March 19, 2007

$640 Billion in Sub-prime Loans Originated. $386 Billion in Alt-A Loans Originated. $1.026 Trillion in Loans at Risk? Priceless.

The L.A. Times issued a cover story regarding the New Century Debacle this Sunday. Yes, it was a smaller story on the bottom left hand side of the newspaper but it did make the cover. The story was well written and talked about top producing employees spending time at a castle in Ireland while the company collapses. Fiddling away as Nero burns Rome. Not only that, but the story parallels the weird black multistory building that New Century occupies in Irvine California next to a defunct savings and loan giant that no longer reigns. I guess Irvine is turning out to be a hub for high risk permabull empire building via wildly risky loans. If we want to take tabs, how much is at risk this year? Many believe that the sub-prime debacle will be contained in a silo and will not have an effect on the overall market. I disagree with this Pollyanna version and wishful thinking that will only add more fuel to the bubble while it takes its last breath during the 11th hour. Let us break down what is at stake:

Digging Deeper into the Numbers

Estimates coming out from the permabull camp state that 7.65% of sub-prime loans are at risk for default while only 1.25% of Alt-A loans are at risk. When looking deeper in Inside Mortgage Finance, an industry publication, we see that in terms of tracking data on sub-prime and Alt-A loans the data is vague. Considering that many loans are stated income I'm not sure how they arrived at their optimistic numbers. Stated income means made up; a recent study by the Los Angeles Times demonstrated that 80% of folks on stated income lied about their income. Of these folks, 60% overstated their income by 50%! Yet again, we realize how distorted the mainstream media is because no one wants to hear "hey, you now have to save up to buy a home!" Why is saving to buy a home important? It demonstrates two principle things of a prospective buyer. One, you are diligent enough to save for something you want (showing your ability to forgo credit for one or two years). And second, it demonstrates financial prudence. The last few years we have dropped kicked financial prudence through the uprights and have flooded the market with instant gratification liquidity. How can we be expected to save for a down payment when our savings rate is negative?

How Much Money is Now Lost Because of Sub-prime?

The general market hasn't felt the pain of the sub-prime implosion because mainly hedge funds have loaded up in these risky plays. However, mutual funds being rather safe from any collateral damage, will begin facing some pain when the rates start resetting and the larger players realize they will need to unload bad debt and overpriced McMansions in a market with no liquidity. Let us take a few top sub-prime operators and run the numbers to see how painful their kick to the groin was:

You notice the trend? Even though in terms of getting hammered IndyMac is still doing okay, they are the largest Alt-A player out there. But look how much market cap was lost by them simply being caught up in the sub-prime rage? Let us not forget the top dogs Freddie and Fannie Mae with a combined market cap of close to $100 billion. This crap will travel all the way to the top and New Century and Fremont are simply the first to get guillotined in this credit orgy we've been living through. Wall Street is rallying today but this is a dead cat rebound. Listen to the permabull housing heads at your own peril. Phoenix just hit a record inventory at 56,000. Some areas in Florida have dropped 20% year-over-year. Southern California is still in wonderland housing rehab but go ahead and jump into a Real Homes of Genius place at 600 square feet for $475,000. Your monthly payment will be approximately $4,000 since you can't go stated-income-suicide-negative-amortization for 1% but hey, you'll get one bedroom and one bath all to yourself. You don't need anything larger since your mortgage will fill up any empty space.


Anonymous said...

While I am a farily new at the real estate arena, I am well versed in basic economy 101. I am in complete agreement with you. The market is insane and will see the crash as never seen before. When a upper middle class person like myself with an annual taxable income of $80,000 can't afford a descent house in a descent area, something is wrong!!!! I was wondering how people were able to afford to buy a house in So Cal until I started doing some research. Thanks Dr. housing bubble. Keep up the good work.

Dr Housing Bubble said...


Don't let the pundits blind you to commonsense. That is great that you are asking yourself basic questions about housing. Yes, it is overpriced. Yes, we are in a bubble. The sub-prime explosion is only the beginning of this bomb.

Housing goes in cycles and we are trending downward. Do not listen to the real estate cartel preaching "new paradigm" rhetoric. They are trying to protect their self interest and finally the mainstream media is picking up on the lunacy of the bubble.

Dr. Housing Bubble

sed said...

Thanks for all your continuing efforts! Stumbling across this website and Piffington's has been a real education in unreal estate. One of the first shocks that hit me back in 1991 moving to LA from the midwest was housing prices. A $30K simple midwestern bungalow selling for $300K and I thought it was unreal then...duh. Half a million bucks for a 800 sq. box in a neighborhood controlled by the Salvadoran M-18 street gang. Sad, maybe even potentially dangerous as the default rate grows in marginal areas.

Believe it or not, the local LA news had a feature on the coming housing bubble burst, so you were simply ahead of the times.

I've started to rebalance my investments -- more bonds, dividend stocks, T-bills, metals. Reducing NASDAQ exposure where possible and anxiously awaiting a chance to buy a home in a couple years (licking chops).

Thanks again....especially for those super MLS listings. Maybe they can include a meth lab as an incentive.

Dr Housing Bubble said...


Welcome aboard. Yes, the Professor's website has a lot of good information. Keep believing your gut instincts because the market is adjusting. I had so many friends that jumped in and bought a house in 2005 and 2006 and now they are feeling the pain. And others are starring at their mortgage as if they had a barrel pointed to their head.

It is only a matter of time when things revert. Your example of gang infested areas being at $400,000+ is not uncommon; just look at Compton, Lynwood, South Gate, and you'll understand why we are in a bubble.

k.o. said...

Thanks for another great post, Dr. H. Reading up on sites like yours really have been a silver lining to the cloud that is the SoCal housing market. Glad to think that all these questions I've had in my head about housing are being answered by people like you, I appreciate it!

Being a young professional I am trying to steel myself by avoiding teaser loans and buying myself a box for 400K. I know I just have to be patient, save for a downpayment, and keep on learning. Thanks!

IrvineRenter said...

Dr. Housing Bubble,

Sometimes I wonder if I am too close to this thing and maybe I am not seeing something. I see denial in the financial markets like I have never noticed before. To me it just seems so obvious that a credit crunch is coming and both housing and the equities markets will get swept away. It gives me comfort when I read posts like this one because it reminds me that I am not alone and that others see what I see. I would not be too surprised if this little dead-cat bounce in the markets will be greeted with some "new" information regarding troubles in Alt-A and prime loans. Then the next leg down will begin. I will probably be adding to my short positions over the next few days.

sed said...

If you took notice today, despite a very solid upswing on Wall Street today (every equity I own or monitor was up save typical losers), all the subprimers and alt A stocks took a 8-12% hit. That is, despite one of the strongest days on the Street in awhile, our favorite lenders were down to new lows.

While a bear market is certainly a more compelling argument than a continuing bull market, I think world economics is more complex and some sectors will do okay. My choice is to invest in companies which produce things we use no matter what and in natural resources, which God still isn't making any more of.

I was talking with my T.RowePrice rep today and I could tell, between the lines, that they are jittery too.


Anonymous said...

Notice that the volume of the NYSE was low today - the negative days have had much higher (3.5 billion average) vs the up days (2.7 billion today). Dead cat bounce.

Dr Housing Bubble said...

Get ready to hear about CDOs a lot more. Collateralized debt obligations. Isn’t it funny how all of sudden, after 9/11 the appetite for CDOs boomed? Wall Street and investors wanted a piece of the housing action and what better way to make money than to securitize debt, give each piece a different rating, and sell it off to private investors. The only problem is that this system was based on accurate reporting of home values and very little fraud in the market; we all know how little fraud and by golly we know every house is worth what the appraiser and agent say it is right?

To give you a perspective, LA based TCW manages $48 billion in their CDO portfolio. $15 billion which comes from the subprime market. I don’t know about you but that seems pretty collateralized to me eh?

sed said...

Thought this might be of interest

Dr Housing Bubble said...


Thanks for that link. That is a great site. Easy way to view the U.S. map and see historical vs. current prices.

It is important to get this type of information out because more and more people are landing on housing bear blogs by querying:

"Housing bubble 2007"
"los angeles housing prices"
"should i buy a home in California"

So there are still people unsure of the housing bubble looking for information.

Dr. Housing Bubble

Steve the Dog said...

Dear Senator Dodd,

I had no idea that when I got my shint new platinum credit card that the bank eag going to charge me interest. Lots of interest. I'm having trouble paying it back because I bought so much stuff. I really don't feel like selling all my stuff, plus, since it is used stuff it isn't worth as much as what I paid for it.

Can you please put together a bailout for me and lots of other folks like me who got in over our heads?

I mean I really like my new plasma TV and stuff but it sucks having to pay so much to the bank.

--Steve the dog

Dr Housing Bubble said...

Dear Steve,

I agree, paying the bank is a drag. Actually paying anyone back is a drag when I really think about it. As an American, it is your right to the following:

1 Plasma HDTV
1 Fully Loaded Hummer with Spinning Rims
1 Faux Marble Jacuzzi
2 Country Club Memberships
1 McMansion with all the goodies

If you are unable to have these things, then what is there to life? I believe Thomas Jefferson said it best that we must be free to pursue life, liberty, free TIVO. Go ahead and get the constitution, its in there.

Now I want you to know that I am fighting for you and will ensure that all those frugal, loser, savers, and I mean LOSERS subsidize your spending habits.


Senator Dodd

P.S. Let me know if you need another credit card to hold you over for March.

Make Mine A Bubble said...

Thanks for such great info, Dr. HB.

Your posts are always very original and insightful. It's blogs such as yours that keep me strong when I start to get the nesting urge to BUY TOMORROW!

It's hard to hold off with a hubby and a new baby in the rental, now. But I'm standing strong and waiting to buy for at least a year and a half.

Thanks for saving my young family so much money! Our cash is nice and safe in CDs earning 5.5% for the time being. Ahhhh....THAT'S a nice feeling!

Dr Housing Bubble said...

Make Mine A Bubble,

Thanks for the comment. Isn't that cash looking mighty attractive right now? Don't you just want to withdraw it, throw it on your bed, and roll in it as if it were a green lawn of freedom?

Now, many friends that bit the bullet for the "nesting" feel of a home are rolling on their bed with mortgage coupons crying their eyes out. I do feel bad for them in a sense. The psychology of providing for your family is a strong one, if not THE strongest. Unfortunately unscrupulous charlatans in the real estate industry capitalized on this and sold the dream of this to many unsuspecting newbie buyers. They made the largest investment of their life without running the numbers. Investors know this spells disasters - never put money into something you do not know.

Now that the market is imploding, fraud rampant, and those that I coin as credit slaves are realizing that their new master wasn't so alluring. That HELOC you took out for granite counter-tops in 2003 is still asking to be paid. That $10,000 trip to New Zealand in 2005 is still costing you $250 a month.

In a deflating market, which is real estate right now, cash is king and the 30 percent of the population that sat out this mania will be sitting pretty when the time comes to purchase a home. If anything, deals will be abound because these folks will still be paying off debts on old mortgages, cars, and other useless liabilities that are worth pennies to what they once paid for.

The subprime market is just starting to massively reset. Most subprime loans will reset by late 2008. Starting this month, they will be resetting at a rate of 15 to 30 billion dollars per month. That is a lot of cash.

If only the subprime lenders followed your advice and sat on some cash they wouldn't be imploding as they are. But greed is a funny thing.

Good luck on purchasing your home soon. Look at it this way. For what you are paying in rent, would you want to put your family in a dangerous environment with poor schools? Not me. I'd rather rent and invest elsewhere.


Dr. Housing Bubble

Make Mine A Bubble said...

Absolutely! My family sleeps VERY well at night, right now. In addition to the downpayment cash we have in CDs, we also have 6 months worth of expenses saved up in a money market as an emergency fund that we promised ourselves we'd NEVER touch (unless we have an emergency, of course).

Any perceived "security" we'd get from owning a home right now would be washed away by the very real insecurity of having NO cash on hand and No emergency fund (because, to buy in this crazy, inflated market, we'd have to use all our stores and then some). Looking ahead, if there is a recession, there's a very real possibility my husband could lose his job and we'll need those funds. What's going to happen to so many families that are indebted to the hilt...and THEN they lose their jobs?

I'm much happier to keep squirreling it away and waiting for prices to come down. Things are a little cramped in our 2-bedroom with a new baby...but we are much, MUCH happier knowing we can afford to cover life's emergencies and live well within our means. It's also very good for my relationship with my new husband to not have money issues and debt hanging over our head.

It makes me sad to think of how many families will be ending up in divorce court because the stresses of bad financial decisions were just too much to bear.

No one ever really talks about the damage this credit bubble will do to our nation BEYOND financial. Think of all the social and interpersonal ramifications of lost jobs, financial stress, blame for bad choices, loss of retirement funds and is this going to affect this country's families, children, grandchildren?

Sometimes, raising a child in SoCal intimidates me because I look around and see so many families and kids with the "I WANT IT NOW SO I'LL BUY IT NOW!" mentality.

I'm going to definitely be swimming upstream trying to raise kids with the ability to put off short-term gratification for long-term gain. But I'm hoping if I live by example - driving an older, paid-off car, saving for the things I want, putting away a percentage of every income check for retirement, etc. - they'll follow suit.

Fingers crossed! :-)

hibbs said...

First off great site. To me the housing credit bubble and its previous evil cousin the bubble can’t be divorced from the Fed money pumping and the fiat currency.
That said, what are the likelihoods that the Fed seeing the financial meltdown in the mortgage industries will just start pumping money like mad? I don’t see this working mind you because the dollar is already under pressure and if it starts to cave the Yen carry trade is off the table and its Katy bar the door. But it could make people think we had dodged another bullet and suck the unsuspecting into buying in to early.
Your thoughts.

Dr Housing Bubble said...


The housing market is toast. Anyone trying to claim that housing didn’t go up in a large part because the Fed lowered rates is living under a rock. If you run a quick analysis you’ll see that there is a direct correlation between cheaper rates and easier access to credit (i.e., mortgages). Remember a few weeks ago when the Chinese market dropped over 10%? Why did it go down? The fear of tightening credit. What about the recent implosion of sub-prime lenders? Again, the fear of losing credit. In this case, many sub-prime lenders had their credit lines removed and now you can see the nations 3rd largest sub-prime lender trading in the minor leagues in the OTC market.

Next up is Alt-A mortages. That is mortgages given to decent credit buyers that for one reason or another didn’t want to document loans or went for a more exotic tasting mortgage. Ever watch late night infomercials? I do when I’m kept awake by seeing Real Homes of Genius everywhere in my neighborhood. These folks tout the most absurd risky mortgages that you’ll literally have a heart attack if you took it over to your real estate attorney. After watching these shows I open my blinds and see red for sales signs on homes that were bought only a few months before. I think to myself, “flippers” and move on. I spoke with one of these flippers and they funneled $60,000 in upgrades and will sell the house for $100,000 more. At least in their minds eye they will because the market is now gone. They’ll be lucky to break even or even come out with a 5 to 10 percent loss.

See, Collateralized Debt Obligations (COD) have essentially set a time bomb in the nation. There is nothing anyone can do now; well, aside from a public bailout but as a hardcore bear investor that is an entirely different subject. The Fed is stuck and looking at long-term rates they are essentially an emperor with no clothing because each time they talk tough the market does nothing. Banks? What are they going to do with all the REOs on their hands? They are setup to sell homes and be done with it - they are not setup as property management companies. Think of it this way, even if the Fed drops rates to zero you are still left with the fact that housing is vastly overpriced and CODs are now starting to show signs of cracks because many had sub-prime loans in their portfolios. Would you buy a Hyundai for $50,000 over 20 years if your payment was $208 a month?

So the argument can go further that housing ALWAYS goes up and a car, well that is a depreciating asset. Okay, but the price of current housing has many things priced in such as:

1. A market with low foreclosures
2. Moderate to High annual appreciation rates
3. Easy access to future buyers via Wall Street
4. A Fed that is supportive of debt
5. Mortgage lenders having flexibility to all buyers

Of course eliminate one of these items and what you have is a house of cards. What we have eliminated (or are starting to at least) is number 5. Wall Street is spooked that foreclosures are jumping (see number 1). So this pushed down #3 and on and on. We are in a vicious circle and frankly I’m not sure how low we will go but we are definitely going down.

Now after that pep talk don’t you feel like going out there and being a patriotic American and buying yourself a nice home?

Anonymous said...

NO theres NO bubble on LONG ISLAND


Dr Housing Bubble said...


From coast to coast, sea to shining sea we are seeing this housing Wonderland. What does your gut say when you look at that place? Go with your instincts.

Sometimes a snap judgment is better than 200 pages of analysis by hedge funds. Just look at how well the sub-prime game is going. Supposedly they had it all calculated out.

Marianne said...

It is obvious that the subprime home financing market is run amok. However, I think that a case can be made for the subprime/stated income commercial lending market. There are family owned financial institutions like Ocean Capital in Rhode Island that take a close personal look at their loan properties before lending. Sometimes, first time small businesses like gas stations, motels and auto shops do not have the capital to get started unless dealing with a non-traditional leander.