As the securitization market for mortgage loans has effectively been “frozen” for several years as I had forewarned many of my readers in various regional and national real estate publications several years in advance of the “official” start of The Credit Crisis back in 2007, we primarily have seen loans being funded which are backed by governmental bodies via Fannie Mae and Freddie Mac (both taken over by the U.S. government back in September 2008) and FHA (government insured financing).
Through the 1st Quarter of 2010, government insured or backed financing represented over 96.5% of all mortgage loans nationwide. This 96.5% number is absolutely staggering for a country which was built upon the idea of a “Free Market” way of life. In recent years, the percentages of government backed or insured mortgage loans may be closer to 97% +.
As I have created financial charts in the past to better support my viewpoints in regard to how bad the world’s financial meltdown is today, there may be over 1,600 TRILLION DOLLARS worth of primarily unregulated derivatives in existence worldwide (as compared to approximately $7 or $10 trillion in combined residential mortgages nationwide).
The Credit Crisis is primarily due to the “unwinding” of these overvalued, complex, and essentially worthless (in some cases) derivatives. It is NOT just a “sub-prime mortgage” problem as portrayed by many in the media as they try to blame the struggling U.S. homeowner for this problem. “Sub-prime” debt represents just a tiny portion (less than 1%) of the overall derivatives debt worldwide.
Many of these same financial derivatives have been leveraged another 10, 20, 30, 40, or 50 plus times their face amount by the owners of these same financial instruments. Many derivatives investments (on and off balance sheet investments) absolutely DWARF the entire combined net worth of many of our largest banks and insurance companies worldwide. If many of the top 20 largest U.S. banks acknowledge how bad their overall financial losses in these complex financial instruments, then they would effectively be insolvent.
To better visualize this risky form of “financial gambling”, please imagine placing $100 on the color “green” on a roulette table. If you win your bet, you may take home approximately 40 times the amount of the bet (or $4,000). However, if you lose the bet, then you owe the casino $4,000. Now, please imagine making that same bet with $1 Trillion Dollars. Could you or your bank afford to take a $40 trillion dollar loss today?
Let’s hope that the FDIC, Fannie Mae, Freddie Mac, FHA, SBA, and other government backed entities will be there for all of us in both the short and long term. Equally as important, let’s hope that more private capital begins to enter or re-enter the financial markets once again in order to begin to “unfreeze” the securities and secondary markets at some point very soon.