With the Subprime bubble decimating all within the blast range, I’ve never had a lot of sympathy for people that have gotten themselves into loans they couldn’t afford. I was of the opinion that they deserved what they got for not reading the fine print. That opinion is changing recently, since I’ve been hearing about a lending practice that gained popularity in the run-up to the Subprime meltdown.

Redline Discrimination – “Normal” redline discrimination occurs when businesses identify areas where they choose not to do business (either because it would unprofitable, or because other circumstances make doing business there extremely difficult). This happens a lot with inner-city and lower-income areas. Pizza deliveries won’t be made, newspapers aren’t delivered, and many ‘normal’ services are not offered to those areas/residents because of socioeconomic discrimination.

An Example: Insurance companies (before being forced to by the government) would not offer insurance to some parts of Florida, as it is repeatedly hit by storms. It was unprofitable, and they didn’t want to take the much higher risk of covering the people in that area.

The New Discrimination

With Reverse Redlining, a new practice arose of focusing on offering sub-prime mortgages to people in these economically challenged areas. On average, the people in these districts were less wealthy, less economically sophisticated, and were fairly easy prey for the sales pitches of the time, espousing that you could squeeze home equity money out of your home, and still make a profit as the home value went up.

Not to mention that the sub-prime mortgages provided the underwriter with more up-front fees and commissions (read: More MONEY) than a normal prime-rate loan. And as those underwriters planned to bundle and re-sell the mortgages as soon as possible, there was no risk to them that the mortgages would default.

It was VERY profitable, and so, became almost a standard practice throughout the industry. Many people that actually qualified for prime rate mortgages were talked into the more expensive, and more risky sub-prime variety.

Shining a Light on the Problem

Now, as the problem is starting to affect cities and states across the U.S. many state and local governments are seriously moving towards suing the larger banks for “predatory lending” practices, to try to recoup some of the lost tax revenues from these foreclosures. Many, if not all states are seeing projected revenue shortfalls, and the larger states (such as California) are taking actions now to try to deal with the expected lack of funds next year.

So far, cities like Cincinnati, Detroit, and others are putting together lawsuits against banks that used Reverse Redline Discrimination, in an attempt to ‘get back’ some of the money their practices eliminated.

I wish them luck, but I don’t know that it’ll be any time soon before the lawsuits bear fruit.

In the meantime, they still have to deal with the spiraling problems of economic downturn, continuing (and in some cases accelerating) housing foreclosures, and a constituency that is just trying to survive these economic storms.

A Change in Perception is Needed

I know that even amongst my fellow bloggers, my initial knee-jerk reaction was not unusual. People should understand what they are signing and what they are getting into. Personal responsibility is a strong belief of mine.

But even with that belief, the apparent ease and widespread application of this unfair lending practice has gone a long way to changing my mind about this. I still believe that the people being taken advantage of should have read the fine print better (and possibly gotten a second opinion) but I can understand how the could have been taken in, by a slick salesperson and the allure of having more cash from their existing home. Everyone has some responsibility in causing the housing meltdown, but maybe in this case, the homeowner isn’t as guilty as I originally thought.

Do you know someone that was ‘fast-sold’ a new mortgage? Or someone that went with a subprime instead of prime rate mortgage on a sales person’s recommendation? Leave us a comment and let us know.

The government’s Stimulus Package, wafting it’s way through the halls of congress, has been received less-than-warmly by the Republican party, and by a number of people, as “too much money, not enough bang”. Even though we’re badly in need of infrastructure spending on, well, EVERYTHING. It’s still an issue of “will it work?!??”

To date, no government stimulus package in history has had an immediate effect on the economy. The idea of trying to turn something akin to a supertanker on a dime, no matter how big the tug boat pushing the change, is insane. The economic situation didn’t happen overnight, there’s no reason to expect it will be solved overnight either.

There’s also the main reason that it’s going on for so long.

The Economic Culprit

There’s lots of blame to go around; Sub-prime mortgage lenders, greedy/stupid/inexperienced mortgagees getting in over their heads, people living FAR beyond their means and having to pay the piper. There’s no end to targets for what’s going on now. But there’s actually only one culprit that is the cause of all this strife.

Fear.

As bad as the subprime meltdown is, it’s only a small percentage of the overall loans in circulation. If the banks/agencies didn’t lose trust in each other and stop inter-bank lending, they would have been able to weather things better. One or two banks going under would have been a certainty, but without the ensuing panic selling by everyone, the markets wouldn’t have dived 40% in just a few short months.

Fear is also the cause for the continuing spate of layoffs going on. We’re in a death-spiral of fear and reaction to that fear.  

As people fear that their jobs are in danger, they scale back their spending, which causes the self-fulfilling prophecy of downsizing.

Businesses have no choice but to lay off people (or in a few cases, scale back on hours for many rather than lay off the few). As businesses lay off workers, a new wave of fear is released into the workforce.

Lather, rinse, repeat.

We end up in a spiral of self-perpetuating fear that only increase in speed as things get worse.

Think of it as an economic tornado – It starts up from a lot of wisps of wind, but combined has the destructive ability akin to a force of nature.

The final fear that is stalling us is the “fear of doing the wrong thing”. When we started down this path, Congress put together a $750 Billion stimulus package to try to forestall the downturn. But the initial actions didn’t (or haven’t seemed to) work. Each legislator after that has their own idea of what will work and what won’t. In reality, this is a situation that no one has encountered before. The fear that they might do the wrong thing causes delays, indecision, and political debate and maneuvering. All things that allow the situation to continue on and get worse.

Deciding to do nothing, even if it’s to stop and debate about the stimulus measures, is still a decision. And waiting for “something” to happen, can lead to that “something” being an undesired drop in the economy.

So, now we know the main culprit. What can we do?

Enter the Economic Militia

Like the Minute Men of the American Revolution, I think it’s time to get the brave souls out there and prepare for economic battle! There’s a small, but growing percentage of the population that has embraced the “live within your means” lifestyle and are weathering the storm. It may not be the best of times, but for them, it’s not the worst of times either.

It’s time for this Economic Militia to step up and start spending.

Just as the American infrastructure needs investment in it, I’m sure lots of American households need investment in them as well. So here’s my plan.

1. Plan - For those starting out in the frugal lifestyle, this may be what you’re in the midst of now. For others that have lived frugally, you’ve already done this step. Find out what your net income is and plan to live at 90% of that amount. Cut back on non-essentials until you have some available income. It won’t necessarily be easy, but we’re in the midst of a crisis here.
2. Invest – Start putting that money into investments (in a responsible way). Start padding your 401k and IRA accounts, Open up 529 Education accounts. Give to charities. Whatever it takes to start getting money circulating again. DO this responsibly, and show the government, the banks, and your neighbors and friends that you have confidence that things are going to come out better.
3. Get Green – As you invest, spend on things that encourage a move towards more responsible stewardship of our planet. Invest in companies that have strict pollution limiting policies, or companies that emphasize renewable resources and green-development. Vote with your greenbacks for a greener planet.
4. SPEND (Responsibly) – We know that you’re a responsible person living within your means. Now it’s time to benefit from that lifestyle. There’s hundreds of different consumer items, all on some kind of sale, that need a good home. Maybe it’s time to replace that car with a more gas-efficient, newer one. Bargain down the car dealer and help both him and the economy by replacing a vehicle. Take a look around the house for things that you’ve been meaning to replace/fix/upgrade, and DO IT. Sales abound, and good bargains are out there to be had for those with some money. Don’t go in debt to get new things, but invest that extra 10% you’ve made into things that both improve your life, and get money into circulation.

The rich are reeling from all the money they’ve lost over the last few months, and the overextended/poor don’t have the ability to get us out of this recession, what with just fighting to survive. It’s time for each and every member of the 5th Brigade of the Fiscally Responsible Economic Militia to grab up their checkbooks, and head out to the battle. With pen in hand, and a careful strategy of only engaging the enemy (fear) on our terms, we can defeat this Recession, and bring the victory of Economic Stability back home.

Are you going to do your part to help resolve the Recession? What do you think it will take? Leave us a comment and let us know.

Unfortunately, the answer is “No”.

That Was Then

Originally, when the markets started free-falling last November (after the government refused to come to the rescue of Lehman Brothers, and allowed them to go under) a wave of panic selling took off, plunging the stock market up and down like some kind of demented roller-coaster. In an effort to stop or at least curtail some of the market jitters, Fed chairman Bernanke and then-Treasury secretary Paulson went begging to congress for enough funds to “buy up” all the “toxic” debt that was causing the banks so much trouble. Those sub-prime mortgages that had fueled the housing bubble had turned into huge packages of debt that were so intertwined, that it was virtually impossible for banks to deal with individual loans. As a group, these ‘packaged’ loans turned out to be financially lethal, as the bad loans couldn’t be separated from the good, dragging them all down.

Bernanke/Paulson wanted funds to take the subprime loans off the bank’s hands, and manage them centrally, until such a time they could be separated, restructured, and sold back to the public (presumably at either break-even or at a profit).

Statements like “catastrophic depression” and “economic meltdown” were standard phrases used throughout the process of securing this money. Congress was in such a panic to do something that they released the money. The allocated $700 billion in funds to the TARP program, basically handing Paulson a huge blank check, to buy up assets as he saw fit.

This is Now

However, it didn’t go quite that smoothly. Along the way, the strategy shifted from buying up the bad assets (and getting them off the bank’s hands) to buying stakes in the banks themselves. Something along the lines of a quasi-nationalization of the major banks. Tens of billions were distributed to many of the top banks, whether they needed/wanted it or not, in hopes of boosting consumer confidence in the banking system as a whole. The overriding idea being if the banks were sufficiently capitalized, they could immediately start making loans to consumers again and get the market back into play, if nothing else.

Didn’t happen.

The banks that received the funds largely sat on them for an extended period of time. No new loans, no consumer help, no NOTHING. Some of the banks (Bank of America in particular) used the funds to ‘buy up’ other failing banks, and make themselves larger. The net effect was that the credit markets came to a halt, all but stopping consumer lending. In a domino effect, many businesses of all sizes saw their lines of credit reduced or eliminated, causing problems with making payroll and buying supplies. This caused yet more problems with closings and layoffs. And the cycle continued, as banks, seeing the closings and layoffs, tightened lending even further.

So How Do We Get Out of This Mess?

There remains an additional $350 Billion in funds to be disbursed. Pres. Obama has received authorization to disburse the funds, but is waiting to formulate a more effective strategy for getting the money to actually help the market get back on it’s feet.

One idea is to go back to the original intention of moving bad debts out of the banks, to a ‘Bad Bank’ owned/operated by the government (similar the Resolution Trust Corporation of the late ’90s) to be centrally managed. This would give the banks leeway to make loans again, and fulfill the original premise of the bailout. There’s no guarantee that even this would work, as the government can’t “force” the banks to lend money. (Yet, that might be written up as part of the requirements for receiving some of the second-half of the bailout money).

As it stands, with half the funds gone, there’s little or no visible effect on the banking system or in the market. It’s time to try something new.

These three offices of commerce have decided that credit card companies are participating in “unfair,” “unreasonable,” and “deceptive,” tactics when dealing with their customers. In light of these practices, they have inflicted a number of changes on the credit card companies, to take effect in July, 2010.

Upcoming Changes

Interest Rate Increases -  The new rules disallow card issuers’ to raise interest rates during the first year a card is issued, and all but bans issuers from retroactively changing a cardholder’s interest rate. This also applies to the penalties for late payments.

Additionally, any interest rate increases can only effect purchases from the point in time the rate was increased! This means that if you’re carrying a balance, and the interest rate increases, it doesn’t affect the balance currently on the card. A VAST improvement over current practices.

Billing Periods – Card issuers must now allow at least 21 days for payment (no ‘immediate’ interest calculations, and any due date that falls on a weekend is moved to the next business day) . Also, the changes  eliminate double-cycle billing (the practice of averaging interest charged over the previous two months’ purchases. Causing some consumers to pay interest, even if they have a zero balance on their card.)

Payments Applied to All Interest Rates Proportionally – As many are familiar with, credit card companies currently apply any payments received to any balances with lower interest rates (as is the case with so-called Introductory Rates) causing them to accrue higher interest payments by ‘trapping’ high interest debt ‘underneath’ lower interest rate debt. This practice has been changed, and now all payments are applied to 
all interest types proportionally.

Any Improvement is an Improvement

This isn’t going to prevent the credit card companies from trying to make as much money as they can before these new rules go into force. There’s about 18 months before any of these new requirements come into effect. It should help the American consumer by putting a little more money back into their pockets that would otherwise flow out of the household.

While many in government saw this as a positive thing, there are still others that believe more needs to be done to help the consumer. For instance, none of these changes even touch the over-the-limit and late penalty fees. Still, a step forward is a step forward.

Wait for the Unintended Consequences

Unfortunately, in the adverse economic conditions we’re in, the credit card companies aren’t immune to losing money. More people are defaulting on their credit cards, and at an accelerating rate. Some of the steps card companies have already taken is to start raising interest rates, and cutting back on consumer’s lines of credit, or canceling accounts entirely. Getting new credit is becoming more difficult, and that means that those with lower credit scores are going to see less and less of the ‘low interest rate’ card offers coming out.

Card companies also have incentive now (and a deadline) to try to make as much extra income as they can, before the new rules go into effect. Don’t be surprised if they come up with new and innovative (to them) ways to separate you from your money before the July 2010 deadline.

Credit is a tool, just like a stick of dynamite or a chainsaw. Powerful, but able to do lots of damage if used wrong. Know how to use it wisely.

Circuit City started life in 1949 as the Wards Company, founded by Samuel S. Wurtzel. It changed it’s name officially to Circuit City in 1984 and went nationwide with a chain of warehouse-styled stores, selling electronic goodies like computers, televisions, audio/video equipment, and later, large appliances.

In 1999, Circuit City created, and eventually spun off CarMAX as a separate company, along with other subsidiaries (First North American National Bank, created to operate it’s ‘Circuit City’ credit card. First North was later sold to Chase)

Bad Business

Circuit City also tried to introduce a new standard for DVD rentals with the Divx (Digital Video Express) disk. This disk, similar in capacity to regular DVD’s, required a unique player, and a phone line, in order to ‘register’ the user with the main Divx system. Otherwise the Divx disks couldn’t be viewed in any system.

As would be expected, after pushing the technology hard, the standard failed. This left many a Circuit City customer with an unusable system, and a number of ‘dead’ disks.

With the death of Divx, Circuit City suffered an proxy. $114 million dollar loss.

Bad Gift Cards

Now with what might be the final chapter of the Circuit City story playing out, even more customers might be left holding ‘worthless’ merchandise, in the form of unredeemable gift cards.

With a normal Chapter 11 bankruptcy, businesses are usually allowed to continue in business while they re-organize and attempt to become profitable. This isn’t always the case, and there’s more than a little speculation that Circuit City will close all it’s stores before the holidays.

Should that happen, getting your money back from a gift card may be all but impossible. Gift cards, once you strip away all the pretty packaging, the sales glitz, and everything else are nothing more than unsecured loans made to the company. That means, when the courts distribute Circuit City’s assets to it’s creditors, customers that have gift cards are near the end of the payout. If the money runs out before they get to redeeming the cards, they become worthless and the customer loses their money.

What to Do?

Unfortunately there’s not much TO do in this situation. Like the closing of Sharper Image a while back, this Circuit City bankruptcy might just cause your gift cards to be worthless. The best thing to do if you have a gift card is to redeem it as soon as possible. If there’s a Circuit City near you that hasn’t closed yet, you can attempt to use it up and possibly get some of those Christmas presents early.

Otherwise, it’s just another casualty of the bad economy.