgage world on investors and the fallout of lenders and borrowers going into default makes it seem that the mortgage market is caving in.

The term “sub-prime” connotes a loan that is related to prime when never the twain ever met or will meet. Reading the individual anecdotes of some of these sub-prime borrowers reflect histories of people who would score exceedingly low in credit ratings; were either fraudulent in reporting income or else their broker was fraudulent in reporting on the borrower’s income and assets; executed sales contracts that had excessive sales prices where the buyer would get a kickback and use the proceeds to pay his first few mortgage payments and/or split some with the seller or broker; and finally broker “sweet talk” lulling the borrower into refinancing where mortgage payments would eventually end up higher than what was previously paid. So what prevailed was a sub-prime lending world comprised of smoke and mirrors if not outright chicanery.

This time, instead of Uncle Sam having to step in with the establishment of an RTC to keep the banking system afloat it appears that the only ones being hurt are those investors who played the high risk game of buying the bonds of the sub-prime CDO’s that were issued by Wall Street. The “invisible hand” of the marketplace so aptly described by Adam Smith [1] is at work in culling out the bad from the good and the risky investment from the prudent one. High risk and high yield vs. low risk and low yield have always governed the marketplace and now is no exception.

It is not a far stretch to remember the principles most of us were brought up on by our parents:

* Don’t play with the bad kids, you’ll get hurt
* Don’t skate on thin ice
* It may look good now but it may give you an upset stomach later
* If it looks too good to be true it probably isn’t
* What makes you think you can get away with it?

And for those who know their Latin
* Caveat Emptor