An Irrational Market Response - The Housing Bubble Blog

Some housing bubble news from Wall Street and Washington. Bloomberg, "The number of Americans who may lose their homes to foreclosure rose to a record in the second quarter as late payments by subprime borrowers surged to one out of every seven loans. The share of all U.S. mortgages entering foreclosure rose to 0.65 percent in the second quarter, an all-time high, from 0.58 percent in 2007's first three months, the Mortgage Bankers Association said in a report today."

"The number of subprime borrowers making late payments rose 14.82 percent from 13.77 percent."

"Growth in overdue payments on U.S. home loans has hurt global markets as investors shy away from risk, driving down the value of mortgage-backed securities and cutting into the profit of lenders."

"'We've got a history of irrational borrowing, irrational lending, irrational homebuilding, and we now are getting an irrational market response to these numbers,' said Jay Brinkmann, VP of research and economics for the Washington-based bankers trade group."

"'The assumption was that home prices would go up forever, which of course is never a good bet to make,' said Brian Bethune, director of financial economics for Globe Insight Inc."

From CNN Money. "Deliquencies hit 5.12 percent of all outstanding mortgages, up from 4.39 percent a year ago, the MBA said in a quarterly survey. Serious delinquencies, those 90 days or more late, jumped to 1.11 percent of all loans, from 0.98 percent in the first quarter."

From MarketWatch. "Driving the numbers were the states of California, Florida, Nevada and Arizona, said Doug Duncan, MBA's chief economist. These are also markets that have experienced a high share of investor loans, Duncan said."

"The share of non-owner-occupied loans that are 90 days or more past due or in foreclosure, as of June 30, was 32% in Nevada, 25% in Florida, 26% in Arizona and 21% in California. Comparatively, 13% of these loans were in default in the rest of the country."

From Builder Online. "Some of the same builders whose companies created the excess inventory that helped push the housing industry into its current downturn are reportedly meeting today behind closed doors with Federal Reserve chairman Ben Bernanke to discuss what can be done to prevent owners from losing their homes to foreclosure."

"The actual agenda of the meeting, however, is not completely clear, as NAHB, which arranged this meeting through its High-Production Homebuilders Council, and spokespeople for several large home builders declined to answer questions about it."

"'[The] housing industry needs a psychological boost right now,' Hovnanian's chief Ara Hovnanian told CNBC."

From Reuters. "U.S. house prices may fall further as credit availability tightens, according to a new study from the Cleveland Federal Reserve."

"'House prices may still fall in the future,' wrote the researchers. 'Any change in the ability to purchase a home, such as from innovations in the lending environment, can have a large impact on the level and volatility of housing prices.'"

"The study went on to forecast that the boom-bust cycle of lending could crimp the ability of households with a weaker credit profile to borrow."

"Turmoil in the credit markets will take a toll on the U.S. economy but the full impact will not be clear for another two or three months, William Rhodes, senior vice chairman of Citigroup Inc, said on Thursday."

"Only when positions in subprime mortgages and other financial instruments are unwound will the extent of the damage become clear, Rhodes told a meeting of the World Economic Forum."

"The Organisation for Economic Cooperation and Development on Wednesday trimmed its forecast for U.S. growth because of the fallout of a slump in housing stemming from subprime mortgage defaults. The Paris-based forum said it could not rule out a recession."

"Rhodes said banking regulators, including the Federal Reserve, should also have acted more swiftly on subprime loans. In a paper presented to a Fed conference last week, Ed Leamer, director of an economic forecasting group at the University of California, gave the central bank a failing 'F' grade for understimating the impact of the housing downturn."

"'My own view is that that's a generous grade,' Stephen Roach, Morgan Stanley's Asia chairman, commented."

"Credit derivatives awarded the top ratings by Moody's Investors Service and Standard & Poor's may be as vulnerable to default as high-risk, high-yield bonds, according to independent research firm CreditSights Inc."

"Constant proportion debt obligations, known as CPDOs, use credit-default swaps to speculate that a group of companies with investment-grade ratings will repay their debt. An increase in credit rating cuts for investment-grade companies may cause losses that CPDOs would struggle to recoup, CreditSights said in a report entitled 'Distressed CPDOs: We're Doomed!'"

"'If you assume defaults and downgrades come in bunches rather than being evenly spaced out, CPDOs' default rates are more what you would expect for low junk ratings than for AAA,' David Watts, a CreditSights analyst in London, said in a telephone interview yesterday."

"Prices of CPDOs dropped to as little as 70 percent of face value last month. New York-based Moody's said on Aug. 21 it may downgrade $244 million of Aaa rated notes issued by ELM BV, a Dutch special purpose vehicle."

"The underpricing of liquidity risk, more than the pricing of default risk, was the weakness in the credit markets that led to the current crisis, said Peter Praet, an executive director of the National Bank of Belgium."

"He said he had not foreseen the degree to which the market would react to the problems in the U.S. subprime mortgage market. 'The extent to which the money markets froze as a result of subprime was beyond my imagination,' Praet said at the European CDOs, Credit Derivatives and Structured Credit Products Summit."

"Short-term funding has dried up in recent weeks for structured investment vehicles (SIVs), whose strategy has run into trouble as the financing freeze has coincided with a sharp decline in prices on their investments, mostly financial debt and asset-backed securities."

"The lack of a strong secondary market for these products, with even less demand in the current liquidity crunch, has meant prices have dropped for even some of the highest-rated structured products, even while their credit quality has remained unchanged."

"Manfred Exenberger, managing director of Omicron Investment Management, told the conference: 'It is sort of a buyer strike. More than a liquidity crisis, it is a crisis of confidence, of credibility.'"

"With structured paper trading at 50 cents on the dollar, it is also a valuation crisis, he said. 'Investors can't believe the ratings anymore, and they can't believe the valuations anymore. It is much more than a market re-rationalisation.'"

"The amount of distressed bonds is increasing at the fastest rate in four years on growing concern that the era of record-low defaults is coming to an end."

"Investor appetite for risk declined in the past two months as losses in securities linked to subprime mortgages caused sudden increases in the cost of credit and sparked concern that the worst U.S. housing market in 16 years would slow the economy."

"Since June, the amount of distressed bonds has risen more than fivefold to $24.8 billion, according to an index Merrill Lynch began compiling in 1997."

"'Unless the market is being totally irrational, it's telling you default rates are going up,' said Lawrence Post, CEO of Post Advisory Group, which manages $8 billion in high-yield, or junk, debt. 'We're moving in that direction.'"

"Until June, companies had few difficulties refinancing debt because investors were confident an expanding economy and rising earnings would allow borrowers to meet their debt payments."

"'The last couple of years we always used to say, 'Gee, isn't it crazy, we're seeing top-of-market behavior and this can't be sustained,' said Thomas Marshella, a managing director of leveraged finance at Moody's. 'It did go on longer and we were wrong. You always thought there'd be an inflection point and, finally, an inflection point came,' he said."