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Originally posted by Iceberg

Can any finance / investment guru explain how the US interest rate cut will help solve the sub prime problem?

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I am no guru, but here is an explanation in simple terms.


Let us say that in 2004 I took a 3 yr closed mortgage at 3.75%. When my mortgage came up for renewal this year , I had to lock in say 5.5%. In that case, I would have to pay a higher amount and maybe I can afford that higher amount or not, who knows. I might pay for a month or two and then not pay for several months and the bank sequesters my property.So by lowering the interest rate, the mortgage rates, inshallah, will also go down and if that isn't enough, then they will reduce it even more so that the increase in payment from 2004 levels is bearable.

This is the simple picture. I have even asked the mortgage gurus and even many are confounded as they say in all probability, the mortgage would have been a standard 25 year mortgage in 2004 and even at the new rate I can now go for a 30 year term and pay perhaps even less than I was actually paying before.

The real analysis and diagnosis still has to be done, though. Maybe there is something even deeper.

Perhaps another maven on CD can come to the rescue.

Anybody?

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Originally posted by chandresh

FED has cut the funds and discount rate by 50 bp each - the maximum that market had expected - and so US$ is going down like hell. USD/CAD has already touched a low of 1.0184 interbank and Euro went up to 1.3962.
For all practical purposed, USD and CAD are now the same!
My personal loss - unimaginable!

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Chandresh,
Was the move not anticipated?. Traders were saying either 25 bp or 50 bp. Every one was sure that the US$ will come down because of a reduction of US interest rates. You and Desi no 1 should have chaged currencies and switched back later atleast to minimise losses. Isn't that what FOREX is all about?
I am amazed as to how you missed this very valuable clue.
TK A

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Originally posted by investpro

Quote:

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Originally posted by Iceberg

Can any finance / investment guru explain how the US interest rate cut will help solve the sub prime problem?

---

I am no guru, but here is an explanation in simple terms.


Let us say that in 2004 I took a 3 yr closed mortgage at 3.75%. When my mortgage came up for renewal this year , I had to lock in say 5.5%. In that case, I would have to pay a higher amount and maybe I can afford that higher amount or not, who knows. I might pay for a month or two and then not pay for several months and the bank sequesters my property.So by lowering the interest rate, the mortgage rates, inshallah, will also go down and if that isn't enough, then they will reduce it even more so that the increase in payment from 2004 levels is bearable.

This is the simple picture. I have even asked the mortgage gurus and even many are confounded as they say in all probability, the mortgage would have been a standard 25 year mortgage in 2004 and even at the new rate I can now go for a 30 year term and pay perhaps even less than I was actually paying before.

The real analysis and diagnosis still has to be done, though. Maybe there is something even deeper.

Perhaps another maven on CD can come to the rescue.

Anybody?

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I will take a shot at this. See if this will make some sense.
Take a very nice city in the US of A. and in that city I will provide you with a scenerio where in one individual, who is living in the older part of town, has been living in there for forty years and is now retired. The property when he bought was worth $30,000 at the time of purchase. Remember it is an older house with bare walls, no insulation, does not have the latest of heating system, no A/c to cool and this individual is currently finding it difficult to even pay taxes and maintain it, due to poor pension and cost of living and is encountering difficulties;...
He now meets with a willing banker who is extending him funds to improve the property and spruce it up. This individual is now building more equity in his property after improvements. The city now says 'we' are going tax 'you' as per current 'market valuation' and the property is now worth $300,000.00. A favourable property evaluvator and a gang of property flippers push the property up to half a million bucks in a period of few months and they find a buyer and get him to hold the sack and walk away with a sizeable chunk of money. At 3-1/4 and 3-1/2 % interest they were able to hold the mortgage with their salary. But if they were in a variable rate or when the feds raised the rate and the current owner finds it difficult to maintain, walk away from the peoperty. Lots of blue collared workers lost their jobs due to closure of industries, due to oversaturation and the down turn in the industry and then the economy etc., etc.,
They also enjoyed living in these homes as long as they were working and the mortgage interest was available to be deducted from their income. Some even got into multiple flippings.
More over, because some of these guys were getting 105% of the value of the house as mortgage, could not care what happened to it. It is like the water off the ducks back. Don't forget that these blue collared workers were contributing $60,000 to $70,000 to the GDP per annum, currently wirh no income, they now end up in the mobile home park, on the pokey.
In the meantime the loan, which is an instrument, has hit the wall street and all these bankers who are in a favourable position to borrow the FED funds now have all of these not so worthy loans and mortgages loaded up in their books.
The housing market gets saturated with newer homes and the demand slackens off. The older homes that were spruced up now looses value faster and there is no one to care for them, no heat or with no maintainance, looks dilapidated and the bank steps in and takes over the property, but first the city gets the 'first call' on the asset and locks the place up and boards it. Vandals and riff raffs take over the place. This is now becomes the sight for the sore eyes. The domino effect takes over the whole neighbothood. There are more forclosutrs and the entire area looses value. Schools close, shops are no longer in business around that area. Plazas are bare. It becomes a deserted area and takes a different look, more like slums.
Flooding the market with newer homes and providing the buyers with more than what the house really costs, and with no income verification, and extremely low interest rates to property buyers which generated substatial revenues to a lot of bankers in the initial stages has now returned to haunt them and in hind sight find all of these as sub prime loan activities, that they should not have entertained and ought to have monitored and scrutinised in time to catch them.
Well.... it sure is a land of opportunity and a few did make a small fortune out of this. Now we find a lot of good people homeless and on the streets. That is the sad part.

There is more to it. And you take it from here.

Freddie.

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Originally posted by GlobalIndian

I sure hope they will come to their senses and begin to raise the rates once again... I was hoping the US will slowly slide into a long recession and sustain high rates. But what do I know. I still hope the recession will hit the US... All these hodge-podge measures can not cover the deep holes in the economy.

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Why do you hope US will slide into recession? You should know world economy is tightly knit now. You can’t view US economy in isolation. If US goes into recession, Canada and India will too go into recession along with rest of the world. China, Japan and India together still don’t drive the world economy. Wish well! Wish good.
Mind you recession and high rates don’t go together in capitalist economy.