WSJ: Mortgage Refinancing Gets Tougher
Submitted by
CalculatedRisk on Wed, 02/07/2007 - 9:23pm (65 comments)
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Looks like a soft landing 'goldilocks' scenario playing out. Hahahaha.
CR, is that in the print edition? If so was it Wednesday or Thursday? I know some folks for whom "if it isn't in the WSJ it doesn't matter" who need to see this.
Subprime Meltdown Summary and a few new rumors!:
Bakersfield Bubble
EEngineer, I found it online. I believe it will be in the Thursday print edition.
There are also a couple of articles on HSBC.
Best Wishes.
CR,
Your scenario regarding how the housing bubble will unfold is spot on.
Unfortunately many folks wıth MBA's at Wall Street are clueless about the dynamics of asset based Ponzi schemes.
Let us hope this process won't substantially reduce retirement funds of millions of US and European citizens.
Not every credit event, or "squeeze", or "crunch", or whatever you prefer to call it, is associated with a recession. However, every recession seems to include some type of credit event and it needn't be economy-wide, although they often transmit to the broader economy thanks to the Fed's lack of appropriate tools or finess.
It seems to me that there is some disagreement here as to what constitutes a crunch, and I hope you'll consider the view that it can be explained from either the demand or the supply side.
Generally speaking, if it's a supply side crunch, rates are rising. Borrowers are priced-out of the market for funds. If it's a demand side crunch, rates are falling due to the lack of demand. Indebtedness ends up falling in either case.
If mortgage rates do not rise appreciably over the coming months, it means the event will have had as much to do with the inability of buyers and sellers to touch fingertips as it did with the availability of borrowable funds. Personally, I suspect this will be the case, and it will have happened because of higher standards consistently applied. The good, old-fashioned, credit decision.
The rate doesn't matter in this scenario because many potential buyers won't have the credit qualifications or cash to buy, and many potential sellers won't be able settle because they won't have sufficient cash to buy out of their negative equity. Mortgage demand will fall, simply because the market is exhausted. Real estate prices don't have to fall appreciably for this to happen. In fact, it's happening now.
Could this problem have been avoided? Absolutely. Are there more elements and possible paths within this scenario? Sure there are, but I've ranted enough already.
Meanwhile, keep the faith. It isn't as if it's the end of civilization as we know it.
Anybody of a certain age in the mortgage business can recite the old "maximum-financing-is-inappropriate-in-markets-indicating-an-oversupply" rule in his or her sleep. I like seeing those oldies come back; it makes me feel useful again. Lord knows it's been a while since the New Generation of Mortgage Wizards needed to know any of the chapters and verses I've committed to memory. Maybe by the time this is all so hosed up that there are no mortgage jobs left, I'll be employable in the mortgage industry again. I'm with mp; we have to put these things into perspective.
It may not be the end of civilization as the old hands know it, but all this is going to come as a terrible shock to the new paradigm brokers and lenders who got into the business in the last few years!
mp
Speak for yourself, civilization as I knew it, ended several years ago.
Now I am a stranger in a strange land where all the realities I once knew, no longer apply.
CR, As a prominent member of the housing bear-osphere I am sure you are tuned in to all the housing news there is.
But you may also be missing something. There is a much broader global liquidity/inflation story out there that may give your housing stories some perspective.
Regards FC
"Unfortunately many folks wıth MBA's at Wall Street are clueless about the dynamics of asset based Ponzi schemes."
Kaan...who do you think securitizes all this stuff? They package and sell off the loans and swap derivatives thereof. It's Wall Street musical chairs and the trades are on until the music stops.
My question is just what will the net effect of increased payments have as a drag on the economy. lets assume half are able to fifi their way out that leave 600 to 750 billion in debt being readjusted. lets assume a 25% reset hike. lets also assume payment is going from 1200 to 1500 median house of about 250,000 that is 2,400,000 homes with $3,600 taken from their discretionary spending. in total $3,600*2,400,000 = $8.64 billion in extra payments. Banks profits go up if these loans still perform but what happens to our consumer driven economy when this little "tax" eats into consumer spending.
Rocky road seen for housing industry until later this year
As it struggles to absorb a glut of unsold homes, the housing industry can expect a recovery to emerge, but not until later this year, three leading economists said Wednesday.
Meanwhile, the road ahead may remain rocky.
"We have to run through those inventories [of unsold homes] to get price stabilization," said David Berson, vice president and chief economist for lender Fannie Mae,
"We have to get rid of these inventories. We need a period where sales run ahead of starts."
"Overall, I expect another big drop in sales this year of about 7 percent," said Berson.
The economist said the industry has yet to feel the full impact of the investors, some of them described as "flippers," who pushed home sales and prices to record levels in 2005. Many have fled the market, some nursing huge losses.
Toll's Revenue Drops 19% as Customers Cancel Orders (Update2)
Feb. 8 (Bloomberg) -- Toll Brothers Inc., the largest U.S. builder of luxury houses, said fiscal first-quarter homebuilding revenue dropped 19 percent as customers canceled contracts. The company said land writedowns will exceed previous forecasts.
Homebuilding revenue declined to $1.09 billion in the three months ended Jan. 31 from $1.34 billion a year earlier, Horsham, Pennsylvania-based Toll said today in a statement.
Plummeting commissions thin real estate's ranks
Orange County real estate agents earned a fifth less in commissions last year, forcing brokerages to close some offices and pushing some agents out of the business
Two percent of all Orange County jobs at least 31,000 full-time workers are in real estate, according to state figures. More than 59,000 people in the county have real estate licenses 44,000 as sales agents and nearly 15,000 as brokers.
While the top 1 percent of active agents are wealthy, earning an average of $500,000 a year or more, the average agent earned about $40,000 in 2005, an earlier Real Data Strategies study showed. About half the agents earned less than $15,000.
Dang burger fippers get about 15 grand.
EEngineer - this is the main article on the front of the Personal section of the WSJ (Page D1).
Fullcarry - what do you mean in regards to the global liquidity story exactly? It is true that spreads for increased risk on fixed income investments has declined a lot (which may have kept the 2005/2006 demand high for no income verification/high debt cover/high LTV loans), but I doubt there is much of a story beyond riskier mortgage rates being 50 to 75 basis points below what they would have been price in 1995. Or is there?
Lama asked on an earlier thread if anyone knew of a reputable lender (!) that could function, basically, as a check to see if the bad news hitting the NEWs and others were affecting the entire sector. The first one I thought of, actually, was USB. If U.S. Bank Mortgage actually traded separately from its parent, I'd have said, actually, that I consider them a good comparison. The problem, of course, is that USB trades like a bank, not like a freestanding mortgage company, so you do have to take that into account.
Nonetheless, I wanted to go on record as having once said something nice about a mortgage lender.
A Broken Record:
Winter (Economic and Market) Watch » A Broken Record
HSBC story is front-page, above-the-fold headline in Thurs. 2/8 WSJ. Enjoy.
Fitch said it was dropping its estimate of prepayments on subprimes by 10%. Fitch assumption change
L Bux is totally on the money with his comment. The salesmen of the larger underwriters don't care which way the market goes, they're hedged for either event. All they care about are the commissions in the sale. Of course that is very short sighted, but it's longer than most jobs on the street.
"Nonetheless, I wanted to go on record as having once said something nice about a mortgage lender"
Definitely one for the record books
Thanks Tanta.
I wonder if the NAMB will place an ad in the WSJ:
"Why it's a great time to buy or sell a banking stock."
And meanwhile, on the NEW front, in case you need a laugh:
NEW YORK (MarketWatch) -- Jefferies & Co. on Thursday lowered its rating on New Century Financial to hold on book value concerns following a warning on loan production from the company and a coming profit restatement. "While we acknowledge this has the hallmarks of a 'downgrade at the bottom', we believe it is better to acknowledge our mistakes than compound a bad stock call with stubbornness," analyst Richard B. Shane said in a note to clients. Jefferies sees the company's book value falling to $24 to $28 a share when the company announces fourth-quarter results.
Actually, the unfortunate part is that this problem was facilitated by Wall Street MBAs who understand the dynamics fully, and as such were smart enough to skim fees out of the system while retaining none of the risk.... Others, of course, were left holding the bag.
So, Jeffries encouraged their clients to buy NEW at $45/sh and now hold it at $22/sh. I'll guess that if it drops to $15/sh, they'll recommend everyone sell.
Isn't that how Gomez Adams invested?
"Actually, the unfortunate part is that this problem was facilitated by Wall Street MBAs who understand the dynamics fully, and as such were smart enough to skim fees out of the system while retaining none of the risk.... Others, of course, were left holding the bag."
This is one of the more insightful comments I have seen on this blog.
Yep the fees, huge salaries and bonus are the brokers and the risks are the buyers.
Lama wrote:
"So, Jeffries encouraged their clients to buy NEW at $45/sh and now hold it at $22/sh. I'll guess that if it drops to $15/sh, they'll recommend everyone sell."
Buy high, sell low, bail us out, you suckers! It's the NEW mantra.
I'd say it wouldn't even be worth a look until $14, and I (risk-averse scared bear that I am) probably wouldn't buy it then. What they've got is the worst, and they're going to have to take a lot back, and they may well be facing major legal problems.
Where the heck is Mr. Bodacious when I need him for an uplift?
The federal government will not allow all the MBs held in 401k's to go bad. This can and will be achieved by keeping the RE market from plunging. This in turn will be achieved by buying up foreclosed properties from lenders, whether it banks or MBS holders. RTC volume II will take care of it. Foreign central banks and/or private lenders will be glad to sop up the federal debt as much as they have in the past 25 years. This whole game is not yet over. Will it be over at one point? - Yes, accumulation of debt is not limitless. Will it be over within the next 5 years? - No.
Tanta,
Remember your friends when it comes time to do those great reo deals!!!
I will put a minimal amount of cash into the deal to move that property off of those lovely books and onto mine with preferred financing.
You will have a job again soon- now all I have to do is keep my job and my credit rating up and buy like mad near the bottom- gonna retire off of this recession.
"... dynamics of asset based Ponzi schemes."
Bricks and mortar!
AllenM, unfortunately, one of the other rules I can recite involves the one where "preferred financing" has to be included in the loss you eventually record on the liquidation of the REO. I'd hate to get hired by the last remaining bank, only to find that it's playing REO-financing games with the last remaining accountant in order to fool the last remaining regulator.
NEW YORK (MarketWatch) -- Merrill Lynch on Thursday downgraded New Century to a sell. "New Century's accounting issues and deteriorating fundamentals at its lending operation could put it at a steep downward slope, in our view, and we are more concerned that liquidity issues and adverse market reactions could undermine its buisness model and financial stability even further."
Was there anyone out there who already had a "sell" rating? I forget what comes after "sell."
I dunno what comes after, but what comes before "sell" is "short"
Yes, Captain Pftt (aka Mr Bodacious) has found time in his busy schedule to post elsewhere it seems.
But AZ Joe has my ear, who figures the government will come to the rescue (RTC II whoever that is). Is this the Japanese model? I wish I could be more certain about this:
as are many fx players who see the gladness only if the risk is gladly compensated for...moving those long term interest rates higher. Not good news for mortgage payers (or even lenders of fixed mortgages).
I could hear some more details from you AZ.
Are we going to see the de-coupling of the long and short yield curve soon? Ramifications? Thoughts?
Hello All,
This is how stock brokers jump start their careers:
1)Make a tournament style draw sheet with, say 128 people.
2)Cold call people at random, tell the first 64 you are able to speak with that ABCs stock is going up.
3)Tell the next 64 that ABC is going down.
4)A week later, see if ABC went up or down.
5)Call the 64 people to whom you indicated the information that turned out to be correct.
6)Tell 32 of those that DEF is going up. Tell the other 32 its going down.
7)Repeat until you have 2 to 4 true believers.
8)Sell the better funded true believers a stock your firm actually believes will do well.
9)Sell the less funded true believers shares your firm is pumping in order to further enrich the wealthier clients.
10)Repeat until you have a nice client base of wealthy people.
The conventional wisdom (now you conventional typers out there Know this is so yesterday) is that the posture (Do not embarrass me and try to tell me this is a position backed by the rock hard numbers of the BEA and BLS.) of spotting threatening inflation and it's attendant response from the Fed (hiking the FF rate)[This B for the slow conventional wise people.] is keeping that very inflation down to manageable levels.
No sh*t.
The not so conventional wisdom, the withit moxy (those folks who can still tie their shoe laces!) is that the Fed no longer has control of the long rates (J Hamilton B wrongo. Greenspan's conundrum B righto.) and that this is a confidence game...on the ebb I make it. Increasing or decreasing the FF rate has a 50% chance of moving those cherished long rates up or down. They dare not decrease the FF rate for fear of sinking the dollar and sending long rates to the moon...and if there was ever any doubt about the housing market busting...
They dare not increase the FF rate because they either discover it just deepens the inverted yield curve making mortgages no cheaper or, traditional wisdom makes a reappearance and those mortgage rates climb higher. In either case the Fed loses credibility and, at this stage, confidence is the name of the game.
The recent meeting of the Central Bankers was all about desperately smiling your ass off.
AZ Joe - we'll see 'stimulus' but gov't won't 'save RE'... just like it didn't 'save farming' after the ag crisis.
In the ag crisis gov't offered increased subsidies to the survivors & created RTC to clean up the bad debts. In effect forced the pig through the python.
But S&Ls & farms failed by the ooddles... and land prices tanked for over a decade (in my county pre-boom $800/acre... boomed to almost $3000/acre... post boom to $400/acre).
Look for housing to do similar but without such an extreme price swing.
But gov't won't buy homes - never happen.
This also in today's WSJ:
Things That Go Boom
By ROBERT J. SHILLER
February 8, 2007; Page A15
It seems that no one in the 1990s forecast the doubling of home prices since 2000 in cities in the U.S. and many other countries. Harry S. Dent published a book in 1998, "The Roaring 2000s: Building the Wealth and Lifestyle you Desire in the Greatest Boom in History," which was a New York Times best seller. Wouldn't you imagine from the title that it predicted a huge housing boom? It didn't. It said of the suburbs that "there will be only a modest appreciation of home values, despite a booming economy." The book concluded only that some "select real estate" should be part of one's portfolio. Mr. Dent was really preoccupied with the stock market, which was booming when it was written.
Books really predicting the housing boom started to appear only after it was well underway, when their forecasts were simple extrapolations. David Lereah, chief economist for the National Association of Realtors, published "Are You Missing the Real Estate Boom? Why Home Values and Other Real Estate Investments Will Climb Through the End of the Decade -- and How to Profit from Them" in 2005. In contrast, his book "The Rules for Growing Rich: Making Money in the New Information Economy," written just before the very peak of the dot-com boom and published in June 2000, spoke first about the stock market and then added only that "real-estate investments have proven, over the years, to be worthy additions to anyone's portfolio."
We shouldn't blame these people for not seeing the boom coming. Nobody did. But those economists who say today that the real estate boom has been justified by "fundamentals" have to explain why they weren't able to forecast the high home prices we have today based on those fundamentals.
With the failure of anyone really to predict today's high home prices, one may well conclude that no one can predict today whether a home-price bust is coming, or whether the housing market will land softly, or even is poised to resume its upward climb. That may be the right conclusion about our ability to forecast the markets.
On the other hand, there is another perspective on this colossal failure to predict. Maybe it doesn't mean that no one can forecast, but instead that the high home prices today are just an enormous anomaly that will have to correct downward sometime, if not right away.
This has been the biggest housing boom in world history, and when one looks at a long-term chart of U.S. home prices, this boom stands out among the other price increases like the highest kite in the park. It certainly looks anomalous, and maybe it is. Moreover, home-price booms, and sometimes at least real estate busts, seem awfully persistent lately, so that it looks like we should be able to forecast them. The market for homes has become very different from the stock market, which is somewhat well approximated as a random walk.
Home
"The federal government will not allow all the MBs held in 401k's to go bad. This can and will be achieved by keeping the RE market from plunging. This in turn will be achieved by buying up foreclosed properties from lenders, whether it banks or MBS holders. RTC volume II will take care of it. Foreign central banks and/or private lenders will be glad to sop up the federal debt as much as they have in the past 25 years."
Back in 1929 the smart people all swore that the Fed would never let the market collapse. But, speaking as someone who's long gold, by all means let them and their foreign counterparts print reams of money to try to support the rotting edifice.
Tanta, but performing beat non any day of the week- let the bean counters figure the loss later!!!
After all isn't that the point of the freddie mac footnote:-}
Now, what you need to do is spice that note up with some knock-in options that are sufficiently opaque that you can bamboozle that pesky auditor;-}
After all Chuckie Keating wasn't wrong on the value of his real estate investments, he just didn't have a high enough cashflow to swing it through the bottom of the recession...but then vulture win while leverage swings.
For those of you thinking that the Federal Government will prevent the housing market from falling, read these comments from Chris Dodd. He has mortgage originators in his gun sights and the net effect of whatever legislation he passes will be to decrease home financing, and thus the number of home buyers at the margin. He hasn't proposed anything specific yet so it's hard to comment on the wisdom of whatever regs might get promulgated, but the short run effect will only exacerbate the downturn.
"Senator Christopher Dodd (D-CT) called for action to address what he characterized as a grave threat from predatory, abusive, and irresponsible lending practices undertaken by too many subprime lenders.
Today, there are too many incentives in the subprime market to make loans that put borrowers at too great a risk of failure, Dodd said, pointing to the fact that more than half of all subprime loans go stated-income rather than full or partial doc.
"Dodd seemed to place as much of the blame at the feet of originating brokers as with the companies that funded questionable loans."
According to a survey of over 2,000 mortgage brokers, 43 percent of brokers who make these loans do so because they know that their borrowers dont have the income to qualify for the loan, he said in his remarks. Why do they make these loans? Because they are paid more to do so.
"Dodd also took issue with broker upsells, saying the practice hurts consumers. [Brokers] put borrowers in loans with higher interest rates than they could otherwise qualify for, because the brokers make greater commissions, called yield spread premiums, by doing so, said Dodd.
YSPs are a perfectly legitimate tool to provide borrowers with no closing cost loans. But HUD has told us that half of the YSPs paid, about $7.5 billion, do not go to closing costs, but go simply to increase broker profits.
I believe [subprime] borrowers deserve every bit as much protection as the homeowners who take out interest-only and option ARM loans, and I want to urge the regulators to move expeditiously to provide the same protections to these particularly vulnerable borrowers.
Page not found : HousingWire || financial news for the mortgage market
It is also worth reading about what has happened in Rhode Island, with the legislation they have passed. A number of lenders left the state completely.
Finally, NEW looks like it will close the day as a teenager - it was at $40 on 11/1.
"Things That Go Boom"
I agree with Shiller that no one anticipated the real estate boom, but everyone knew the stuff they were writing was junk. They went into it thinking they could "distribute" the risk and that is now backfiring. Reminds me of LTCM. It all looks great on paper, but at some juncture it returns to Earth.
Oops - Schiller got cut-off. I take him to mean that if the market were more efficient the people writing junk may have had a better picture of the risk and not written the junk in the first place. His punchline:
We are left with a deeply uncertain situation, but one in which it would seem that a sequence of price declines continuing for many years has some substantial probability of happening. Traditional finance theory has trouble reconciling even a semi-predictable sequence of price declines with basic notions of market efficiency. The situation we are facing is a reminder of the glaring inefficiencies and incompleteness of existing markets for residential real estate, and may be regarded as evidence that institutional changes will be coming in future years to fundamentally change the nature of these markets.
Tanta,
In general, what tends to contract credit creation more?
I realize that both are occuring right now, but I want to know which has the greater effect in the contraction of available credit.
While I have a degree in economics, I would appreciate it if you would please over-simplify your hoped for response to the point that a 12-year old could understand it. (grin)
Robert, I am a banker who once studied the classics. I know precious little about economics that a 12-year old couldn't follow.
The very short version of the story Tanta is sticking to is that reserves come right out of income. The more you have to reserve (because of increasing credit losses), the more you have to charge the borrowers to keep that net interest margin up. Result: "price rationing" contracts credit.
Tightening underwriting standards can happen ahead of losses (because the regulators made you, or because your forecast is far-ahead) or as a response to them. Result: "nonprice rationing" contracts credit.
As the process unfolds, it gets harder and harder to tell the difference between the two. I think they both operate at the same time. Lender A will refuse to make a certain loan, and thus can maintain lower rates on the loans it will make. Lender B will take the certain loan, but jack up the rate. One result--a happy one, I think--is that you can then start telling the difference between prime and non-prime lenders again; we kind of lost the ability to do that in the boom. In any case, if it stays at this level, all you get is that famous "efficient market" that people keep telling me about.
My definition of a true credit contraction would be when Lender A engages in so much non-price rationing that it can't make enough loans, and therefore must charge more for the loans it makes, and Lender B can't price the risk it's taking because it's no longer possible for the borrowers to pay their true risk premium. The points converge, and everything looks like price rationing.
Yup, that is the infamous "You don't qualify for a loan because you haven't deposited the money in my bank so I can lend it to you."
That was said to my father and myself in 1990 by bankster Leroy, the local dipwad branch manager of then "very small hometown bank". We walked out to First Interstate and got a loan. At that point I realized that banking was and continues to be a scam and that you have to buy your loan officer lunch a bunch of times.
Back to the Future- Tanta- would you like me to buy you lunch so that I might be a "preferred party" when the time comes? After all banking is all about the relationships- till those friends and family come up snake eyes on the old cashflow meter....
AllenM, that's a load of rubbish.
Robert,
I wasn't asked, but I'll try an answer anyway. The short answer is that (1) the increase in loan loss reserves (or provisioning) leads to (2) the tightening of underwriting standards. But, mathematically, it's (2) the tightening of underwriting standards that ultimately has the larger effect on available credit. I'll use an example to illustrate.
Say we have a Bank with $500 million in assets, $400 million in loans, $50 million in equity, $5 million in net income and a loan loss reserve equal to 1% of loans, or $4 million. Now let's say that nonperfomers and chargeoffs rise to the point that Bank feels the need to double its reserves today and double its provisioning going forward (as happened with lots of banks in the early-90s). Well, Bank now needs to add $4 million to reserves, which is one-time hit to earnings and equity AND needs to double its provisioning going forward, probably from 30 bps or so to 60 bps or so, depending on a lot of factors which I won't go into. So, the immediate dollar impact of the additional reserves and provisioning is a few million dollars. BUT, now the Bank is shit scared (and paranoid), and lending standards are going to get tightened up and while the Bank may have grown loans by 10%, or $40 million, last year, now it's probably not going to grow loans at all, and maybe even shrink. So, that's at least $40 million of lending capacity that our Bank has pulled out of the market because of tightened lending standards. So, clearly the tightening is ultimately the big issue for credit creation, but it's generally a result of issues with the loan loss reserve and provisioning.
Does that make sense?
Robert,
Don't forget the impact of fear and greed on credit availability. In the last nine months we have transitioned from greed phase where the worst transgression at the bank was not meeting your production target to the fear phase where the regulators are breathing down your neck and the glass is always half empty. In the first phase there are underwriting rules but they are stretched, twisted or ignore in the name of holding market share or delivering the volume Wall Street is expecting. In the fear phase the rules are followed to the letter and the smallest blemish gets your loan kicked out because someone is afraid of losing their job when the regulators inspect the loan files.
You are right regarding the effect on banks/S&L's ALLL, but it is even more insidious. Many of these institutions have booked/accrued the negative amortization interest earnings that have never been received.
These "earnings" have become part of equity. When the loan goes bad it is the reversal of these earnings, since they were never collected, which is going to be the humdinger.
Many of these institutions only receive 2% and accrue the 5% balance. They have to pay depositors with real dollars. As a result they have huge negative cash flows. When these loans don't pay off your net interest margin goes upside down.
The mortgage bankers are a completly different animal. They are loosely regulated from a capital standpoint. Take NEW they have a $17 Billion Warehouse Line of Credit. They do between $12-17 billion of loans per quarter. They borrow the money on the line to fund the loans and then resale in the bond market.
They only have $350 Million in cash. If 1% of their loans are "putted" back on early default. That is a $500 million buyback.
The warehouse line is now currently in default because of no audited financials. So if the bank pulls its line NEW is history. You can bet the warehouse lenders are scrutinizing this very closely. They don't want their money purchasing the defaulted loans.
The problem is exacerbated because NEW and others need to sell loans to pay off their warehouse lines of credit. The appetite for these loans is diminishing therefor their value is depreciating.
Markit Homepage
So if they sell their existing loans in the bond market for less than face value they don't have enough money to pay off their warehouse line. This is a death spiral.
The banks & S&l's are slightly better off because most rely on deposits to fund their loans and do not use warehouse lines of credit that can be pulled. However it is the regulators that these institutions really have to worry about.
The interesting play is that all these mortgage companies have put them up for sale with no bidders. It looks like the warehouse lenders are trying to get there existing loans packaged & sold and reduce their exposure. They hope this can be done without quietly and slowly without a blowup.
I would expect NEW to significantly be reducing the loans they make and especially any subprime loans.
It will take a miracle for NEW to make to the 4th of July picnic. And there are many more on the roadside.
Tanta, Dave, Brian, and Frank:
Thank all of you for your own individual and excellent way of answering my question.
I have to tell you, when I was taking economics courses at UCLA, in addition to the textbook that was required, I would often read a similar textbook by another author to help me make sense about the confusing subject matter at hand. LOL
Another question ...
If the need arises to increase reserves for bad loans does in fact result in the need for a bank to raise it's rates on loans - in order to maintain it's profit margins - how does the troubled bank stay competitive with banks that didn't get into trouble, and can thus offer loans at lower rates?
Or am I missing something here?
Robert Campbell,
It doesn't look to me as if you're missing anything. The problem is that even Tanta could only muster one example of a responsible lender.
"The problem is that even Tanta could only muster one example of a responsible lender."
Gee, there must not be any then...
Very funny, producer.
I happen to know of more than one source of what I consider good loans--not excessive risk, priced adequately, processed responsibly, serviced proactively, etc. Most aren't publicly traded, or are not traded as freestanding mortgage entities. As I said before, last I looked USB produced a good book of loans, but they trade like a bank, not like a mortgage originator. Frankly, if you want to see a pretty loan, try your local credit union. But don't expect their share price to tell you that. There is, however, a story about how the big producers of loans (the public ones) got so sloppy--not to mention how they got so big in the first place.
The problem in prime lending, which predates the boom and in some ways has been driving the "exotic" problem, is that prime loans are incredibly commodified. This is largely a function of the GSEs. The short version is that everybody offers the same product at the same price, give or take a tick or two, because they're all being sold into the same GSE trade. Compete on a prime-credit 30 year fixed? Like grocers "compete" on selling bananas. You can do it with massive volume to make up for the razor-thin margins (become very big), or you can do it by offering some non-price incentive like speedy approval, which morphs reliably into "documentation relief," which gets you . . . stated income, stated assets, overreliance on FICO alone (which is, unlike traditional analysis of creditworthiness, not very time-consuming), AVMs instead of real appraisals, toeholds for fraud of various sorts.
What you don't want to do, if you're a depository, is put a big bucket of fixed rate loans in your portfolio, because you cannot afford the interest rate risk. So if you want portfolio investments, you offer ARMs. The same "commodification" ensues: every plain vanilla treasury-indexed 5/1 amortizing capped prime ARM looks like every other one, and competition is extremely hard. Without looking up the numbers, I'd say that three or four big aggregators bought 80% of the "vanilla" ARMs originated for sale during the boom.
The whole "Alt-A" phenomenon had less to do with meeting a real market need than in providing something for originators to profitably originate. Yes, yes, we're all told that there are these self-employed people who are great credit risks who need a good stated deal . . . of course there are. There just aren't enough of them to support a market in the stuff. The whole joke about "these products were 'tested' in private banking" before the boom is a joke because, well, we ran out of "private banking" clients to offer this stuff to. So Alt-A goes main market, with such perversities as "stated W-2" and "stated fixed income." We have all focussed, appropriately, on how this sort of credit bubbling fed into the house price bubbling in a vicious cycle. But it's also a matter of "de-commodifying" the prime market to create "competitive niches." My view is that we're at the point where the "Alt" became another commodity, and suffering the consequence that it doesn't perform like a commodity.
This is a round-about way of answering Robert's second question. There's a lot of overcapacity we have to burn off before anyone can figure out a "good" way to compete in a tighter environment. The banks will have to learn to go back to being bored by their mortgage portfolios.
I should add, we like to use the term "liquidity" around here, and I have been trying to use it in the way you people in the "real economy" do. But back in my day, in the mortgage side of life, "liquidity" was an issue for your mortgage portfolio in the sense that, well, you needed those assets to retain a certain liquidity because the day might come where you'd need to convert them into cash. The Sandlers made their fortune amassing a big pile of loans that no one else would buy at World Savings; they sold at the top of the market transformation in which suddenly lots of buyers would buy that stuff (neg am ARMs). Whatever you think about World, that was a hell of a bet. Most lenders don't want a huge portfolio of illiquid assets. Mortgages become more "liquid" as they approach conformity with whatever the "standards" are of the marketplace. Side A of the coin is that, for the last several years, everything was "liquid" and nobody worried about it. Side B of the coin is that lidquidity was achieved at the price of incredible credit risk escalations, neatly offsetting the reduced risk of illiquidity.
So if and when "the music stops," you will have either a liquidity problem or a credit risk problem, depending on how you choose to look at it, just as you will have a non-price or price rationing problem, depending on how you choose to look at it.
Sorry for the mis-quote Tanta. I'll post a formal retraction on page 57 of my homepage...if I ever have one.
Tanta, very helpful(clear) explanation of the situation.
Makes me suspicious that if mortgage problems in ALT A become bad (a possibility, not certainty) the industry may become mainly large players producing standard products for GSE's for awhile.
No, no, Lama, that's not the way to deal with it. You have now just "admitted" that you don't have a homepage, which makes you a target for the next irony-deficient anemic to pop by CR's place.
The appropriate response would have been, "Oh, shut up, Tanta, you silly twit." 'Course, CR would have had to edit your comment, and then we'd all have to wonder what you meant by "Oh *** Tanta, you ****."
Tanta,
There is no question that the music has changed.And the party is over.
We all know what the the Lenders made loans they had no intention of keeping. They extended weak credit for the simple reason they could flip the loan out to Wall Street.
Wall Street loved the simplicity of FICO scores. And made underlying the assumptions that these loans would serially refinance. What is hitting these MBS, CDO's and ABX's are that these mortgages are not being refinaced as quickly.
Fitch assumption change
The warehouse lines are attempting to an orderly exit. That is they want the Mortgage Comapny to sell off the existing paper pay down their lines and are either not allowing any new subprime loans to be created or drastically changing the standards.
The telltale sign of the problem the Mortgage Companies are having with their Warehouse Line is they usually all make the same comment "We are exiting the subprime market".
Yesterday seem like a watershed day. Heretofore, subprime & Alt A traded around like the Queen of Spades in a Hearts game. Now nobody wants to be near it.
The music is slowing down rapidly. The buyers of this paper and the Lenders are stuck with the girls they brought to the party.
And the borrowers are not going to be able change partners (refinance) like a toga party at the Playboy mansion.
But it was a great party while it lasted.
I am an amateur who has interest in the subject. My humble take on this situation is that the stage is being set for something of big proportions. Remember, FED's primary business is to make money for their owners (whoever they are, btw, does anyone know?). So, in order to do that they need to create artificial ups and downs (aka business cycles). Now, we know that the down is imminent. For me the question is who the scapegoat is (they need this to direct the anger of ordinary public). I think this answer we got yesterday. It is gonna be subprime lenders. But it is FED who provided conditions for their existence in first place. Those who practiced excessive leverage will as always lose their shirts. It is FED who supplied cheap money and promoted leveraging. They are not in business of providing economic stability, just opposite, the stability is their worst enemy. And, a few years later, there will be "recovery" again forming a bubble somewhere else. The game is simple, public memory is very short.
Just to add a few other points. I am an IT guy (sorry English is my sec. lang).
There is inflation big time in front of our eyes, but it takes different form than usually. Instead of prices (used for the index) going up, we have real wages going down. Yet the employment appears to be a record high. Someone says the economy is strong to compensate job losses. Yes but instead of $20/hr, one gets paid $10. Wow,the economy is so strong to pick up job losses.
Now is the time for a truly aggggrrressive wall streeter bunch to step bravely into that subprime space and make mahjor moneta off of the collapse of those warehouse lines of credit. Umm, who just bought some subprime outfits last quarter- oh yeah! Wall street firms!
Who is pulling the plug on the warehouse lines? Same folks.
It is a short jump to see that the people who will benefit from the consolidation of the subprime space are causing it- imho.
As for being full of it- ask DMB partners- the private billionaires that used a small fortune in Campbell Soup stock to fund an asset buying spree of epic proportions from the RTC and the banks in the early 90's here in Pahoenix. Subsequently they have developed, sold, and cashed out tremendously the last few years.
They are building their own city in the West Valley: it is called Verrado a small city that is eating a small town called Buckeye- of which you shall hear more in the future.
This page helped me a lot to know more about refinancing and the things that come associated with it.
Thank you.