Will Subprime “Spillover”?
Readers suggested a discussion on subprime ‘contagion.’ “Topic: Debunking the ’subprime is contained’ meme, which is propagated from above by top U.S. economic policymakers.”
A reply, “Some are saying spill over, others say no problem. Being that alot of the debt was sliced, diced, pureed, and distributed, who’s to say any spill over will occur. News reports from various sources are contradictory.”
To which one said, “Yeah, I’m making a layered cake. I’m starting with PRIME eggs and butter, mixing in Alt-A sugar, flour and yeast then I feel like I will throw in just a smidgen of SUBPRIME dogs*@t. Because hey, I have to get rid of it and just a little bit shouldn’t hurt the overall product since it is just a small percentage of the ingredients. Any takers on the taste test?”
Others question what the prime borrowers reaction will be. “Will prime borrowers who could pay the mortgage if they accept perpetual house poverty and a very low standard of living, continue to do so if they know the value of their home has dropped?”
“We’re getting the fraud defaults. We’ll get the payment shock defaults. And we’ll get the usual divorce, illness and job loss defaults. The question is whether or not others will walk away rather than pay 50% of their income for housing.”
A reply, “I don’t think people will walk until they are forced to walk. People think their house is valued at the price they paid for it (even more) despite any contrary evidence that is presented to them, hence they will fight to keep their home.”
“Drilled into homebuyers is the mantra ‘real estate always goes up in value,’ thus any decline in price obviously must be temporary, and even a buying opportunity. If they sell out at a lower price than at which they bought then they demonstrate to themselves that they are something less than the financial astute people they imagined themselves to be.”
Another said, “That may have been the case in the past, but this time is different. These people have grown accustomed to thinking they are entitled to spend $5,000 on rims, and go out for sushi once or twice a week.”
“Once the house stops providing that lifestyle for them, they will stop paying. These are NOT responsible people who care about their reputations (that includes their credit scores). Better to rent for half the cost and still be able to party it up.”
From MarketWatch. “American Home Mortgage Investment Corp. said that it’s stopped offering some types of so-called Alt-A mortgages because of the high cost of delinquencies on those loans.”
“The warning suggests that problems in the subprime-mortgage business have begun spreading to other parts of the home-loan industry.”
“‘During March, conditions in the secondary-mortgage and mortgage-securities markets changed sharply,’ said Michael Strauss, American Home’s CEO. ‘While the market may recover…our working assumption must be that current market conditions will persist.’”
“American Home also indicated that it continues to be affected by the high cost of delinquencies, especially on Alt-A mortgages, and that it’s been forced to repurchase some of these loans.”
“The company announced that it’s stopped offering certain types of Alt-A loans that have been particularly prone to rising delinquencies and repurchases. Those are loans where the homeowner borrows a relatively high portion of the value of a property and simply states an income, rather than documenting it.”
“American Home isn’t a subprime lender. In early March, the company issued a statement to clear up any ‘confusion’ about the type of loans it offers. Most are adjustable-rate mortgages and so-called Alt-A loans, which often require less documentation.”
“American Home said Friday that earnings will be lower because investors in the secondary-mortgage market and the market for mortgage-backed securities (or MBS) offered to buy its loans at ‘materially lower’ prices.”
“Lower prices for AA-, A-, BBB-rated MBS and riskier bits known as residual-mortgage securities also triggered losses in American Home’s investment portfolio, the lender added.”
From Reuters. “Citigroup Inc., the largest U.S. bank and one of the largest U.S. mortgage lenders, is telling brokers that on Monday it will stop making some riskier home loans, documents obtained by Reuters show.”
“The changes at Citigroup’s main home loan unit, CitiMortgage Inc., would limit no-money-down second mortgages and raise the minimum credit scores needed to obtain them. Borrowers take out second mortgages when they cannot get 100 percent financing from a single lender.”
“According to e-mails obtained by Reuters, CitiMortgage will stop offering second loans to some customers who want to finance 100 percent of homes’ values and cannot fully document their own finances.”
“The unit will require 5.01 percent down on some second, sometimes called combo, loans, and 10.01 percent down where financing involves home equity or interest-only loans, the e-mails show.”
“The documents also show that CitiMortgage will raise the minimum ‘FICO’ credit score needed to obtain any combo loan to 650, and eliminate the 620-649 category. Borrowers with FICO scores below 620 are commonly labeled ’subprime,’ meaning they have higher credit risks.”
“The documents also show that CitiMortgage will raise the minimum ‘FICO’ credit score needed to obtain any combo loan to 650, and eliminate the 620-649 category. Borrowers with FICO scores below 620 are commonly labeled ’subprime,’ meaning they have higher credit risks.”
I guess it is up to the government to somehow pick up the subprime ball and run with it, as subprime boutiques are shuddered and subprime loans are suddenly phased out by strong-handed lenders.
Does this mean Casey with his 450 Fico is locked out?
Soon to be locked up?
Is FICO450 one of those new Ford pickups ?
Freudian slip GS? it “shuttered” as in closing the shutters, but “shudders” as in send shudders down my spine - appropriate in this instance;)
I suppose they “shuddered” before they were “shuttered.”
Its called FHA. Greed and underfunding kicked it to the curb during the bubble. Now everyone is re-discovering that its the safest way to grow/expand homeownership amoung those on the cusp of a station in life that makes homeownership a challenge.
And some in congress seem to be eager to make FHA into a federal subprime lender, doing away with its traditional underwriting and downpayments of 3%.
100 percent lending to people with a bad credit history worked so fantastic in the private lending sector, so now the government will offer the same deals by dropping downpayment requirements on a federally insured program. If you think the pending Fannie Mae day of reckoning is scary, just wait until when and if Congress pushes through these changes in FHA lending requirements.
The warning from American Home Mortgages, that their earnings are being slashed because the market for their Alt A loans has gone bad is clear evidence that the “subprime has spread.” It’s not that they can’t offer these loans to consumers. The problem is that they can sell them in the securities market for any where near the price that there were going for in February, 2007. I am expecting lots of red in the bank and finance sector next week. I expect to be buying more puts and maybe, to take profits on April positions.
Note: in the comment above, it should say that “they can’t sell them…”
thanks bill
I think that Citi’s glacial slowness to make “adjustments” to the changing conditions (what’s really changed anyway?) means that my savings account interest rate will be going back up again.
My gosh, even Wells Fargo beat them to stop offering no-doc second loans to 100%.
i think it is already hapening but the public has not realized it yet
a good tightening of credit is what this country needs
it is now a socially acceptable thing to have major debt
well it is also the in thing to go to rehab as well
this mtv generation is up to its ears in debt
“it is now a socially acceptable thing to have major debt”
Credit profligacy is not contained, and is, in fact, encouraged by the War on Savers.
I heard that in the past, people even had parties when they paid off their mortgage. What a quaint idea!
Seriously, I agree this is what the country needs, unfortunately, the spillover effect is going to hurt us all to one degree or another.
All during the bubble, I kept thinking, “There’s no way The Powers that Be are going to let all these regular people keep all this bread. That’s just not how our country’s financial system is set up to operate. I knew the rug would be pulled out at some point, but who could tell when?
“There’s no way the PTB are going to let all these regular people keep all this bread”.
I keep hearing this on this board and I could not disagree more. The profits of this RE Bubble were there for ANYONE (witness the subprime loan debacle) while it lasted.
All you needed was the common sense to get out of the market at the right time.
Common sense is found across ALL income categories.
I know several “average ” Americans who made out very nicely in the past few years with their (now unloaded ) RE holdings.
And I know just as many “above average” income people who are about to get slaughtered because of the fantasy land their minds dwells in.
Congrats to those with common sense who got rich, whatever their income before the bubble.
Tough luck to the idiots who have no common sense and can’t let go of their RE ” faith based religion mania”.
Common sense and reality triumph once again.
You give the upper classes far too much credit when you assume that they are the only ones who profited from this. And conversely, you give people of modest means far too little credit by ignoring the profits they made by simply using their heads.
People who got screwed by the Bubble deserve it, no matter what their income level. The whole situation was just too freaking obvious to ignore, if you were just clear-headed enough to accept the obvious truth.
Well said, Seattle!
How about a taxpayer funded bailout of the FB’s and lenders? Every Democratic Presidential candidate has called for it. Dodd seems to have backed down a little, but with Jesse Jackasson and LULAC pimping the race card, I have a feeling something will be done to hurt the responsible middle class once again to aid the irresponsible morons and the bankers of course.
That’s just it… by definition everyone can’t get out.
Common sense is always overpowered by arrogance, wherein people assume they know better and can successfully time these things. History proves over and over that most can’t and won’t.
Arrogance is always at the heart of people’s “this time it’s different” intransigence, too. The logic behind “They won’t let it happen” and “We know better now” also kills me.
Human nature never changes.
I agree. Not easy to get out at the top of the market. Only hindsight can tell you where the top is. Before the top is hit, the mania is in full swing, remember the real estate shills saying real estate can only go up. Greed gets a hold of people. Most people wait until the main stream media tells them “the parties over.” The manin strem media helped whip up the frenzy too!
Although I agree people should be responsible and stay informed on important isues like this, (I sold my house in ‘04, not the top), my point is it is easier said than done.
i was able to retire at age 50 (1999) because i sold too soon.
Are there any data out there on how debt is distributed among the different generations? I’ve seen it in the 20s through the 80s. It seems as though “debt people” (thanks, Catherine) span the gamut.
“Debt people” has been around for a long while. It wasn’t coined last week.
I see debt people….
coined months ago by our brilliant poster HARM.
Oops, that’s the first time I saw it used.
http://tinyurl.com/2tcjk2
Here’s a report on debt distribution from Great Britain. Scroll down for chart.
Thanks, CarrieAnn. Now that I look at the bar graphs in pink and red it’s not surprising, since most debt is mortgage, and older groups have less total debt. I’ll look for survey data regarding credit card debt.
Interesting that net worth climbed as debt went down.
Whoda thought?
How will the “containment” crowd reconcile developing cracks in the Alt-A sector? For instance:
http://market-ticker.denninger.net/labels/AHM.html
Alt-A and subprime are one late payment on a revolving debt different. So how different are they on a major debt like a house? Same pig with smeared lipstick!
A hint at the schedule of subprime and Alt-A defaults may be gleaned from implode-o-meter’s 3/19/07 graph of ARM resets. The big bulge (from $25B/mo to $50B/mo) at the end of 2007 is basically subprime. Hence, most foreclosures in 07-08 will be subprime. The resets decline to around $12B/mo briefly in 2008, then rise to $40B/mo towards late 2010: very little subprime, mostly Alt-A, option ARMs, with some prime and some “unsecuritized”. This second bulge persists at $30B/mo or more through most of 2011. Therefore I conjecture the 2010-12 wave of foreclosures will be mostly NOT subprime.
April 6 – Bloomberg (Jody Shenn): “Fannie Mae and Freddie Mac, the largest packagers of home loans into securities, last quarter had their greatest share of U.S. mortgage-backed bond issuance since 2004, Inside MBS & ABS reported… The government-chartered companies accounted for 45.9% of mortgage-securities issuance, or $246.2 billion, up from 39.9% for all of 2006…”
Bail-out by 2010? I would say 2008 but they haven’t filed books in years and still trade on the NYSE. It is possible in my opinion that the true books and and how corrupt they are will never truly be known. Needle in a haystack is one thing, fly-poop in a pepper mill is a completely different level of prestidigitation…..AKA-Black Magic Accounting….p
Don’t get me wrong I do not agree with a Bail-out, but not doing so would pull confidence from Markets, Governments and a lot of emotional levels that I do not think the Guberment would consider allowing.
Wow, OCBear, I think that’s a double word score!
pres·ti·dig·i·ta·tion (prěs’tĭ-dĭj’ĭ-tā’shən) Pronunciation Key
n.
1. Performance of or skill in performing magic or conjuring tricks with the hands; sleight of hand.
2. A show of skill or deceitful cleverness.
There was some discussion on calculated risk on this subject, and I think the general consensus was that ’spillover’ and ‘contagion’ are kind of meaningless terms. You don’t contract forelcosure - it isn’t like cooties. Of course, after this discussion, people then continued using the terms .
There are two senses in which ‘contagion’ is a sort of appropriate word, although I still think it’s imprecise. One is the extent to which foreclosures in an area trigger price drops in an area, which trigger more foreclosures. I think this is happening, but the extent is a little overstated. I think many price drops would have happened anyway, and the foreclosures make them happen a little faster. The other mechanism for ‘contagion’ is bad/fraudulent underwriting. To the extent that lax practices in one part of the market contributed to an attitude of permissible laxness in the other parts of the market, you’ll probably see the same bad appraisals, phony income, etc. in Alt-A and prime that you see in subprime. How much of this happened time will tell, and would it have happened, and to what extent, without the growth of subprime is an interesting question?
If you don’t like “spillover” or “contagion” as words to describe this then I would suggest “positive feedback loop” as a completely accurate description of the effect you’re trying to describe.
Contagion could refer to a sudden collapse of many subprime lenders resulting in a lack of subprime loans to support unaffordable prices, which would result in less demand and lower prices than before, which would lead to fears among surviving lenders about making 100% financed deals, which would lead to a general tightening of credit standards, which would lead to even less demand and more price declines.
Not to suggest the above might ever happen…
No, that could never happen!!
Contagion:
3 a : rapid communication of an influence (as a doctrine or emotional state) b : an influence that spreads rapidly
Works for me!
I think it all comes down to affordability. Most of these dolts should have never got a loan. Hopefully with few who do not understand the value of anything or fewer dopes able to buy a house with these toxic loans, the rational buyers can move prices lower to some kind 3-5% trend appreciation line.
We have heard ’subprime is contained’ from Bernanke, Paulson and Dallas Fed’s Fisher, among others. I find this word choice significant.
Uncle Sam is no slouch when it comes to sentence construction, and the use of the action verb ‘contained’ (rather than saying, for instance, that “the subprime lending crisis will not spread to the rest of the economy”) implies that some agency is undertaking measures to ‘contain’ the problem. Can anyone shed light on this subtilely-announced containment policy?
I would assume that this wording is intended to keep people thinking that the gov is on the case when in fact they are sitting around the conference table staring at each other and wondering, “Now what?”
Good one
Like a scene from “Dr Strangelove”, except a little more absurd.
I’m not saying that Alt-A lenders won’t get their hair mussed, but 10 to 20 M foreclosures tops, depending on the breaks???? I can just picture George C. Scott
Cut to Slim Pickens riding several megatons down to the inevitable boiling mushroom cloud over the housing market.
Oh the horror of losing all our precious bodily fluids.
Gentlemen, gentlemen! You can’t fight in here. This is the boardroom! I’ve never SEEN such behavior in the boardroom.
Actually, it’s even funnier than that:
“Gentlemen, gentlemen! You can’t fight in here. This is the war room! I’ve never SEEN such behavior in the war room.”
I know… I was paraphrasing.
“Can anyone shed light on this subtilely-announced containment policy? ”
The govt wants to avoid a run on the banks.
The sub-prime crisis is in it’s last throes?
Perhaps the Fed is monetizing the mortgage debt obligations in some way? Dunno.
“Contained” is a word our government seems to apply liberally to situations that are not really under control, but which they hope somehow to muddle through. Hmm, Saddam Hussein was “contained” in the late 1990’s, right? This suggests that Stucco’s “war on savers” may escalate … obviously, WE are the WMD problem that is keeping RE from Always Going Up.
They have referred containment of the contagion to the Centers for Disease Control, who have lined it up behind anthrax and bird flu.
(Sorry to interrupt the serious discussion, guys.)
alt-a was totaly solid 3 weeks ago
now ?
One of the columnists over at Forbes.com wrote an article about Subprime cracking first, because the teaser periods before the loan resets are shorter - usually just 1 or 2 years. AltA typically has 3 or 5 years before the loan resets. So, it’s not that there won’t be problems up the food chain, but they just aren’t surfacing yet.
AltA could get 100% financing just like Subprime, so there’s no reason to suspect payment shock won’t be any less for these folks. If you can’t afford your mortgage, it doesn’t matter what your FICO score was when you got the loan. And anyone who did an 80/20 probably did so because they couldn’t afford or qualify for traditional financing in the first place.
There are neg-am and other teaser rate loans still being originated today. Each one of them a time bomb that will blow up in the future, which is why any talk of a “bottom” or “containment” is ridiculous. Wake me up when these loans stop being available and maybe it will be time to start looking for a bottom to the correction.
Did any of you guys notice in AHM’s earnings press release that they will be charging higher rates now on their loans in addition to eliminating certain types of loans (which I read as they are eliminating no doc or NINA’s).
Alt A is following the same path as Subprime. No bottom here yet.
“AltA could get 100% financing just like Subprime, so there’s no reason to suspect payment shock won’t be any less for these folks.”
Bingo! Moreover, I am guessing that this was even more true for prime than Alt-A, as the chance a 100% LTV loan will be repaid goes up with the creditworthiness of the buyer, and the lenders were obviously counting on home prices always going up to make it somewhat irrelevant whether the 100% LTV deal was offered to a subprime, Alt-A or prime borrower.
I would suggest that the brilliance of the Prime borrower at 100% LTV will convince them to walk on a depreciating asset a hell of lot faster than Billy bob will walk on the mobile home.
tom stone, who’s in the North Bay (Sonoma-area) of the “Alt-A Bay Area” is already reporting that he’s hearing about and seeing Alt-A borrowers with problems.
And he says all of them have $125K plus incomes.
See athena’s “Sonoma Housing Bubble” blog
“Pulling the cork out of the wine country real estate bubble”
http://sonomahousingbubble.blogspot.com/
Right, I hadn’t seen Lisa’s comment before I posted something above about the ARM reset calendar. Her post explains why subprime resets are peaking in late 2007, other ARM resets in 2010 through 2011.
YEP. The other reason that subprime is collapsing first is the number of Early Payment Defaults. These are either outright moneyback fraud or people who simply couldn’t even make the pre-reset mortgage. My prediction is that subprime goes down first, hardest, and then Alt-A is a long, slow fall.
Can anyone shed any light on how the different speed of collapse will affect the bond (and therefore credit) market? The underlying subprime mortagages are SO awful that the, say A-, tranches of them will be in worse shape than A- tranches of Alt-A loans. I suspect that the highly visible mis-rating of bonds by the bond rating agencies will intensify the “pox on all MBS” thinking by investors. I think that it’s unlikely that most fund managers spent alot of time delving into the details of what they were buying, they just looked at the bond rating and the interest rate. If the rating turns out to be a bad predictor of risk….
In the last three minutes of the subprime “event”, March 28th at the American Enterprise Institute, the chief economist of FDIC asked the panelists how much spillover there would be from subprime to prime. Tom Zimmerman offered to get him a number.
Of course it will.
As more and more home owners realize they cannot afford their mortgages we will see more and more defaults - in every class, prime included. Many, many prime borrowers bought right at their limits all because they felt their new house was the best INVESTMENT available to them. When they realize their house is not the investment they were sold they will evaluate their $$ situation with new eyes and make changes. Will some choose to walk? You bet some will and not all of these folks would be considered “deadbeats” in any other circumstance. Unaffordability will be foremost in their minds rather than the past 12 years of “wealth effect” emotion that has allowed these people to justify their housing debt.
Contained in Sub prime? No way. Everyone who bought in the last few years stretched to get those mortgages, to get started on the “ladder” and just as a flood tide lifts ALL boats an ebb tide does just the opposite.
“Many, many prime borrowers bought right at their limits all because they felt their new house was the best INVESTMENT available to them.”
And because of another common mantra from the REIC: Buy the biggest, most expensive home you can “afford.”
Unfortunately, we live in a age of instant gratification - where manymore people want something NOW w/o doing the hard work of investing and saving
The entire easy-loan/pay later/have it now mortgages over the last 5 yrs -represent that
THAT factor alone in this disposable, channel snapping, age is not a good sign
For that reason: I suspect many people who all of a sudden find themselves with a negative equity of (lets say) 150k - just won’t have the fortitude to stick it out. Now that is only referring to individuals who can in fact make the payments. We know many many 1000s more are going to fail anyways
Bottom line: this is going to get alot worse
People with Alt-A loans will walk from their collateral for the same reason the subprime borrowers have been doing it. Because they’re underwater, no longer see any appreciation in their homes, and will decide to save money by renting.
One interesting thing might be that Alt A folks may not qualify for a short sale and will be forced to sell other assets to bring money to the table.
I am willing to bet Alt-A folks have little, if any, other assets.
I know a recent seller of an 800k house last year. Probably no equity beyond the increase. Sale took a year to make but he got seriously lucky to my mind. He then bought a 600k house in Texas (probably paid off a few credit cards at least - good so far.) Now he hasn’t had income for 4 months due to job problems, the mortgage and taxes are not being paid… One wonders if a $300K house or G-Forbid a 200K house might have been the better choice.
Yeah, but what about the tax bill? Real estate transactions are expensive, but still less than the tax bill, no? I wonder if transaction expenses rise to the level of the taxes or almost there are people still think they’re getting a “deal” until the tax bill is exceeded. Hmm. I mean, the loan fees, title insurance kickbacks, and ridiculous broker fees are all “extracted value”, skimming by a middleman, and don’t represent anywhere near the real (much tinier) added value.
There is no way these jobs numbers are not bogus at this stage, what a travesty. What’s amazing to me is how they are being discussed as real. Just taking the 3.3 million people (including contractors) who work in residential construction alone we can see that completions between Sept-Feb are already down 18.4% and sinking fast. That’s over 600,000 jobs. Even if much of this represents reduced work for contractors rather than job loss, the effect is the same. To think the job market added 54,000 construction jobs in March is patently absurd. I have gone through and posted about 40 recent news reports in the comment section here to illustrate this.
http://wallstreetexaminer.com/blogs/winter/?p=600#comment-20196
“To think the job market added 54,000 construction jobs in March is patently absurd.”
54K added? total BS. Sales down, starts down, permits down, etc., but jobs up! Back to the Corona Light.
I enjoy your posts Russ. It is pretty obvious that with all the relatively recent announcements of major construction layoffs that this number is total BS. My question is whether this is some sort of intentional message or whether the BLS just figures everyone out here in bloggerland are total dolts? I mean we all know that the MSM wouldn’t say sh*t if their mouth’s were full of it, but clearly the backroom analysis of this number would have the BS sensors going off all around the world? It almost has to be intentional so I wonder what is up with that?
Well, one thing that might be happening is that all the construction workers have been laid off with a promise to be rehired in a few months. By BLS definitions, that makes them not unemployed. However, when those jobs never come back… THEN all these people will count in the unemployed as long as they are looking for jobs. Once they either (1) give up and stop looking at all or (2) get jobs at ClownBurger, they will be ‘employed’ again.
Once they either (1) give up and stop looking at all or (2) get jobs at ClownBurger, they will be ‘employed’ again.
Err, in the first case they would be out of the labor force.
The “discouraged” who are not looking for a job at all are not counted among the unemployed.
Or, people aren’t starting new projects, but ARE pushing like hell to finish quickly before the market goes down further. Also, are these numbers seasonally adjusted? In many areas, construction is very seasonal, you really have to look at the YoY numbers to get an idea of how things are going.
The numbers on employment just happened to be massaged whilst an expansion of H1-B numbers is up for re-evaluation. Too convenient for coincidence.
Great topic!
I think a spillover effect of the mortgage situation and falling market could be a lot of short sales or owners “trapped” in their homes. My wife and joke that her sister and brother and law can never move out of their house since they have refinanced so many times to extract equity. They have a nice home in Eagle, ID they built for around $330k a few years ago and was recently appraised at $700k. Why was it appraised? They refinanced for more cash! On top of that, they bought the place with an interest only loan.
With the Markey going down in a lot of areas, many homebuyers can’t sell without taking cash to the closing since values have dropped, they have little equity, and RE commissions will need to be paid.
“…recently appraised at $700k. They refinanced for more cash! On top of that, they bought the place with an interest only loan.”
What is their debt balance? A 1% increase in interest rates on an I/O loan of $500K adds an additional $5000 / year ($417 / month) to your mortgage payments.
Most of the subprime is in fact refi. Many long time homeowners have used these teaser rate ARM loans to do these high cash out refi and left their fiixed rates loans. Hey since RE always goes up nobody cared about the future since their home would be worth double in a few years..now these clowns are finding out the how cruel the world can be.
How does one accurately determine if 1.X million defaults/foreclosures will “slam” the entire financial system? If lenders are working with defaulters to stay in their homes and banks are regaining some of the losses by selling foreclosures, then the shock shouldn’t be as bad as purported by some sources.
I’m sure about one thing: When the banks start unloading foreclosed properties, they will unload a shot gun blast at the housing bubble. Can’t you see the irony in that?
One needs look no further than the issuance of 100% financing, to subprime borrowers or otherwise, as the reason for the meteoric rise in home prices. If you don’t think that the correction in prices will be as severe as the increases, then you have your head in the clouds.
The Shadow Knows….
And evidence like 75% of foreclosure hot-line callers in Colorado were refi’s, proving that it isn’t just recent buyers that are in trouble.
On this week’s show, Jim Puplava went over the percentage of RE loans as overall loan portfolio at major banks, sch WaMu, WFC, Bof A, etc. for most of them, it was about 50%. He predicted at some point one of the big boys will be in trouble, at which point the Ben would come in with his fleet of helicopters to do a money drop.
20% of WFC’s loans are residential seconds, a third of those in CA alone. I can’t see how WFC can survive this.
The notion that the inability of the borrowers to service their loans is limited to subprime is delusional. If Alt-A borrowers were such a low risk, they would be prime. While there are certainly legitimate cases where self-employed borrowers are credit worthy but cannot prove income or assets, many of these Alt-A loans did exactly the same thing as the subrimes-put people into homes they could not afford, and simply had no business being in in the first place. I would argue that many had good credit scores, but their verifiable income was too little to go traditional based on the purchase price, so they went stated to get into the house before they were “priced out forever”. It’s no coincidence that as prices were rising, so were these types of originations. There is a reason for traditional lending standards. When someone cannot provide a decent credit history, and verify income and assets, they’re a much higher risk. And, I personally know a few PRIME borrowers who are, right now, trying to sell because their monstrous house is eating them alive. This isn’t “contained”. While subprime borrowers will prove to be the weakest in terms of repayment, Alt-A and prime defaults will shock many.
People forget.
Last time around, in the early 90’s, when there were record defaults, foreclosures, and jingle mail there was no “Sub-prime” then.
If you can’t pay the payment, you can’t pay the payment. Doesn’t matter if your credit rating is perfect.
I think EVERYBODY AT EVERY CREDIT LEVEL reached and bought more house than they could afford cause “Real Estate always goes up” and “when the payment resets, we’ll just refinance”.
Now with a FED rate 4% points higher and credit tightening many are caught.
Therefore I would conjecture that a percentage equal to Sub-prime defaults will occur in the Alt A and Prime Sectors as well.
JMHO
“EVERYBODY AT EVERY LEVEL reached” … Make that, everybody except us chickens here at hbb.
“I think EVERYBODY AT EVERY CREDIT LEVEL reached and bought more house than they could afford cause “Real Estate always goes up” and “when the payment resets, we’ll just refinance”.
Think of all the markets where the median home price is way more than 3x the median gross income. In the Bay Area, it’s pushing 8x+ in some areas. People HAD to stretch to buy, no way around it.
You’re right, imploder. I can remember people advising “buy the most house you can” recently. In the old days people never advised that.
No, that’s been around a while, at least here in SoCal. The idea was that inflation and income growth would eventually take care of things. However, you still had to qualify traditionally — people like Casey Serin couldn’t finance an outhouse back then.
People used to say that all the time. But the limiting factor was usually how much the bank would lend you.
I don’t agree that it will be an equal percentage. Some (much?) of subprime was just plain irrational. People who were delinquent in the first 90 days… we’re not even talking about resets here. I would guess it’s more like the same percentage of subprimes that made it to the reset before defaulting will be reflected in Alt A and prime.
Here’s what I see. All those ARMs will have to be refied or defaulted on. There’s just no universe where they are sustainable when the market isn’t appreciating at least 10%/yr. And now people are talking about 40yr fixed! Have you ever looked at the amortization table on a 40yr loan? It’s INSANE. You would have to be financially retarded to choose that as a path to home ownership. So Alt A will be reseting into the teeth of record inventories, empty homes everywhere, underwater at market value. Selling will not be possible for many.
So it all comes down to what the banks choose to do when the refies come knocking. How tight is tight?
The concept of “spillover” is not an accurate descriptor of what is really going on. The contagion is already there in many mortgage market sectors (Prime, Alt-A & Sub-prime). WHY? because loans in all catagories were not made based upon the ability to pay, but instead upon whim. Granted, Prime paper is likely not directly infected, but the HELOCs prime borrowers took out, the Alt-A’s based purely on stated income & FICO scores etc all are out there and they all have the same problem, the borrower does not have the requisite ability to pay. Thus as Alt-A and prime defaults rise, it will not be due to sub-prime spill-over but for the same lack of fundamentals in lending that infected all mortgage market sectors.
It’s like the poison pet food. We keep discovering that the contamination is wider spread than we thought; but the poison was in the package from the get go, not spreading from package to package.
The real problems will occur when the problems begin to show up in CDOs. Think of these as mutual funds containing tranches of mbs pools. The problems are now apparent in the lower-grade tranches, but the top level CDOs are still performing adequately.
Buyers of these securities are all over the world. Think about it — as much as readers of this blog have learned about Florida, San Diego, Nevada, Arizona, etc., I would guess that most have only the vaguest of ideas about London, Barcelona, Sydney, Tokyo, Taipei, Shanghai or Mumbai.
The same is true for foreign buyers of CDOs. They are not deeply aware of the tremors and collapses that we are reading about on a daily basis. Their primary source of information are rating agencies.
When these rating agencies begin to downgrade CDOs, then the s*** will truly hit the fan.
“When these rating agencies begin to downgrade CDOs, then the s*** will truly hit the fan.”
Pardon my ignorance but:
What will that s*** hitting the fan look like?
and
What will be the end result of that s*** hitting the fan?
If I knew, I would be a rich man.
After a mortgage is made, it is quickly securitized by Wall Street. First, pools of mortgages are assembled into mortgage backed securities.
Second, these pools are divided into tranches from highest credit quality to the lowest quality tranche (often called the equity tranche). This is Wall Street’s way of creating gold from piles of subprime. The way this works is that the top-level tranche gets paid first. Then the second level tranche and so on. So if you have a pool of 1000 subprime borrowers broken into 5 tranches, investors in the top-level tranche get paid first. This tranche can trade with AAA-ratings. At the same time, all the pain is first felt in the lowest level tranche. In effect, tranching concentrates the pain.
Tranches are bought by CDOs — these are effectively large mutual funds that invest in all sorts of securities.
CDO shares are sold to investors.
Pretend you’re an investor in London. Someone on Wall Street has convinced you to invest $100M in a CDO. This CDO generates great yield by investing in the bottom tranches of MBS pools. You know and care very little about the rumblings in San Diego or Tampa. All you care about is the fat yield your CDO is spitting out.
Sometime later this year, a ratings Agency suddenly lowers the rating on the CDO in your portfolio. In effect, they say it is now a greater principal risk. The value of the CDO and others like it will drop immediately.
This drop will be felt as a widenening spread to everyone down the chain. The London investor will demand and get higher premium for taking on the CDO risk. This will eventually propogate all the way down to the mortgagee — who will be expected to pay a higher interest rate or present a lower risk (higher FICO, higher income, more assets, larger down, etc.). All this will effectively reduce the amount any random borrower will be able to pay.
To make a long story short:
1. As the bubble inflated and prices rose, lending risk DROPPED.
2. Therefore investors all over the world threw money at the mortgage market.
3. Now that the bubble is deflating and prices are beginning to fall, lending risk is RISING.
…
4. The S*** hits the fan when the largest buyers of mortgage assets in the world demand greater yields for lending out their money.
5. This will squeeze prices further.
6. Go back to step #4.
“If I knew, I would be a rich man.”
That’s why I asked.
Thank you that was helpful.
Nice summary, CB.
best case: massive credit crunch
worst case: hedge fund failure, financial melt-down, the Rapture.
Given the extremely high levels of indebtedness and excessive leverage employed, your best case cannot help but lead to your worst case.
Lovely to be those foreign buyers. An ‘investment’ with negative returns, paid in devaluating dollars. Considering how nasty toilet paper is in Europe, they ought to just use their excess money for TP, it would be a better investment…
It’s not just a matter of waiting for resetting mortgages as scheduled — the imminent recession, job loss, and subsequent specuvestor panic will cause their share of defaults in Alt-A and prime mortgages. It’s gonna get ugly for a lot of people, subprime or not.
“”Others question what the prime borrowers reaction will be. “Will prime borrowers who could pay the mortgage if they accept perpetual house poverty and a very low standard of living, continue to do so if they know the value of their home has dropped?””
The number one risky factor of home lending is 100% financing. They have always gone bad at a much higher rate than loans with a down payment. Add to this, stated income and short term (2/28) unsustainable, artificially low payment loans and you have our current situation.
Prime or “Alt-A” scores do not mean much when people have no money in the game and their ability/desire to make high housing payments has not been shock tested. To young co-workers I usually ask if they are willing to give up for 5 years: vacations, new cars, new clothes, eating out, new toys, new furniture. It makes them think about whether they are willing to sacrifice to buy a house here in SoCal….is it worth it.
Also, then you sell a house it costs 6 to 7% in total fees. Many prices are down 10% from the peak of last year, so last years buyers can be down 17%. When faced with continuing price drops, their decision is to continue the $4,500/month housing nut, or rent for $2,400….
> The number one risky factor of home lending is 100% financing.
You are so yesterday. I wish all the lenders were like that. Isn’t it obvious that without skin in the game, the borrowers would first take on to much risk and second walk more easily? A FICO score reduction that is gone after a few years seems to be all that a borrower risks by defaulting in non-recourse states.
Therefore, any bailout talk should be countered with talk of a return to the use of debtor’s prisons.
only if it include prison for the people making the loan…and everybody else who profited from the transaction.
Actually - I do know there are people in their mid 30’s that could buy a house - but they have realized that the payment would be double what rent is. In many tony neighborhoods in Austin, you can rent a house in the downtown area for 1500 to 1800 per month. Howver, to buy the same house would result in a mortgage payment over $2500 - assuming a large down payment.
So, people are starting to catch on to the idea that renting is better than buying. Renters go on vacation, go to movies, have a 401K account, etc… Home owners sit in the dark and eat top ramen.
The closing fees when you buy can reach 5% and the selling fees are normally around 5%. You lose 10% right off the bat.
I actually think that teaser rates are worse than 100%. At lease with 100% loans there is a CHANCE that borrowers could make the payments if they WANTED to. The teaser rates loans were sold to those who have NO CHANCE of making the full payment.
“This will eventually propogate all the way down to the mortgagee — who will be expected to pay a higher interest rate…”
The interest rate increase is already happening. Friday when AHM (a large Alt-A lender) warned on 2007 earnings, they also announced that they would increase interest rates to help make up for the losses they have incurred.
It is important to note that interest rate increases will only worsen the effects of the bubble pop, by futher depressing home prices and by further limiting the number of qualified buyers. Foreclosures will rise too along with rates as fewer mortagees will be able to save themselves through a re-fi.
Lenders like AHM apparently are more concerned with short term performances (however illusionary) for Wall Street than long term survival. It seems the financial industry is determined at this point to turn the RE bubble they caused into a Hindenburg style blow up. Unfortunately they may explode whats left of our economy in doing so.
AHM is leveraged to the eyeballs. I considered buying the stock but backed away when I couldn’t figure out if they could keep borrowing money. If AHM can’t keep their lenders happy with interest payments (and meeting performance conditions) in the short run, there is no long run.
Long term survival is only worth considering if one’s short term survival is assured. The only way AHM will survive is surviving the short term.
“It is important to note that interest rate increases will only worsen the effects of the bubble pop, by futher depressing home prices and by further limiting the number of qualified buyers.”
Exactly, there might be some latency, but it will happen. Just like when rates initially dropped, prices stayed relatively low for awhile until people caught on that the same house came with a lower monthly payment. Demand ramped up, then prices.
Same thing is happening now, but in reverse.
You can’t charge TODAY’S customers for YESTERDAY’S losses in a business where the barriers to entry are as low as they are in the mortgage industry. A newly formed company can simply undercut you because they don’t have such losses on their books.
Didn’t the Fed say that the subprime problem “appeared to be contained” as opposed to it “is” contained. When I used to do my corporate loan credit write-ups I would use the word “appears” when I wasn’t 100% sure of what I was deducing from the financial statements.
I read the new Kipplingers finance magazine that came today. An interesting article recommending that investors follow Buffet’s advice to “be greedy when others are fearful.” In this case, the advice was to buy subprime lenders since they have already taken big hits and the crisis is over blown. Unfortunately, this advice is clearly outdated. Since the Alt A’s are now suspect, subprime lenders and the prospect for more subprime loans are completely underwater. I expect that the loans to keep Accedited and Novastar solvent will dry up and these subprimes will go into bk. Moveover, New Century will not be able to get out of bk as a subprime and it’s already clear that the big banks, like Wells Fargo are running from the subprime market.
There was an idiot from the Motley Stool who wrote an article about it being too late to short subprime. At the time, NEW was at $17, LEND at $22, NFI at $11, FMT at $12 and so on. Reading these rags will only cost you money. Subprime lenders will still be going bankrupt in the coming months and years, and so will some Alt-A lenders.
we are all subprime now.