The Truth About How We Got Here (Part 2)

The real estate bubble and inevitable crash was fueled by several factors that in retrospect should have been crystal clear. However, greed is a blinding force that allows people to ignore the obvious.

The incredibly rapid climb and equally as rapid crash and burn in the real estate market got its start with President Bush’s desire to keep his campaign promise of expanding home ownership, especially amongst lower income families and minorities. In June 2002, he unveiled his plan called “Renewing the Dream," which would give nearly $2.4 billion in tax credits over the next five years to investors and builders who developed affordable single-family housing in distressed areas. Along with this, he created the "American Dream" down payment initiative, which provided down payment assistance to approximately 40,000 low-income families.

President Bush also issued America's home ownership challenge to the real estate and mortgage finance industries to encourage them to join the effort to close the gap that exists between the home ownership rates of minorities and non-minorities. Banks were all too happy to expand their market into this new untapped area. This was given incentive with the advent of fractional reserve lending which suddenly allowed banks to lend 10 to 30 times their reserves. The Federal Reserve fell right in line and dramatically lowered interest rates making money less expensive to borrow. The trap was set.

New buyers flooded the market, now able to get down payment assistance and an inexpensive loan. This sudden demand drove up the prices of properties on the market. Financial institutions responded by creating new loan packages to accommodate the higher prices – 100% financing became the norm. This unfortunately drove prices even higher since it allowed even more buyers in the game. As expected, lenders responded and came up with 106% financing (6% to cover closing costs). Prices climbed even higher – basic supply and demand. The feeding frenzy was on!

Current homeowners saw the equity in their homes skyrocket to obscene amounts (in some cases 500%). Homeowners began to pull that equity from their properties refinancing as much as every three to six months. In 2005, homeowners extracted $750 billion of equity from their homes (up from $106 billion in 1996), spending 2/3 of it on personal consumption, home improvements, and credit card debt.

Lenders excited about the money pouring in would lend to almost anyone that stated they had money and a decent credit score which quickly exhausted the market of qualified borrowers. When the banks ran out of creditworthy borrowers, they had to turn to “sub prime” borrowers; and to avoid losses from default, they moved these risky mortgages off their books by bundling them into “securities” and selling them to investors. To induce investors to buy, these securities they were then “insured” with credit default swaps (see “The Truth about How We Got Here” part 1).

They also enticed greedy buyers with low teaser interest rates on adjustable rate mortgages (ARMs) offering as little as 2% fixed for the first two years and 28 years adjustable based upon the prime rate. With greed blinding the consumers into thinking the market would continue to grow and they would be able to refinance out these loans were readily accepted.

The growth was unsustainable. Some of the cities that had experienced the fastest growth during 2000–2005 began to experience high foreclosure rates as those adjustable rate mortgages adjusted. The sub prime market fell first followed by the mainstream market. As refinancing suddenly ground to a halt, the economy saw a sudden loss of the consumption that had been driven by the withdrawal of mortgage equity. Real estate related industries began to crumble and consumer retail markets saw an instant drop in sales revenue.

The massive defaults on foreclosures caused insurers not to be able to cover CDS defaults. Banks and business failures occurred in a dramatic fashion. The credit card industry quickly followed behind the real estate industry and the rest is history – Recession 2009!

The truth About How We Got Here (Part 1)

It’s all over the news, the internet and talk in the street - we are in the midst of a full blown recession the likes that have not been experienced since the Great Depression. Yet some people are steadily building their fortunes as we witness long standing financial giants topple. Having had first hand experience with big movers and shakers in the real estate and business world (and insight from political powerhouses) I have a unique perspective on this mess that few others have had the privilege to bear witness to. I am dedicated to revealing to you the little known facts about how to develop wealth and be successful in any economy based upon my unique experience. In order to fully understand how to make money in any economy, it is important to understand the mindset of the players (buyers and sellers) in the “market,” and how it led to the situation we find ourselves in.

It is critical to realize that it is the emotional state of the players in the market that create bubbles and their inevitable bursts. How did we get into such a quagmire with the economy? The simple answer is pure greed, but that wouldn’t adequately sum it up. You see the market is driven by two emotions fear and greed. During a recession fear is the prevailing emotion and buying, selling, lending and investing grind to a halt. However, during boom times greed or the prospect of making outrageous sums of money at little risk drives investors to invest, lenders to lend, business owners to expand and consumers to spend recklessly. Unfortunately, it also lures the unskilled and unknowledgeable into the game as well. The prospect of easy money makes people and institutions take chances on things they clearly don’t understand.

Our economic disaster started out fifteen years ago like a scene from a stereotypical Hollywood movie about greedy bankers. In 1994, a team of JP Morgan bankers was having what they call one of their “Off-Site Weekends." Typically these are yacht parties, with bikini models, and $1,000 bottles of Cristal; and this trip wasn’t much different at the Boca Raton Resort & Club in Florida. The difference was, as they were holed up for most of the weekend in a conference room at the pink, Spanish-style resort, these JPMorgan bankers were brainstorming how to free up their capital reserves and still be able to lend tens of billions of dollars skirting the current banking regulations (By the mid-'90s, JPMorgan's books were loaded with tens of billions of dollars in loans to corporations and foreign governments, and by federal law it had to keep huge amounts of capital in reserve in case any of them went bad). They pondered how they could create a device that would protect them if those loans defaulted, and free up that capital at the same time so they could lend even more (Greed).

What those hard partying bankers came up with was a sort of insurance policy where a third party would assume the risk of the debt going bad, and in exchange would receive regular payments from the bank, similar to insurance premiums. JPMorgan would then get to remove the risk from its books and free up the reserves. The scheme was called a "credit default swap," and it was a twist on something bankers had been doing for a while to hedge against fluctuations in interest rates and commodity prices.

The difference is JPMorgan hired young math and science grads from schools like MIT and Cambridge to create a new market for these complex instruments. In 1997, the credit default swap (CDS) was launched and quickly became the hot financial instrument, and the “safest” way to mitigate risk while maintaining a steady return. There are very few people on the planet that can tell you exactly how a CDS works, yet they were being gobbled up like hot cakes by foreign nations, major US corporations, hedge funds, pension funds and anyone with big money looking for an easy return. By 2007 it is estimated that the CDS market grew to more than $45 trillion (Greed).

When the economy turned and many of the loans that the CDS’s were created to cover went bad, the banks didn’t have the cash reserves to cover them and it started the domino effect of failing financial institutions. AIG became the best known casualty to CDS’s having to be bailed out by US tax dollars after it defaulted on $14 billion worth of credit default swaps it had made to investment banks, insurance companies and dozens of other entities.

In the next segment of this article, I will reveal the truth about how the real estate bubble was created and what really caused the bubble to burst. As usual, I welcome your questions, comments and insight and look forward to sharing more insider wealth tips with you.

Wealth Building Secrets

I want to welcome you to a new and revolutionary look at wealth building that transcends any economic swing – positive or negative. I want to share with you the fundamentals of how a free market economy, such as that which we live in, has the potential to produce wealth consistently if you are able to both see and, in a timely fashion, seize the abundance of opportunities that are constantly created.

Wealth building starts with a shift in perspective that requires a close examination of how the entire system works. Once you understand the rules (allowances and restrictions), and the nature of the economy it becomes easy to master over time.

This starts with understanding the foundation of our economy which you can find in Adam Smith’s 1776 masterpiece, “An Inquiry into the Nature and Causes of the Wealth of Nations.” Without getting into a long winded economic explanation of what a free market economy is based upon, it can be summed up in three major points:

1. It allows competition domestically and is open to trade with the rest of the world
2. It has institutions that make an economy work
3. It has a judicial system that enforces the rights of ownership

In the coming weeks, I will explain exactly how to employ these fundamental rules to creating an abundance of wealth through business ownership, real estate investing and securities investing that can be passed on from generation to generation.

To understand the nature of free market economies and how wealth is developed requires you to tap into your primitive survival mindset. It requires you to understand that “the market” like nature can provide everything you need to flourish, but “the market” just like nature is unforgiving if you do not pay attention. Mistakes can be catastrophic if you do not respect the power of the market.

Alan Greenspan summed it up best in this quote:

“Market economies have succeeded over the centuries by thoroughly weeding out the inefficient and poorly equipped, and by granting rewards to those who anticipate consumer demand and meet with the most efficient use of labor and capital resources.”

We are about to witness the greatest transfer of wealth in US history. For those who have the courage and tenacity to succeed, I will be offering - from my personal experience and the experience of others - tips, secrets and opportunities to be on the receiving end of this massive shift of wealth. I welcome any and all questions or comments and look forward to sharing with you.