It's a good point jzeide. The DOW will continue to inch up now that oil is falling back below $6o/bl --giving the consumer a chance to invest.
Ok, maybe not that much, but inches are inches.
Ok, maybe that doesn't really reflect who is invested in the DOW (the large money managers) and THOSE people see the lower oil prices as the miracle 2nd wind for the consumer they've been praying for.
Ok, maybe not much of a wind. A pleasant breeze, maybe not all that fresh. Or reliable.
Ok a cough before Ben slams the lever into reverse?
oil losing 20% in a month is weird...with the dow continuing to May highs...the Dow has risen on the back of big oil the past 2 yrs...some big $$ must be losing big on such a move so quickly in oil. While its nice for the consumer to add 30-60 bucks a month back bc of oils drop, I think the mortgage resets adding 100-300 a month will be the catalyst. I am just amazed at how the street has not budged yet. its like its playing chicken with a super tanker
I've heard that 10-20 dollars worth of the oil price run up has had to do with people buying oil futures. In it very unusual that the current price of oil would be lower than the future price, but that has been the case for quite a while now. (Usually, it costs more to buy it now).
So, people have been making essentially free money by buying oil and then turning around and selling it as a future.
Clearly the speculative market found a top and the selloff began. It has little to do with the fundamentals. One might also argue that the oil speculators believe a U.S. economic and manufacturing slowdown is imminent, which would drive down the price of oil on the merits and make it a bad idea to be holding large quantities of oil.
This would explain why the U.S. govt now finds itself with large surplusses of oil and gas. Because they will always be the buyer of last resort.
All this is to say that lower oil prices are not necessarily bullish going forward.
The same issue of BusinessWeek (pg. 94) offers the following explanation for the recent drop in oil prices:
"The recent short-term drop came as hedge funds and other speculators liquidated more than half of their bets in the futures markets in just four weeks. That has left the market poised for an upturn, according to analysts at Barclays Capital."
i wouldn't expect the dow to fall harder than the other indices. in fact i would say it has a higher probability of hanging in there. in a recession, traders might try to capture alpha by buying dow and selling higher beta indices. in my opinion, oil (and emerging markets) is just a high beta play. the run up in smaller cap oil companies resembles the tech stocks before their year 2000 crash and burn. during the prior cycle the tech stocks showed weakness first, then the sp, then the dow. it's a rotation my friends, and higher beta usually succumbs to the downturn first after the yield curve inverts and the fed pauses. we'll see how things pan out this time. things can always be different.
below is a big-picture technical view of some of the emerging markets if anyone is interested:
I love the part in the end of the article about Wall Street gonna clean house by buying its own subprime lenders. The Smartest Guys In the Room meets Glengarry, Glen Ross. These people don't need mortgage consultants; a good film critic could tell them how well this is going to work out.
National City, your basic regulated financial institution with a large mortgage lending operation and very experienced managers, bought First Franklin because they convinced themselves they could "bring discipline" to subprime lending whilst basking in margins that prime lenders can only dream about. Frank(lin)ly, Nat City's lucky to have gotten out from under that illusion at the price Merrill paid. Now comes Merrill Lynch with some genius plan to "disintermediate" the process of getting toxic waste into its whole loan pools. Why mess around with inefficiencies like due diligence and buyback litigation when you can just be on the hook for the whole enchilada yourself? Why worry that your correspondents are "adversely selecting" the crap they sell you, when you can buy the whole pipeline and discover that what actually looked like adverse selection turned out to be the cream of the crop?
The internal culture of a subprime lending operation is like one of those microbial infections you pick up in the hospital. Every subsequent purchaser of the business infuses a new antibiotic, to which the operation becomes resistant in a couple of weeks. Let's hope Merrill enjoys its experience as the current Cipro of Subprime.
A few lenders have refused to buy back loans, prompting arbitrations and lawsuits. Bear, Stearns & Co.'s (BSC ) mortgage affiliate, EMC Mortgage Corp. of Irving, Tex., is suing New York lender MortgageIT over $70.5 million in disputed buybacks. ... And Lehman Brothers Inc. (LEH ) is trying to recoup $20 million on toxic loans bought years ago from Beverly Hills Estates Funding Inc., whose principal, Charles Elliott Fitzgerald, is believed to have fled the country to a South Pacific island.
Where is the insurance the system 'assumed' was there.
vader, how much "due diligence" do you think investors have to do on some outfit calling itself "Beverly Hills Estates Funding"? They couldn't have waved a bigger red flag unless they had named themselves "ScumBanc."
I have a lot of little due diligence tricks I use that I do not discuss in public. Why not? Because we learned our lesson years ago with doing anti-fraud training with loan officers: it was like dryfly's story about DUI class. We showed them the little mistakes that fraudsters make--like forgetting to recalculate FICA on a fake W-2--and the little bastards diligently went out and fixed that bug on their fake W-2 production software.
So I learned to stop giving ideas to the wrong people. However, I don't mind sharing the fact that there exists something called Tanta's Mortgage Asset Due Diligence Operations Guide (MADDOG), an unpublished masterpiece, in which there is a risk variable for "counterparty d/b/a name." Over the years my risk weight for the name alone has performed almost as well as my risk weight for the number of financial statement footnotes. Some days you don't have to even open the financials: you learn everything you need to know from the business card.
From the article: In typical deals, banks agree to buy mortgages back from Wall Street in the case of a payment default within the first 90 days. 90 days!!!These aren't people hit by resets, these are people who couldn't make 3 mortgage payments before they were in trouble. Holy cr@p! This will get REALLY ugly.
Vader remembers the days when banks sent unsolicted credit cards to potential customers. The ultimate pre approval. Druggies and other folks followed the postman around and got the cards in the plainly marked envelopes.
I bid on networking a local 'mortgage mill' The principal was a Cuban and it looked like one of those old time Florida Swamp Land Sales Offices. The principal had the only copy of the approval software.
I was UE (offically 'self employed') at the time, but could have gotten a 100K mortgage according to the brother of a friend that worked there.
There is too much greed and too little consequences in the financial fraud schemes. THe execs get their bonuses, the approvers get their commissions, and the little guys get time if anyone.
Now if we took the China way and shot high execs that are corrupt, things might be a bit different.
In any case, I view it like a game where everyone professes faith in the system as long as they get their 'cut'. They claim that when Doomsday happens, someone else will cover the bill. Most times they are right.
CR, This post over bad loans and MBS buybacks was the general subject of an ealier comment I made over the weekend.
Think US bankruptcies will taint MBS sold in Europe or the Far East? Cause risk aversion? Another commentor said France didn't have a system of MBS creation, so might be insulated from US housing problems.
This is the same issue that drove Spiegles into bankruptcy. They initially increased revenues by giving away cheap credit to those with bad scores. Eventually they could not sell the debt and the defaults set in... Will Amerquet endup like Spiegles??
Here's what I don't get: clearly those selling the loans realize they are risker than, say, coporate bonds: otherwise, why would they have to offer the 90-day default buy-back in order to sell them?
On the other side, you've got buyers who are more than happy to receive their monthly stream of payments, but demand a refund if suddenly their is any risk involved. Seems like the buyers are expecting a risk-free investment and the sellers know that they are selling a risker-than-average investment. It also seems like this is a market distortion, although I don't know what is causing it. Perhaps the market would better price the risks if there was regulation that did not allow buy-back clauses?
Paul, the buy-back provisions aren't a market distortion IMHO. They're really a way of compensating for the inherent lack of transparency in the secondary market sale of a mortgage. Even the most informed bond buyer probably doesn't know how to read half the documents in a loan file, and certainly doesn't have the time to read every document in every loan file underlying a $250MM pool (which is a small one). At some point, the bond or loan buyer just has to take the lender's word for it (representations) that the loans used good underwriting methods and were perfectly legal and so on. The smart buyer will require the lender to put its money where its representations are (warranties). The bottom line is that if there is no breach of reps/warranties, the bondholder can't pass eventual default back to the originating lender.
Here's an example: the seller represents that no loan has a debt-to-income ratio greater than 45%. If it turns out an actual loan has an apparent DTI of 45% but a real DTI of 55%, because the lender did not calculate correctly, the lender can be made to take the loan back. If the DTI is really 45% and the loan goes bad because that's too much debt for the borrower to handle, it's tough nuggies for the bondholder. If the lender followed the rules, the credit risk passes on with ownership of the loan.
EPDs are a special case. They aren't really rep issues (who can make a representation about the borrower's future behavior?). They are covenants. You just agree to take back an EPD loan. They have always been an issue, especially with Ginnie Maes, but they have never been especially common. The fact that EPDs are showing up all over the place (or so it seems) these days is telling me that rampant mortgage fraud is starting to be unmasked. Except for those rare and tragic situations where the borrower gets into a car crash the day after closing, EPDs are nearly exclusively a matter of fraud, either on the borrower's part or seller's or the lender's or as a matter of collusion. It is extremely rare to review an EPD file and not find misrepresentation, omission, or negligent underwriting. I have also found it extremely rare that investors enforce those clauses for the truly "innocent lender" loans like the borrower in the car accident.
If loan sale contracts "distort the market," in my view they do so the other way around. Wall Street investors are so yield-hungry that they keep publishing looser and looser underwriting guidelines, which lead more and more lenders to see these guidelines as "normal," and hence to stifle their own misgivings about credit quality of the loans they're making. But in this case it will be mostly the investors, not the lenders, taking the hit for it when the music stops.
Tanta -- thanks again for the excellent education. This leads me to a (perhaps obvious) follow up question:
Would what I am calling a "distortion in the market" be greater or lesser if the GSE did not exist to provide a "buyer of last resort"?
Further: Would the housing bubble have been less bubblicious if the accounting "irregularities" at the GSEs been found and delt with sooner? If the GSEs had not been such voracious consumers of mortgage securities over the last 10 years?
Paul, you're perfectly welcome. This is the first time in my UberNerdly life that anyone is actually interested in all the boring stuff I know, so I'm enjoying myself. As the late Saul Alinsky once quipped, don't worry, boys. We'll weather this storm of approval and come out as hated as ever.
First, the GSEs are not the buyer of last resort. Not even close. I wish I knew where this idea keeps coming from. I suspect it's the confusion of their massive accounting f*ckups and duration risks with the issue of the credit quality of their book of loans.
Fact is, the term "nontraditional mortgage" can be translated to mean "mortgages the GSEs won't buy." Oh, they buy a little bit of IO ARMs, at conservative LTVs and FICOs, and for moderate loan amounts. They take modest amounts of "stated income" on conservative loan terms from high-quality originators. They take some risks with their affordable housing programs (although less than you might think, since they get mortgage insurance on them and are not, therefore, usually in first loss position). But overall, Fannie and Freddie pools are good clean consistent prime-credit well-documented mostly fixed rate loans, and I for one happily have some GSE MBS pass-throughs in my retirement account. They are way, way, way less risky than corporate debt.
The housing bubble could not have sustained itself without investors, generally Wall Street, big-ass banks, and hedge funds, who wanted to push the envelope further than the GSEs either would or could (a lot of the GSE's credit practices are a matter of their charter; they can't just ignore that when they feel like it). Go back and read the article and see who is trying to put back these icky loans: Bear Stearns, Lehman. Not Fannie, Freddie.
The GSEs also don't do business directly with mortgage brokers. A financial institution or a mortgage banker with a warehouse line has to be the "wholesaler" who takes the loan from the broker. The wholesaler can then sell the loans to the GSEs, as long as they play by the GSE rules on third-party originations and so on. This means that the GSEs have a counterparty with some net worth to go after if things don't work out right. The wholesalers have, practically, do-squat to go after, because brokers don't have anything as respectable as net worth in most cases. The slimiest brokers do business with the wholesalers who are selling to Wall Street.
Everything's relative, but you can rest assured that what the GSEs buy is pretty close to your father's Oldsmobile. The "nontraditional" nightmare is a private sector phenomenon.
It seems to me that things like the home's true value, and hence LTV, or the borrower's true income, in the case of no-doc loans, are really only known by the appraisers and brokers, who both have a vested interest in fudging and keeping things moving. I don't see how someone living in Japan buying a bond backed by American mortgages can have any real chance of ascertaining the true risk.
No you have give-aways and rebates, aren't these distorting the LTVs?M Someone takes a $400,000 loan to buy a house they get appliances, upgrades included valued at $60,000. The house is really worth $50-60,000 less than they paid.
Now with prices falling, in Florida about 6% yoy, LTVs are way beyond merely suspect.
If you look at NAR's pending sales index, it fell 7% in July and generally has about a two month lag to existing sales. Existing sales for September could fall below 6milliion and inventory top 8 months.
I guess I knew that the GSEs weren't (couldn't) buy non-traditional mortgages, but it must have slipped my mind. I guess in a more macro sense I was seeing a chain of events where the GSEs were providing so much liquidity to the traditional mortgage market, which increased demand, driving up property prices, and resulted in the dramatic increase we saw in the use of non-traditional mortgages. Now that I am saying it out loud, it seems a little far-fetched.
I guess my thesis is simply that the housing boom could not have happened if there were not also better qualified buyers participating and utilizing more plain-vanilla mortgages. I'd also supposed that this explained the very large share of the mortgage market that was occupied by non-traditional products in the last two years.
Bob, you're quite right about the LTV effect of sales concessions. That's why the GSEs have this rule that concessions and incentives over modest limits have to be subtracted dollar-for-dollar from the sales price; then LTV is calculated on the lesser of appraised value or sales price. The GSEs also require that the appraiser account for the effects of sales concessions on the appraisal report itself.
If the originators of these loans are selling them to the GSEs, then they're being charged a butt-ugly guarantee fee, which is only right. I am rather more inclined to think they're being sold to private investors with "nontraditional" guidelines for such things.
Paul, you're right that at some level the updraft-beneath-the-bubble is an issue of the enormous liquidity that the GSEs pump into the housing marketplace. It's just that if you define "bubble" as some level of deviation from "fundamentals," I see GSE liquidity as one of the fundamentals--one of the things that can get out of whack but that also performs the essential function of keeping local markets liquid and generally maintaining housing access at affordable levels--from which we deviated.
Here's something you might find interesting. Caveat Lector: the author is a Freddie Mac economist.
Thanks for the link -- good stuff. I am feeling more like an ubernerd every day. One day I hope that you and CR will be handing me my nerd diploma...
This is a totally of-topic question, but why does the government want to encourage home ownership anyway? Because people build wealth that way? Because it prevents there being an over-class of owners? Because it keeps people from noticing the things that would otherwise have them rioting in the streets?
I'm inclined to think that having a so-called "ownership society" in housing is a public good in the sense that people should theoretically care more about their communities. (Although strictly speaking I don't know that this is true any more). But there must be some economic reasoning behind it, too?
Maybe you can help me to answer another question I've not been able to find much info on.
Who is holding the first loss position on the exotic mortgages that get securitized? One piece I read said that the bank had to keep some first loss position. Then I read elsewhere that this too was securitized.
I tried looking at the SEC filings of Countrywide and Washington Mutual, but could find no mention. Though both seem to be carrying a lot of loans on their books.
The originator doesn't 'have to' keep the first loss piece, but often does. I don't know how things work anymore, but back in the old days when people cared about things like incentives, due diligence, and other quaint concepts the thought was that keeping the first piece gave the originator the right incentives. If you expected a 2% loss rate (say, 6% of the loans go bad and you lose one-third on each loan) then by keeping the first 5% you told the buyer of the safer 95% that you would make a ton of money if losses were only 1% (an extra 1% on a piece only worth about 3%) and would lose your shirt if losses were really 4% (drop 2% on a piece only worth 3%). Thus the originator had an incentive to do careful underwriting even if 95% of the loans were to be sold.
Tanta - In my experience in prime and depository-originated subprime lending, early payment defaults were almost never over 1%, and were a signal of fraud if they were more than a couple of tenths of a percent. I noticed that all the lenders in the BusinessWeek piece were non-depository subprime lenders, except First Franklin (sort of, a non-depository that was bought by, and then rapidly sold by, a depository). And Option One has had early payment defaults of almost 10% for several years. What gives with that? Are these guys just pushing the envelope so deep into low FICO/high DTI territory that people can't even make 3 payments, or are they beset by fraud on a truly massive scale (or is there paperwork just screwed up, with first payments going to the wrong place all the time)? And does this say anything about non-depository subprime lenders taking on a lot more risk than depository subprime lenders?
Paul, the day you find yourself sitting in the car with the engine running in your driveway so that you can listen to the end of the builder incentive ad on the radio so that you can go in the house and enter it into the spreadsheet you've started keeping to track pricing concessions, you will have become an UberNerd. It's not a diploma, it's a diagnosis.
Bob, don't feel bad if you can't figure out an institution's exposure to residual credit risk on securitized nontraditional mortgages. During the hearing, Senator Reed asked the regulators how much the financial institutions hold (in whole loans on the balance sheet as well as off-balance sheet securities) and the answer was basically "we don't know, we think lots, we're working on finding out." Christ, if the OCC can't find this information, mortals like we aren't going to find it.
I am told by those who are in a position to know that issuers are increasingly selling off the subordinate tranches because the hedge funds and other high-rollers have made a market for unrated toxicity. That's either the good news or the bad news. As mort_fin notes, selling it off removes an incentive (thus increases risk to the holders of the senior pieces). On the other hand, holding it increases the exposure to institutions which are ultimately insured by us folks. God only knows what's in the banks' trading accounts for the purpose of hedging the risk they already have. I also have this problem wondering how many banks are writing loans or letters of credit to hedge funds, which hedge funds use to take the residuals off the banks' hands . . . "net risk washout" or "recipe for systemic implosion"? You be the judge.
mort_fin, if these EPDs are non-fraudulent delinquencies, I'd bet the farm that they're speculator loans. I also sincerely doubt we have payment credit/transfer of servicing problems here--nothing motivates a lender to find and forward a misapplied payment like the prospect of buying the loan back. I think you're seeing "straw buyer" flips and equity skimming scams crawling out from under the woodwork. Option One has 10%??? Can that be right? That's a death sentence.
You folks are so great for contributing so much in the last few weeks, I really must add my appreciation.
Tanta, you have resolved some of my (mis)understandings, and I am glad that you have still have faith in FNM bonds, but I still have lingering concerns if there is a significant reduction in house prices. Since FNM can now buy $450,000+ loans as of last winter, I would assume that a 20% decrease in prices will cause LTV's of some previously-acceptable loans to fall outside of the agency requirements.
Do you see any significant risks in a price decrease of that magnitude (20%) on agency bonds? If not, what percent pullback would start causing you to worry? Even if there is no huge concern about foreclosure problems for Fannie and Freddie, wouldn't the bonds likely get downgraded?
[I love that you guys are always going over my head, as that inspires me to stretch my neck. Having said that, I could really use a massage about now.]
One more thing, Tanta, you wrote I also have this problem wondering how many banks are writing loans or letters of credit to hedge funds, which hedge funds use to take the residuals off the banks' hands . . . "net risk washout" or "recipe for systemic implosion"?
Isn't that what they learned how to do from the LTCM 'bailout'? If it could work once...?
A drop of 20% would not "cause LTV's ... to fall outside of agency requirements" exactly. The only "requirement" is that a senior lien LTV over 80% WHEN ORIGINATED must have a credit enhancement (usually mortgage insurance). Their credit standards prevent them from buying much in the way of high LTV loans, but there's nothing that would require a forced sale or anything of that nature if prices fall and current LTVs rise.
A 20% drop in the nationwide average price might not hurt very much, if most of it is concentrated in high price areas - San Diego, Boston, NYC - because the conforming loan limit means they don't buy that much in those areas anyway. It would hurt more if it was spread out evenly. Even spread out evenly, it wouldn't kill them (maybe the rating agencies would downgrade, almost certainly a watch).
They are usually more exposed to interest rate risk than to credit risk. If house prices were dropping while inflation was rampaging, and everyone expected the Fed to zig and they actually zag, so that they get hit with a big interest rate shock at the same time that they are hit with a wave of foreclosures - now that would be kind of scary.
Thanks, mort_fin, so they would just have to insure those that break the level, gotcha.
I am presently in the 20% decline everywhere camp, with 30-40% on the coasts, so I am trying to figure out what the those dire scenarios might produce.
I will definitely need to stretch more to better grasp the interest rate hedging the agencies use. Again, your input is much appreciated.
is it possible that MBS buyers and the whole process actually account for mis-rep's in the product they are buying?
for example,
credit card companies no longer require signatures for certain purchases! can you believe that?? i was shocked at first but now its starting to happen more often - starbucks fresh fields chipotle etc...(can you tell i'm a yuppie).
so my point is that the credit card companies know that some people are going to have their cards stolen and there will be charges that get made that will have to be reversed. and in not requiring signatures, the probability of that happening increases. but they can do this b/c of the laws of large numbers...
any chance of this level of sophistication and awareness in the MBS market?
Thank you for taking the time to answer my questions. It all kind of buttresses Nouriel Roubini's scenario for the coming few years. And it make me feel a little more comfortable with my relatively large portfolio of puts.
mort_fin, thanks for the link. Nice of you to warn me that I should have paid more attention in German 101 30 years ago. "Rückkäufe total überraschend"--yes, it sounds even more ludicrous in German. However, reading this wasn't a total loss, as it were. I have now decided that the opposite of an UberNerd (who obsessively wrings hands over credit quality) is a BasisPunk (who believes all problems will be solved by the Law of Large Numbers).
Which brings me to dc1000. The answer to your question is, sure. It cuts both ways. In my lending days I was, actually, mostly a BasisPunk (secondary marketing/loan sales department, not credit underwriting) and I can remember going ballistic over some anal little-picture underwriter who didn't want to approve a 68% LTV no-cash-out refi for a longtime homeowner with a perfect mortgage payment history because the borrower had a $1000 medical collection. "JEEE SUS H CHRIST! You people want me to lose fifteen ticks on this loan because it has a medical collection??? You ninnies, the only people who don't have medical collections are the ones who are terribly sick but don't know it yet!! AAAAAAHHHHH!" (BasisPunks are famous for impromptu interoffice fit-throwing.)
On the other hand, there are things like gel pens that just drive me crazy in perfect UberNerdly fashion. In the old days, nobody ever let a borrower get close to a stack of loan documents without a blue ballpoint in their hands. If they had a black pen, especially a felt tip, you took it away from them. These days, title companies seem to take a perverse pleasure in encouraging people to sign shit with those black gel pens which make the original documents utterly indistinguishable from copies. You get used to reading copies rather than originals and faxes rather than copies, you stop being able to catch even elementary types of fraud.
Why do I have so many copies and faxes? Well, because everybody offers the same products and rates that everybody else does since we all sell to the same MBS market, we ran out of places to cut origination fees, and so now we have to compete on speed. As in, I can blow past the details on your loan documents faster than that other lender. If I build up enough volume, the Law of Large Numbers will offsest the risks I take by abandoning incrementally expensive preventative measures. Then all of a sudden I find myself in third lien position on a $650,000 loan because we were kinda rushed at closing and didn't get a title endorsement over a couple of pesky little mechanics liens. This can probably be fixed, but it will cost all the fees I charged on an entire week's production and by the time I'm done the market will have moved half a point. I guess I'll have to lay off another Quality Control Analyst. And so it goes . . .
Bob, may the Force be with your portfolio. All this reminds me of a little toast from back in the days when the best thing that happened at work was getting in first thing in the morning and finding out that the RTC wasn't there yet:
Loans may come and loans may go
And forward trades go south, you know,
So we'll buy puts through thick and thin
Money out and money in.
I actually have a client that has irrefutable evidence that loan fraud was perpetrated against him the mortgage officer who wrote a first and second on NINE homes for him in Las Vegas. Bear Stearns/EMC won't so much as speak to him about any loss mitigation, etc. I suspect Bear Stearns/EMC of not wanting to buy back those loans because they knew that many of them were 'kinky' to begin with, got smug thinking they had so much paper to offer/sell that no one would dare actually ask them to do so. You can't imagine on the default list that comes out 5 days a week here in Las Vegas how many defaults I see each day that were just funded in the last 120-160 days. Many look as if there was only one payment ever made... What a coincidence. Isn't the first mortgage payment due about 45 days after the closing? So, actually; these are first payment defaults. How can Bear Stearns/EMC sell that paper off, and then claim no responsibility? Many of the fraudulent loan activities I've seen were perpetrated by the same loan officers, and hung with EMC..
when will wall street price in the reality of the housing mkt?
It's a good point jzeide. The DOW will continue to inch up now that oil is falling back below $6o/bl --giving the consumer a chance to invest.
Ok, maybe not that much, but inches are inches.
Ok, maybe that doesn't really reflect who is invested in the DOW (the large money managers) and THOSE people see the lower oil prices as the miracle 2nd wind for the consumer they've been praying for.
Ok, maybe not much of a wind. A pleasant breeze, maybe not all that fresh. Or reliable.
Ok a cough before Ben slams the lever into reverse?
oil losing 20% in a month is weird...with the dow continuing to May highs...the Dow has risen on the back of big oil the past 2 yrs...some big $$ must be losing big on such a move so quickly in oil. While its nice for the consumer to add 30-60 bucks a month back bc of oils drop, I think the mortgage resets adding 100-300 a month will be the catalyst. I am just amazed at how the street has not budged yet. its like its playing chicken with a super tanker
Re: the falling price of oil and especially gas at the pumps, I predict continuing falling prices until the election - after that, watch out!
I've heard that 10-20 dollars worth of the oil price run up has had to do with people buying oil futures. In it very unusual that the current price of oil would be lower than the future price, but that has been the case for quite a while now. (Usually, it costs more to buy it now).
So, people have been making essentially free money by buying oil and then turning around and selling it as a future.
Clearly the speculative market found a top and the selloff began. It has little to do with the fundamentals. One might also argue that the oil speculators believe a U.S. economic and manufacturing slowdown is imminent, which would drive down the price of oil on the merits and make it a bad idea to be holding large quantities of oil.
This would explain why the U.S. govt now finds itself with large surplusses of oil and gas. Because they will always be the buyer of last resort.
All this is to say that lower oil prices are not necessarily bullish going forward.
The same issue of BusinessWeek (pg. 94) offers the following explanation for the recent drop in oil prices:
"The recent short-term drop came as hedge funds and other speculators liquidated more than half of their bets in the futures markets in just four weeks. That has left the market poised for an upturn, according to analysts at Barclays Capital."
i wouldn't expect the dow to fall harder than the other indices. in fact i would say it has a higher probability of hanging in there. in a recession, traders might try to capture alpha by buying dow and selling higher beta indices. in my opinion, oil (and emerging markets) is just a high beta play. the run up in smaller cap oil companies resembles the tech stocks before their year 2000 crash and burn. during the prior cycle the tech stocks showed weakness first, then the sp, then the dow. it's a rotation my friends, and higher beta usually succumbs to the downturn first after the yield curve inverts and the fed pauses. we'll see how things pan out this time. things can always be different.
below is a big-picture technical view of some of the emerging markets if anyone is interested:
Are emerging markets just a bubble made of BRICs? - Daniel L Charts's MySpace Blog |
I love the part in the end of the article about Wall Street gonna clean house by buying its own subprime lenders. The Smartest Guys In the Room meets Glengarry, Glen Ross. These people don't need mortgage consultants; a good film critic could tell them how well this is going to work out.
National City, your basic regulated financial institution with a large mortgage lending operation and very experienced managers, bought First Franklin because they convinced themselves they could "bring discipline" to subprime lending whilst basking in margins that prime lenders can only dream about. Frank(lin)ly, Nat City's lucky to have gotten out from under that illusion at the price Merrill paid. Now comes Merrill Lynch with some genius plan to "disintermediate" the process of getting toxic waste into its whole loan pools. Why mess around with inefficiencies like due diligence and buyback litigation when you can just be on the hook for the whole enchilada yourself? Why worry that your correspondents are "adversely selecting" the crap they sell you, when you can buy the whole pipeline and discover that what actually looked like adverse selection turned out to be the cream of the crop?
The internal culture of a subprime lending operation is like one of those microbial infections you pick up in the hospital. Every subsequent purchaser of the business infuses a new antibiotic, to which the operation becomes resistant in a couple of weeks. Let's hope Merrill enjoys its experience as the current Cipro of Subprime.
A few lenders have refused to buy back loans, prompting arbitrations and lawsuits. Bear, Stearns & Co.'s (BSC ) mortgage affiliate, EMC Mortgage Corp. of Irving, Tex., is suing New York lender MortgageIT over $70.5 million in disputed buybacks. ... And Lehman Brothers Inc. (LEH ) is trying to recoup $20 million on toxic loans bought years ago from Beverly Hills Estates Funding Inc., whose principal, Charles Elliott Fitzgerald, is believed to have fled the country to a South Pacific island.
Where is the insurance the system 'assumed' was there.
Quick note: The Beverly Hills Estates Funding scheme happened 3 years ago.
MortgageChronicle.com -- Archives 10.13.03
404 File Not Found | Find Articles at Bnet
vader, how much "due diligence" do you think investors have to do on some outfit calling itself "Beverly Hills Estates Funding"? They couldn't have waved a bigger red flag unless they had named themselves "ScumBanc."
I have a lot of little due diligence tricks I use that I do not discuss in public. Why not? Because we learned our lesson years ago with doing anti-fraud training with loan officers: it was like dryfly's story about DUI class. We showed them the little mistakes that fraudsters make--like forgetting to recalculate FICA on a fake W-2--and the little bastards diligently went out and fixed that bug on their fake W-2 production software.
So I learned to stop giving ideas to the wrong people. However, I don't mind sharing the fact that there exists something called Tanta's Mortgage Asset Due Diligence Operations Guide (MADDOG), an unpublished masterpiece, in which there is a risk variable for "counterparty d/b/a name." Over the years my risk weight for the name alone has performed almost as well as my risk weight for the number of financial statement footnotes. Some days you don't have to even open the financials: you learn everything you need to know from the business card.
From the article: In typical deals, banks agree to buy mortgages back from Wall Street in the case of a payment default within the first 90 days. 90 days!!!These aren't people hit by resets, these are people who couldn't make 3 mortgage payments before they were in trouble. Holy cr@p! This will get REALLY ugly.
Vader remembers the days when banks sent unsolicted credit cards to potential customers. The ultimate pre approval. Druggies and other folks followed the postman around and got the cards in the plainly marked envelopes.
I bid on networking a local 'mortgage mill' The principal was a Cuban and it looked like one of those old time Florida Swamp Land Sales Offices. The principal had the only copy of the approval software.
I was UE (offically 'self employed') at the time, but could have gotten a 100K mortgage according to the brother of a friend that worked there.
There is too much greed and too little consequences in the financial fraud schemes. THe execs get their bonuses, the approvers get their commissions, and the little guys get time if anyone.
Now if we took the China way and shot high execs that are corrupt, things might be a bit different.
In any case, I view it like a game where everyone professes faith in the system as long as they get their 'cut'. They claim that when Doomsday happens, someone else will cover the bill. Most times they are right.
CR, This post over bad loans and MBS buybacks was the general subject of an ealier comment I made over the weekend.
Think US bankruptcies will taint MBS sold in Europe or the Far East? Cause risk aversion? Another commentor said France didn't have a system of MBS creation, so might be insulated from US housing problems.
This is the same issue that drove Spiegles into bankruptcy. They initially increased revenues by giving away cheap credit to those with bad scores. Eventually they could not sell the debt and the defaults set in... Will Amerquet endup like Spiegles??
Here's what I don't get: clearly those selling the loans realize they are risker than, say, coporate bonds: otherwise, why would they have to offer the 90-day default buy-back in order to sell them?
On the other side, you've got buyers who are more than happy to receive their monthly stream of payments, but demand a refund if suddenly their is any risk involved. Seems like the buyers are expecting a risk-free investment and the sellers know that they are selling a risker-than-average investment. It also seems like this is a market distortion, although I don't know what is causing it. Perhaps the market would better price the risks if there was regulation that did not allow buy-back clauses?
Paul, the buy-back provisions aren't a market distortion IMHO. They're really a way of compensating for the inherent lack of transparency in the secondary market sale of a mortgage. Even the most informed bond buyer probably doesn't know how to read half the documents in a loan file, and certainly doesn't have the time to read every document in every loan file underlying a $250MM pool (which is a small one). At some point, the bond or loan buyer just has to take the lender's word for it (representations) that the loans used good underwriting methods and were perfectly legal and so on. The smart buyer will require the lender to put its money where its representations are (warranties). The bottom line is that if there is no breach of reps/warranties, the bondholder can't pass eventual default back to the originating lender.
Here's an example: the seller represents that no loan has a debt-to-income ratio greater than 45%. If it turns out an actual loan has an apparent DTI of 45% but a real DTI of 55%, because the lender did not calculate correctly, the lender can be made to take the loan back. If the DTI is really 45% and the loan goes bad because that's too much debt for the borrower to handle, it's tough nuggies for the bondholder. If the lender followed the rules, the credit risk passes on with ownership of the loan.
EPDs are a special case. They aren't really rep issues (who can make a representation about the borrower's future behavior?). They are covenants. You just agree to take back an EPD loan. They have always been an issue, especially with Ginnie Maes, but they have never been especially common. The fact that EPDs are showing up all over the place (or so it seems) these days is telling me that rampant mortgage fraud is starting to be unmasked. Except for those rare and tragic situations where the borrower gets into a car crash the day after closing, EPDs are nearly exclusively a matter of fraud, either on the borrower's part or seller's or the lender's or as a matter of collusion. It is extremely rare to review an EPD file and not find misrepresentation, omission, or negligent underwriting. I have also found it extremely rare that investors enforce those clauses for the truly "innocent lender" loans like the borrower in the car accident.
If loan sale contracts "distort the market," in my view they do so the other way around. Wall Street investors are so yield-hungry that they keep publishing looser and looser underwriting guidelines, which lead more and more lenders to see these guidelines as "normal," and hence to stifle their own misgivings about credit quality of the loans they're making. But in this case it will be mostly the investors, not the lenders, taking the hit for it when the music stops.
Tanta -- thanks again for the excellent education. This leads me to a (perhaps obvious) follow up question:
Would what I am calling a "distortion in the market" be greater or lesser if the GSE did not exist to provide a "buyer of last resort"?
Further: Would the housing bubble have been less bubblicious if the accounting "irregularities" at the GSEs been found and delt with sooner? If the GSEs had not been such voracious consumers of mortgage securities over the last 10 years?
Paul, you're perfectly welcome. This is the first time in my UberNerdly life that anyone is actually interested in all the boring stuff I know, so I'm enjoying myself. As the late Saul Alinsky once quipped, don't worry, boys. We'll weather this storm of approval and come out as hated as ever.
First, the GSEs are not the buyer of last resort. Not even close. I wish I knew where this idea keeps coming from. I suspect it's the confusion of their massive accounting f*ckups and duration risks with the issue of the credit quality of their book of loans.
Fact is, the term "nontraditional mortgage" can be translated to mean "mortgages the GSEs won't buy." Oh, they buy a little bit of IO ARMs, at conservative LTVs and FICOs, and for moderate loan amounts. They take modest amounts of "stated income" on conservative loan terms from high-quality originators. They take some risks with their affordable housing programs (although less than you might think, since they get mortgage insurance on them and are not, therefore, usually in first loss position). But overall, Fannie and Freddie pools are good clean consistent prime-credit well-documented mostly fixed rate loans, and I for one happily have some GSE MBS pass-throughs in my retirement account. They are way, way, way less risky than corporate debt.
The housing bubble could not have sustained itself without investors, generally Wall Street, big-ass banks, and hedge funds, who wanted to push the envelope further than the GSEs either would or could (a lot of the GSE's credit practices are a matter of their charter; they can't just ignore that when they feel like it). Go back and read the article and see who is trying to put back these icky loans: Bear Stearns, Lehman. Not Fannie, Freddie.
The GSEs also don't do business directly with mortgage brokers. A financial institution or a mortgage banker with a warehouse line has to be the "wholesaler" who takes the loan from the broker. The wholesaler can then sell the loans to the GSEs, as long as they play by the GSE rules on third-party originations and so on. This means that the GSEs have a counterparty with some net worth to go after if things don't work out right. The wholesalers have, practically, do-squat to go after, because brokers don't have anything as respectable as net worth in most cases. The slimiest brokers do business with the wholesalers who are selling to Wall Street.
Everything's relative, but you can rest assured that what the GSEs buy is pretty close to your father's Oldsmobile. The "nontraditional" nightmare is a private sector phenomenon.
It seems to me that things like the home's true value, and hence LTV, or the borrower's true income, in the case of no-doc loans, are really only known by the appraisers and brokers, who both have a vested interest in fudging and keeping things moving. I don't see how someone living in Japan buying a bond backed by American mortgages can have any real chance of ascertaining the true risk.
No you have give-aways and rebates, aren't these distorting the LTVs?M Someone takes a $400,000 loan to buy a house they get appliances, upgrades included valued at $60,000. The house is really worth $50-60,000 less than they paid.
Now with prices falling, in Florida about 6% yoy, LTVs are way beyond merely suspect.
If you look at NAR's pending sales index, it fell 7% in July and generally has about a two month lag to existing sales. Existing sales for September could fall below 6milliion and inventory top 8 months.
I bet the stock market takes notice of that.
I guess I knew that the GSEs weren't (couldn't) buy non-traditional mortgages, but it must have slipped my mind. I guess in a more macro sense I was seeing a chain of events where the GSEs were providing so much liquidity to the traditional mortgage market, which increased demand, driving up property prices, and resulted in the dramatic increase we saw in the use of non-traditional mortgages. Now that I am saying it out loud, it seems a little far-fetched.
I guess my thesis is simply that the housing boom could not have happened if there were not also better qualified buyers participating and utilizing more plain-vanilla mortgages. I'd also supposed that this explained the very large share of the mortgage market that was occupied by non-traditional products in the last two years.
Bob, you're quite right about the LTV effect of sales concessions. That's why the GSEs have this rule that concessions and incentives over modest limits have to be subtracted dollar-for-dollar from the sales price; then LTV is calculated on the lesser of appraised value or sales price. The GSEs also require that the appraiser account for the effects of sales concessions on the appraisal report itself.
If the originators of these loans are selling them to the GSEs, then they're being charged a butt-ugly guarantee fee, which is only right. I am rather more inclined to think they're being sold to private investors with "nontraditional" guidelines for such things.
Paul, you're right that at some level the updraft-beneath-the-bubble is an issue of the enormous liquidity that the GSEs pump into the housing marketplace. It's just that if you define "bubble" as some level of deviation from "fundamentals," I see GSE liquidity as one of the fundamentals--one of the things that can get out of whack but that also performs the essential function of keeping local markets liquid and generally maintaining housing access at affordable levels--from which we deviated.
Here's something you might find interesting. Caveat Lector: the author is a Freddie Mac economist.
http://fic.wharton.upenn.edu/fic/papers/05/0535.pdf
Thanks for the link -- good stuff. I am feeling more like an ubernerd every day. One day I hope that you and CR will be handing me my nerd diploma...
This is a totally of-topic question, but why does the government want to encourage home ownership anyway? Because people build wealth that way? Because it prevents there being an over-class of owners? Because it keeps people from noticing the things that would otherwise have them rioting in the streets?
I'm inclined to think that having a so-called "ownership society" in housing is a public good in the sense that people should theoretically care more about their communities. (Although strictly speaking I don't know that this is true any more). But there must be some economic reasoning behind it, too?
Tanta,
Thanks for the link.
Maybe you can help me to answer another question I've not been able to find much info on.
Who is holding the first loss position on the exotic mortgages that get securitized? One piece I read said that the bank had to keep some first loss position. Then I read elsewhere that this too was securitized.
I tried looking at the SEC filings of Countrywide and Washington Mutual, but could find no mention. Though both seem to be carrying a lot of loans on their books.
Paul,
The originator doesn't 'have to' keep the first loss piece, but often does. I don't know how things work anymore, but back in the old days when people cared about things like incentives, due diligence, and other quaint concepts the thought was that keeping the first piece gave the originator the right incentives. If you expected a 2% loss rate (say, 6% of the loans go bad and you lose one-third on each loan) then by keeping the first 5% you told the buyer of the safer 95% that you would make a ton of money if losses were only 1% (an extra 1% on a piece only worth about 3%) and would lose your shirt if losses were really 4% (drop 2% on a piece only worth 3%). Thus the originator had an incentive to do careful underwriting even if 95% of the loans were to be sold.
Tanta - In my experience in prime and depository-originated subprime lending, early payment defaults were almost never over 1%, and were a signal of fraud if they were more than a couple of tenths of a percent. I noticed that all the lenders in the BusinessWeek piece were non-depository subprime lenders, except First Franklin (sort of, a non-depository that was bought by, and then rapidly sold by, a depository). And Option One has had early payment defaults of almost 10% for several years. What gives with that? Are these guys just pushing the envelope so deep into low FICO/high DTI territory that people can't even make 3 payments, or are they beset by fraud on a truly massive scale (or is there paperwork just screwed up, with first payments going to the wrong place all the time)? And does this say anything about non-depository subprime lenders taking on a lot more risk than depository subprime lenders?
Paul, the day you find yourself sitting in the car with the engine running in your driveway so that you can listen to the end of the builder incentive ad on the radio so that you can go in the house and enter it into the spreadsheet you've started keeping to track pricing concessions, you will have become an UberNerd. It's not a diploma, it's a diagnosis.
Bob, don't feel bad if you can't figure out an institution's exposure to residual credit risk on securitized nontraditional mortgages. During the hearing, Senator Reed asked the regulators how much the financial institutions hold (in whole loans on the balance sheet as well as off-balance sheet securities) and the answer was basically "we don't know, we think lots, we're working on finding out." Christ, if the OCC can't find this information, mortals like we aren't going to find it.
I am told by those who are in a position to know that issuers are increasingly selling off the subordinate tranches because the hedge funds and other high-rollers have made a market for unrated toxicity. That's either the good news or the bad news. As mort_fin notes, selling it off removes an incentive (thus increases risk to the holders of the senior pieces). On the other hand, holding it increases the exposure to institutions which are ultimately insured by us folks. God only knows what's in the banks' trading accounts for the purpose of hedging the risk they already have. I also have this problem wondering how many banks are writing loans or letters of credit to hedge funds, which hedge funds use to take the residuals off the banks' hands . . . "net risk washout" or "recipe for systemic implosion"? You be the judge.
mort_fin, if these EPDs are non-fraudulent delinquencies, I'd bet the farm that they're speculator loans. I also sincerely doubt we have payment credit/transfer of servicing problems here--nothing motivates a lender to find and forward a misapplied payment like the prospect of buying the loan back. I think you're seeing "straw buyer" flips and equity skimming scams crawling out from under the woodwork. Option One has 10%??? Can that be right? That's a death sentence.
Tanta, mort_fin, et al. (but especially Tanta!)
You folks are so great for contributing so much in the last few weeks, I really must add my appreciation.
Tanta, you have resolved some of my (mis)understandings, and I am glad that you have still have faith in FNM bonds, but I still have lingering concerns if there is a significant reduction in house prices. Since FNM can now buy $450,000+ loans as of last winter, I would assume that a 20% decrease in prices will cause LTV's of some previously-acceptable loans to fall outside of the agency requirements.
Do you see any significant risks in a price decrease of that magnitude (20%) on agency bonds? If not, what percent pullback would start causing you to worry? Even if there is no huge concern about foreclosure problems for Fannie and Freddie, wouldn't the bonds likely get downgraded?
[I love that you guys are always going over my head, as that inspires me to stretch my neck. Having said that, I could really use a massage about now.]
immobilienblasen: update conference call h&r block / hrb
slide 9 shows early payment defaults for option one. thanks to jan-martin federsen on Ben's blog for pointing this out.
One more thing, Tanta, you wrote I also have this problem wondering how many banks are writing loans or letters of credit to hedge funds, which hedge funds use to take the residuals off the banks' hands . . . "net risk washout" or "recipe for systemic implosion"?
Isn't that what they learned how to do from the LTCM 'bailout'? If it could work once...?
dotcommie
A drop of 20% would not "cause LTV's ... to fall outside of agency requirements" exactly. The only "requirement" is that a senior lien LTV over 80% WHEN ORIGINATED must have a credit enhancement (usually mortgage insurance). Their credit standards prevent them from buying much in the way of high LTV loans, but there's nothing that would require a forced sale or anything of that nature if prices fall and current LTVs rise.
A 20% drop in the nationwide average price might not hurt very much, if most of it is concentrated in high price areas - San Diego, Boston, NYC - because the conforming loan limit means they don't buy that much in those areas anyway. It would hurt more if it was spread out evenly. Even spread out evenly, it wouldn't kill them (maybe the rating agencies would downgrade, almost certainly a watch).
They are usually more exposed to interest rate risk than to credit risk. If house prices were dropping while inflation was rampaging, and everyone expected the Fed to zig and they actually zag, so that they get hit with a big interest rate shock at the same time that they are hit with a wave of foreclosures - now that would be kind of scary.
Thanks, mort_fin, so they would just have to insure those that break the level, gotcha.
I am presently in the 20% decline everywhere camp, with 30-40% on the coasts, so I am trying to figure out what the those dire scenarios might produce.
I will definitely need to stretch more to better grasp the interest rate hedging the agencies use. Again, your input is much appreciated.
is it possible that MBS buyers and the whole process actually account for mis-rep's in the product they are buying?
for example,
credit card companies no longer require signatures for certain purchases! can you believe that?? i was shocked at first but now its starting to happen more often - starbucks fresh fields chipotle etc...(can you tell i'm a yuppie).
so my point is that the credit card companies know that some people are going to have their cards stolen and there will be charges that get made that will have to be reversed. and in not requiring signatures, the probability of that happening increases. but they can do this b/c of the laws of large numbers...
any chance of this level of sophistication and awareness in the MBS market?
credit card debt is securitized and sold too..
Tanta,
Thank you for taking the time to answer my questions. It all kind of buttresses Nouriel Roubini's scenario for the coming few years. And it make me feel a little more comfortable with my relatively large portfolio of puts.
mort_fin, thanks for the link. Nice of you to warn me that I should have paid more attention in German 101 30 years ago. "Rückkäufe total überraschend"--yes, it sounds even more ludicrous in German. However, reading this wasn't a total loss, as it were. I have now decided that the opposite of an UberNerd (who obsessively wrings hands over credit quality) is a BasisPunk (who believes all problems will be solved by the Law of Large Numbers).
Which brings me to dc1000. The answer to your question is, sure. It cuts both ways. In my lending days I was, actually, mostly a BasisPunk (secondary marketing/loan sales department, not credit underwriting) and I can remember going ballistic over some anal little-picture underwriter who didn't want to approve a 68% LTV no-cash-out refi for a longtime homeowner with a perfect mortgage payment history because the borrower had a $1000 medical collection. "JEEE SUS H CHRIST! You people want me to lose fifteen ticks on this loan because it has a medical collection??? You ninnies, the only people who don't have medical collections are the ones who are terribly sick but don't know it yet!! AAAAAAHHHHH!" (BasisPunks are famous for impromptu interoffice fit-throwing.)
On the other hand, there are things like gel pens that just drive me crazy in perfect UberNerdly fashion. In the old days, nobody ever let a borrower get close to a stack of loan documents without a blue ballpoint in their hands. If they had a black pen, especially a felt tip, you took it away from them. These days, title companies seem to take a perverse pleasure in encouraging people to sign shit with those black gel pens which make the original documents utterly indistinguishable from copies. You get used to reading copies rather than originals and faxes rather than copies, you stop being able to catch even elementary types of fraud.
Why do I have so many copies and faxes? Well, because everybody offers the same products and rates that everybody else does since we all sell to the same MBS market, we ran out of places to cut origination fees, and so now we have to compete on speed. As in, I can blow past the details on your loan documents faster than that other lender. If I build up enough volume, the Law of Large Numbers will offsest the risks I take by abandoning incrementally expensive preventative measures. Then all of a sudden I find myself in third lien position on a $650,000 loan because we were kinda rushed at closing and didn't get a title endorsement over a couple of pesky little mechanics liens. This can probably be fixed, but it will cost all the fees I charged on an entire week's production and by the time I'm done the market will have moved half a point. I guess I'll have to lay off another Quality Control Analyst. And so it goes . . .
Bob, may the Force be with your portfolio. All this reminds me of a little toast from back in the days when the best thing that happened at work was getting in first thing in the morning and finding out that the RTC wasn't there yet:
Loans may come and loans may go
And forward trades go south, you know,
So we'll buy puts through thick and thin
Money out and money in.
Then you put your head in the pitcher.
I'm afraid there is going to be much more of this.
I actually have a client that has irrefutable evidence that loan fraud was perpetrated against him the mortgage officer who wrote a first and second on NINE homes for him in Las Vegas. Bear Stearns/EMC won't so much as speak to him about any loss mitigation, etc. I suspect Bear Stearns/EMC of not wanting to buy back those loans because they knew that many of them were 'kinky' to begin with, got smug thinking they had so much paper to offer/sell that no one would dare actually ask them to do so. You can't imagine on the default list that comes out 5 days a week here in Las Vegas how many defaults I see each day that were just funded in the last 120-160 days. Many look as if there was only one payment ever made... What a coincidence. Isn't the first mortgage payment due about 45 days after the closing? So, actually; these are first payment defaults. How can Bear Stearns/EMC sell that paper off, and then claim no responsibility? Many of the fraudulent loan activities I've seen were perpetrated by the same loan officers, and hung with EMC..