"Never Get Into and Argument With a Fool..."

"Never get into an argument with a fool, people from a distance may have trouble deciding who is who"

In today's Daily Reckoning Bill Bonner explains the fallout of sub-prime defaults:

"Until only a few months ago, the constant welling up of house prices gave
them some traction. When a sad-sack subprime buyer gave up and defaulted,
the lenders, and the lenders to the lenders, and the lenders to the
lenders to the lenders, could still tread confidently, secure in the
knowledge that they could sell the shacks and get their money back - and
more.

"What they didn’t seem to realize was what seemed most obvious - that house
prices wouldn’t go up forever. Indeed, some day they might even go down.
And when they went down, lenders would have neither a strong borrower to
make payments, nor decent collateral to sell, nor even a buyer with any
money to sell it to."

The problem is that originators allowed fools to buy houses they couldn't afford at prices that no reasonable man would pay by borrowing money from banks at interest rates that didn't compensate for risk. The banks would only loan at those rates because they knew they could repackage the loans and sell them at even LOWER rates to investors.

The release valve was the fact that they could resell the house to some greater fool at an even more ridiculous price if the first fool defaulted on the note. The problem is that when a lot of the original fools start to default investors start getting worried and ask for higher rates and more documentation. Well at higher rates, and if you actually make the borrower disclose their true financial status (things sensible people have demanded all along) then suddenly it gets very difficult to put all the pieces in place for a fool to buy a house he can't afford and an insane price. If fools can't buy at high prices, suddenly you can't resell a highly priced home that really doesn't have the features or location that would cause a sensible person to pay a high price.

So with the fools out of the equation all you have left are serious investors who will only buy homes and bonds at reasonable prices. This breaks the virtuous circle of higher prices and lower standards, in fact it breaks it twice.

Back to the fundamentals, a reasonable decision making process based on the facts and not on unreasonable hope that the future will be totally different from the past. Nobody wants to buy a shack for $500,000 and nobody wants to lend hundreds of thousands of dollars to a deadbeat who won't show you his pay stub or credit card balance, imagine that.