Category: Housing Crash

Real Estate Update

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existing household real estate assets declined $67 Billion in the 3rd quarter. That’s about $200 for every man, woman, and child in the US.

You can see this in declining home equity percentages over time (there are more graphs at the link):

While we’re at it, Morgan Stanley analysts are saying that home prices could be falling for at least the next three years.

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The property derivatives market seems to be suggesting that we are in a very different environment, on the heels of market events that could force a housing recession like none ever imagined or experienced,” Morgan Stanley analysts said.

“The fundamental argument for going long housing is that history has never seen such extended periods of house price declines,” Morgan Stanley said. “We think that such arguments have limited credibility because of limited periods of data and over-reliance on analysis using national level data.”

While home price declines for three years or longer have not occurred in recent years on a national level, regional data demonstrates that unusual price increases often lead to sustained corrections, the report said.

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And then we have Standard and Poors sayint that the mortgage relief program might cause downgrades on some of the related bonds.

Honestly though, I don’t see how the action will make things much worse:

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The share of all home loans with payments more than 30 days late, including prime and fixed-rate loans, rose to a seasonally adjusted 5.59 percent, the highest since 1986, according to a report today from the Washington-based bankers trade group. New foreclosures hit an all-time high for the second consecutive quarter in a survey that goes back to 1972.

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Steven Pearlstein Explains the Credit Crunch

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He does not get into the why this crunch has happened, short form is that you had regulators who allowed investment banks to use fairy dust and call it innovation, but its a very good picture regarding what forces are in motion now, and where they are likely to lead.

His OP/Ed is aptly titled It’s Not 1929, but It’s the Biggest Mess Since:

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The financial giants that originated, packaged, rated and insured all those subprime mortgages were the same ones, run by the same executives, with the same fee incentives, using the same financial technologies and risk-management systems, who originated, packaged, rated and insured home-equity loans, commercial real estate loans, credit card loans and loans to finance corporate buyouts.

It is highly unlikely that these organizations did a significantly better job with those other lines of business than they did with mortgages. But the extent of those misjudgments will be revealed only once the economy has slowed, as it surely will.

At the center of this still-unfolding disaster is the Collateralized Debt Obligation, or CDO. CDOs are not new — they were at the center of a boom and bust in manufacturing housing loans in the early 2000s. But in the past several years, the CDO market has exploded, fueling not only a mortgage boom but expansion of all manner of credit. By one estimate, the face value of outstanding CDOs is nearly $2 trillion.

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Those are scary numbers, but he goes on to explain why we are in trouble:

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In the simple version, each investor owned a small percentage of the entire package and got the same yield as all the other investors. Then someone figured out that you could do a bigger business by selling them off in tranches corresponding to different levels of credit risk. Under this arrangement, if any of the mortgages in the pool defaulted, the riskiest tranche would absorb all the losses until its entire investment was wiped out, followed by the next riskiest and the next.

With these tranches, mortgage debt could be divided among classes of investors. The riskiest tranches — those with the lowest credit ratings — were sold to hedge funds and junk bond funds whose investors wanted the higher yields that went with the higher risk. The safest ones, offering lower yields and Treasury-like AAA ratings, were snapped up by risk-averse pension funds and money market funds. The least sought-after tranches were those in the middle, the “mezzanine” tranches, which offered middling yields for supposedly moderate risks.

Stick with me now, because this is where it gets interesting. For it is at this point that the banks got the bright idea of buying up a bunch of mezzanine tranches from various pools. Then, using fancy computer models, they convinced themselves and the rating agencies that by repeating the same “tranching” process, they could use these mezzanine-rated assets to create a new set of securities — some of them junk, some mezzanine, but the bulk of them with the AAA ratings more investors desired.

It was a marvelous piece of financial alchemy, one that made Wall Street banks and the ratings agencies billions of dollars in fees. And because so much borrowed money was used — in buying the original mortgages, buying the tranches for the CDOs and then in buying the tranches of the CDOs — the whole thing was so highly leveraged that the returns, at least on paper, were very attractive. No wonder they were snatched up by British hedge funds, German savings banks, oil-rich Norwegian villages and Florida pension funds.

What we know now, of course, is that the investment banks and ratings agencies underestimated the risk that mortgage defaults would rise so dramatically that even AAA investments could lose their value.

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As part of the unwinding process, the rating agencies are in the midst of a massive and embarrassing downgrading process that will force many banks, pension funds and money market funds to sell their CDO holdings into a market so bereft of buyers that, in one recent transaction, a desperate E-Trade was able to get only 27 cents on the dollar for its highly rated portfolio.

Meanwhile, banks that are forced to hold on to their CDO assets will be required to set aside much more of their own capital as a financial cushion. That will sharply reduce the money they have available for making new loans.

And it doesn’t stop there. CDO losses now threaten the AAA ratings of a number of insurance companies that bought CDO paper or insured against CDO losses. And because some of those insurers also have provided insurance to investors in tax-exempt bonds, states and municipalities have decided to pull back on new bond offerings because investors have become skittish.

If all this sounds like a financial house of cards, that’s because it is. And it is about to come crashing down, with serious consequences not only for banks and investors but for the economy as a whole.

That’s not just my opinion. It’s why banks are husbanding their cash and why the outstanding stock of bank loans and commercial paper is shrinking dramatically.

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This may not be 1929. But it’s a good bet that it’s way more serious than the junk bond crisis of 1987, the S&L crisis of 1990 or the bursting of the tech bubble in 2001.

What’s the Deal With the So-Called Mortgage Bailout

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To paraphrase Atrios:

To qualify:

  • have an income and live in their homes
  • are currently making their payments on time
  • would default if their interest went up
  • ARM mortgage has to have been taken between 1/05 and 7/7
  • Has a rate reset between 1/8-1/10

The following rules you out:

  • have missed payment
  • can afford mortgage rate increase
  • don’t have an income
  • own homes which are worth less than their mortgage

So, if you are poor, you are more likely to have missed a payment, and more likely not to have put anything down, and so be under water. As Duncan Black puts it:

I became increasingly skeptical that such a broad-based bailout would be workable for various reasons, but as is usually the case with anything the Bush administration gets involved in, they aren’t even really trying.

As Kevin Drum puts it:

The lower your income, the more likely you are to have missed a payment already, and the lower your income the more likely you are to have been sold a no-down loan that’s already left you underwater due to falling housing prices. Net result: no help for low-income folks.

Like Atrios, I’ve become increasingly unsure that any kind of broad-based bailout plan can work — or work well, in any case — but if you’re going to do it everyone ought to have a shot at getting help. Bush’s plan, conversely, pretty transparently doesn’t care about anyone with a modest income. Not part of his base, I guess.

My assesment is less charitable. He does not want to do anything but score political points.

Banks That Purchase Loans May Be Liable for Original Lender Misdeeds

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When I originally came across this story, it was just a glitch in foreclosures. Cleveland federal judge Christopher Boyko tossed 14 foreclosures without prejudice, because the plaintiffs could not show that they owned the loans.

Basically, the title on the loans was never changed, they just put it in the transfer contract.

I figured, this isn’t a big deal…It just means that before foreclosing, the banks have to do some paperwork, so amidst a sea of financial ice-bergs, this is a spring rain.

Well, once again, I am wrong.

It appears that the methods used to pool loans into CDOs and similar instruments may also mean that the organizations holding the CDOs are legally liable for any unethical or illegal tactics used whenever the loans were first made.

The problem stems from a shortcut that many players in the fast-moving securitization business have used in recent years. Normally, when a loan is sold, a simple document is prepared showing that the debt and any collateral attached to it has been transferred to the purchaser. That piece of paper is called an assignment. But in buying up thousands of mortgages at a time, Wall Street commonly skips this step, which requires separate paperwork for each loan. Instead, the industry customarily relies on a lengthy contract, known as a pooling-and-servicing agreement (PSA) to spell out arrangements for all of the loans in a pool. But, as some recent court rulings indicate, a PSA may not be good enough when it comes time to foreclose.

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There also could be a more troubling consequence for investors, says Kathleen C. Engel, a professor at Cleveland-Marshall College of Law. Players in the secondary market for mortgages rely on an obscure but critical legal theory–known as the “holder in due course” doctrine–to insulate themselves from problems with the underlying loans.

Under the doctrine, a homeowner who believes that a lender deceived him about the terms of a loan can’t press such claims against the purchaser of a mortgage, such as a mortgage-backed securities trust. The holder-in-due-course doctrine protects pension funds and the like from having to worry about any misbehavior by home lenders–and thereby greases the wheels for the whole mortgage-securities market. But it’s a different story if, as appears to be common practice, the trust waits to complete paperwork transferring a loan until after it goes into default. In that case, the holder-in-due-course protection evaporates, and anybody who tries to foreclose could face defenses from the borrower that he or she was lied to when seeking a loan.

Ouch!

Some People in the Subprime Loan Trap Qualified for Better Loans

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This is what an unregulated lending market gets you, people with good credit steered toward sub prime loans because the lenders made more money that way.

According to the WSJ article, 55% of all sub prime loan borrowers were qualified for prime loans.

The brokers make big bucks over this.

This is a legacy of Republithug philosophy….The idea that, unfettered by regulation, sophisticated players will be honest.

Whiskey Tango Foxtrot????! Florida SHORT TERM Funds Parked in CDOs and Other Shaky Investments???

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We are talking accounts used for day to day expenses and salaries, and when it was discovered that. “after learning that the money- market fund contained more than $700 million of defaulted debt”, there was a run on the fund, with over 35%, over $10 Billion of the $28 Billion in the fund, of its assets being withdrawn.

As a result, they have suspended withdrawals from the fund, which may leave some governments unable to pay their employees this week. (See also here.)

It’s gets better:

Stipanovich raised the possibility of having the state pension fund shoulder the risk of some of the troubled securities with a credit-default swap, through which the retirement fund would guarantee the debt in exchange for an insurance premium.

“It will be a wonderful diversifier,” Stipanovich said.

Sink immediately rejected the executive director’s plan.

A “Wonderful Diversifier”???? Talk about throwing good money after bad.

A brief list of bad investments:

  • $168 million of debt from KKR Atlantic Funding Trust cut to D, or default, from B by Fitch Ratings on Oct. 8
  • $356 million issued by KKR Pacific Funding Trust, cut to D from B by Fitch Ratings on Oct. 2
  • $180 million of paper from Ottimo Funding, cut to D from C by S&P on Nov. 9. S&P said an auction of Ottimo’s collateral “did not generate cash proceeds” to repay the asset-backed commercial paper.
  • $175 million of short-term debt issued by Axon Financial Funding, an SIV. It was cut to D from C by S&P when Axon failed to pay liabilities maturing Nov. 26, causing an “automatic liquidation event.”
  • $650 million of certificates of deposit from Countrywide Bank FSB, a unit of Countrywide Financial Corp., that now amounts to more than 3 percent of the pool’s assets. The bank’s rating was cut to Baa1, three levels above junk, by Moody’s on Aug. 16.

In a MONEY MARKET FUND? I’d sooner have Sweeny Todd give me a shave than trust Florida’s financial judgement.

Today’s Real Estate Update

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HUD is starting to dump foreclosed homes, teachers, police officers and firefighters in Charlotte, NC can get homes for fifty cents on the dollar, Third-quarter home prices dropped 1.7% from the second quarter as measured by the Case-Shiller index, and houme values are expected to drop $1.2 TRILLION next year, with a drop of $6.6 billion in property taxes.

So a federal agency is marking down homes that they can’t get rid of 50%, house prices are dropping at an annualized rate of about 7% a year, and property tax revenues are falling through the floor, and what is likely a 5+ year decline is only about 14 month along.

Arabs Bail Out Citigroup…AGAIN!!!!

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In 2001, Saudi Prince Alwaleed bin Talal rescued Citigroup, and this time, it’s the Abu Dhabi Investment Authority.

BTW, look at the terms:

  • They get a 4.9% stake.
  • In exchange for its investment, ADIA will receive convertible stock in Citigroup yielding 11% annually. (They are making the loan at 11%, when junk bonds get 9%, WTF????)
  • The shares are “required to be converted into common stock at a conversion price of between $31.83 and $37.24 a share over a period of time between March 2010 and September 2011.” (It’s currently trading at $29.75, the lowest since 2002, so this means that the conversion essentially means that they are very nearly paying for this investment)
  • This gives them a bigger stake in the firm than Saudi Prince Alwaleed bin Talal. (remember him?)

If this company isn’t functionally insolvent, then its management needs to go to be fired, and criminally investigated, because the only way a non-insolvent company takes a deal this bad is if someone is breaking the law.

Investors have increasingly expressed concerns about Citigroup’s “tier 1” capital levels — a common measure of a bank’s capital adequacy — which for the first time in years fell below its 7.5% target in the third quarter. Although the bank is still considered to be well capitalized, investors worried that Citigroup would be forced to cut its dividend.

H/T The Big Picture.

Congress Reviewing Bill to Allow Bankruptcy Judges Review Terms of Mortgage Loans

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Brad Miller (D-NC) and Linda Sanchez (D-Ca) have proposed legislation in the house, and there appears to be a push for this in the Senate.

It is anticipated that this could reduce foreclosures by 2 million.

One of the wierd things that I discovered in reading this is that, Judges already have this power for “Vacation homes, farms and investment properties.”

But not for principal homes…Weird.

If this passes, it may save the mortgage industry from itself.

Renters Look to Congress for Forclosure Relief

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Something that I hadn’t thought about before, but when a property is foreclosed on, renters are frequently evicted. As a result, renter protection was included in the House mortgage reform act, and Chris Dodd has proposed the same in the Senate.

Generally the protections come in the form of requiring purchasers continue leases of for 6 months following foreclosure.

Considering that about more than 10% of all foreclosures are non-owner occupied, and as the Times notes, “This figure probably underestimates the problem, according to the association, because buildings receive tax benefits if they are registered as owner-occupied”, we could see well in excess of 100,000 tenant evictions.

Bank of America Purchases $2 Billion in Preferred Countrywide Stock

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This is a bailout. Bank of America will purchase $2 billion worth of preferred Countrywide stock yielding 7.3%, and that can be converted into common stock at $18 per share. It should be noted that Countrywide is currently selling at $26.19, up 20% from before the infusion purchase.

This is a juxtaposition of desperation on the part of Countrywide and vulture opportunism on the part of BoA.

Honestly, I think that they will end up losing money on this.

So Cal Home Prices Drop 20 2005 Levels

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Additionally, home sales are at a 20 year low. Of interest is the reports of some “bargain hunters” returning to the market.

When one looks at crashes, whether real-estate, or other assets, I think that this qualifies as a whistling in the dark.

We’ll have some more of that, and at least one dead cat bounce* before this is over.

*It refers to a short term spike in values during a bear market. It comes from the expression that “even a dead cat will bounce if it falls from a great height”.

The Myth of Home Ownership and Plunging African American Home Ownership Rates

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In 1994, Black home ownership was at 42.3%. In 2004, it was 49.7%. It has now dropped to 46.7%.

The rise in home ownership rates was really pretty meteoric, and the drop is even steeper.

Dean Baker makes the point, which I agree with, that the idea that increased home ownership is a good in and of itself is a bad policy with significant negative consequences, or as he so eloquently puts it, “In other words, the big push to increase African American homeownership rates was in reality a big push to increase foreclosure rates among African American households, but the ideologues of homeownership were too blind to notice the impact of their policies.”

Home ownership provides benefits, like the creation of equity, but it also adds significant risks to the equation. When something major breaks, roof, hvac, plumbing, the home owner can face SIGNIFICANT unanticipated expenses, and the downsides of foreclosure are worse than those of eviction.

This policy was a centerpiece of the conservative “Ownership Society”, and it is having disastrous consequences, and it appears that these consequences will become more dire for the foreseeable future.

Fannie Mae Changing Accounting Practices to Conceal Losses

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Fannie Mae has changed the way it computes credit loss ratio, a measure of the quality of its loans.

Bigger numbers are bad, and under the new scheme, the number is 4 basis points, but under the old scheme, it would have been 7½ basis points.

I believe that Fannie is the 2nd biggest issuer of debt in the world, and the fact that the quality of their loan portfolio is almost twice as bad as their numbers suggest is scary.