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| What is The GAP? Why am I Talking About It? |
| April 03, 2008 | ||
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What is The GAP? Why am I Talking About It? (FEAR will preside over the INSTITUTION’S ability to make loans and sell them!) By Pete Brady, President, One Touch Lending and 1Million Liquid  (This is part 1 of a 2 part series: An informative look at the inside of the new business of credit from a mortgage broker's perspective.) 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 will talk about Private Lending ("The Silent Mortgage Boom") and the GAP.
I’m going to define the “GAP” as the demand for money (desire to borrow) which resides between what institutional lenders can “safely” fund and sell on the secondary market, and insanity – the line in the sand where your parents wouldn’t even lend you the money! This “gap” was very narrow in 2006. The secondary market would accommodate just about any loan we could create, as you well know. Bill Dallas started First Franklin then sold it and bought it back & sold it again 3 times in two years (National City ultimately bought it for 220M, then sold it for 1.2B, then…well…the rest is history.) Bill once told me directly two very important things,” Just because you can make a loan doesn’t mean you should,” and he also said, “I live in fear every day that the loans I create won’t have enough value.” It took me a decade to fully understand 20 years of experience that was conveyed to me in these two sentences. Bill’s one of the brightest minds in the business, and I’m sure he’s well read on the subject that you may or may not be versed in. THIS ONE IS NASTY – THIS DOG WILL BITE. I wasn’t aware until just recently just how large and fragile the credit markets have become. The Fed regulates banks and S&Ls, but Wall Street now regulates the “real credit markets,” and investors regulate Wall Street based on their propensity to accept risk for potential reward. Who are the investors? Essentially…Wall Street! It’s classic incest perpetuated by greed, and the desire for continued massive fees generated by “the game.” This house of cards is much larger than the “Sub prime Meltdown” you read about. You’ve got to understand this and get prepared. Before I tell you what I’m doing about this nasty dog that may unexpectedly come from behind a car and chew us all a new one, let me describe this animal. As I said last week, invented by Wall Street in the pursuit of perpetuating massive “deal fees” that are “earned” when the big boys move money across their desks, this dog or more like an entire new breed of hungry canines multiplied like…well…rabbits from 2003 to 2006. This dog is called a “CDS” or Credit Default Swap by the investment banking community. It was created in the mid 1990s Why am I talking about CDSs, and what does this have to do with “The Gap” you were mentioning in the secondary market? A fair question. CDSs have everything to do with much of the secondary market. Look, there are essentially two kinds of Americans: those who get information and vote (at least during presidential elections) and those who are lethargic slugs and voice no opinion and take no action regarding their future. The second group just “lets life happen to them.” I am encouraging you to be part of the first group and educate yourself on this. It’s going to affect us all. Credit Default Swaps are essentially an insurance policy against the risk of default on a particular piece of credit (usually CLOs & CDOs). A premium is paid buy the buyer and is collected by the seller. Unlike the traditional insurance industry which provides for loss reserves in all “highly rated incidences,” the CDS market is this huge new credit insurance industry whose providers have reserved nothing for future losses. OK, I could really get technical and go deep on this subject, but I won’t. Most of you would fall asleep. However, that’s the nature of business, most sleep and wonder, “What happened?” while others prowl and kill what they eat each day. Next week I’m going to wrap up this discussion (and hopefully when I bring something this important to light again my blog will be up on my site.) In the mean time I’ll leave you with some staggering numbers to consider. CDSs grew from 4 Trillion in 2003 to over 45 Trillion last year. That’s almost five times the US national debt and more than 3 times the US GDP. If just 5% of these CDSs have to pay out proceeds on losses, that would require 2.25 Trillion to be paid to the buyers of the polices. In an article I read by Ted Seides in John Mauldin’s newsletter, it is said that the reserves required to fulfill these commitment fall dramatically short. So Pete, What does this “mountain” of Credit Default Swaps and “The Gap” have to do with my origination business anyway? Again, a great question. Understanding macro-economics is frankly, well…your responsibility if you’re a career player in this biz. This is heavy stuff, but just recognition of its existence puts you a huge leg up. CDS(s) are a brand new untested instrument that are now responsible for a great portion of the financial infrastructure that you operate in. You originate. Mortgage banking channels fund. They sell to investment bankers. Those guys securitize. The securities get pooled into and included in CDO(s) or Collateralized Debt Obligations which are huge bundles of debt spreading across multiple industries, for purposes of diversification AND maximizing investor yield. The swaps (CDS) provide the “insurance” that protects the risk of default on the whole enchilada. Insurance on credit risk is a nice idea, but many of the sellers have no reserves. In our next discussion, we’ll continue our discussion on reserves, the GAP and how this relates to your business and the importance of Private Money Lending to help youmake big origination fees. (This article is part 1 of a 2 part series. click here for part 2.) 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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