Wednesday, January 16, 2008

Short Memories

Back in 1978, the real estate market in the Seattle area was booming. The average price of a typical 3 bed one bath home shot up from around $20,000 to near $60,000 in just one year. Everything was great. I had just switched from real estate sales to mortgage lending in 1978. Things slowed down a little in 1979 and we saw interest rates rise to 8.75%. Then 1980-1983 happened. Inflation became severe, interest on a thirty year fixed loan shot up to 24% and as a result, home prices in many categories dropped by 50%.

By 1984, the economy had started to improve. By 1985, a new boom market occurred plus thousands of homeowners refinanced to lower their interest rates, then refinanced again, for the same reason. Part of the refinance every time interest went down 2%, was that people were operating in a panic mode, that didn't allow them to think that anything would be normal again. Many borrowers refinanced three and even four times, believing that the market would sour again and that this was their last chance. It wasn't, but I made a lot of money because of that fear.

During the years 1983-84, the market developed many adjustable rate loans. The industry standard ended up being the one year adjustable, where the rate would fluctuate up or down, based on a constant, either the one year T-bill or libor. An even more revolutionary loan was added. The step-rate adjustable. The way they worked, was the payment rate would start 3% below the prevailing ARM interest rate, while the payment rate rose by 1% each of the first three years. The thought there, was that incomes would increase, after all, aren't we in a period of inflation? The catch was the negatively amortized loans were eating up equity for the first three years, leaving the borrower, in some cases, owing more that the purchase price or value of the home. Many walked.

If some of this sounds familiar, it is. Because both borrowers and lenders are either too young, or, lack the long term memories to judge risk correctly, we have a crunch in the "sub-prime lending market. "Those who don't learn from history, are bound to repeat it." I'll expound more on this and the parallel universe we find our selves in today, in my next post, where I'll make some disturbing predictions for the near future.

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