January 14, 2008

Leverage - it'll wipe you out real quick on the way down

Buy $15,000 worth of stock using $10,000 of your own money and the max 50% margin limit from your brokerage, and the stock falls 30%, you just lost $4,500 or 45%, and you say "damn, that sucks"

Buy a $500,000 house using $10,000 of your own money and the rest mortgaged from the bank and the house falls 30%, you just lost $150,000 or 1500%, and you say "damn, I'm bankrupt"

Want to lose some serious money? Gamble on real estate with insane leverage. You can lose everything in just a few months.

This will make 1929 look like a cakewalk. And it was because of out-of-control leverage.

25 comments:

Anonymous said...

Sell that stock for $8.95 in one second

Sell that house for $40,000 in one year

Anonymous said...

Plus you cannot declare the losses in the sale of a home on your taxes like you can do for "investment losses" because a primary residence is a home & not an investment! (Contrary to what realtwhores spew!! Its the tax code the counts!!!)

i.e. - (purchase price - lower sale price = a total loss with no income tax offset for the loss!!!)

Why? Because Uncle Sugar knows that RE sometimes goes down and he does not want to have his revenue taking a hit for the RE market cycles they create/induce!!!

Semi-Unemployed Loan Officer said...

I knew this was coming!
As a Loan Officer for a bank I kept thinking it was insane for our bank to keep making zero down loans to investors. It seemed everyone was trying to buy an investment property with zero cash. I had one customer, a hairdresser, who bought 4 properties all zero down, no income verification. In almost every case, the rental income these investors are making is not enough to cover the PITI payment. I would point this out to them but they had to get in on the Gold Rush too.
I now am seeing groups of rental houses listed for sale all advertizing "short sale".
One guy who was my customer owned 3 townhouses in Scottsdale all rented with a $1,200 per month loss. He told me he didn't care about the rental losses when the property was appreciating at $3,000+ per month.
Take it from me-- a bank insider-- there are thousands of Casey Serins out there. Most have decent paying jobs, savings, and 750 credit scores. They have covered the monthly negative cash flow so far; hoping and praying the market turns back around and they can just break even. Eventually, it will eat away their savings, eat away their will, and they will realize it's easier to walk away too.
STAY TUNED HPers, YOU HAVEN"T SEEN ANYTHING YET!

Anonymous said...

You want to talk about leverage?

How about put options?

I bought some "priced for perfection" COSTCO puts (PRQSJ) for $1.20, they went down to $0.60 (50% loss) then up $1.35 (12.5% gain), then back down to $1.20 (break even). Then I sold them. This happened over a period of less than a month.

But, I did make 400% profit on my CFC puts, and that was AFTER the buyout was announced. Banks really are too big/too important to fail. But we'll see...

The thing with put options is that at least I know it's high risk, and the fluctuations happen over days or weeks, not months or years.

I did make a 100% profit on a unit, but I held onto it for eight years, moved into it, fixed it up (with the help of some skilled friends), and sold it about one year too early, but it's difficult to time the markets. (It was cash flow positive too, with a P/E of 12.5 - In fact the real estate agents used to advertise this fact - "look, it's a dump, but it produces 8% rental returns" - This is in Australia).

I think people who bought investment properties with the aim of selling them within 12 months for a big profit, took bigger risks than I'm taking with options. At least my risks are limited to the premium, those flippers are stuck with multi-hundred thousand dollar losses, and loans they can't afford to pay.

Leverage!

wc said...

The 30% loss on a house is not as much of an issue if you actually plan to live in for 20-30 years - assuming you can comfortably afford your payments. Americans have really bad long term memory making it very likely to lead to another up cycle within the next 20 years. Investors and people that thought their lenders had their best interests in mind are totally screwed. Sadly the rest of us are going to have to pay for the party we chose not to attend.

Brian said...

Know what drives me bananas about those idiots, Keith?

That all those people who thought they were so smart using "leverage" FORGOT COMPLETELY which end of the lever they were on.

Here's the diagram:

buyer...................debt
----------------------------
_____^______________________

This is not leverage - it is the opposite. The buyer holds the short lever and monetary inflation does the lifting on the other side.

If the price inflation stops, well, here comes the debt down to wipe you out.

NO ONE is 'levering up' their gains. They are amplifying gains to be sure, but a far better analogy for what homedebtors do would be drafting, a la Nascar, etc. You get a bit of free ride from the car in front of you (inflation) until it runs out of gas.

Brian

Honest Abe said...

Leverage is the key behind derivative instruments. So how quickly can we bankrupt the entire system using derivatives?

born to lose said...

That picture isn't so scary if the guy the bottom of the see-saw can just jump off.

If you put nothing down you cant lose any money. It was all reward no risk.

Even if the house is worth 100k less, thats the banks loss.
The buyer's teaser rate was less than rent, then just stop making payments and live rent free for 6 months to a year.

The funny thing, is now these people are being forced to rent at the BEST POSSIBLE TIME to be a renter.

This crash is worse than a stock market crash because a lot of people with no money, lost a lot of money and just walked away.

Anonymous said...

It's so funny that you think someone put down $10,000 on a home in the past few years.

Most buyers leveraged 100% of the purchase price.

Financial Death.

Jymkata

edd said...

"…house falls 30%, you just lost $150,000 or 1500%, and you say "damn, I'm bankrupt"
---------------------------------
This might be amended to add:
"…if I can't sell it now at a huge
loss covered with penalized
withdrawals from my retirement
accounts, or make the payments
for X years then sell at a
bearable loss after eating ramen
20 times a week and selling
counterfeit Rolex watches from
my car to pay for my mortgage
and drug addiction."

Anonymous said...

ATTENTION HP-Shoppers!!

( based on some old "Buy now - No Money Down , Cash Back scheme" )

Here is how this mess works.

1) Get a "creative mortgage". You just dont put any of your money down. Lying is a PLUS, greedy bank and brokers don't care so go and lie some more!

2) Get an appraiser to lie about the price of the house. Your broker knows some ex-cons.
Even better, get the seller to come up with cash - back "under the table".

3) Try to sell for profit. Add a couple of plywood drawers and screw the next idiot.

4) Go back to step one, get another property and Lie Some More. But if things go south go to step 5)

5) Stop paying all your properties, but COLLECT Rent. It is taking about 12 to 18 months to foreclose a property. So 10 houses*1400 a month....do the math.

In the end, the "investor/liar/scumbag" pockets tons of money: money on the purchase, money on the sell or money on the collected rents".

Then walks away and the only thing he will miss is his credit report.

But WAIT!.... he has filed for bankruptcy back in 1997... so he knows how to work the system.

Sorry,sad... but true

edd said...

Maybe soon private mortgage
insurance companies will file
actions for civil and criminal
conspiracy, and deceptive trade
practices, due to losses caused
by reic confidence games.

And maybe some PMI's were in
on the schemes when defaults
and foreclosures could be a
net revenue stream.

One PMI has lost class-action suits recently (eg, Brantley v
RMIC, Barnes v RMIC).

On another note ...
The auction lists in my Ohio county
have shown a trend recently of
appraised values being well below
the mortgage balances as the
values fall and the creative
mortgages come home to roost.
Short sale now, or shorter later.

Anonymous said...

Do you really think the government will allow the real estate market to crash? Especially in an election year? The government will slash interest rates, buy up the mortgages that no one else wants, give credits, change tax laws, etc... and other actions to prevent this from happening. If you believe that the government will just stand by and do nothing, then you are an idiot. A complete idiot at that. I can't wait to see the government help out homeowners and then this blog will explode in anger.

edd said...

We need to see reic perp walks
on the news this year.

If current regulation, or lack
therof, doesn't prevent scams,
then scammers need to worry about their career choices.

They can't find enough diesel
mechanics, nurses, programmers.
But we have a glut of con artists
now looking for the next con, or
the cocaine distribution biz.

Anonymous said...

A lot of people bought properties for zero down. So they actually have nothing to lose if they just walk away and mail in the keys Keith. So you are wrong.

Anonymous said...

Anonymous said...

Do you really think the government will allow the real estate market to crash? Especially in an election year? The government will slash interest rates, buy up the mortgages that no one else wants, give credits, change tax laws, etc... and other actions to prevent this from happening. If you believe that the government will just stand by and do nothing, then you are an idiot. A complete idiot at that. I can't wait to see the government help out homeowners and then this blog will explode in anger. January 14, 2008 6:37 PM

You're trolling right? Scroll down and watch the Glen Beck/Head of GAO tell you how screwed it all is. The U.S. govt is broke, bankrupt, totally insolvent and in debt to the entire world. They ain't gonna be saving anybody. This blog exploded in anger years ago. Everyone appears to be more or less resigned now. The govt isn't your Mom and Dad anymore. They spent the cookie jar money.

Andrew Hac said...

Quote:
#####
This will make 1929 look like a cakewalk. And it was because of out-of-control leverage.
#####

This will make the average home-debtor, CC-debtor shit in their pants due to uncontrollable panicky reaction.

Out-of-control leverage is a mild term. I would say "Freaking brain dead, stupid-ass S.O.B, poorer-than-a-beggar but want to live like Michael Jordan damn trailer white trash" is the main stream of this Americano bubble crisis and CC crisis.

Yes, hooray on the news:
"Citigroup could write down as much as $24 billion due to subprime and credit-related losses, CNBC has learned. In addition, the company could lay off as many as 20,000 workers as part of a comprehensive plan to slash costs and raise capital."

Damn the Americano !

Happy Homedebtor said...

Poor, poor Keith - unlike a stock, you don't lose "everything". Your house is securitized by the house itself, so you lose the house. You really should take a basic economics class. The bank forecloses, they lose a ton, and it's nearly impossible for them to come after you for the diff - hence it's very stupid to not work something out to keep someone out of foreclosure. You know who's going to bail the banks and us homedebtors out? People like you and HP'ers that don't "own", along with homedebtors - the diff being we get to keep our houses, you get...higher taxes.

This isn't fantasy, this is reality son - books only tell you theory.

eric in vegas said...

"I can't wait to see the government help out homeowners"

How would their lame bailout plans that are doomed to fail going to help them?

Frank@Scottsdale-Sucks.com said...

Let's not forget, on top of losing $150,000 on the house, the average dumb homedebtor who was stupid enough to buy at the top also took out 2nd mortgages and HELOCs to pay for the Hummer H2, vacations, botox, plastic surgery, private school for the kids, etc etc etc.

So on top of that $150k loss most have another six figures in consumer debt.

k.w. - southern, ca. said...

Beyond Schiller and Schiff, I'm not sure how much more information people need to see to accept the fact that house prices *must drop way down* before any real appreciable buying starts again.

The problem is, for appreciable buying to really start, the econony - beyond the public sector - had better start picking up.

However, with the eagerness of CEO's to outsource as much as they can, I don't see much promise for future employment with decent wages in this country for too many of our citizens.

Batman said...

To Happy Homedebtor:

Yes, you are right, the homeowner walks away with only their credit rating killed. They also take a tax haircut since the writedown from the bank gets sent to them in the form of taxable income.

But you're right, after that, U.S. taxpayers pay the rest. But if enough bagholders offshore get pissed, the U.S. investment capital influx (recycle) coming from offshore can dry up. That is a death knell to the U.S. economy.

Frank@Scottsdale-Sucks.com said...

Beyond Schiller and Schiff, I'm not sure how much more information people need to see to accept the fact that house prices *must drop way down* before any real appreciable buying starts again.

No amount of information is going to convince the holdouts who insist that there's no crash. Remember that homedebtors who are f*cked are in total denial. The emotional impact of accepting financial ruin is just too much to bear so they deny it and tell themselves everything will be fine.

And for the few homedebtors who bought at the peak, who got real loans or who have high enough incomes to make the payments, everything really will be fine, but for the 90% who bought at the peak who got suckered (and it's at least 90% because nobody with a brain bought at the peak), they're going to be financially ruined for a long, long time.

Anonymous said...

anon said...
Do you really think the government will allow the real estate market to crash? Especially in an election year? The government will slash interest rates, buy up the mortgages that no one else wants, give credits, change tax laws, etc... and other actions to prevent this from happening. If you believe that the government will just stand by and do nothing, then you are an idiot. A complete idiot at that. I can't wait to see the government help out homeowners and then this blog will explode in anger.
___________________________________

Um, Japan couldn't stop their housing bust, and they spent trillions trying to stop a deflationary cycle. We're now 18 years past peak in Japan and real estate prices are STILL FALLING!

Total value of US Residential Real Estate is currently about $20 TRILLION (and I'm not even including commercial or industrial real estate). That's about 1.5x our current GDP and more than 6x the Federal Government's annual budget.

WTF can the Government do to stop that from going down? Anything they do will just be a drop in the bucket.

Jymkata

bob said...

Buy a $500,000 house using $10,000 of your own money and the rest mortgaged from the bank and the house falls 30%, you just lost $150,000 or 1500%, and you say "damn, I'm bankrupt"

Not exactly. If you can afford the payments, if you didn't do stupid financing, and you don't have to move or otherwise sell your home for a long time, it may not mean that much. Odds are 10 or 15 years from now, you'll get out in one piece. Not happy, not richer, but not mortally wounded. It certainly doesn't mean that you have to declare bankruptcy, if you have income and are paying all the bills and living within your means, though if you calculate your net worth right now, it certainly is depressing.


The deal where leverage can kill you right now is when you borrow to buy something and the loan is called (think margin call in the stock market). Thank god they made that crap illegal (on home mortgages anyhow) after the big D.