Finance Basics, Part Three

Here is a little more info on the basics of the current financial crisis.

Another part of the puzzle of the housing crisis, which led to the financial crisis, has to do with the appraisal of property. Typically, when property is purchased, an appraisal is done to determine the value of the property. This appraisal assures the lending entity, usually a bank, that the property has the necessary value to secure the loan, and then, too, the buyer knows that the property is generally worth the amount being paid for it. If Randy comes to you and says, "Hey, can you lend me a hundred bucks? I'll let you hold this watch until I pay you back." What's the first thing you want to do? Ah, no, no. I mean besides kicking my butt out the door. You want to know the value of the watch. If I get $100 from you, and the watch is only worth $10.00 (Hey, can I help it if one of Mickey Mouse's fingers is broken?) Anyway, you get the point.

Okay, so what's this got to do with what's been happening in housing? Much of the magnitude of this is still to be determined, and it seems that not all mortgage companies/banks or appraisal companies were involved, BUT at least some mortgage companies or banks were in cahoots with the appraisers to have the appraisal given at a "bloated" amount. In other words, if you wanted to finance a house for $100,000, but in reality, it was only worth $80,000, the appraiser was "nudged" by the mortgage company to make sure the appraisal covered the $100,000 amount! I'm sure you can see that this is dangerous business. As long as property prices kept going up, it essentially covered up this practice, but once some people couldn't pay the mortgage and prices came down, it showed how vulnerable things were. I believe New York State has brought charges against some lenders for this practice, and there may be other states that have done, or will do, likewise.

The other problem was with rating agencies. These companies rate various investments as to their safety for investors. If you read the first two parts of this series, you'll know about "bundles" of mortgages sold to investors (see links below), or used as collateral. It seems that many of these "bundles" were given high ratings, when it was known full well by the rating agencies that they didn't deserve such ratings, but the rating agencies are paid by those wanting their items rated!!! Get it!!! If you invested in a "bundle," figuring that it was pretty much of a safe bet, only to find out later that many of the mortgages in the "bundle" were in foreclosure .... again... you get the point. As this whole situation was uncovered, these "bundles" became unmarketable, as investors or banks wouldn't take them for fear that they were full of bad loans. Now, the "sit on their ass class" want government regulations for rating agencies! And here you thought they hated the government! (A word history is below the links)

Below are links to the first two parts:

http://pontificating-randy.blogspot.com/2008/10/some-financial-world-basics.html

http://pontificating-randy.blogspot.com/2008/10/finance-basics-part-two.html

Word History:
Berry-This is only found in the Germanic languages, and originally, it meant "grapes." It came from Old Germanic "basj" or "basjom." I'm not a linguist, but they can tell you why the "s" sound became an "r" sound in some, but not all, Germanic dialects. In Old English is was spelled "berie," and gradually it came to be applied to the various fruits that we use the word for today. Some examples in other Germanic languages: German has "Beere," while Dutch has "bas" (Hey, I told you not all dialects gave up the "s" sound!), Danish has "baer." Some linguists have tied the word to Sanskrit "bhas," which meant "eat." Sanskrit was an early form of writing for the Indo Aryan part of the Indo European languages, and is still used (very sparingly) in some parts of India for religious ceremonies.