The liquidity crunch and your home
For years, I have advocated the importance of liquidity and how critical it is to individuals and to economies. What I mean by liquidity is having the cash available to respond appropriately when life’s circumstances come knocking on your door; whether they are knocks of adversity or opportunity. We all know it is going to happen. The primary question is: “Will you be prepared”?
When we watched the mortgage market contract dramatically over the last several months, we witnessed a liquidity crunch emerge on a macro level almost overnight. Essentially, what happened was that many large mortgage lenders were not prepared. You see, these lenders developed loan programs based on guidelines that were designed by Wall Street investment firms that were looking for ways to provide better rates of returns for their clients. We all know that with increased returns come increased risks.
Next, the mortgage lenders made the loan programs available to their network of banks and mortgage brokers, who subsequently found borrowers like you and me, who needed the lenders for the purchase or refinancing of real estate. These lenders would fund the loans and their operations, using large lines of credit provided by many sources, including the investment firms themselves. Once the loans were “closed and funded” (sold to the borrowers), the lenders packaged millions of dollars worth of the mortgage notes and sold them to the Wall Street investment firms that would subsequently sell them to the general public in the form of securities. The sale of the securities in the marketplace generated cash and provided additional liquidity back to the investment firms and subsequently to the lenders; then the whole cycle started all over again. As long as the mortgage lender was able to sell its loans at a profit to investors in the public markets, everything was fine.
However, home appreciation and home sales eventually slowed down. Interest rates for many of the aforementioned loans started to adjust to levels that were outside the budget of the borrowers who took them out. That’s when things got a bit sticky. Add to the mix that Wall Street began to realize that foreclosure rates were higher than expected, well…the whole thing began to unravel. The Wall Street investors quickly lost their appetite for the loans and stopped purchasing them from the lenders. Because many of the lenders had very little access to cash outside of the lines of credit provided by others, it did not take long for them to run out of money.
Was this a series of unfortunate events or the perfect storm? Who really knows? The reality is that once Wall Street evaluates the appropriate levels of risk that need to be attached to the various types of mortgage programs, there will be more liquidity once again. We have already started to see the markets begin to come back. Very few believe that the programs will be as flexible as they were during the last few years, but there will be plenty of opportunity for people to borrow money to purchase and refinance real estate.
What I find particularly interesting is that this macro economic experience is no different than what most Americans are on the verge of every day. By leaving the equity trapped in the bricks and mortar of their homes, and having very little liquidity available themselves, they are just one unfortunate event away from a personal financial disaster. We regularly show people how to safely reposition the equity in real estate into a side fund that provides them with the liquidity, choice, and control they need to respond to the knocks of adversity and opportunity.
As you develop your goals and plans for 2008, make sure that you consider the importance of liquidity in the management and optimization of your personal finances and resources. When you accomplish this, you will have the confidence of knowing that you are prepared for just about anything life presents to you - whether it is adversity or opportunity.
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