There are many who predicted the inevitable crash of the US housing market, but others were shocked when a market that had plenty of go over the past few years began it's downward slide. One of the main causes of the current tumble was the crumbling of the subprime market. Because of many subprime loans, companies were quickly faced with foreclosure. Even if companies weren't facing foreclosure, they saw the loss of billions of dollars. The news has been filled with reports regarding the subprime market crash; however, while it has affected most property owners to some degree there remain many of remain uncertain exactly how this came to be. A few years ago many property buyers found subprime mortgages as a great advantage. Low credit ratings, eager buyers and institutions willing to give out subprime loans combined to allow investors to buy properties rapidly. On subprime loans, the underwriting guidelines are are easier to meet than on more convential mortgages. These gave people with poor credit a chance to obtain a loan. Lenders were able to charge higher rates of interest to these buyers with less than good credit. Additionally, lenders had the belief that if they had to foreclose on the home due to non-payment, they would be able to sell the property at a profit. The money which funded these loans came from a variety of sources. Low interest rates made it possible in many instances for lenders to actually borrow money and then loan out those funds to home buyers. In other cases, the money was obtained from more complicated sources. As you may or may not be aware, it is not uncommon for governments to borrow money from central banks. This practice is particularly common in the United States. At this point in time the housing market was stable. The real estate market was seeing a high that had not been seen in quite a few years. In addition to many homeowners taking an massive debt they couldn't afford, there is another problem. The forecasts for the real estate market were completely unrealistic. Future growth was predicted at double digits for an infinite number of years, it seemed. The last two years of the real estate boom occurred in 2005 and 2006. During that time period lenders did not hesitate in the least to lend money to borrowers regardless of their credit profile. These loans represented a tremendous money-making opportunity for lenders. Problems really began to occur; however, when interest rates began to rise from their previous lows. Historically, rising interest rates have always had a negative effect on the real estate market. When rates are low they help to produce demand; however, when they are high they ultimately cause prices to fall. Until mid-2006 home builders could not build new homes fast enough to meet the growing demand. During mid-year; however, the demand began to slow. It was also about this time that the rate of defaults on loans began to increase. Very soon many mortgage lenders began to find it hard to access money from their previous sources of funding. As a result, most would be buyers found it harder to obtain loans as cheap money to the lenders was harder to find. In addition, investors became wary of the increasing risk and made their underwriting guidelines stricter. Homeowners with adjustable rate mortgages began to find it hard to meet their monthly mortgage payments in the face of increasing interest rates. When they tried to refinance with the stricter underwriting guidelines, they found it impossible to obtain a fixed rate mortgage. As a result, defaults continued to rise fueling a huge mass of foreclosures.
The third week of September, 2008 saw one of the biggest crises ever to exist on Wall Street. It's not every week that starts with a major investment bank, Lehman Brothers, filing for bankruptcy and ends with a massive rally prompted by the U.S. government's willingness to bail out struggling banks.
Some analysts, however, suggested the jubilance would be short-lived. Seattle hedge-fund manager Bill Fleckenstein predicted the U.S. government's moves are bound to fall flat given the weighty problems plaguing the world's biggest economy.
"They're not going to fix the fundamental problem that the homeowner has a house he can't afford. The economy is weak and getting weaker," he said. Fleckenstein has long warned about many of the problems, such as unrealistic real estate prices and excessive consumer and government debt, now plaguing the United States. He argues there was a "complete abdication of responsibility on the part of regulators."
Is there a ready solution for this market crisis? Warren Buffett, the world's second richest man, responded on Friday by announcing he was buying Constellation Energy, a company badly beaten down by the market. But he also responded by staying put in the market. Warren Buffett's Berkshire Hathaway Inc. which has avoided major acquisitions in the financial sector in recent months, may have had a $3.5 billion two-day paper profit on six major banking and financial services investments.
Buffett has long favored investments in undervalued businesses with strong earnings and management. That has helped him transform Berkshire since 1965 from a failing textile maker into a conglomerate with at least 76 companies.
"He's always felt Wells was very well-managed," said Frank Betz, who oversees more than $800 million at Carret/Zane Capital Management LLP in Warren, New Jersey. "Why does he like banks? Like Willie Sutton said, it's where the money is."
In times of crisis, it is wise to follow leaders. Here's some of his wisdom (taken from Andrew Kilpatrick's Of Permanent Value.
" I am not in the business of predicting general stock market or business fluctuations. If you think I can do this, or think it is essential to an investment program, you should not be in the partnership." Buffet partnership letter, July, 1966.
"As Ben Graham sad "In the long run, the market is a weighing machine _ in the short run, a voting machine [OR WRECKING BALL, SOME SAY!] I have always found it easier to evaluate weights dictated by fundamentals than votes dictated by psychology . Buffett partnership letter, 1969
"The sillier the market's behavior, the greater the opportunity for the business like investor. Follow [Ben] Graham and you will profit from the folly rather than participate in it." Preface to the fourth edition of The Intelligent Investor, 1973
"The market, like the Lord, helps those who help themselves. But unlike the Lord, the market does not forgive them who do not know what they do," 1982 Annual Report
"I don't know what it'll (the stock market) will do tomorrow or next week or next year. But I do know that over a period of 10 or 20 years you'll have some very enthusiastic markets and some very depressed markets. The trick is to take advantage of the markets rather than letting them panic you into the wrong action. (widely quoted).
"Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised." (Fortune, December 19, 1988).
"Stocks are simple. All you do is buy is buy shares in a great business is intrinsically worth, with management of the highest integrity and ability. Then you own those shares forever." (Forbes, August, 1990).
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