Dallas Refinance Guide

If you’ve been paying attention at all to the news lately (and it is probably safe to say that the majority of folks with a Dallas home loan have been), you’ve probably heard a lot of discussion (fighting) about the rule called “Mark to Market” and whether or not changes need to be made to it.

What exactly is Mark to Market and what does it mean? Is this going to have any affect on the general housing market, and more importantly, how might it directly affect your Dallas home mortgage?

We’re going to try to give an explanation of it below so you can better understand what it is, and more significantly, understand how it has played such a important role in our existing economic crisis, which includes the Dallas mortgage market. It may come as a surprise to you to discover that this accounting stipulation (i.e. law) has significantly more to do with the economic crisis than probably anything else.

Before we even look at how Dallas mortgage rates are affected, let us first discuss why Mark to Market exists at all

To grasp Congress’ motivation behind creating this accounting regulation, we need to go back and look at the stock market crash of 2000 – 2002.

At that time, before this rule was created, companies such as Arthur Anderson, Enron and others figured out ways of ‘cooking their books’ in order to make the balance sheets seem significantly healthier than they truly were. This, in turn, assisted their stock values to be falsely high, contributing to the ‘bubble’ that, as we all know, eventually popped. When that occurred,many, many people lost all kinds of money. To suggest they were unhappy is more than an understatement. Something neededto be done.

The idea of “Mark to Market” accounting was created in an attempt to make things significantly more transparent and to be sure of fair valuation of companies and their assets. Basically, what it means is that all assets must be valued as if they were sold on a daily basis. For those dissenters who decided not to do this conservatively, they put themselves at risk for potential jail time.

Let’s now take a look at how this rule can create a problem affecting the whole economy, including Dallas mortgages.

When you think about the massive amounts of money handled by banks - and the vast (and bizarre) variations of financial instruments they use, - it can be challenging to attempt to get one’s mind around exactly what it is they do. It will be simpler to describe how this accounting system works using an analogy more approachable to the rest of us.

Let us say you live in a neighborhood and all the houses are worth about $200,000. Let’s also imagine that your neighbor owns his house free-and-clear.

Suddenly, you neighbor has some major medical expenses and needs to sell his house in order to pay for them. He needs his money right now and does not have the luxury to shop for a Dallas refinance, and he isn’t in any position to wait for the best offer he can get. So rather than wait, he sells his house for $150,000 to get rid of it fast, even though it’s obvious that the house is worth considerably more than that.

If you so happened to live across the street in an identical house, does the fact that your neighbor’s house sold for $150,000 mean your property just lost 25 percent of its value? No, of course that’s not accurate. If you decided to sell your house, you would take the time needed and get the fair market price for it; you wouldn’t be forced into a “fire sale” situation.

However, if you were a publicly traded company and were required by law to go by the Mark to Market accounting rules, you, and all of your neighbors as well, would now have to claim that your home was now only worth $150,000 instead of the $200,000 everyone knows to be the true value.

Let’s take a look at how this would apply to a bank.

Let’s continue with the ‘make believe’ to further the explanation.

We’re going to pretend you decided to begin a brand new bank, called YOUR BANK. You get started with a $2 million initial purse to get Your Bank going. Your strategy to make money as a bank is to take in the public’s money as deposits, paying them a low but safe rate of return, and then using the money to create loans, such as Dallas home loans, that pay you a higher rate of return. The difference between the two is the profit you keep.

Let’s say that from our $2 million of deposits, we created $30,000,000 of loans. Our Capital Ratio (the ratio of loans to capital on hand) is at a comfortable 15:1 ($15 million in loans for every $1 million in deposits). This ratio is completely acceptable by banking standards.

We’re going to say that you run an extremely conservative bank, and the Dallas loans Your Bank agrees to make are only of the absolute highest quality. For example, you require a 30 percent down-payment (normal is 20%, or sometimes even less), a credit score over 800 (this would be an extremely high credit score), you require full documentation of all income and assets and only allow a DTI(debt-to-income) ratio of 10 percent (40% is the industry norm).

It’s abundantly clear, Your Bank will only make an excellent quality Dallas loan. And it is evident. All your borrowers are paying on schedule, no one is unhappy and Your Bank is making plenty of money. This causes Your Bank stock to continue to climb.

Very quickly, the Dallas real estate market starts to slow down a lot and go soft, and Dallas home values start dropping (but your borrowers continue to make all their payments on time, with no problem).

The problem is, with the systemic drop in home values, you have to re-assess your loan portfolio value. Now, the loans aren’t 70% of the value of the home, they are now at 90% (your equity position in the home just went down a lot). This means these loans are significantly riskier than back when you had a lot more equity, and since they are higher risk investments, people are less interested in buying them than before and therefore they have less value.

Now comes your accounting team to let you know that, according to law, you need to “Mark to Market” if you do not want to risk a serious penalty (such as jail time!) In the Mark to Market analysis, it is estimated that Your Bank is now at $1,000,000; it has been cut by 50%!

Don’t forget, not a thing has changed regarding your borrowers or your loans (they all still pay on time so the funds are still coming in just like it always has). Now however you now must reflect the fact that the ‘value’ of Your Bank has been cut by 50% to only $1,000,000.

Here’s the thing; you still have $30,000,000 in loans outstanding, and with a valuation of only $1,000,000, your capital ratio is now at at 30:1 which is a LOT different than 15:1.

Alarm bells start going off everywhere because it’s a concern that with just a handful of bad loans that you would have to cover, you might quickly run out of funds. This would place depositors at risk of losing their deposits.

So now suddenly the FDIC starts looking into Your Bank and after that the SEC (Securities and Exchange Commission) is asking all kinds of questions. Your Bank stock price begins to to fall. Every one of the financial news networks hear of the situation and just add fuel to the fire.

Your Bank is in some serious trouble.

The problem is, Your Bank is ‘over leveraged’, and to counteract for that you will be forced to start selling off some assets. (Another option could be to try to raise some capital, but considering the way the situation looks and your capital ratios totally out of whack, no one is going to be willing to lend you the $1,000,000 you need).

Since you need to get that money as soon as possible, you find yourself in a situation similar to that of your neighbor who was forced to ‘dump’ his property quickly at a below-market price. As you sell your assets to raise capital fast, at the same time you are reducing the value (i.e. quantity) of assets you own, further skewing your capital ratios.

This is a kind of death spiral that is nearly impossible to stop once it begins. The other issue is, the problem does not stop with just Your Bank.

Let’s now imagine that my Dallas mortgage company (we will call it “My Bank”) bought those assets from you. You were unloading them at such a low price that My Bank felt like we were receiving such a excellent deal that we couldn’t help ourselves, so we bought a whole lot of them.

The trouble is, with the Mark to Market regulations, the loans My Bank just purchased from Your Bank at such a good price need to be used as comparables that all the other financial institutions also use in order to value their assets. So now each $200,000 Dallas mortgage loan that My Bank is holding (not only the ones I bought from Your Bank) now only have a value of $150,000 each despite the fact that they were perfectly good performing loans.

So now we have a situation where the value of My Bank also goes down. This, in turn, skews My Bank’s capital ratios and forces me to sell assets fast in order to generate funds… and so the cycle goes on.

It’s easy to see how fast and wide-spread the problem gets, despite the fact that there wasn’t necessarily any ‘bad business decisions’ that were made. It’s all due to good intentioned, but over reaching, accounting rule.

When considering the scenario above, you might ask, “Why don’t they have everyone just stop buying the discounted assets from the other guys and just make the cycle stop?” This is a very fair question.

If the cycle is stopped, not only will some financial institutions go under, but the whole flow of money in general just stops. This is what is referred to as the ‘credit freeze’. When there is no credit available at all, mortgage loan originations come to a crawl, car and truck sales basically stop, people are laid off their jobs and the whole economy goes into a recession.

We’ve been in, and gotten out of recessions in the past. Why don’t we do whatever we did the last time?

The minor recession of 2001 recovered pretty quickly because the Fed lowered interest rates and mortgage lending standards were more relaxed, which led to nearly $3 trillion worth of funds being extracted in the form of home equity and put back into the economy.

Today, mortgage guidelines everywhere (not just the ones Dallas mortgage brokers are dealing with) are considerably more restrictive, home values are much lower (and they have been heading in the wrong direction for a while). And as was mentioned earlier, the sad truth is that there is just not very much money flowing out there for Dallas mortgage companies to access for either home purchase loans or for a Dallas mortgage refinance.

However…

How about some good news for a change!

April 2, 2009 – Today the Financial Accounting Standards Board (FASB) voted favorably in regards to relaxing the Mark to Market standard. They have decided to allow financial institutions to use alternatives such as cash-flow analysis in valuing assets. This change will significantly reduce the write-downs banks have needed to take on assets and investments like mortgages. This could very well mean more liquidity will soon be available to your local Dallas mortgage companies. We certainly hope so.