10 Things That Will Change

What will U.S. regulatory and financial climate will look like in a few months from now? It may look remarkably like the climate of five or 10 years ago.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter
Renuka Rayasam, Associate Editor, The Kiplinger Letter

September 26, 2008
When the smoke clears on the current financial and legislative turmoil -- the economic landscape will look considerably different than it did just a few months ago. Here's what we see ahead:

1. A much less leveraged economy. Cash will be king. In practical terms, that means: Little financing of speculative building and higher pre-leasing hurdles for commercial real estate. More money up front on merger and acquisition deals. Bigger mortgage down payments. Lower limits on credit cards. And higher capital reserves for banks. And less risk-taking in other ways as well. Borrowers will need squeaky-clean track records. Financial deals at publicly traded firms will be more transparent. Buyers will demand a much clearer understanding of exactly what they're getting.

2. More modest rewards -- the natural consequence of less risk taking. Fewer stocks racking up double-digit gains. Slower appreciation of property values. Smaller returns on endowments for universities and nonprofits. For consumers: Fewer second homes, boats, new cars and so on. More households will live within their means.

3. A feast for bottom fishers. Investors with cash, the patience to wait out a gradual recovery and a heart stout enough to withstand periodic wild swings, will be in the catbird seat. They're positioned to make a bundle, snapping up undervalued assets -- businesses, real estate, securities, etc. Even out-of-work talent will go cheap to employers savvy enough to nab it.

4. Fewer financial firms, as big universal banks swallow up midsize regionals.

5. More government oversight of financial markets. Better communication and coordination among regulatory agencies. Increased disclosure requirements. A tighter rein on short-selling. Closer supervision of credit rating agencies. And more.

6. But a revival of private financial firms -- investment banking partnerships and boutique merger and acquisition houses, for example. Their allure: minimizing regulatory burdens and filling a need for investors willing and able to take larger risks for larger returns.

7. Simpler forms of securitizing debt -- plain vanilla ways to spread risk. Secondary markets for mortgages and other assets won't vanish. But the instruments bought an sold will be less exotic.

8. Greater scrutiny of executive compensation, whether mandated by Congress or not. Shareholders are sure to take on the issue more aggressively in the near term.

9. Higher taxes and/or a bigger federal deficit as Uncle Sam shoulders the load of Wall Street's toxic debt. Although eventually the government may make money on the deal, in the short term, the Treasury -- and therefore, the taxpayers -- will pony up billions.

10. Higher long-term interest rates. Treasury yields must rise to lure capital -- foreign or domestic -- driving up mortgage and corporate bond rates. Short-term rates will slide, though, as the Federal Reserve tries to keep the economy afloat and put banks back on solid ground.

In reality, the change isn't to a new environment. It's a return to traditional norms of the past, before cheap money inflated asset values, undermined lending standards and encouraged excess risk. It's bitter medicine, but it's necessary.

Buy and Bail

The term “buy and bail” is becoming more popular. This is where the homebuyer purchases a more affordable dwelling with the intention to cease making payments on the previous mortgage. The mortgage industry has tightened underwriting guidelines on primary residences that are pending sales or converting them into investment properties. The following are guidelines for FHA and Conventional:

FHA – The following went into effect September 19.
On a temporary basis FHA will not consider any rental income from the property being vacated except as described below:
Relocations: An executed lease agreement signed by the homebuyer and the lessee for at least one year’s duration after the loan is closed is required. Evidence of a security deposit and/or first month’s rent paid to borrower.
Sufficient Equity in Vacated Property: The homebuyer has a loan-to-value ratio of 75% or less as determined by either a current (no more than 6 months old) residential appraisal or by comparing the unpaid principal balance to the original sales price of the property.

Conventional – The following goes into effect October 1.
The current primary residence is pending sale that will not be closed (title transfer to the new owner) prior to the close of the new loan transaction, or the current primary residence is converting into a second home:

• The borrower must qualify using both the current and proposed mortgage loan


• 6 months principal, interest, taxes and insurance (PITI) reserves for both properties are required, or as determined by Automated Underwriting
  o If there is documented equity of at least 30% in the existing property a reduced reserve requirement of 2 months for both properties is permitted. The 30% equity in the existing property must be documented using a full appraisal or automated valuation model (AVM).
  
• If the current primary residence is pending sale, the PITI for the property for sale does not need to be included for qualification purposes provided the following is provided:
  o The executed sales contract for the current primary residence
  o Confirmation that any financing contingencies have been cleared
  o Evidence of PITI reserves as outlined above


• If the current primary residence is converting to a second home the property must be located in an area that can reasonably function as a second home.


• If the current primary residence is converting to an investment property there needs to be documented evidence of 30% or more equity in the existing property. The borrower may continue to use 75% of rental income to offset the mortgage loan payment amount.
  o The 30% equity in the existing property must be documented using a full appraisal or AVM
  o The rental income must be documented with both a fully executed lease agreement and the receipt of the security deposit from the tenant and evidence of the deposit into the borrower’s account
  o Standard reserve requirements apply.


• If equity of 30% in the existing property cannot be documented the borrower must qualify using both the current and proposed mortgage loan payment amounts.

Mortgage News September 15, 2008

Lehman Brothers will declare bankruptcy. The US Government decided that they did not want to back up Lehman’s $60 billion of bad real estate investments. Bank of America said it will acquire Merrill Lynch in an all stock transaction worth about $50 billion. What does all this mean? The Lehman and Merrill news has pushed the stock market down over 300 points and caused rates to drop. Fixed rate mortgage prices are better by .50 - .75, depending on product and coupon.

History on Lehman Brothers
Henry Lehman, an immigrant from Germany, opened his small shop in the city of Montgomery, Alabama in 1844. Six years later, he was joined by brothers Emanuel and Mayer, and they named the business Lehman Brothers. Lehman Brothers, an innovator in global finance, serves the financial needs of corporations, governments and municipalities, institutional clients, and high net worth individuals worldwide. Lehman Brothers maintains leadership positions in equity and fixed income sales, trading and research, investment banking, private investment management, asset management and private equity. The Firm is headquartered in New York, with regional headquarters in London and Tokyo, and operates in a network of offices around the world. In a nutshell they provide cash liquidity to our state and local governments, large corporations now will have difficulty getting funded for projects.
Lehman Brothers started in the 1840’s and survived the: *railroad crash of the 1890’s,* the stock market crash of 1929, *World War I of 1917, *World War II of 1939, *the 1980s real estate crash, *the tech bubble of the 1990’s during the Clinton administration, * 911. We can all agree that these events listed and many more crises not listed were significant events in history. This might put in perspective at really how bad is our current credit crunch. For more details go to: http://www.lehman.com/who/