Global Housing Bubble: International House of Subprime Lending.
The Revolving Reset Door
For the last decade we’ve been obsessed with the housing market. With new underwriting software, mainstream media shows, and the ability to tap home equity we became a nation fueled by housing appreciation. Never have we had so much refinancing activity and mortgage equity withdrawals hitting the economy. The perception that your home is an ATM and a virtual American Express card is something new. Even in past housing bubbles, the money was made by flipping or assigning rights of the property to another person. This bubble is in another dimension because with cash-out refinances and buying 2nd homes, home owners became on a microcosmic level mini banks. They had the potential to lend money to themselves. They assigned the ability to purchase 2nd homes via the leverage of their first home and the perceived equity. Many folks are learning a hard lesson that the equity in your home isn’t yours until you sell and have the cashier check in your hand.
The slow decline is happening because there is a systematic time bomb of mortgage resets waiting in the wing. Like a jaguar stalking its prey, it is lingering in the corner ready to pounce. How much is really resetting? According to Credit Suisse, the biggest month of mortgage resets will be October 2007 where $50 billion loans will reset for the first time. In addition, we are already in the full reset mode with $30 billion in loans resetting each month from now until September 2008. You think it is bad now? The market is still thriving a bit because summer does bring out buyers and sellers that really have no idea of the credit bubble working behind the scenes. If anything, this is the absolute last leg of the housing market for a long time. See, the Ponzi game could only last for so long. With housing in major metro areas going up each year, it masked the financial naiveté of many buyers who got in trouble because they simply listed their home and actually made some money by selling in record time. Or they played the refinancing musical chair game and bought time by giving themselves a short-term carry over loan. However, this all ends when lending gets tighter and the lava like pace of the mortgage reset is creeping to you and there is nothing to do except watch. How does this wave look like? We’ve all seen this fantastic chart of mortgage rate resets from Credit Suisse (by the way, we are at number 7):
Overly Optimistic Scenarios
Optimism is good. In fact, it is better to be optimistic in your life. It is healthy for you. You may be thinking, “Dr. Housing Bubble is optimistic? What is the world coming to!†Indeed, you should be hopeful for the future but blind adherence to positive thinking will only lead you down a disastrous road. Prudence must be exercised especially in the credit bubble we are living in. However, in the last few years we’ve witnessed an entire syndicate of people hedging their entire lives and careers on the housing and credit industries. Even the insurance companies and lenders have overly optimistic scenarios because they used faulty models of housing appreciation. Let us run through an absurd model used by some subprime lenders. They factored in a percentage of defaults, yet with these defaults they assumed that they would be able to unload the properties at market rates and recoup their losses! Think about that for a second. Even though they had assumption models predicting certain losses they were also factoring in the sale of the home at an optimistic sales price. What if the home doesn’t sell? They became flippers without even knowing it. Somehow the belief of the new economy was built on managing and repackaging credit from now until the end of time. Of course debt is not wealth. But look around your immediate environment and you will see artifacts of the false gods of debt. Leased cars. Massive McMansions. Multiple vacations a year to exotic locations. All under the umbrealla of credit. Our society drank the Kool-Aid and bought the line that debt is wealth.
Well the game could only go on so long. With the massive consumerism of this culture being funded through foreign entities, there had to come a point where you reach a credit watershed event. We’re not there yet. I know many are calling the bottom but as you can see from the above chart, we are only shifting into the next stage. In order to purge the market unfortunately, there will be a prolonged shift on the credit markets and how people perceive debt. Foreclosures are rising but are not in crisis mode. All this bail out talk is absurd because it doesn’t address the underlying economic neurosis. I think I can best convey this point by giving a personal example.
A very successful friend who is a business owner decided during the technology bubble days to invest $300,000 in technology stocks. He got in one year before the bust. He saw his portfolio jump to $340,000 in one year and I thought he was a genius even though the companies he picked had no projected earnings. Well, the bubble burst and his portfolio dwindled to $60,000 in a matter of months. Turns out a few of the companies had accounting “irregularitiesâ€; funny how they use words as if it were a digestive problem. So what did he do? He decided to hold onto these losers until they came back again! “They’ll come back. These are great companies.†Indeed, the companies that survived were great but absurdly overpriced. They never came close to their peak prices even to this day. So you would think he learned his lesson. Fast forward a few years and now we are in the housing frenzy. He decides that he will purchase rental properties in
Financially, his family is doing really well so it won’t impact him aside from taking a hit to the ego and a drop in his net worth. But the underlying psychology behind this has no merit in economics. Essentially, people jump from one bubble to another like folks that jump from one bad relationship to another. At a certain point, you start to realize that maybe the problem isn’t the other people but potentially it is the person looking back at you in the mirror. Unless the credit using public understands the nature of debt and how bubbles inflate and then bust, this endless cycle of bubbles will keep on occurring. And from all financial literacy surveys I have seen, Americans need a major financial makeover. The problem? The so called gurus are dependent on the system as well. From banks, home repair stores, electronic departments, credit card companies, and the housing syndicate these sectors rely on the continuance of the housing and credit bubble expanding. After all, if you bought items with money you did have, why would you need credit? Because of a FICO score? Who owns FICO? As you can see, the rabbit hole goes much deeper than most would like to admit.
Market Psychology
It is interesting to hear certain media outlets say that housing will not pick up until 2009. In fact, they stop short of saying housing will be a horrible investment for the next two years. Try telling that to the person that just had their home foreclosed. Or the person that just saw a 50 percent increase in their housing payment. Suddenly the eager lender who went stated income is hesitant to offer them a refinance or payment support. When you hear talk about bailout why don’t they chase lenders that committed fraud and create a restitution fund from their earnings or profits? Companies and banks that benefited the most with fraudulent loans should pay something back. This way, those that actually managed their finances wisely won’t be taxed and subsidize this credit bonanza. And even President Bush was questioned directly about the subprime debacle. The reporter asked if a crisis in the housing markets existed and the President replied that everything was okay and we don’t need to worry about the market. No bail out from his administration even though they got loads of money from housing Political Action Committees. Maybe he got advice from the NAR which on a monthly basis adjusts their housing figures down. It is now becoming a running joke that whatever the NAR states, subtract one from it.
To a certain extent, I think folks are catching on that simply because you can charge something doesn’t mean you should actually buy it. Just because I can “buy†a Ferrari tomorrow doesn’t mean I will. Just because you can swim with sharks with T-Bone steaks tied around your neck probably doesn’t mean you should. It is called using restraint and assessing your actual situation. All it takes is a simple budget and a realistic assessment of the market. Something that has been absent since 2000. Like the amazingly well written letter from a lawyer during the Great Depression, from crash to an actual daily impact in the society took about 3 years. I’m still in the camp that doesn’t think we’ve hit the “crash†point. I’m thinking October will hit us hard for a couple of reasons. First, the record month of rate resets will hit a psychological tipping point. And second, we will have Q2 numbers coming out and housing companies (those that aren’t in bankruptcy) will be reporting more disappointing numbers. This bubble went global and together, we will share in some of this pain.
What are your prediction for the remainder of the year?
Did You Enjoy The Post? Subscribe to Dr. Housing Bubble’s Blog to get updated housing commentary, analysis, and information.
Subscribe to feed
22 Responses to “Global Housing Bubble: International House of Subprime Lending.”
Thanks for the post. You do good work. I have not left comments in the past because of the Google sign-up stuff. But, I finally took time to do it. Too bad you aren’t on a different service that does not force people to sign up for their accounts just to post a comment, but I suppose you have your reasons.
My prognostication:
DOW 12500
GDP of 2Q adjust downward, reccession by 3Q
Presidential candidates who support illegal immigration amnesty will get toasted and will plead with front runner for the VP jop or a secretary position
unemployment approaching 6%
Still mire in Iraq
Bush will challenge Nixon’s lowest approval rating ~25%
Credit meltdown never seen in history. Cash infusion will only exacerbate the problem.
On the brighter side, oil will be ~$50 and gas will be ~$2.50.
John Doe throws in the towel. Debt just broke his back.
It seems the spigots have been opened to the tune of $500b, not just $130b.
http://tinyurl.com/2jqpq4
My prediction for the remainder of the year: I’ll continue to rent my apartment and will put as much of my income into savings as I can every month. (I’ve been totally debt-free for three years.) I will also continue to monitor the credit and real estate situations closely, and keep up hope that in another two to five years, I might actually be able to purchase a condo or house for myself here in Los Angeles.
Hi Doc,
incisive work, as always. Thanks.
My predictions:
Stock drops followed by infusion of liquidity which pundits will call the “invisible hand of the market” but will actually be the PPT. Consumer confidence drop will drag personal consumption portion of GDP down to 60%. An incident in the middle east will cause oil prices to spike, Cheney will demand the Saudis open the spigots and we’ll discover they don’t have the capacity to act as swing producer anymore. This along with lack of refineries will cause a brutal rise in fuel prices and what to about this rise will overshadow the war leading up to the elections. Anger will turn to malaise next year and 28% of the electorate will turn out to give Edwards a close victory over Romney.
Hey what the hell do I know, other than that Planobcl is wrong about one thing – ALL of the presidential candidates support illegal immigration. If they didn’t all you foreigners (Dr HB you can stay)would go back across whatever oceans you came from.
Yep, I’m planning on renting till summer 2008 unless a home builder gives me a great deal ie 100K or more less than current rediculous pricing.
I have family members that don’t believe this thing will go as badly as I think it will. They will continue to think that through the rest of the year.
My wife will continue to push to buy a home. I will continue to read her articles from the website and a few others.
I will continue to monitor the bubble markets inventory tracking blog to back up my emotions with hard facts.
Silly sellers in Upland will start to figure out that lowering their prices from 1,060,000 to 1,030,000 won’t make a lick of difference.
Stock market is definitely hosed… I’m guessing DOW 8000 within 6 months.
Housing market is grinding to a halt, but it will take months for just the paperwork to settle.
Sure seems like all lenders (even Countrywide now) are running outa cash….
So what about the credit card industry? When do they run out of cash?
Can you imagine your Visa card not working at Wal-Mart because your bank can’t resale junk bonds on the open market? Spooky…
Pop goes the Bubble!
I predict companies announcing “unprecedented” market conditions after the market closes:
Countrywide Down 12% After Hours
Is there a pattern emerging here? We had American Home Mortgage announce their bad news on Friday evening letting the market marinate over the weekend.
And doesn’t it seem ironic to anyone that the market had a massive injection of credit to solve credit problems? The reason we are in this mess is easy credit so they decide to pump more credit into the market. Wow. Lesson number 1, don’t chase bad money with good.
Another great article. I too believe that in October 2007 the fat lady will sing. Christmas sales should be bleak this year and that will have a real and psychological effect.
I can predict everything but the future.
But how about ten years of flat real estate prices before the next bubble?
Steve – you bring up an interesting point. Our economy runs on credit. Many people I know wouldn’t survive without their credit cards because they don’t have enough income to cover their expenses and/or lifestyle. At what point do credit cards max out? I’ve never been a fan or heavy user of credit cards, but it seems like I get at least 2 mailers a day for a new card. Can anyone with a pulse get a credit card despite their credit score and (lack of) of income? I suppose credit cards are the original no-doc loan.
Another great post Dr. HB. You are one of the only people in the blogosphere that is already ahead of the curve in analyzing the root societal cause of this still to be determined global effect. And NO ONE in the MSM would dare touch that, natch. As far as predictions go, I’m in the stagflation camp. It’s a difficult topic to explain, esp. on a blog post but all the planets are lining up that way:
Differential accumulation theory sees stagflation (which oscillates inversely with periods where mergers and acquisitions is dominant) as a major strategy of dominant capital groups to beat the average and exceed the normal rate of return on investment. Stagflation, which appears as a crisis at the societal level, contributes significantly to differential accumulation at the disaggregate level, that is, of dominant capital groups accumulating faster than smaller businesses. Since the 20th century, the dominant capital group which has benefited from stagflation has been the “weapondollar-petrodollar coalition” during periods of Mid-east crises and rising oil prices. These periods have oscillated between periods of relative “peace” during which mergers and acquisitions have been the dominant strategy for beating the average.
Historical stagflation
Stagflation in the late Classical Keynesian Period (1968-1982)
Stagflation occurred in the economies of the United Kingdom in the 1960s and 1970s and the United States during the 1970s, most famously during the Carter Administration. The difficulty in fitting its existence within a Keynesian framework led to a greater acceptance of monetarist theories in the 1970s and 1980s. The pendulum has, to some extent, swung back in the other direction as monetarism has seemed to encounter increasing difficulty predicting the demand for money and the long period of low inflation and high employment during the Y2K/Dot-Com Bubble of the late 1990s and again during the 2004-2006 period, which temporarily drove oil prices high enough to measurably increase inflation during the first three quarters of 2006.
The monetarists would respond that inflation was remarkably stable during the dotcom boom and recession and that the oil price driven inflation was nothing more than the natural increase in price of one commodity rather than true inflation. The rise in oil prices was just that, a rise in oil prices. It had nothing to do with the value of the overall currency even if consumers lost effective currency as a result. The elimination of oil as a commodity would eliminate this “inflation”.
more complete discussion:
http://en.wikipedia.org/wiki/Stagflation
Stagflation – Wikipedia, the free encyclopedia
Great post Doc.
Its ging to be ver painful for the next 12 months. I feel for anyone on this planet who bought Real Estate in the past 3 years. Most are under water now.
My prediction? To quote Clubber Lange from “Rocky III”:
I predict PAIN.
Subprime Credit Liquidity Crisis?! http://www.chicagomortgagefinance.com
From Borrower to Mortgage To Secondary Market…The REAL Problem.
By Jon Miller, Senior Mortgage Banker
Chicago Bancorp
The Borrower
Chicago, IL – Consumers interested in purchasing or refinancing a home will pay a given interest rate based on their personal financials, current market conditions and product/debt strategy chosen. Risk assessment is based upon the borrower’s income and debt ratios, credit scoring and history, liquidity and asset base, leverage scenario and level of approval obtained…which criteria for the aforementioned is tightening significantly by the day. If the borrower’s credit will not permit A+ levels of qualification – or if income and assets cannot be sufficiently documented – an alternate course of lending is needed. Unfortunately, this course of subprime and Alt A lending has not been utilized in the way it was intended by the borrower and in some cases, the lender as well. Now we have issues. Starting from scratch, let’s take subprime for example –
Scenario – John and Jane Doe decide to purchase a home. In fact, they went home shopping first and negotiated a purchase agreement which is now fully executed and earnest money is on the line. Both borrowers had not yet retained a professional mortgage advisor and have been shopping around by telephone and the internet, which always incurs unreliability and inefficiency in the transaction (but that is another story). John and Jane find me and agree to move forward. Upon a credit and financial analysis, I discover that both John and Jane have credit deficiencies that will not permit a higher level approval (hence, lower cost) and also cannot document income do to tax return complexities. John and Jane also are just barely able to afford the home as 50% of their gross annual income is being utilized for the housing payment and personal debt. They also have very little liquid assets (1 month housing payment) in reserve. They will need to utilize subprime or Alt A (alternate lending) loan programs in this case as it is the only viable solution. Due to my discovery, it would be advised that they get their earnest money back during the attorney review period, put the contract on hold and wait until a better formal plan of action is determined by their mortgage professional (me) and hard numbers can be provided. Most likely, a credit repair plan would be issued. By following the plan, the borrowers would potentially have the ability to qualify for A+ level paper within a 45 day time frame – which equates to a lower cost of funds (interest rate, etc.), more affordable payments and better terms all around. Rather, John and Jane want to move forward with the purchase instead of going through the credit repair plan (they may not have the time, $$ or some other reason). Now it becomes my job to utilize the best financing option out of the very limited options available to get them into the home on time and STILL prepare them to utilize a credit cleanup action plan after closing – which absolutely needs followed over the next 12-18 months. The only product for which John and Jane qualify is a 2 year subprime ARM (assume so for this example). Remember, this is a 2 year subprime ARM loan. We only have 24 months to get everything in order for better financing.
We close. From there forward on a quarterly basis, John and Jane are followed up with to determine how much progress has been made on the credit repair. They respond with “no progress made.†Further advice is reiterated as to what to do, how to do it and another set of instructions and email are sent to the clients to be certain they are on top of things. Another quarter goes by. Still no action. Another, and another and…all of a sudden John and Jane are a month away from the ARM adjusting.
Well, we have arrived. Due to 1) the housing market being in a slump (mostly, a state of stagnancy with some areas substantially in decline during the last 2 years) and 2) higher default rates on precisely these types of loan products from the previous two years, investors are no longer willing to extend credit loosely to this type of mortgage financing situation. Now, we have two borrowers who failed to follow a course of action to improve their credit over time; a housing market providing no rate of return (appreciation) on the home they purchased; no equity in the home due to the lack of appreciation; no loan products available for highly leveraged property with little equity (John and Jane’s situation) due to the housing and default rates over the last year and subsequent guideline tightening from investors… And a housing payment for John and Jane that will adjust the full 3% when the time comes, increasing their payment by $600 per month with no opportunity to refinance due to the previous conditions mentioned. Now the default cycle continues… You can see where this is going.
The most frustrating aspect of a mortgage planner’s profession is the inability to do anything for a client to rectify a potentially hazardous financial pitfall. A situation such as this, which is based around several absolutely true situations, is completely out of our control. The media and hype discuss fraud and predatory lending being the issue for problematic mortgage defaults. I have to tell you, this is absolutely not the case but in a very small percentage of mortgage loan fundings.
The Market
There are no issues with conforming loans at this point. Subprime, Alt A and some non-conforming is the problem area. Upon the street’s reassessment of the mortgage market, the risk level has gone up substantially due to higher default rates and stagnant/declining housing over time…so a much higher yield is required on those loans to offset the higher risk (based on the recent valuation). Essentially the mortgage bond is discounted (price deterioration/valued less) to the net present value which ends up deteriorating the bonds below a par yield. What was going to be a mortgage sold to Wall Street at 101 now is being sold at 98 or 99 due to the devaluation. It will now cost the mortgage company XX dollars per loan to fund the loan rather than making XX dollars in premium from which it otherwise would have profited…creating a total loss and depletion of the lender’s liquid assets to cover the discount. Secondly, margin calls (due to the discounted value of the mortgages backing the assets) exorbitantly heightened this depletion scenario in which the necessary margin shortages required additional liquidation of the mortgage lender’s assets (it may or may not have had) to cover the minimum maintenance requirement or “initial margin”.
In summary, put the two together – Wall Street (the market) adjusted what it needed for compensation – demanding a higher yield on funds already locked and being delivered at a lower yield – creating a total loss on each loan funding within the next 30-60 days. Simultaneously, margin calls added to the depletion of the company’s assets already being utilized to cover the devalued (discounted) mortgage paper. Mortgage companies cannot go back to the consumer and ask for the higher yield to offset this difference. Either the company has the liquidity to weather the storm or it shuts its doors (think AHM) as the cost per day to stay open can be millions of dollars in a credit crisis such as this.
One Day of business in a normal credit market…100M in loans (in one day) going to secondary @ 6.5% => 101M sell price => 1M profit in one day
Today’s credit market…Wall street says 8% is the return needed for the additional risk – which discounts the current loan to a net present value and COSTS the mortgage company. 100M in loans to secondary at 6.5% => value is 97M => 3 Million Dollar loss in one day…not including margin call coverage.
Two things need to happen:
1. The credit market needs to stabilize. It cannot continue a cycle needing 8% this month to offset the higher risk only to then need 9% next month and so on. Polls will identify a given stability figure and will eventually ease itself in the long term.
2. Loan pipelines need to be covered. Clients need to get closed as soon as possible. The mortgage professional needs to have a couple of backup plans just in case an overnight change occurs with an investor’s product initially selected for that client which no longer becomes available.
Although the Fed has been talking about stepping in to provide some relief to some parts of the secondary market which have essentially seized, the bid/ask spreads are just too wide for the MBS to trade; leaving lenders with large inventories and facing additional margin calls. In my opinion, if the Fed steps in to add liquidity and help stabilize the credit markets – by their own admission – this greasing of the cog wheels will be “limited” in the overall effect. If they are able to move the secondary markets a bit, it will only flush out the already fundamentally undesirable portfolios. Since most high-leveraging, alternate documentation subprime lending has ceased, a Fed move will mostly affect only market portfolios already warehoused. Those loans that that were originated at 102… and now needing to fetch 103 or 104 on the street… might be offered at 98 to 100 only narrowing the spread and limiting the lenders net losses – but not saving them entirely. Even then, only the strongest banks (with large amounts of cash on hand) will be able to weather the storm after the Fed’s assistance. Aggressive investors will still be needed to move behind the fed to uphold any momentum the fed initiates and pull through the market deterioration within a reasonable time frame.
Recommendation – CLOSE YOUR LOAN AS SOON AS POSSIBLE!
The flood gates are now open:
“Stocks trim losses after second big influx from the Fed – bringing central bank’s total infusion to $35 billion. Move helps soothe nerves.”
They’ll be injecting more liquidity into the system. Apparently people making $14,000 a year and buying $720,000 homes wasn’t enough liquidity; now we’ll have people unemployed with zero income landing $2.2 million in mortgages. That’s right, we’ve already been down that road.
$19 billion injection is about two weeks of mortgage resets. So it’ll be like insulin for the market; we’ll keep doing this every month until September 2008.
Another hero of after hours trading:
Accredited Home Lenders
First they go up by 41% for the day and go down 47% in after-hours trading. They need to create an after hours home lender index. These companies are taking a hint from AHM by releasing information just before the weekend. Get used to this pattern for many months.
Regulators deny Fannie’s request to grow investments. Great news to digest over the weekend.
Even after this massive orgy of credit injections, the DJIA was still down, 30+ for the day. The Fed has become the new uber-subprime lender!
Dr HBB – I know its OT, but I haven’t seen a Real Home of Genius for a while, and though you might like to take a gander at this little beauty:
http://tinyurl.com/3yudz5
MLS# P593620
It’s an REO in Encino – North of Ventura Blvd, South of the 101. 1,065 sq ft, 2b 1bth – in apalling condition.
Priced competively at $678,5000 – zillow say $904K (wtf?)
Bought in 2004 for $725K….
Anyway, all 4 ziprealty photos show a place that’s been neglected for months – the worst bit is the scummy half-filled pool in the back yard (at least they had the decency not to call it ‘sparkling’), which by now must be harbouring mosquitos up the wazoo.
Anyway, thought you might enjoy it!
I don’t think all of the added liquidity will do anything. People will not buy something that is worthless, especially investors. If nobody is buying your nice pretty little finacial product, it is worth exactly zero. Nothing will change that. I wouldn’t call it a panic either. Panic implies activity.
As the Market goes, I honestly don’t care :). I have been trading options for about three years now and I’ve learned how to make money going short or long on my select companies.
I think ForEx trading will be really interesting since so many countries seem to be dumping cash in to the economy and selling gold to prop up the greenback.
I can only speak about the DFW housing market since it is all I know. I don’t see a lot of fallout here as it is hasn’t been a hot appreciating market. I guess lending will keep tightening up here as well.
As far as investing in RE, I do see it a being a little less difficult since a lot of the pretenders will be scared out of the market.
As someone who has been negotiating short sales with banks for the last 2 years I am getting pretty excited. It looks like we are on the verge of a transfer of wealth. I just hope people are ready for it.
A great article, Doc HB, but I think you exaggerated a bit in this example:
“He started buying a few years ago and now has a few properties that are negative cash flowing but they’ll go “up like crazy†according to his market analysis. Many of his homes are now back down to 2005 and in some cases 2004 prices therefore giving him zero equity even with the ridiculous appreciation.”
Hmm, as long as he purchased the estates with his own money and not a credit, he still has a positive cash flow, right? It may not be a great ROE, but as long as he hasn’t to pay interest to a bank, it’s still positive. Same with the equity: He may have lost a lot, but there is still equity left, as long as he doens’t have mortgages on the home. Or am I missing something here?
@ Peppermint Hippo
Credit cards are the ultimate no-doc loan. Basically any balance on a credit (even when you are “locked in” to a rate for “life”) is a 2 week quicky no-doc loan.
I’m not sure how often they check your credit worthiness, but they have the legal right to change the term of your loan every 15 days and most people are clueless to this fact. Being late by 5 days on your water bill can trigger them to reduce your credit worthiness.
So basically if I go buy a TV on 36 months at zero %, I better be able to pay it off at any time because during that loan period they have 72 opportunities to change the terms from 0% to 29.99% or higher.
Very scary that people live off these things. Once I learned how crazy this is, I stopped carrying a balance for more than 2 weeks. So now I’m a “deadbeat” in credit card company terms because all they make off of me is a transaction fee.
Leave a Reply