Housing Bubble Bursting?

[Steve Owen]

Steve,
Your opinion is very simplistic to the problem at hand.

Wow! Now I've been accused of being simplistic by both Santora and Malekpour... that ought to be worth an award of some kind.

It is very easy to tell an obese patient just not to eat but it is not the way to diagnose the problem nor to cure it.

Or, it might be the only way to cure it. I have a cousin who is going in for stomach surgery... the surgeon told her if she was not willing to change her lifestyle, not to bother with the surgery.

...and that is what we have, housing recession.

Not in my market. (Not yet, at least.)

One of the consequences of excess credit is that people tend to accumulate debt.

Now who's being simplistic?

Heavy mortgages are just one of the ways excess debts is acquired. The inflated prices of homes encouraged people to borrowing against their properties. Artificially low interest rates drive up the value of homes, which then encouraged the owners to borrow more from the banks, which were doing everything in their power to rid themselves of their excess deposits. Sooner or later the monetary brakes must be applied and that is what the Fed has been doing but the result is housing recession.

All of that is pretty much true... except for the last statement (not in my market).

This is a very complicated scenario that was designed by the Fed and you are doing one-sided judgment that people shouldn’t outspend the readily available credit. What would you do if someone offered you easy money?

I'd do what I did. Keep borrowing in check based on my ability to repay. (Guess that's too simplistic for some folks, though). :glare: As I posited in another thread... maybe the "decline" is a good thing.

 

[Randolph Kinney]

Fannie Mae could be hit hard by housing bust

http://www.marketwatch.com/news/story/Story.aspx?guid=%7B843C8E17%2DB688%2D452B%2D96A8%2D524381ACC223%7D&siteid=

I am editing the full story because of length and showing excerpts.

Mortgage giant could lose $29 bln, long-term bear argues in investor letter

By Alistair Barr, MarketWatch
Last Update: 12:19 PM ET Sep 18, 2006


SAN FRANCISCO (MarketWatch) -- The worst of Fannie Mae's regulatory troubles may be behind it, but one longtime skeptic of the mortgage giant thinks it could face bigger problems from trouble in the U.S. housing market.

Fannie's main business is buying mortgages from banks and other lenders, packaging them into so-called mortgage backed securities (MBS) and selling them on to other investors. The company gets fees for providing credit guarantees on these pools of loans. Fannie is currently responsible for more than $1.6 trillion of MBS and is involved in the financing of roughly a fifth of all U.S. mortgages.

By taking mortgages off the hands of other lenders, Fannie helps them free up more capital so they can sell more mortgages.

It held a little more than $730 billion in mortgage-related securities on its balance sheet at the end of June.

Subprime exposure

Fannie has traditionally specialized in higher-quality, fixed-rate mortgages, which are less vulnerable to interest-rate fluctuations and volatility in the housing market.

But the company has been investing more in subprime MBS in recent years. Subprime loans are sold to home buyers who fail to meet the strictest lending standards, so this area of the mortgage market is expected to be hit harder by any housing downturn.

Fannie and Freddie bought 25.2% of the record $272.81 billion in subprime MBS sold in the first half of 2006, according to Inside Mortgage Finance Publications, a Bethesda, Md.-based publisher that covers the home loan industry.

In 2005, Fannie and Freddie purchased 35.3% of all subprime MBS, the publication estimated. The year before, the two purchased almost 44% of all subprime MBS sold.

Ofheo, Fannie's regulator, has noticed that the company has increased its subprime exposure.

"They've expanded in that area in recent years, but it's still not an enormous part of their business," Andrew Lawler, chief economist at Ofheo, said. "It's an area we're increasingly looking at because they're increasingly involved in it."

An Ofheo report due out later this year is expected to show Fannie's subprime exposure is "generally moving up," he added.

Given those recent moves, Berg said it's not implausible that 15% of Fannie's mortgage exposure is subprime.

If a housing slowdown causes subprime foreclosure loss rates to rise to between 6% and 8%, Fannie could lose $22 billion to $29 billion, Berg estimated in his letter.

That's more than half of the roughly $40 billion in capital that Fannie had at the end of March, according to Ofheo.

"There's a high probability of a sharp increase in credit losses in the second half of 2007 and into 2008," said Robert Lacoursiere, an analyst at Banc of America Securities. "This will be more pronounced in subprime and will hit earlier in that area, too."

Subprime stress

Early signs of stress are beginning to appear.

H&R Block announced an unexpected $102 million charge in late August related to its Option One mortgage business, which specializes in home loans to borrowers with credit scores at the lower end of the spectrum. The company said the losses cover loans it could be required to buy back should a borrower default on the first payment.

Mortgage-lender National Citysaid recently that, while it has refrained from entering the riskier areas of lending, it has seen a marked increase in first-payment defaults on loans.

In California, one of the hot markets where home prices soared in recent years, defaults surged 67% in July from a year earlier.

Mortgage-insurance specialist MGIC Investmentreported a 17.35% delinquency rate on A- rated and subprime loans as of the end of June. That's up from 12.38% in late 2002.

Fannie may have increased exposure to the subprime market in response to restrictions on its growth by regulators, Lacoursiere explained.

Subprime mortgage debt offers higher yields than better-quality loans. So one way for Fannie to generate more profit in the midst of restrictions on its portfolio is to invest in higher-yielding debt, he said.

"They've been getting into asset classes that haven't been a big specialty for them in the past," the analyst added. "Combine that with a credit environment in the mortgage market that is fundamentally deteriorating, and you start to wonder whether they're doing something that they may regret."

The problem is exacerbated by the fact that Fannie Mae hasn't disclosed financial statements for more than two years, Berg said in his letter. That makes it hard to gauge Fannie's true exposure to subprime mortgages and the housing market as a whole.

"Simply writing down these points in summary fashion illustrates the unprecedented and complex puzzle of a $46 billion market cap company that doesn't file financial statements," he wrote. "Moreover, the company has instituted a share buyback for the benefit of employees in the midst of this void! You can't make this stuff up."

 

[moh malekpour]

Or, it might be the only way to cure it. I have a cousin who is going in for stomach surgery... the surgeon told her if she was not willing to change her lifestyle, not to bother with the surgery.

Yes, "Just say No" to drug and you are no more addict. so simple.

Not in my market. (Not yet, at least.) All of that is pretty much true... except for the last statement (not in my market).

You mean there were no option arms, interests only, adjustable loans, 100% financing loans in your market?

 

[Randolph Kinney]

Contagious Expectations and Malfunctions: Lessons From Japan

http://www.imes.boj.or.jp/cbrc/cbrc-25.pdf

Contagious Expectations and Malfunctions of
Markets: Some Lessons from Japanese Financial
Institution Failures of 1997*

Abstract

This paper discusses contagious effects of expectation in financial markets. We first review developments of Japanese financial markets towards the end of 1997 when a number of financial institutions collapsed. We then consider a simple model and study conditions under which contagious expectation triggers a financial crisis. Finally, based upon these, we derive some policy implications regarding the role of central bank lending.

2.1 Successive failures of financial institutions

Since the bursting of the bubble in the early 90’s, Japanese financial institutions have had to deal with increasing non-performing loans. From October to December in 1997, three banks and three securities companies failed (see Tables 1, 2, 3, and 4 for more details) due to solvency problems. Among these failures, the cases of Sanyo Securities Co., Hokkaido Takushoku Bank, and Yamaichi Securities Co. are considered to have had a large impact on financial markets.

Administration Reiterates Call for GSE Reform, Reduction in Mortgage Portfolios

Taken from Valuation Insights & Perspectives, Third Quarter 2006, Page 26

Warning of potentially serious financial effects from systemic risk posed by Fannie Mae, Freddie Mac and other government-sponsored enterprises, the Bush Administration reiterated its call for GSE regulatory reform and for a reduction in GSE investment portfolios. In a June 26 speech before the Housing Policy Council of the Financial Services Roundtable, Emil W. Henry, Jr., Assistant Secretary of the Treasury for financial institutions, said the Administration is “deeply concerned” about widespread repercussions from deteriorating financial conditions of the GSEs because collectively they have more than $2 trillion in outstanding debt.

The potential consequences are comparable to the panic and volatility in financial markets that resulted from the 1998 collapse of Long-Term Capital Management, Henry said. “And sadly,” he added, “some are not heeding the important lessons from this experience in the GSE reform debate.”

Henry warned that the actual or perceived inability of a GSE to meet debt or mortgage-backed security obligations, as well as potential reductions in market value of GSE debt obligations, could have both direct and indirect consequences for the financial sector and the economy. Commercial banks, he pointed out, held $264 billion in GSE debt as of December 31, 2005. If key commercial banks suffered a loss because of their GSE investments, the availability of credit could decrease and “financial markets across the board would likely become very illiquid and volatile as firms with significant losses attempted to unwind their positions,” Henry said.

In addition, short-term instruments account for more than 20 percent of all outstanding Fannie Mae and Freddie Mac debt. In a financial crisis, Henry said, the GSEs may have trouble accessing debt markets, forcing them to liquidate MBS holdings, which could lead to price drops. Asset sales also would likely undermine investor confidence and exacerbate market panic, further adding to the losses of the GSEs and holders of their obligations, he said.

Although GSEs are unlikely to get into serious financial trouble, that remains a possibility, Henry said, recalling Fannie Mae’s problems in the late 1970s and early 1980s. “During this time period, Fannie Mae’s balance sheet looked a lot like a savings and loan,” he said. “As interest rates rose, Fannie Mae’s cost of funds rose above the interest rate it was earning on its long-term fixed-rate mortgages. Like many S&Ls, Fannie Mae became insolvent on a mark-to-market basis.”

 

[Randolph Kinney]

Contagion: Chronology of the Asian Financial Crisis

Dick K. Nanto, Specialist in Industry and Trade Economics Division
[FONT=Arial, Helvetica]
[/FONT]
[FONT=Arial, Helvetica]February 6, 1998[/FONT]


Contagion: Chronology of the Asian Financial Crisis

Chronology of the Asian Financial Crisis

• Early May (1997) - Japan hints that it might raise interest rates to defend the yen. The threat never materializes, but it shifts the perceptions of global investors who begin to sell Southeast Asian currencies and sets off a tumble both in currencies and local stock markets.
• July 2 - After using $33 billion in foreign exchange, Thailand announces a managed float of the baht. The Philippines intervenes to defend its peso.
• July 18 - IMF approves an extension of credit to the Philippines of $1.1 billion.
• July 24 - Asian currencies fall dramatically. Malaysian Prime Minister Mahathir attacks "rogue speculators" and later points to financier George Soros.
• Aug. 13-14 - The Indonesian rupiah comes under severe pressure. Indonesia abolishes its system of managing its exchange rate through the use of a band.
• Aug. 20 - IMF announces $17.2 billion support package for Thailand with $3.9 billion from the IMF.
• Aug. 28 - Asian stock markets plunge. Manila is down 9.3%, Jakarta 4.5%.
• Sep. 4 - The peso, Malaysian ringgit, and rupiah continue to fall.
• Sep. 20 - Mahathir tells delegates to the IMF/World Bank annual conference in Hong Kong that currency trading is immoral and should be stopped.
• Sep. 21 - George Soros says, "Dr Mahathir is a menace to his own country."
• Oct. 8 - Rupiah hits a low; Indonesia says it will seek IMF assistance.
• Oct. 14 - Thailand announces a package to strengthen its financial sector.
• Oct. 20-23 - The Hong Kong dollar comes under speculative attack; Hong Kong aggressively defends its currency. The Hong Kong stock market drops, while Wall Street and other stock markets also take severe hits.
• Oct. 28+ - The value of the Korean won drops as investors sell Korean stocks.
• Nov. 5 - The IMF announces a stabilization package of about $40 billion for Indonesia. The United States pledges a standby credit of $3 billion.
• Nov. 3-24 - Japanese brokerage firm (Sanyo Securities), largest securities firm (Yamaichi Securities), and 10* largest bank (Hokkaido Takushoku) collapse.
• Nov. 21 - South Korea announces that it will seek IMF support.
• Nov 25 - At the APEC Summit, leaders of the 18 Asia Pacific economies endorse a framework to cope with financial crises.
• Dec 5 - Malaysia imposes tough reforms to reduce its balance of payments deficit.
• Dec 3 - Korea and IMF agree on $57 billion support package.
• Dec 18 - Koreans elect opposition leader Kim, Dae-jung as new President.
• Dec 25 - IMF and others provide $10 billion in loans to South Korea.
• Jan 6 - Indonesia unveils new budget that does not appear to meet IMF austerity conditions. Value of rupiah drops.
• Jan 8 - IMF and S. Korea agree to a 90-day rollover of short-term debt.
• Jan 12 - Peregrine Investments Holdings of Hong Kong collapses. Japan discloses that its banks carry about $580 billion in bad or questionable loans.
• Jan 15 - IMF and Indonesia sign an agreement strengthening economic reforms.
• Jan 29 - South Korea and 13 international banks agree to convert $24 billion in short-term debt, due in March 1998, into government-backed loans.
• Jan 31 - South Korea orders 10 of 14 ailing merchant banks to close.
• Feb 2- The sense of crisis in Asia ebbs. Stock markets continue recovery.

This financial crisis is of interest to the U.S. government for several reasons. First, financial markets are interlinked. What happens in Asian financial markets also may affect U.S. markets. Second, American banks and companies are significant lenders and/or investors in the region, in terms of bank loans, subsidiaries of U. S. companies, and investments in financial instruments. Third, attempts to resolve the problems have been led by the International Monetary Fund (IMF) with cooperation from the World Bank and Asian Development Bank. Some legislative issues dealing with IMF funding and operations were deferred by the 105* Congress at the close of its recent session. In 1998, Congress is considering New Arrangements to Borrow by the IMF, a proposed increase in IMF quotas or capital subscriptions, and a proposed amendment to the IMF's Articles of Agreement. Congress also may intensify its oversight U.S. activities in the IMF.

The fourth reason that the Asian financial crisis is of interest to the United States is that the turmoil affects U.S. imports and exports as well as capital flows and the value of the U.S. dollar. The U.S. deficit on trade is now rising as these countries import less and export more. Fifth, the crisis is exposing weaknesses in many financial institutions in Asia. Some have gone bankrupt. The economic problems of the so-called Asian Tigers not only are adversely affecting the economies of Japan and others in the region, but, to some extent, an economic slowdown could spread to Latin America and the United States.

 

[Brad Ellis]

Moh,

I do own stock in NDE. I am not buying mortgage banks at this time as the market has reacted to the sub-prime folks like H+R Block and have driven all the stocks down. Just waiting for it to turn and then I'll be a buyer- and I will load up on NDE sinceour entire lending universe has only a very small non-prime compnent.

Randolph,

On the change in credit worthiness- I do agree with you that all this has changed. But, will it continue? Not sure about that. I think it will depend upon Wall St.'s experience with this paper. If it continues to perform overall, then perhaps no change in the credit standards will result. But, if it really goes down the tubes, then I would expect them to tighten. In the end, if you cannot sell your paper in the market then you cannot do the mortgage loans.

Pam,

Forclosures up 67%? Really good news so far. We had all expected 300%. But, it is not over yet- the 300% was forecasted by some insiders to be the end game. We shall see.

Brad

 

[Randolph Kinney]

Brad, quoting from the article above about Fannie and Freddie:

"They've been getting into asset classes that haven't been a big specialty for them in the past," the analyst added. "Combine that with a credit environment in the mortgage market that is fundamentally deteriorating, and you start to wonder whether they're doing something that they may regret."

It is being acknowledged that credit environment is and getting more sick with time. Both GSEs have loaded up on sub prime mortgages. It is also acknowledge why they are doing that; higher margins and profits.

The article from AI magazine points out that Commercial banks hold $264 billion in GSE debt as of December 31, 2005. The Bush administration is worried that if there is any significant rise in defaults in mortgages, it is going to impact the banking industry and cause these GSE debt instruments to become very illiquid and volatile as firms with significant losses attempt to unwind their positions. And short-term instruments account for more than 20 percent of all outstanding Fannie Mae and Freddie Mac debt. GSEs may have trouble accessing debt markets, forcing them to liquidate MBS holdings, which could lead to price drops. Asset sales also would likely undermine investor confidence and exacerbate market panic, further adding to the losses of the GSEs and holders of their obligations. It is the Japanese contagion experience.

As you say, "In the end, if you cannot sell your paper in the market then you cannot do the mortgage loans."

 

[moh malekpour]

Moh,

I do own stock in NDE. I am not buying mortgage banks at this time as the market has reacted to the sub-prime folks like H+R Block and have driven all the stocks down. Just waiting for it to turn and then I'll be a buyer- and I will load up on NDE sinceour entire lending universe has only a very small non-prime compnent.
Brad

Thank you Brad,
Finally, you acknowledged that you are not buying the stock of your own company. I don't blame you, I wouldn't buy it either. With that acknowledgment, can we assume that you believe in your heart that there is going to be a hard landing and a market crash but you just don’t want to say it? What an individual stock of one company has anything to do with another . You are talking about an individual company not an index. Yes, the sentiment about the sector trend is down but each one has different strategy. H&R Block has more sub-prime and your company may have less but both are dealing with residential market. Any company that is dealing with real estate residential market is down. Just look at the trend of NDE since last May.

 

[Steve Owen]

It is being acknowledged that credit environment is and getting more sick with time. Both GSEs have loaded up on sub prime mortgages. It is also acknowledge why they are doing that; higher margins and profits.

I read that article this morning... interesting. That really gets to the crux of the issue. The cause of most financial crashes... greed.

You mean there were no option arms, interests only, adjustable loans, 100% financing loans in your market?

Moh, I noted in a post a couple of years ago that I was beginning to become concerned because I was seeing some of these in my market. I made the statement that only a fool would take on an ARM in an interest environment so low that rates had only one possible way to go... up. I was promptly criticized by several Forumites for going against the grain of the thinking at the time... one even quoted Volker (I think it was) saying that Americans were losing out on the savings from ARM's, which Europeans were using to advantage. Some went almost so far as to say the fixed-rate loan was dead.

Well, the number of ARM's, interest only options, and other exotic loans seems to have been rather small in this area. Many of them were taken by doctors and other high-income earners, most of whom probably knew what they were doing and have since been converted. The other big market for them here was low-income people, which is a real concern... don't see much aftermath yet, but expect to.

Interestingly enough, the one area where our housing market seems to be suffering a bit is the high end, which is roughly anything above $300k around here (or maybe even $250k). Maybe all those high-income earners really didn't know what they were doing after all.

 

[Randolph Kinney]

Missing a mortgage payment is rising

September 15, 2006

U.S.A.
Late exotic loans All other
June 06 1.21% 4.48%
Mar 06 0.91% 4.12%
Dec 05 0.73% 4.13%
Sept 05 0.49% 3.53%
June 05 0.38% 3.20%
Mar 05 0.33% 3.26%
Dec 04 0.27% 3.48%
Sept 04 0.21% 3.38%

Quarterly data on the percent of mortgages in LoanPerformance's database* that are 90 days or more late.

"Exotic" is defined as loans offering interest-only or negative amortization.