Economics

As someone that just made a financially risky move - left large corporation for small corporation 3000 miles away, downsized materially - sold a house, car, lots of furniture and stuff, I'm wondering what the ramifications of that are. I seem to be doing alright - but what does the future hold economically - is buying a residence with the proceeds from the last one a smart decision right now - what about going back to school, how will the job market fare - these are rather expensive questions to ask.

For all the reasons given in the news for why the US economy is in trouble, here is my attempt (as someone who has er, just over a year of business class experience) at summarizing what's happening. I may miss things, but hope to explain the basics somewhat correctly.

- The home value question.
Are home prices simply supply vs. demand?
This seems to be a local issue and not a national one - if the economy in a city is strong then it is a desirable place to live and home values will be higher than an economically depressed city (i.e. Detroit). However there seem to be national forces at work here as well: value of the dollar and the availability of credit. Basically - where does the money come from for people to mortgage a home, and how much is that money worth.

Mortgage market problems - what's the deal?
Pretty much anyone that buys a home does so with a mortgage. So the bank gives you money to buy a house, and expects that you'll pay it back with interest over some period of time. Assume you have a fixed rate mortgage at 6% - the bank then generally knows what payment to expect and when it will receive it. This is pretty predictable. (mortgage prepayments and defaults being the risk, however the riskiness is tied to how much interest they charge to make it worth their risk)

The issue at work here is where does the money come from that the bank loans you. People deposit money in savings accounts or CD's - so the bank pays them say 3% for their reduced liquidity and then loan that money out to other people at 6% (even if after some of those loans are paid down early or default the bank only gets 5% on average) - yay profit. Sounds nice and simple however it's a bit more complicated than that.

The loans that the bank creates can then be bundled and traded as mortgage backed securities - basically banks bet between themselves and other trading houses on how much of the full value+interest of the loan portfolio they'll get back based on the riskiness of the group of mortgages - 30 year fixed conforming loans are low risk, something like a 3 year ARM is on the risky side.

If the economy slows down people may choose not to buy a house or may be laid off and not be able to pay their mortgage. The result of that is lowered values on those mortgage backed securities. If the properties are foreclosed on, the end result of the bank sale may be far less than the value of the loan. Each individual loss may average under $100k, but after a few thousand, or few million, of those small losses it adds up to a fairly large loss of value. The holders of those securities may find themselves in need of lots of cash to cover the difference. Recently Countrywide, Carlyle Capital, and a few others, are companies that forgot that there had to be sufficient cash to cover that possibility and ran into trouble.

Also involved in the 'where the money comes from' is the Fed, and the value of the dollar. But it's quitting time.

More thoughts to follow...