Portland Home Mortgage Guide

If you have been watching the news at all lately (and it’s probably safe to assume that most people with a Portland home loan have been), you have probably heard a lot of discussion (bickering) about the concept “Mark to Market” and if changes need to be made.

What exactly is Mark to Market and what does it mean? Is this going to have any affect on the housing market, and more importantly, how might it directly affect your Portland home mortgage?

We are going to attempt to give an explanation of it below so you can better understand what it is, and more significantly, comprehend how it has played such a important role in our existing economic crisis, which includes the Portland mortgage market. It may come as a surprise to you to find that this accounting rule (i.e. law) has much more to do with the economic down turn than possibly anything else.

Before we even begin to look at how Portland mortgage rates get affected, we’re first going to discuss why Mark to Market exists at all

To understand Congress’ inspiration behind the creation of this accounting requirement, we need to go back and look at the stock market crash of 2000 – 2002.

At the time, before this rule was devised, companies such as Arthur Anderson, Enron and others found methods for ‘cooking their books’ so as to make their balance sheets appear significantly healthier than they truly were. This, in turn, made their stock values to be artificially high, contributing to the ‘bubble’ that, as we all know, eventually popped. When that occurred,many, many people lost tons of money. To insinuate that they were unhappy is a huge understatement. Something had to be done.

The concept of “Mark to Market” accounting was created in an effort to make things more transparent and to ensure fair valuation of companies as well as all their assets. To summarize, what it means is that all assets are required to be valued as if they were sold on a daily basis. For those who opted not to do this conservatively, they put themselves at risk for potential jail time.

Let’s now look at how this regulation can cause a problem affecting the whole economy, including Portland mortgages.

When you consider the huge amounts of money handled by banks – and the wide (and odd) variations of financial instruments they use, – it’s difficult to try to get one’s mind around exactly what it is they do. It will be much easier to illustrate how this accounting strategy works using an analogy more realistic to the rest of us.

We’re going to pretend you live in a neighborhood where all the homes are similarly worth right around $200,000. Let’s also imagine your neighbor owns his house outright.

All of a sudden you neighbor has some serious, major medical expenses and needs to sell his house to pay forit. He needs his money right now and doesn’t have the luxury to shop for a Portland refinance, and he isn’t in any position to wait for the best offer he can get. Instead of waiting, he sells his home for $150,000 to get the money right away, even though it is clear that the property is worth quite a bit more than that.

If you happened to live two houses down in an identical house, does the fact that your neighbor’s house sold for $150,000 indicate your house just lost 25% of its value? Of course it doesn’t. If you decided you were going to sell your house, you would be able to take your time and get a fair price for it; you would not be forced into a “fire sale” situation.

On the other hand, if you were a public company and were forced by law to go by the Mark to Market accounting rules, you, and all your neighbors too, would now be forced to claim that the house you live in was now only worth $150,000 and not the $200,000 everyone knows to be the true value.

Now we are going to see how this applies to a bank.

Allow me to stretch the hypotheticals a bit further.

Let’s pretend you decided to start a new bank, we’re going to call it YOUR BANK. You get started with a $2 million initial investment to get Your Bank started. Your plan to make money as a bank is to take in people’s money as deposits, paying them a low but safe rate of return, and then use that money to create other loans, such as Portland home loans, that pay you a higher rate of return. The difference between the two is the profit you get to keep.

Let’s say that from our $2 million of deposits, we create $30 million of loans. Our Capital Ratio (the ratio of loans to capital on hand) is at a respectable 15:1 ($15 million in loans for every $1 million in deposits). This ratio is completely acceptable by banking standards.

We are going to say that you run an extremely conservative bank, and the Portland loans Your Bank agrees to make are limited to those of only the very highest standards. For example, you require a 30% down-payment (normal is 20%, or sometimes even less), a credit score over 800 (this would be a VERY high credit score), you demand full documentation of all income and assets and will only tolerate a DTI(debt-to-income) ratio of ten percent (industry norm is 40%).

It’s clear, Your Bank will only make a superior quality Portland loan. And it shows. All your borrowers pay on schedule, no one is unhappy and Your Bank is making plenty of money. This causes Your Bank stock to continue to climb.

All of a sudden, the Portland real estate market begins to slow down and go soft, and Portland home values begin dropping (however, your borrowers still make all their payments on time, no problem).

The problem is, with the systemic drop in home values, you have to re-assess the value of your loan portfolio. Now, rather than the loans being 70% of the value of the home, they are at 90% (your equity position in the home went down considerably). This means these loans are considerably riskier than when you had more equity, and because they are more risky investments, investors are less interested in buying them than they were before and because of that they have less value.

In comes your accounting team to tell you that, according to law, you must “Mark to Market” if you don’t want to risk a serious penalty (such as jail time!) In their Mark to Market analysis, the estimated value is now at $1,000,000; it has been reduced by 50%!

Do not forget, nothing has changed regarding your borrowers or your loans (everyone continues to pay on time so the funds are still coming in as it always has). Now however you now must reflect the fact that Your Bank’s ‘value’ has been cut by 50% to only $1,000,000.

The problem is, you still have $30 million in loans outstanding, and with a valuation of $1,000,000, your capital ratio is now at at 30:1 which is a LOT different than 15:1.

Red flags begin to go off everywhere because it’s a concern that with just a couple of bad loans that you would be required to cover, you might quickly run out of funds. This would place depositorsin danger of losing their deposits.

So now suddenly the FDIC is starting to look into Your Bank and then the SEC (Securities and Exchange Commission) starts asking all sorts of questions. Your Bank stock begins to to fall hard. All the financial news networks hear of the story and just add fuel to the fire.

Your Bank is in deep trouble.

The trouble is, Your Bank is ‘over leveraged’, and to compensate for that you are forced to start selling some assets. (You could try raising capital, but when you think about the way the situation appears and your capital ratios totally out of whack, no one in their right mind is going to be willing to lend you the $1,000,000 you need).

Since you need to get that money as soon as possible, you find yourself in a similar situation to that of your neighbor who was forced to ‘dump’ his house very quickly at a a lower than market price. As you sell off your assets to raise capital as fast as possible, at the same time you are reducing the value (i.e. quantity) of your remaining assets, further skewing your capital ratios even further.

This is a kind of death spiral that is nearly impossible to stop once it gets started. The thing is, the problem doesn’t end with just Your Bank.

Now let’s say that my Portland mortgage company (called “My Bank”) purchased those assets from you. You were selling at such a great price that My Bank got the feeling we were getting such a great deal that we could not resist, so we bought a whole bunch of them.

The trouble is, with the Mark to Market regulations, the loans My Bank just acquired from Your Bank at such a good price must be used as comparables that all other financial institutions also use to value their assets. So every $200,000 Portland mortgage loan that My Bank was holding (not just the ones I purchased from Your Bank) now only are worth $150,000 each despite the fact that they were loans that were performing perfectly.

So now we have a situation where the value of My Bank goes down. As this happens it disrupts My Bank’s capital ratios and makes me to sell assets as quickly as possible in order to generate money… and so the cycle continues.

It’s not hard to see how fast and wide spread the problem gets, despite the fact that there weren’t necessarily any ‘bad business decisions’ made. It’s all caused by a well intentioned, but over reaching, accounting regulation.

When considering the scenario above, you might ask, “Why don’t they have everyone just quit buying the discounted assets from the other guy and simply stop the cycle?” This is a good question.

If the cycle is stopped, not only do some financial institutions fold, but the whole flow of money just stops. This is the ‘credit freeze’. When there is no credit available at all, mortgage lending comes to a crawl, car and truck sales all but stop, jobs are lost and the whole economy slips into a recession.

We’ve been in, and gotten ourselves out of a recession before. Why don’t we do the same thing we did to get out the last time?

Our ‘mini’ recession of 2001 recovered pretty quickly because the Fed lowered interest rates and mortgage lending standards were considerably more relaxed, which led to roughly $3 trillion worth of cash being withdrawn in the form of equity from homes and put right back into the economy.

In today’s world, mortgage loan guidelines everywhere (not just the ones Portland mortgage brokers are dealing with) are far more restrictive, home values are way lower (and they have been heading in the wrong direction for a while). And as was mentioned above, the truth of the matter is that there is simply not very much money available out there for Portland mortgage companies to access for either home purchase loans or for a Portland mortgage refinance.

However…

Some good news for a change!

04/02/09 – The Financial Accounting Standards Board (FASB) voted favorably regarding relaxing the Mark to Market standard. They are going to allow financial companies to use alternatives such as cash-flow analysis in valuing assets. This change will significantly reduce the write downs banks have been forced to take on assets and investments like mortgages. This could very well mean more options will soon be available to your local Portland mortgage companies. We’ll hope so.