September 22, 2008, 6:00 am

A Story About Banks: They Are NOT In The Real Estate Business

by: The Financial Blogger    Category: Banks and You,Properties
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Once upon a time, there was a guy with a family, high ambition but without a penny in his pocket. This man wanted to provide a safe place for his family and he wanted to manage his own piece of land so he can live from the products he would cultivate. He had a good plan, he was ready to work hard but yet he didn’t have a penny.



There was this other man; he had a family, money and not much ambition. He didn’t know what to do with his money but was surely interested to have it working for him. Once day, the two men meet each other and they start talking about their project respectively.

I’m trying to put money aside so I can buy my own farm. I am tired to rent a small place; I want something good for my family. The problem is that I don’t have enough money to buy anything! Says the first one.

– Really? I’m actually looking for a way to make money from my money. I don’t want to work anymore, but I would surely lend you some money in exchange of a steady payment at a low interest rate. In order to make sure I don’t lose my money, I would keep possession of the land and the farm until you pay me back.

After a few beers, both men agree on the term of the contract. After a few months, the man who had money was quite happy to receive the other guy’s payment every month. He was making more money everyday and he didn’t have to do much. He thought that he could lend more money to more people.

His process was simple; he simple had to calculate if the counterpart was able to make their payment back. Since he knew everybody in his village, it was quite easy to know if he could or couldn’t lend money to an individual. So he started to lend more money to more people.

He never thought this would be that easy to make money! After a year, he was receiving so many payments that he decided to expand his activities and not only finance farms but homes and lands. After all, he had rights over all those properties and they were increasing in value. What could go wrong?

The man shortly became the richest individual of the village. Everybody had a debt with him and “he owned” half of the place.

Unfortunately, good things turn sour if they are left on the counter for too long. The village economy was based on a factory that buys vegetables, fruits and meat from the farmers. So if you were not working at the factory, your job was indirectly dependant of this business from one way or another.

One day, the manager announced that he had to cut down the production by half since there were another factory in another village offering lower prices. This is how half of the village lost their jobs because of this bad news.

People were starting to have difficulties in paying the rich man back. At one point, he was receiving only half of what he used to get. Therefore, he decided to take back farms, properties and land thinking he can sell them and lend to other people.

So he gradually took back “his” properties and put them for sale. The problem is that people were leaving the village to work elsewhere since there was no future for him. After a few months, the rich man had a lot of properties on his hand and nobody wanted to buy them. He started to run out of money and had to sell everything at a fractioned price to another wealthy business man.

In the end, the rich man lost everything he had built because he was in the lending industry and not in the real estate business. And this is why banks are not interested in lending to people who show lack of income. They do not want to repossess your property since they are not in that business. We presently have a really good example of what happen when they are trying too much in the real estate business!

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Comments

Very interest take on what’s happening in today’s overall downturn on the sub-prime crisis.

Great article!

The best way to explain concepts is through a good story.

[…] greed was a big part of what did Lehman in. That’s not the point right now, but here’s a link to a great non-technical blog post by The Financial Blogger explaining what […]

Thanks for clarifying what happened on Wall Street – this really made the issues very clear. I especially like how you explained how the entire village was affected by the fall of the “market.”

Anyway, because banks are “NOT in The Real Estate Business,” this issue can and probably will spread to other industries, which is why employees all over Manhattan are extremely worried. In Lehman’s case, thought, the Barclays deal may help a bit. Here’s what I wrote about the issue after I attended Comptroller Thompson’s briefing about the Wall Street crisis: http://blogs.journalism.cuny.edu/interactivefundamentals/2008/09/22/the-multiplier-effect/

[…] The Financial Blogger looks at why banks don’t want to be in the real estate business. […]

It looks to me that not only are banks NOT in teh real estate business, they are NOT in the insurance business also 🙂

[…] Financial Blogger: A Story About Banks: They Are NOT In The Real Estate Business […]

[…] A Story About Bank: They Are Not In The Real Estate Business! […]

But surely the banks know a few real estate folks who would be happy to take care of this on their behalf for the same nominal fee?

It’s incestuous. But this was a great article 🙂

[…] Financial Blogger presents A Story About Banks: They are Not in the Real Estate Business. Personal […]

Great article!

Stories and fables are a great way to teach principles.