Investor Homework Assignment: Go See “The Big Short”

Business, Investing on February 3rd, 2016 Comments Off on Investor Homework Assignment: Go See “The Big Short”

TheBigShortI recently saw the movie The Big Short, and it blew me away. In fact, I plan to make it required viewing for all my mentoring clients and will definitely make my kid watch it when he’s old enough to understand it. I found the story cautionary and yet tragic, because we as humans always repeat history, so all we can do is prepare for it. Some will profit, some will panic, and some will stock up on guns, food and water filters for the apocalypse that may accompany it one of these times.

The movie (based on a true story) follows three separate but parallel stories of people working in high-finance who predict the US mortgage housing crisis of 2008 and then bet against the banks, hoping to make a huge profit when their predictions prove true, and expose all the terrible flaws in our banking and Wall Street system today. It also touches on the human side of things, in a humorous way.

Maybe it particularly resonated with me because I came from the banking industry and was there when Bear Stearns and the others started to go down — it was the perfect storm for the mortgage and banking industries. I was new to real estate back then, but not to finance and we processed a TON of “CDS”s as they came to be known, or “credit default swaps” as you find in the movie (keep reading).

I admit I’m a banking and financing nerd, AND I think anyone investing in real estate will find the movie a valuable education. It discusses how mortgages work and how mortgage-backed securities (MBS) were created in the 1980s, which are basically a whole bunch of mortgages grouped together that you can invest in, which then began to be rated by the traditional security ratings agencies (S&P, Moody, etc).

The main characters in the movie then discover that while these funds have AAA ratings, they’re backed by boatloads of non-performing and subprime mortgages. The smart people decided to bet against those loans at the big banks in something called credit default swaps (Ah! There it is.). One of the characters literally goes to one of the biggest banks around, and tells them he wants to buy these things, which would pay out if the mortgages fail that are behind it – and since “real estate always goes up,” the banks laughed while they took his money. And we know what happened next.

In case you haven’t seen the movie yet, Wikipedia has a helpful primer on mortgage backed securities.

Ok, I’ll stop now so you can go see the movie. And in case you’re not convinced yet, here are 5 reasons you should go:

Bubbles floating1. We’re in a real-estate bubble

Signs of a bubble: Rising prices, but incomes and job creation are not rising at the same pace to meet it — the numbers being reported by the Fed do NOT take into consideration people who stop claiming unemployment because they’re past the 6 month mark. What does that mean? People are starting to get priced out of the market… and… see below:

2. We’re in a “Phase II Seller’s Market”

This means sellers have known for a while now that there’s a lack of inventory, and they can get the prices they want if they hold out for the right buyer, who was following the trend and just HAD to get into THAT house, right NOW. The challenge here is that it can only last for so long, just like in every real estate cycle. Inventory starts to shift, or buyers start to dry up due to economic factors that no longer allow them to buy such an expensive house, and prices start to adjust slightly. Don’t believe me? Check out new construction pricing in the higher end communities — Bedford, Lexington, Andover — yes, luxury typically can always sell to a luxury buyer, who may be less affected by shifts in the economy — but what about all those buyers looking at homes between $600K and $1.2M? Check the price declines in YOUR area.

3. The warning signs are all around us

Our agent and in-house statistician (Shaun) has been pulling stats on every town in MA and southern NH for a while now, and the trend is clearly there. His report on foreclosure petitions perhaps is most telling. One can only speculate on why the number of petitions may be up 50% in 2015 from 2014 (see article for drilldown), but the fact is that there are a lot of people having more and more trouble paying their mortgages. And with the legislation that helped clear title from the Ibanez homes (the homes that were stuck in a legal battle, former homeowner vs. their lender on the foreclosure proceedings), don’t be surprised when that first wave of foreclosure inventory starts to hit the MLS. Even if released slowly, it will have a dramatic impact on pricing, over time. Another reason to think we’re about to have a signficant decline in pricing.

4. Educating yourself is the first step to protect yourself

What happens when you pair overly-cautious buyers with lower-priced foreclosure inventory and a lot of loans about to go bad? I don’t think we’re set for another HUGE crash like in 2007-2008, but you should definitely prepare for sharp price declines, and then watch the flood of scared buyers sit on the sidelines again, and wait as we enter a BUYERS MARKET Phase I, when we finally start to see good inventory at opportunity pricing again. For an INVESTOR, this is definitely a great time to get in the game — unlike most newbies, who love to get “in while the water is hot,” but like me, they jump in when it’s TOO hot in 2005, and get burned. (See my post on what happened to me HERE, if you’re new to my blog!)

5. It features a stellar cast and is hailed by Variety as “a spinach smoothie skillfully disguised as junk food.”

Keep calm, educate yourself, and rehab on.

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