The following arrives courtesy of REG and Metrocities Mortgage.

The Chinese have a proverb: “May you live in interesting times.” And we are living through interesting times indeed.

Whatever the political posturing regarding the current rescue plan, a plan needs to be passed. Credit
markets are frozen and banks are going bust every day. This is not totally because of “toxic” mortgages.
This has a lot to do with FASB 157, also known as “mark to market”.

Each day lenders must mark their assets to the marketplace. It’s like you having to appraise your home
everyday and if your neighbor was under duress because they got very ill, divorced, lost their job and
was forced to sell their home quickly they may have sold it super cheap. Now, does that mean your
house is worth that super cheap price? Clearly not. Why? Because you are not under duress. You have
the time to sell your home and get a more normal price, which more accurately reflects true market
conditions. But “mark to market” does not allow for this, which creates a vicious cycle.

Why is this so bad? Because as lenders mark down their assets, the amount that they have loaned
previously becomes much riskier in relation to their assets. For example, say a bank has $1 million in
assets and say they have $15 million in loans outstanding. Their ratio is an acceptable 15 to 1. But
should they take a paper write down of $500 thousand due to “mark to market” requirements, their
ratio suddenly changes to 30 to 1. This is because their assets are now only $500 thousand after taking
the paper loss, while their loans outstanding are $15 million. And at 30 to 1 this bank is viewed as a
risky investment. So the stock price starts to get hit, it becomes harder to borrow, and most
importantly harder to make money. The bank is then forced to sell some of its loans to reduce its
ratio…at cheap prices. And this makes the vicious cycle continue.

And a quick look at the holdings of these loans show that 95% are problem free. Additionally, the
Credit Default Swaps (CDS) that are used with the pools of mortgages are relatively safe. But this
requires a bit of understanding. You see, when a pool of mortgage loans is put together, it isn’t just A
paper or B paper etc….it’s everything. It’s got some A paper, B paper, C paper…and even what looks
like toilet paper. An “A” investor buys the whole pool but because they are an “A” investor their safety
is greater because they can avoid the first 20% (an example) of defaults. So they own the whole pool
but are sheltered from the first batch of defaults, and for this they get the lowest rate of return. As you
can figure from here the more risk investors want to take, the higher the return. So the investments
are relatively safe, but the accounting rules currently place undue pressure on the banking institutions.

Now add to all this, the opportunistic “shorting” done on the financial stocks, much of it illegal because
those shorts did not legitimately borrow shares (called naked shorting), and you exacerbate this whole
problem. Thank goodness for the recent temporary ban on shorting in the financial sector. As for the
plan the government is the only one who can step in to do this. And they have to do this. And they will
do this. The nauseating political posturing from both sides is just part of the process.

This is not easy to understand for the general public. In fact most politicians don’t get this either. That’s
why it is a difficult yet critical bill for them to vote on.

Once this is done it will take some time but the markets will stabilize. As for the real estate and
mortgage industries, it will take a bit of time but we will make it through this. Rates will remain
attractive and the influx of credit availability will help the housing market gradually improve. This
ultimately will be the medicine needed to improve the situation overall.

To your success,

Kyle Rohrbaugh & Eric Engelland

253.858.2640
reg@metrocitiesmtg.com