Average Reviews:
(More customer reviews)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 ($1 Trillion versus $250B).
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
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Financial Shock: A 360ยบ Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis"The obvious place to start is the financial crisis and the clearest guide to it that I've read is Financial Shock by Mark Zandi. ... it is an impressively lucid guide to the big issues."
—The New York Times
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