The Truth About Mortgage Loan Usa

Review by Dale C. Maley:

In this age of full disclosure, I received this book free from the Amazon Vine program….with the condition that I publish a book review.

I may have purchased this book anyway. Back in the middle of 2007 when the sub-prime problem first surfaced……I remember a talking head on TV saying the sub-prime issue would not become a problem. His rationale was that sub-prime only represented a single digit percentage of the total mortgage market……and therefore it would have no major impact on financial markets……even if all sub-prime debt went bad. Boy was he wrong!! I have been curious how the sub-prime fiasco almost brought down the entire world financial markets.

Another disclaimer is that I have not personally been involved much with mortgage loans. My first mortgage was back in 1978. It was a 30 year fixed mortgage, and since I only put 10% down, it was mandatory to have mortgage insurance……until my equity reached 20%. I got additional 30 year fixed mortgages in 1980, 1994, and 1995 due to job location changes. In 1999, I got a variable rate loan on a new home…….put 50% down……and then converted to a 15 year fixed rate in early 2007. I also live in Illinois, not one of the national hotbed markets for sub-prime lending.

Zandi says there has been a financial markets panic about every 10 years. He predicts the next one will involve U.S. government debt with all our under-funded liabilities. Other authors have said there is a stock market crisis about every 25 years……..because it takes this long for the “burned” generation to retire and be replaced with youngsters who have no memory of the last bubble.

Zandi explains the sequence of the sub-prime fiasco like this:

1. Fed lowered interest rates after 9/11 to stimulate the economy

2. Fed was not worried about creating inflation because the shift in manufacturing to China actually threatened deflation, not inflation

3. With returns on savings accounts being so low, plus the stock market going nowhere after the Tech stock bubble burst…….people chose to invest in their homes

4. Foreign countries could not get decent returns on fixed income investments due to low interest rates……so they chose to buy slightly higher yielding mortgage backed investments

5. Local banks changed from being prudent lenders holding mortgages to simply financial intermediaries driven by loan processing fees. Since they no longer held any mortgages, they didn’t have to worry about making sure they were issuing loans that homeowners could really afford.

6. New companies jumped into the mortgage lending market …with the same motives as the banks. The majority of borrowers did not even realize how risky their new loans were….especially if home prices declined.

7. Wall Street created exotic mortgage backed financial instruments and marketed their higher returns.

8. The Federal Reserve Chairman and all the regulators were asleep at the wheel.

9. Financial rating firms completely missed the boat on how risky these new financial instruments really were.

10. Eventually the music stopped…..there were no people left to keep bidding up the prices of homes. The house of cards came tumbling down.

Zandi points out that sub-prime mortgages peaked at ½ of all mortgage originations.

A way was found to avoid the mortgage insurance if you put down less than 20%. You simply borrowed 80% on the first loan, then immediately took out a 2nd loan for the remaining 20%……apparently mortgage insurance is not required on either the 1st or 2nd loan.

Verification of income also went out the window.

Zandi points out that Americans lead the world in terms of how much housing cost we incur. Americans spend 33% of spending on their homes, while New Zealand spends 25%, France 20% and Japan 14%.

Zandi points out that at the peak of the boom in 2006, foreign investors owned 1/3 of all U.S. mortgages.

Zandi also points out that the price-to-rent ratio is a good bubble indicator…….analogous to the PE ratio in stocks. This ratio has been about 17 the last 25 years……but it peaked at 25 at the height of the boom. For this ratio to return to its 25 year average of 17, national U.S. house prices must drop 25%……..and the hottest markets must drop 35%.

The author says the sub-prime bubble is 4 times as bad as the S&L fiasco ( Trillion versus 0B).

The author has some recommendations to avoid another sub-prime crisis including:

1. Lenders must verify income and assets

2. Lenders must verify borrowers are able to pay back the loan

3. Mandatory escrow for taxes and insurance

4. Start teaching personal finance in high school

I found the book easy to read and entertaining. However, I got very frustrated with the color coding of his charts. I could not distinguish what the variables were in most of his charts. Maybe he made them in color, and then the black-white conversion process made them illegible.

Given my background, I am shocked at how loose the lending process has become compared to 20 or 30 years ago. As the author points out, everyone in the lending food chain assumed “the other guy” had checked out the quality of the loan made…and in reality nobody checked it out.

After reading about the Tulip bulb and South Seas bubble……plus living through the 1989 S&L crisis, the 2000 Tech wreck, and the 2007 sub-prime fiasco………this book has help give me a better idea of how to recognize the next financial bubble.

Some of the key indicators of bubbles include:

1. “It’s different this time”

2. TV shows and advertisements on speculating including store owners who sell stock instead of their normal goods (Tulip craze), ads showing taxi drivers who quit hauling passengers and day-trade (Tech Stocks), and TV shows dedicated to flipping houses

3. Historic valuation ratios are far exceeded (Tulip bulbs, PE ratios of 100 for Tech Stocks, Price-to-rent ratio for housing)

All in all, I thought the author did a good job of exposing the role of each member in the housing loan food chain had in creating the sub-prime mess.

In this age of full disclosure, it can be noted that I am the author and publisher of the book INDEX MUTUAL FUNDS: HOW TO SIMPLIFY YOUR LIFE AND BEAT THE PROS. This book is an introduction to the concept of index funds is and is sold on Amazon. I am also a contributing author to the book THE BOGLEHEADS GUIDE TO RETIREMENT PLANNING available from Amazon with an estimated release date of October 2009. I have also written 21 short stories on investing which are also available on Amazon.

If you are done speculating in the housing market, these books on conventional stock and bond investing may help you slowly grow more wealthy:

The Richest Man in Babylon

Bogle on Mutual Funds: New Perspectives for the Intelligent Investor

The Millionaire Next Door

The Four Pillars of Investing: Lessons for Building a Winning Portfolio

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, Ninth Edition

The Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get On With Your Life

The Bogleheads’ Guide to Investing

Review by Kathleen San Martino:

I’ve learned how securitization, unsavory lending, lies by borrowers and lenders, the effect home flippers had on the market, the accounting standard of “mark to market,” and other various lending practices and financial instruments have caused the economic havoc we are now experiencing. Lenders are currently leary of lending money to financially sound borrowers due to fears of further financial crises. There are also more rigid lending criteria which further compounds the problem.

The author does a fantastic job of explaining the complexity that evolved in the mortgage market over the last 10+ years. As a result, this book is a plethora of information on how the housing crisis has snowballed into what we are experiencing now.

The author explains everything in detail in an engaging and easy-to-understand narrative that even the most financially illerate person can understand. I would have rated this book TEN STARS if that option were available. “Financial Shock” is an outstanding text!

Review by Steven A. Peterson:

Do your eyes glaze over when commentators try to describe the financial products that were at the heart of the recent real estate boom? The mortgage boom? This book described the instruments clearly–and gives the reader a great sense of what was fundamentally wrong with the whole process. The title is “Chain of Blame,” but there is plenty of blame to go around.

The book is well written and lucid. Nonspecialists can understand it well. I heard talking heads on TV and radio described tranches, REITs, “liar loans,” “warehouse line of credit,” and so on. The authors describe these terms–and others–clearly and in such a way that the reader can begin to see what had happened–and why the meltdown in the mortgage world should not be seen as so surprising.

It is also the story of clever businessmen and women, who could develop new tools for investment from subprime loans. Subprime loans, simply, are (Page 325): “A loan originated by a lender that is A- to D in quality. Consumers with the best credit ratings. . .are considered ‘A’ credit quality.” In short, loans are being made to purchasers who carry some to a lot of risk. If they can’t keep paying their mortgages, the house of cards can fall down. And that is, in short, what happened (although the story is quite a bit more complex than that).

Among the innovators were pioneers such as Roland Arnall (of Ameriquest and Argent) and Bill Dallas (of Ownit Mortgage Solutions). Then, those who adopted practices of the innovators, such as Angelo Mozilo of Countrywide.

The book makes pretty clear that a number of factors contributed to the mortgage problem. Regulators didn’t get involved; Wall Street firms ignored the volatile nature of subprime loans in a desire to realize enormous profits; banks bought into the profitable business.

Anyway, if the reader wants a well written, if not overly deep, analysis of the mortgage crisis, this is not a bad place to start.

Review by BK:

This book clearly spells out what went wrong to precipitate the mortgage crisis that catapulted the financial markets into a global meltdown. The book uses simple language to describe complex concepts, which is very helpful to the financial novice like myself. In this sense, this book is wonderful.

However, the book is way too long. Some whole paragraphs are repeated almost verbatim in different chapters. Each paragraph chronicles the life and times of another major mortgage company. While this concept is ok for telling stories about the individuals involved in the business, it makes for highly repetitive reading, as the mistakes made by one company are often made by others. The first 150 pages is a tough slog of similar people and similar stories, but the book picks up steam in the final 150.

Finally, while this book does a great job of explaining the mortgage industry and their role in the financial crisis, the authors make a cursory explanation of what truly happened on the Wall Street side of things. (This isn’t too unexpected because the authors are mortgage experts.) For example, there is basically no mention of the subsequent credit crunch that was precipitated by the sub-prime mortgage disaster.

For a good explanation of what went wrong on the Wall Street side of things, I recommend ‘The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash’. That book is not an easy read, because the author expects the reader to have a solid understanding in Wall Street lingo. But ‘Chain of Blame’ is a useful primer.

Review by Sadiqa L. Dickens:

Randy Johnson is very informative and contains alot of useful information…once you understand what he is trying to explain. In my opinion this is not the book to read if you have absolutely NO idea how the mortgage process works and how and what lenders do in that process. If you are a total novice , the terminology Mr. Johnson throws around may sound very cryptic; and his examples might make sense to you if you were either a finance major in college or have some minor experience with terms of finance. In my opinon, the total novice should read another book for the basics before coming to this one . I recommend Eric Tyson’s Mortgages For Dummies. It is very concise, clear, easy to understand and concentrates solely on the basics. After you have acquired some basic knowledge of the lending process, then come back to Mr.Johsnon for some serious nuts and bolts tips and strategies. To me, that is the best way to maximize the insider info and stratagies mapped out in Mr. Johnson’s book. However, for those of you versed in the lending lingo and who have been around the block a time or two when it comes to the home buying process, this book is definitely a must read. You need look no further for info that really will help you to save money on your next loan or refinance(but I still recommend MFDs , it can compliment or elaborate on alot of the info mentioned in Randy’s book). So, all in all, a good read for the novice and for the semi-pro.

Review by BookGuy:

This is one of the books I bought when I bought my first house. It’s a fine reference source if you want to know what all the different mortgage options are (e.g., what’s the difference between a fixed-rate mortgage and an adjustable-rate mortgage, what indexes are ARMs tied to, etc.). And the author–Randy Johnson–makes honest recommendations on which mortgages best suit certain typical lifestyles or income scenarios. Also, one of the books great strengths is the discussion of how many discount points to pay. The one thing I found missing, though*, was at least one real-world scenario that you’re likely to see used if you visit a mortgage broker in my neck of the woods [Silicon Valley], or other high-priced regions. And that is the use of a ‘first’ and a ‘second’ mortgage in a so-called “piggyback financing” or “80-10-10 financing” arrangement which can help you eliminate Private Mortgage Insurance (PMI). There’s no in-depth discussion of this technique–which is very common–which I found incredible. There’s all this advice on getting an ARM tied to the CD index vs. the LIBOR index with a balloon payment if you stay in your house for 3 years instead of 10 years and so on and so forth…but nothing about getting a conforming, fixed-rate, 30-year first mortgage and a smaller second in a technique to reduce your overall payments during the lives of the loans. It’s a simple technique, and very worth a detailed analysis, but I couldn’t find it. Anyway, like I said, if you want to know esoteric information about mortgages, then this is a worthy book. It helped me, it’s just a little shy of a full-fledged 5-star effort.*Please Note: The review written above pertained to the 1st edition which I initially gave a 4-star rating. The second edition–which I now own also–has effectively covered “Piggyback” loans (i.e, 80-10-10 transactions), which I think propels this book into a solid 5-star work. The second edition also has updated information on shopping for a mortgage on the Internet, and some [though not all] of the examples that show different types of mortgages have had their interest rates brought more into line with present-day (i.e., 2002) rates. This is an excellent book for folks who want to know all about mortgages.