September 25, 2007

Press Zero for Reset: Are we out of the Subprime Mess?

Before the subprime issues, there were many articles and research papers highlighting the impending challenge the mortgage market would face once rates started their inevitable reset descent. Two camps emerged; one believed that the subprime market would be contained while the other camp saw it as the tip of something much larger. There is no point in rehashing which side won this debate since it is already clear. The next step is to focus on a market analysis and assess the current situation. Recently, we haven’t seen much analysis in this area because it is a foregone conclusion that many subprime loans are resetting and this is causing a profound market impact beyond the subprime sector. But what does the future potentially hold? There is a great article that was published in the O.C. Register talking to a BofA analyst, Robert Lacoursiere discussing the future of the mortgage correction. The chart provided on the site provides a disturbing picture:

*Soucre: O.C. Register

From past articles and projections, we already knew that September through December of 2007 would see the largest number of subprime resets. We've seen a couple of reports putting monthly rate resets in the range of $50 billion to over $100 billion. This is important because it will be a litmus test on the resiliency of the housing market. It is clear that many lenders and financial institutions are buckling even with the current environment. A few other things will place additional strain on the market including third quarter results that unfortunately, will reflect a slow and underwhelming summer housing market. This coupled with growing inventory, stalling appreciation, and the massive wave of resets will make it very difficult for housing prices not to depreciate.

Option One – Refinance

According to DataQuick, during the first half of the year over 43.4 percent of loans in Southern California were jumbo loans. Jumbo loans are home mortgages that go above $417,000. The typical monthly payment buyers committed to was $2,421. Sellers facing reset issues have the option of refinancing into a fixed rate mortgage. Thanks to a low interest rate environment, rates are still hovering at all time lows. Unfortunately, many home owners are unable to refinance even into reasonable conventional loans because they stretched into their current home. If we take a look at notice of defaults (NODs) in Southern California, we are seeing an exponential jump:

The illuminating thing of this data is that many of these NODs are turning into foreclosures. This is a phenomenon absent in the previous decade of the housing boom. Sellers facing trouble were bailed out by a rising market and rapid appreciation. There was no need to refinance aside from taking out money or lowering a higher previous rate. Those sellers that desperately wanted to stay in their home, used creative methods such as tapping into a home equity line of credit and bought extra time for paying off their current mortgage. The burden has now shifted since the mortgage markets are tightening their belts and appreciation is stagnant. In fact, this is the first year of serious market issues in Southern California in over 10 years. The refinance option may not be a viable choice for many home owners that have a subprime loan and are facing a reset in the next few months. That is why many housing bears cautioned that these loans had a biased toward continued appreciation and no insurance in case the housing market started losing any steam.


Option Two – Sell

Last month sales volume fell over 50 percent in Los Angeles on a year-over-year basis. The last option of hope for many home owners in trouble was selling. In fact, many sellers were able to unload their homes before their rate reset and profited nicely. This went on for multiple years. In a bubble, rational behavior and fundamentals seem to take a backseat. Even staunch opponents of housing started singing a different tune. It is almost a historical prerequisite that once a bubble forms and is in full stride, rhetoric regarding a “new era” creep into the mainstream lexicon. Selling is becoming a challenge in the current market because of market depreciation, increased inventory, and buyer psychology. Another characteristic of any bubble is irrational logic guiding fundamental economic decisions. There was really no reason for housing prices to run up the way they did with no income support, population growth numbers that didn’t instigate amazing jumps, and renovations that didn’t reflect hundreds of thousands of dollars in price premiums. In addition, buyers are no longer fighting for the one home on the block. Any person living in Southern California need only get in their car for a weekend drive and cruise the local streets. Without fail you will find one or two homes for sale within your field of vision. The growing number of foreclosures doesn't help:

Sellers are also competing with short-sales and foreclosures. The worst time to negotiate is when you are hostage to spiraling debt. Many of these sellers have no choice but to sell. Life goes on and things such as divorce, employment disruptions, or crushing debt payments are enough reason to move out. At a recent presentation by Countrywide, they announced that the number one reason for people facing foreclosure was “curtailment of income” at 58.3 percent of all causes. The second leading cause? Medical or illness coming in at 13.2 percent. This paints a contrasting view to the current reports that employment and income is strong and healthy. We need to start examining leading indicators such as building permits, insurance claims, and the money supply because this will tell us where we are heading. Looking at lagging indicators such as the unemployment rate only tell us where we have been. They are both important but clearly we are at a tipping point of market data not reflecting market reality.

Option Three – Foreclosure

It goes without saying that most people do not want to lose their home through foreclosure. It is a financially and emotionally stressful life event. 100 percent of people do not want to lose money. Yet looking at the exploding number of foreclosures, it is becoming more apparent that the country debt load is becoming too much to handle. Keep in mind that we have never witnessed a time in history of such extraordinary national real estate appreciation. We had previous regional housing bubbles such as the Florida housing boom during the 1920s. In addition, our unemployment rate is relatively low and inflation according to government statistics is still under control. We examined this in a previous article and highlighted that in modern day society, avoiding debt is nearly impossible for most working class Americans. The cost of education, healthcare, housing, food, and energy have all gone up dramatically in the last decade. Let us take a look at the national mortgage debt load for the entire country:

As you can see from the above chart mortgage debt has tripled from 1992. It went from approximately $4 trillion to about $12 trillion in the current market. You can also see the inflexion point at roughly 1999. It is hard to imagine that such a booming economy with relatively low unemployment is facing the debt struggles that we are facing. One of the main reasons is that employment in the housing sector has boomed in the last decade. It goes without saying that a slower housing market will equal unemployment for those in the housing industry.

Solutions

Policy makers are providing their solutions to this mortgage crises. Initially what started as a subprime problem is now spilling over into multiple sectors. This has the potential of pushing the economy into recession and more and more economist are chiming in with future odds. What are some of the current solutions on the plate?

*Tax forgiveness for those in foreclosure

*Lowering the Fed Funds Rate trying to make credit products more attractive

*Increasing loan caps through government sponsored entities (GSEs)

*Funding for credit counseling

These solutions may help but they only put a bandaid on the overall broken housing market. In a politically charged environment with so much at stake next year, both sides of the political spectrum are treading water carefully. No one wants to be seen as the party that didn’t help suffering home owners. Bernanke is a student of the Great Depression and realizes that history doesn’t bode well for a Fed and government that doesn’t act swiftly. Even though they publicly echo fears of inflation, policy moves and data point toward a more permeating fear of deflation. I truly believe Americans do not want to see their fellow citizens fail and suffer. In fact, I believe most Americans have a strong work ethic and hold that people that sacrifice and work diligently should be rewarded. What frustrates most Americans is a game where the uber-wealthy are given corporate welfare when times are tough but poorer Americans by these same groups are seen as not being able to pull themselves up from their own bootstraps. The solution to this, even though people do not want to hear this, is a market correction. This means that local income levels and the new tighter credit standards will dictate future housing prices. In some areas this means 10 percent drops while in others this can reach 50 percent or higher. Will this happen? The data is already pointing toward this. Even if property drops 30 percent over 5 years, combined with inflation adjustments this is close to a 50 percent drop. Some areas in Los Angeles are already seeing 20 percent adjustments year-over-year.

By looking at the reset charts, we realize that the housing correction still has a long way to go. What will happen in the next year through policy and market sentiment will set the tone for the next decade of housing in America.



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18 Comments:

Nathan said...

I just tried to get a loan through Country wide. Make 300K household, stellar credit. Everything documented as you might expect.

Best Countrywide could do was 5% down. No zero down loans available. I have better options, but if I can't do it, then most can't. The days of 100% financing are likely a thing of the past.

Dr Housing Bubble said...

@nathan,

What was the loan amount and what rate were you given? Times are changing.

oilwelldoctor said...

Another good article. One more thing. Groceries in Tucson are up 10% from a year ago according to the local newspaper. Gasoline is going to head up soon with crude oil around $80.00/bbl (you CA types love to drive the freeways!). Think there is going to be a big squeeze.

Exit said...

Other forward looking indicators: restaurant sales, retail sales, auto sales, and biofuels (commodoties) futures. Yep - the demand for biofuel has caused corn prices to record highs, and puts beef ranchers in direct competition with biofuel factories. Which means higher prices, which means inflation.

@Doc, you in the mortgage biz? I am, and it is funky weird out there. Lost a lot of realtor clients the last 4 years when I'd tell their buyers that neg loans were highly volatile - "don't blow my deal!" - and then no more referrals. What comes around goes around, I believe.

@Nathan - it seems a bit imprudent to buy zero down right now unless you truly have a 30 year timeline, based on the data that Dr HB et al present on the impending dip in prices, and how long it will take to recoup. There are jumbo 100% financing deals out there but the 2nd mortgage piece is NOT pretty, so you'd want to make sure your plan is to pay the thing off ASAP.

But that begs the question - why buy now?

W.C. Varones said...

"staunch opponents of housing"

That's me! I think everyone should live in a dumpster, dammit!

thamnosma said...

Dr. HB:

Maybe I read the graph wrong, but it appears to me the highest volume of resets will occur in the first 2Q of 2008 not the last Q of 2007 as you write in the column. Would you straighten me out on that?

Also...this article is just so on target

http://www.hyperinflation.net/essays/englund46.html

Here's a bit of it:

From Prime to Subprime, America’s Home-Mortgage Meltdown Has Just Begun

by Eric Englund


Inflation is an immoral tax that leads to immoral values
~ Anonymous South American banker


Having been in the credit profession for the past 23 years, I have observed several cycles involving the loosening and then the inevitable tightening of credit-underwriting standards. Of course, the Federal Reserve stands at the epicenter of such cycles. While money and credit are flowing like beer at an Irish pub on St. Patrick’s Day, everyone ends up looking like an attractive credit risk. When it appeared that the U.S. economy was heading into a recession, after the collapse of the dot.com and telecom bubbles, the Federal Reserve opened up the taps and encouraged one and all to imbibe its tasty, low-cost credit – with the most popular "flavor" being the mortgage loan. At this point, mortgage lenders merely became bartenders serving anyone who walked in the door. To reach this nadir in mortgage-lending standards, it is inescapable that the "Five Cs" of credit were ignored regardless if a mortgage loan was deemed prime, Alt-A, or subprime. This is exactly why the home-mortgage meltdown has just begun.

One aspect of my job entails analyzing personal financial statements. Twenty years ago, without a doubt, households had much healthier financial conditions. Back then, in proportion to household net worth, savings were much higher and debt levels (especially automobile, credit card, and mortgage debts) were dramatically lower. It is alarmingly common, today, to see households with well under ten thousand dollars in savings yet half-a-million dollars in mortgage debt – not to mention thousands of dollars in credit card debt and tens-of-thousands of dollars in automobile debt. Such households are literally one or two missed paychecks away from being destitute. Yet, amazingly, the heads of such households are considered to be prime-level borrowers (as long as there is adequate income to cover monthly debt service and expenses). What has happened, in the sphere of personal-credit underwriting, is that risk parameters have been redefined with the word "prime" having been defined downwards.

Credit Socialism

America’s unfolding mortgage-debt crisis did not emerge in a vacuum. When Alan Greenspan’s Federal Reserve pounded the federal funds rate down to 1%, in June of 2003, it is crucial to understand that such a low rate materialized due to the Fed’s aggressive creation of money and credit. In other words, America’s monetary central planner "knew" that massive inflation was needed to "rescue" the economy from the above-mentioned dot.com and telecom implosions. Housing was specifically targeted by the Federal Reserve to serve as "…a key channel of monetary policy transmission." With this colossal inflation of the money supply, I would argue that a hyperreality surfaced in the housing market – with corresponding bubbles emerging in consumer electronics and automobiles. During such episodes of heavy inflation, people tend to lose their sense of value including suspending any fear of debt.


The rest is so worth reading, including an explanation of the five "C"s of credit, which is somewhat what I had to contend with as a young adult home-seeker.

Regards and stay safe out there.

Exit said...

CNN just had a bit on about the foreclosure capital of the country - Stockton, CA - with a realtor showing a dump. Which wasn't really any better than a dumpster. Last owners trashed it before they left. So, sure, their dumpster had doors and a roof, but what's the difference?

The house had a mortgage that impovershed the "owners".

John said...

Dr HB:

I have a question for you and anyone else here:

Beginning in 2010, the baby boomer retirement wave begins in earnest (born in 1945 and they turn 65 in 2010). From 2010 and beyond, millions of baby boomers will start putting their homes on the market in order to fund their retirement.

What effect will this have on the housing market and has anyone done any research into this?

thamnosma said...

John:

My opinion is that it's almost impossible to estimate what the situation will be at that time.

With what the Fed and other central banks are doing, we may be entering a period of hyperinflation. If that's the case, then people with home equity and fixed incomes will almost be forced to sell or try to sell just to keep eating.

Even if this hyperinflation occurs, we have no idea how it will last. At the end of it will be a crash of some sort, likely generally deflationary. In that case, the retirees/fixed income people will want to hold on to their homes as at least a safe place to be. They may be wiped out on other assets.

Seems to be an extremely volatile and tricky environment, not even taking into consideration political upheavals, wars, commodity shortages and runaway socialist taxes that are surely coming.

Lastly, we gotta wonder how long the "social security" funds will hold out given our debt level and weak dollars...once the Chinese and Japanese dump the USD holdings.

I think one needs to be flexible and prepare for rapidly changing conditions.

planobcl said...

@John,

I don't think it will be as bad as some of us predict. What will happen to raise our pessimistic predictions?

Boomer will put their house on market (J6P too can play the mark to market game). They'll find out that it will not be enough (deflationary or inflationary enviroment). Some will sell, but most will have to work pass 65.

Working pass "retirement" or 65 has become a stigma in our country. Why is this? I think this is a tragic view of working and retiring in general. I'm sure there are data out there to support this i.e.: people who enjoy their work, will tend to work much longer than those that don't. I suppose the point that I'm trying to make is that the key to happiness is not through retirement, but through productive and beneficial work to self and to his/her community.

That is my 2 cents.

Planobcl

John S. said...

Two words that describe the denial in the Market by Real Estate "Professionals"....



Barbara Corchoran.



In case you missed her, she's the industry's spokeshole that attempts to apply damage control, by being interviewed on MSNBC. Check out her latest video right here on MSNBC. (GO TO: http://www.msnbc.msn.com/id/20970287/ and click on the video of her.) Every time I see her she is trying desperatley to temper fears by injecting false information to the viewers. They started having her on a few months ago when she said things were actually going up. Of course the National Association of Realtors are willing to provide data, they have skewed, to make things look more rosey than they really are. Today, she actually had the nerve to insist that only 1% of the loans in the entire nation are actually in the subprime sector. Wow! There are charts that clearly disprove this. She also claimed that this is not as bad as the the 1987 Crash. WHAT? First of all, Barabara, the crash began in 1991 and didn't hit bottom until 1996. NOT 1987. Any reputable real estate expert will know that. I don't think it was just here in California either, because it happened in other states too. I think it's time we all stop paying attention to what real estate "EXPERTS" say. They just have an agenda. Sell Houses.

Dr Housing Bubble said...

People still think there is no housing bubble. They profiled Patrick.net over at the San Francisco Chronicle today. The story is interesting but the comments take the cake; take a look at the comments:

Comments regarding bubble bloggers

People still think there is no bubble. You'll notice a common argument such as "well if he would have bought in 1999-2005 he would be happy and would be rolling in green hundred dollar bills."

You'll also notice that the main argument is prices will go up because they always have. People don't look at income/price ratios or economic trends. One reader made the argument that housing prices will be higher in 30 years. Bwahaha. And minimum wage will be $40/per hour. But will prices be cheaper next year? Yes. Two years from now? Yes.

Few people do make economically based comments on price jumps. Either way, we are standing at the Housing Alamo and no one is making the first move.

Exit said...

Doc et al,

Read this on minyanville, directly apropos the 'reset' button, on Countrywide re-arming a portion of its portfolio. Moral hazard isn't specified by name, but is acknowledeged in practice:
http://www.minyanville.com/articles/bank-HOV-CFC-arms-ABX/index/a/14253

Oh, and the commenters that posted their posts - well, they conveniently ignored the 2005 and 2006 people who bought, the last ones into the Ponzi scheme, didn't they? Nice...

joanne said...

"One reader made the argument that housing prices will be higher in 30 years"

Well gee, if I bought a total stock market index it would in all likelyhood be higher in 30 years as well. So assuming I had several multiples of the cost of my rent in disposable income (what housing costs in L.A.), why exactly should I invest it in housing rather than stocks?

And do most people really have that much extra money, or is it only that funny loans are easier to get to buy houses than to buy mutual funds.

John said...

@john s

"They just have an agenda. Sell Houses."

Like Alec Baldwin said in "Glengary Glen Ross",
A - Always
B- Be
C- Closing.

Put down the coffee Barbara. Coffee is for closers.

linda said...

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Costa Rica condominiums, condos for sale, Costa Rica homes.
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thamnosma said...

Gee Linda, thanks for that really helpful information. You're not a troll...

I apologize for tooting my own horn a bit, but I did predict exactly this a couple weeks ago here..and "we've only just begun"

(from the LA times)

L.A. County CEO cites concern for cash flow

Projected property tax revenue -- which provides a key part of the county's general fund money -- may decrease as home values continue to fall, he warns.

By Susannah Rosenblatt and Jack Leonard, Los Angeles Times Staff Writers
September 26, 2007


Following years of rosy economic forecasts, Los Angeles County supervisors were warned Tuesday that the cooling housing market could cut into property tax revenue, which funds local services including public safety, health services and foster care.

Expressing concern, board members requested that the county chief executive update them in January on the fiscal outlook for the county's $22.4-billion budget.

"The market is slowing down right now, and we know how much [you] depend on property tax," county Chief Executive William T Fujioka told the board. "It's something we will have to look at."

In the 2006-07 fiscal year, property taxes grew 8%, compared with 11% the previous fiscal year. In spite of the current national sub-prime mortgage crisis, Fujioka estimates property tax revenue will increase 8% to 9% this fiscal year, which began July 1.

Property taxes constitute a majority of the money that the county can choose to spend as it sees fit, unlike federal funds, which are designated for specific programs.

Supervisor Don Knabe voiced anxiety that there was "quite a bit of difference between what the economic indicators are right now and what our presumed growth rate is. That's obviously of some concern."

County sales tax revenue that supports public safety was 6% below projections last fiscal year, which will cost the county about $40 million through July 2008, Lizzari said.

Fujioka will analyze the first round of property taxes received in mid-December and report his findings to the board in January in an effort to avoid the program cuts and layoffs of leaner budget years.

As home values fall, especially in recently developed northern Los Angeles County communities such as Lancaster and Palmdale, the county assessor has been fielding increasing requests from people wanting to reappraise their homes, Fujioka said.

The county's property assessment roll topped $1 trillion for the first time last year.

Exit said...

Doc

Read Depew's 5 things on Minyanville today?

In addition to being spot on target with real estate, he is very funny. Maybe add him to your list of links, if he is copacetic with that? I think he's a must read, and he really is funny.