Friday, September 17, 2010

How NINJAs ruined the United States economy!

Open to a small home, in the wrong part of a large US city.  Smiling in front of the home is the new buyer.  They put $0 down and provided no documentation on their income, expenses or verification that they have a job.  This is the modern day NINJA - not some bad 80s movie with fast moving people covered in black cloth or some Jet Li movie, these are real, everyday people, who through the system's greed, got in over their heads ... so the story begins ...

In the aftermath of the terrorist attacks on September 11, 2001, Alan Greenspan, Chairman of the Federal Reserve of the United States, decided to lower interest rates to stimulate the US economy. This lowering of rates had the perfect effect on a nation that was in disarray. Consumer spending went up and household savings dropped drastically.
Resulting from this, Americans started using their homes as “debit cards”, increasing their consumer spending and then refinancing their home to pay off high credit card debts. This refinanced debt, on home equity lines of credit, was tax deductable, meaning the higher the debt, the more write offs average American households had. The tax laws in Canada are different, we are not able to write off mortgage debt on our taxes, unless that debt is used for investment purposes.

With this increased emphasis on consumer spending, mortgage requirements were relaxed further, starting the popular NINJA mortgages (no income, no job, no assets). This accounted for about 22 percent of the United States mortgage market (compared to less than 5% of Canadian mortgages). The American system also did away with requiring documentation supporting income, expenses, etc.

These no doc mortgages were doomed to fail, evidenced by the story about Alberto and Rosa Ramirez. They are the migratory strawberry pickers from San Bernadino, California who purchased a home for $720,000.00. Their combined annual income is $30,000 USD. They bought this home with $0 down. It was a miracle of 'sub-prime' - a real life NINJA in action.

The Ramirez's make $300 per week each, which totals $2400 per month in income. Each of these people make approximately $15,000 per year. In Canada, regulations state that approximately 1/3 of our earnings could go towards housing debt, or in this case $10,400 per year in principle, interest and tax payments ($867 per month). In Canada, this couple could likely purchase a home in the $180,000 range (assuming they have limited other debt and a 5% minimum down payment). A far cry from $720,000!

For this property that was purchased by the Ramirez's, the mortgage payments would work out to approximately $5378. The taxes are approximately $750 per month. The couples monthly income does not even cover their housing expenses. They bought the house with a two year teaser rate, with negative ammortorization, meaning the value of the mortgage grows each year, instead of declining. At the end of two years, the idea was to re-finance the property and pay out the balloon payment due and get another super low teaser rate.

In many parts of the United States mortgage debt is handled differently than in Canada. Mortgage deficiency judgements (failure to pay your mortgage and entering into repossession) are handled differently in Canada than those states. In Canada, a lender can go after other assets you own if the proceeds from the sale of the property do not cover their losses. In many States, this is not the case, so if a person defaults, they keep their other relevant financial assets and only lose the house.

Where things became catastrophic, is that these mortgages were sold to Wall Street in bundles. Traditionally, mortgage debt was considered rock solid debt, as it was backed by an asset and had loan to values in the 80% of better range. This sub-prime debt was sold under the same assumption, but in many cases, the majority of these debts were ‘C’ level debt, not the ‘AAA’ that Wall Street thought they were buying.  So Wall Street was overwhelmed by the NINJAs, never a good situation!

As the market fell, large companies that bought these portfolios for income, were now losing millions and millions of dollars. This spidered through the economy and cast a destructive path through the whole US economy.  These NINJAs became responsible, in part for the collapse of Wall Street giants Bear Stearns, Lehman Brothers and others.  The underlying greed of Wall Street magnified the problems caused by these deadly NINJAs.

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