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| What is The GAP? Why am I Talking About It? (Part 2) |
| April 17, 2008 | ||
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What is The GAP? Why am I Talking About It? (You should be in control of the deal. Private lending is the ONLY way to accomplish this!) By Pete Brady, President, One Touch Lending and 1Million Liquid  (This is part 2 of a 2 part series: An informative look at the inside of the new business of credit from a mortgage broker's perspective. - click here for part 1 .) With an unprecedented credit crisis, you will need to be prepared. You should be in control of the deal. Private lending is the ONLY way to accomplish this and make big origination fees. In the first of this two part series I talked about Private Lending ("The Silent Mortgage Boom") and the GAP. In this, the second part, I will talk about reserves, the GAP and how it relates to your business and the importance of Private Money Lending to help you make big origination fees.
The next piece of the puzzle…the lack of reserves to actually pay benefits on the insurance should it be called on to actually protect against default…gets spooky. The buyers of swaps (primarily investment bankers) do not show any reserves on their books to protect against the failure of the sellers of the “insurance.” I guess that would be like you buying “benefit failure insurance” on your life insurance policy to protect against nonpayment. Life Insurance cos. are required to have reserves by the insurance commissioner. Not the case with CDS Why bother? Well, the life insurance industry has proven actuarial tables and a track record that spans over 200 years. The massive leverage stapled together by these CDS is really only 5 years new and untested in a down market. Yeah, the mortgage piece is showing its ugliness, but that’s just the tip of the iceberg Swaps are sold with no reserves set aside. The primary sellers of the CDS are banks in a big way. 40% or $18.2 trillion of CDS have been issued by banks. They claim to be hedged against the risk, but if the sub prime meltdown is any indication of bright minds assessing and hedging against risk, then banks may be in for a big surprise. Hedge funds own another 32% of this stuff, to the tune of $14.5 trillion. Net assets under hedge fund management total $2.5 trillion. Do the math. Large unexpected defaults practically wipe out that whole industry as they are forced to liquidate assets to cover benefit payments. Hedge funds are highly leveraged in other ways too. Bank loans are the lenders to hedge funds. The biggest chunks of debt that are wrapped into this whole mess are corporate issues, of which 40% since 2004 have been junk bonds. These babies do have history. Recall that Drexel and Milken practically invented this market in the 80s. Default stats have shown that 28%-47% of junk bonds default 4-5 years after issuance when there is a recession. When times are good, all industries leverage more, strap more debt onto their balance sheets, and drop underwriting standards. As assets grow, so does the propensity to leverage even further if allowed. Real estate is an asset and so is everything else on the left side of a corporate balance sheet. Does this habitual borrowing sound like any of your borrowers? Well Wall Street and large banks apparently haven’t behaved much differently than many of our “favorite” clients who have continued to refinance, borrowing excessively though the boom times. Good times allowed issuing tons of debt, and there were no unexpected defaults yet for any of this. The corporate, junk bond piece of this puzzle absolutely dwarfs the mortgage piece. That’s the biggest reason for concern. Because of the nature of these derivatives, the massive financial engineering and overleveraging that has taken place in these last four years, the actual underlying risks have apparently been completely obscured. Most analysts have trouble peeling away the layers to the underlying pieces of credit which are so far removed from the surface investment that has so many moving parts. And these analysts of course work for the money machine that generates the huge fees from the movement of this whole machine. This is all according to the author (Ted Seides) of the article a read from John Mauldin’s E letter. (I guess it helps to have a former hedge fund manager as a dad!) If the corporate side of this piece begins to really unravel, the worst case scenario plays out. This might appear as profound bank failure accompanied by huge losses on Wall Street and a credit crisis much larger than that being experienced as a result of the sub prime meltdown. NOT GOOD. I can’t believe I actually read all this Pete…fascinating…but what about The Gap and my business? Recall, “The Gap” that I was taking about was the space now unattended to by the secondary market and that spot where nobody in their right mind is going to make a loan for any reason! OK, so what happens if some or all of this doomsday scenario plays out in the next couple years? With an unprecedented credit crisis, you will need to be prepared. It doesn’t mean that there’s no money to lend and nobody that wants to borrow. It simply means FEAR will preside over the INSTITUTION’S ability to make loans and sell them – NO LIQUIDITY. It doesn’t stop YOU from personally evaluating one borrower’s likelihood of repaying. It doesn’t mean that there’s no equity anywhere! 24 million homes in the US don’t have loans! You should be in control of the deal. Private lending is the ONLY way to accomplish this. The next best thing to lending your own funds is having trusted, private investors in your back pocket who believe in your deals. Then you make big origination fees. Either way, this “silent mortgage boom” in this niche could potentially get a lot louder! Thanks for listening. An ounce of prevention and preparation could make you wealthy. Sincerely, Yours Truly, Pete Brady (This article is part 2 of a 2 part series. Click here for part 1.) Pete Brady is President and co-founder of One Touch Lending. Pete and his partner have over 35 years of combined lending experience, which they have applied to develop an elite team of mortgage consultants who concentrate on residential financing that can hardly be considered "Plain Vanilla!" They love to teach their associates the compassion required to help people with extra special circumstances when financing their home. OneTouch Lending is a group of specialists concentrating on financing credit challenged borrowers and making their dreams of home-ownership & financial independence a reality.
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