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25 comments on The Round-Up: August 31st 2007

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ilargi on August 31, 2007 - 4:34pm Permalink | Subthread | Comments top

A good read. Aaron knows a thing or two.

Interview with Aaron Krowne (Mortgage Implode-O-Meter)

The Robbo Report (RR): As of 08/2/2007, 135 mortgage lenders have 'imploded'. How many more lenders will fall?

Aaron Krowne (AK): I honestly don't know how many at-risk outfits are left….dozens, perhaps. We're trying to gather together ALIVE and stable lenders for our industry readers to bring their business to. But as far as continued fallout, I'm more worried about banks at this point.

Banks are between 50 and 60% exposed to real estate by their net assets. Banks have held up thus far because they have much deeper pockets than the non-bank lending specialists, though a few have taken sizeable write-downs on mortgage portfolios.

But it is well known the write-downs have been largely put off by delaying the mark-to-market process; even the bulk of the ratings downgrades have still not happened, so the real balance sheet hit is yet to come. And banks will see their real estate holdings of all sorts deflate in value. Those that weren't sufficiently diversified or aren't considered "important" enough for a bail-out could see failure.

After an interlude since the last recession, we've already had a few small credit union and bank failures. I expect this to turn into a tidal wave, short of a massive intervention by the government (i.e. a blanket bailout which the public will shoulder-this would not be a "good" thing).

RR : Why are these mortgage companies closing?

AK : Two main factors. One was a genuine foolishness regarding the expectations of continued appreciation, a continued low interest rate regime, and a lack of historical perspective regarding default rates (many of these companies had relatively humble beginnings but proliferated and expanded aggressively in just the past couple years).

Of course the symptoms of this foolishness were low capitalization, poor underwriting standards, and outright fraud. But these are symptoms, not causes.

The second cause is less talked-about, however: it is the fact that for years the real income of median America has been declining…arguably, since the mid-70s. The trend has accelerated under Bush II. Wall Street and the government have ignored this or worse, aggressively pursuing a campaign of spin and denial.

But now anyone who originated or invested in mortgages is getting burned by it. In sum, the ability of Americans to service their mortgage debt was lower than thought, and continues to decline. Until that trend reverses, the level of home ownership will have to fall. Home prices will have to fall. The wealth to support the wished-for "ownership society" and high asset valuations is simply not there.

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new account on September 1, 2007 - 10:58am Permalink | Subthread | Parent | Comments top

the ability of Americans to service their mortgage debt was lower than thought, and continues to decline. Until that trend reverses, the level of home ownership will have to fall. Home prices will have to fall.

1) Current house prices are at approximately 5x incomes. Prior long run average was approximately 3x incomes. This argues for a 20 to 30% decline in house prices. But this figure may be optimistic due to:

2) US economy has been supported by consumer purchases sustained by increased mortgage debt. This source of funds will no longer be available.

3) Since wages represent 70% of corporate expenses, a downturn in the economy will result in increased unemployment, and an increasing debt service problem.

4) Labour mobilty has been the key response to a declining local economy. Relocating homeowners will be forced to sell into a declining market and this will further pressure prices.

5) The "oil crash" of the late 1980's was confined to that sector. Those outside the oil sector had no understanding of what took place (and still don't). The dot.com bust was a California problem and a telecom sector problem. Those outside these sectors were not exposed. The housing problem is very different in that 70% of the population is exposed and, apart from a few local markets, all will have concerns. Such concerns will likely lead to a retrenchment of consumer spending. This in turn reinforces 1) above and we go through the cycle again.

6) At some point the path presented above will become clear to the equities markets and these will sell off. The consequence of this is that neither one's house nor one's 401k are likely to hold value. This will occur at a time when a significant proportion of the population will be nearing retirement. This will shape the domestic political environment. With regards the US, I think there is the possibility of significant internal conflict.

7) The international system has basically hinged on US strength as a major global investor and as a safe and secure investment location. Given the above scenario this sentiment is bound to change. Within the US, I suspect rising anger over the fact of a government focus on life in Iraq while paying no attention to domestic issues impacting the citizenry.

8) I don't know how this plays out with respect to PO. I expect the price of oil to rise in US dollar terms and this will deepen the interlinked problems presented above. AGW will also exacerbate this problem set and make a postiive response to this challenge less likely.

I do not see any means for the Fed to undertake a meaningful intervention. This will not be a liquidity crisis so much as a crisis of confidence, a Minsky Moment that results in a reconceptualiztion of personal, domestic, and international relationships.

Comments and critique welcome.

Cheers!

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musashi on September 1, 2007 - 12:39pm Permalink | Subthread | Parent | Comments top

Re#6 and significant internal conflict.

Have you seen some of the proposals making the rounds?

http://globaleconomicanalysis.blogspot.com/

It is a total outrage that they would even consider some of these things. Basically they are saying that if someone lied enough they get a free house, and many of these are illegal aliens.

Why should anyone in the US even work under these rules? Hey quit your job, claim victimhood and get a free house.

There is something very wrong when liars and criminals are rewarded.

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new account on September 1, 2007 - 2:05pm Permalink | Subthread | Parent | Comments top

From Mish:

But what about the person who decides to lose his job to take advantage of the process? Certainly if one does not have a job one cannot afford to pay a dime. Handling this "properly" requires still more government intervention to decide who can afford to pay what and who is losing a job on purpose.

And what about the obvious drawbacks of discouraging someone from seeking higher paying jobs, working overtime etc etc out of fear of being bumped into a "you can afford a bigger mortgage payment" bucket.

Is there a monitoring agency that keeps track of job status, kids, health, etc etc etc to decide whether or not a mortgage can be adjusted and/or if someone should be working overtime to pay off the original mortgage?

Clearly this tracking agency function should be the responsibilty of the Department of Homeland Securitization.

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CrystalRadio on September 1, 2007 - 12:07pm Permalink | Subthread | Parent | Comments top

Hi ilargi,

About Pay Options, mentioned in the article, do you know if they are the same as the Option ARM's in the graph of ARM's I've included? If not, can you tell me what an Option ARM is?

from Aarron Krowne article:

In addition I believe lots of prime ARM portfolios are really pay option waste dumps under the hood, which are time bombs.

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new account on September 1, 2007 - 12:58pm Permalink | Subthread | Parent | Comments top

Option ARMs come in four flavours:

Minimum Payment - you contract for some minimum payment for a the first year. Unpaid interest will be added to loan principle and will be payable when the loan resets to a standard payment schedule.

Interest Only - For the initial period you pay only interest and no principle. After reset you pay both interest and principle.

Fully Amortized 30 year schedule - same as a fixed 30 year except the rate floats according to prime

I believe the 4th flavor is a 15 year amortization.

I suspect the no-pay option ARM is cynical humour. If you get a minimum payment option ARM you are basically renting the property from the bank. Default and it takes 6 months to evict and reposses so you live for free.

Note that the Credit Swiss graph is a bit out of date and that some of the mortgages had overiding reset clauses which have the effect of moving the rest point forward in time. This may have the effect of removing the valley which exists between the two peaks on the Credit Swiss graph.

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CrystalRadio on September 1, 2007 - 2:03pm Permalink | Subthread | Parent | Comments top

Thanks new account,

Interesting about the reset clauses, I guess filling the gap would ease things to some degree? I wonder what proportion of the first two flavours there are in those option ARMS, they seem to be in the second half, in the main.

Six months to evict, eh? I would have loved that as a student ... take out a strip of mortgages and immediately default as they come into effect, I moved pretty often then anyway:)

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