BofA

It won't surprise (m)any of you, but I hate the B of A deal with Countrywide. First of all, I don't think it was much of a bargain. Sure, they paid $4 billion for a bank with a book value of $12 billion but, really, who can be sure what the true book value of this pig is?

Second, why buy it now? If they were really interested in the business, why not wait until Countrywide files Chapter 11? It would have delayed the transaction by what, a week? Two?

Third, I understand that Countrywide owns something like 1 in 5 mortgages in the US, and B of A is not (was not) a major mortgage player. I also understand that B of A is anticipating having that portfolio once the housing market turns around. What I fear (for them) is that by the time the market turns, they may still be a smaller player in the mortgage market, but a huge landlord.

Many are pointing to this deal as evidence that the market works, that companies are able to find their own fixes and government need not "interfere with the market". The cynic in me believes that Ken Lewis had a long and fruitful discussion with both Hank Paulson and Ben Bernake before agreeing to take the plunge here. Let's see what happens once the write downs begin in earnest.

I guess the one upside of all of this is for B of A retail banking customers - they will probably enjoy some seriously good rates on deposits as B of A ramps up the funding mechanisms to feed the Countrywide pig.

Thoughts?

Rate freeze

Well, it doesn't really look like anyone has a really solid understanding of what's going to happen. On a quick read around, I think that the actual number of people that will be eligible and participate in this program is far lower than the 1-1.5 million I keep seeing quoted.

I don't think that this is really going to do all that much for the economy or the housing crisis - at best it avoids some foreclosures (which is a good thing). At worst, it's lots of activity with little impact.

Mortgage Workout

Still trying to work through it, I'll have something tomorrow. Right now I'm trying to figure out who is left holding the bag, and it seems like it may be the bondholders. I can't see how that happens though. More tomorrow.

Housing and the Economy - Chapter 35

In which Jim links to Nouriel Roubini who solidifies Jim's current biases:

In this regard, evidence is mounting that a debt-burdened and saving-less US consumer – that until recently used its home as an ATM and borrowed against its housing wealth - is now on the ropes and at its tipping point.

Roubini's post is long, but worthwhile to read in its entirety.

Housing

Good stuff here. Still much more to come in the housing correction.

Larry Yun, COME ON DOWN!

You're hacktacular!

Lawrence Yun, NAR senior economist, notes that widening credit availability will help turn around home sales. “Conforming loans are abundantly available at historically favorable mortgage rates. Pricing has steadily improved on jumbo mortgages since the August credit crunch, and FHA loans are replacing subprime mortgages,” he said.

And a surge of troops will help people who hate each other work together, and cutting taxes always increases revenues, yadda, yadda, yadda. YOU'VE GOT TO BELIEVE, PEOPLE!

A little perspective:

Data released over the past few weeks suggest a further weakening of the housing market, exacerbated by the breakdown in the subprime and prime jumbo mortgage markets. Delinquencies among subprime loans are increasing by more than expected, home sales continue to fall, unsold inventories remain near all-time highs, national house prices are falling, and housing starts have dropped to the lowest levels recorded since 1995. Amid these disruptions in the mortgage and housing market, lenders reported a lack of investor demand for high credit quality jumbo mortgages and other mortgages not eligible for agency purchase. This dislocation pushed the cost of prime jumbo financing significantly higher relative to rates on conforming loans... This spread has moderated somewhat over the past couple of weeks, however, and fell below 80 basis points in late September, suggesting some modest improvement in the market conditions for prime loans with balances above the conforming loan limit. Even so, the spread remains historically wide -- suggesting that the prime jumbo market remains in distress.

Yun is living in his own world if he thinks that (1) housing has bottomed (2) 2008 is going to be any better.

Look out!

August jobs data:

Investors were unpleasantly surprised by the Labor Department's report that payrolls fell by 4,000 in August, the first decline since August 2003, while the unemployment rate held steady at 4.6 percent as expected.

June and July were also revised downward. Without the ability to extract wealth from their houses, people cannot fund lifestyles that are built upon a negative savings rate. Credit at all levels is evaporating.

At some point corporate profits will have to suffer because at some point people will have to stop buying things. I'd predicted a Q3 '07 recession and I'm becoming more convinced that will be a correct statement.

NAR, it's hacktacular!

Guess who's won More Palaver's "Hack of the Day" award for the second time? Yes, it's Lawrence Yun! Congratulations Mr. Yun for being the first multiple (and so far only) winner of this prestigious award! Here is a link to the first win for Mr. Yun. Here is why he is winning again today:

The National Association of Realtors' index for pending sales of existing homes decreased at a seasonally adjusted annual rate of 12.2% to 89.9 in July from June's 102.4, the industry group said Wednesday.

[...]

"These temporary problems are primarily with jumbo loans, and there are continuing issues for subprime borrowers, but there are no serious problems for the majority of buyers who qualify for conventional financing or FHA-insured loans," Mr. Yun said. "Some consumer concerns remain, but since mid-August the market has been stabilizing somewhat.

"[S]tabilizing somewhat"?!!! "Some consumer concerns remain"?!! He increasingly looks like the ROTC cadet standing in the middle of the street at the end of Animal House. Sorry, but everything is not going to be OK.

More housing

Same article as a prior post.


For those of you without subscriptions to the WSJ, the article profiles a family, the Montes, who bought a house 2 years ago in Fullerton, California. Their credit wasn't that good, and they had a combined income of $90,000/year. They decided they should go and buy a $567,000 house with no money down and a 2/28 interest-only mortgage.


They are going to lose their house. It doesn't say so explicitly in the article, but there is no way they'll be able to keep it. The current payment on the house is $3,200/month in interest, which will reset in December for the remaining 28 years on the note. They estimate that their monthly payments may rise to $4,200/month. That's just the note. On top of that they have taxes, insurance and $700/month in car loans. The article doesn't mention credit card debt, but I'm going to assume that the Montes are like every other American family out there and throw in some of that too. Figure $200/month in credit card debt. That's over $5,000 in debt servicing, a ratio of 66%.


Let me say that again, 2/3 of their GROSS income will go to servicing debt.


They are going to lose their house.


This is where this whole housing mess gets very complicated for me. Clearly, the Montes bought a house that they couldn't afford and have, for the past two years, been living in a house that they shouldn't be living in. I'd usually be inclined to write them off - hey sometimes bad decisions have consequences. But I waver when I read things like this:

Like many people who jumped into the rising housing market in recent years, they had little money for a down payment and chose a loan that would hold their monthly payments down for the first two years, then "reset" to a much higher level. Mr. and Mrs. Montes say their mortgage broker assured them they would be able to refinance in a couple of years to keep their payments affordable.

And this:

The Montes family got their loan through a mortgage broker in Rancho Cucamonga. Using what was then a common formula, the broker offered to arrange for two loans, one to cover about 80% of the home price and the other, a so-called piggyback loan, for the rest. For the first two years, their total monthly mortgage payments are about $3,200. The loans are initially interest-only. Mr. Montes recalls feeling edgy about whether he would be able to afford the higher costs -- about $900 more per month -- due to take effect after two years. But he says the broker assured him he could refinance before those costs kicked in.

paired with this:

Worse for the Monteses, they learned that they faced a $12,000 prepayment penalty if they refinanced within three years of the original mortgages -- something that Mr. Montes says wasn't made clear to him when he took out those loans.

Housing is one place where I really struggle balancing the free market with paternalism. At a minimum, mortgage brokers should have a fiduciary responsibility to the people they arrange mortgages for. I think there are a huge number of people who got talked into something - namely a house they couldn't afford - that they wanted very badly. They got talked into it by a series of people who likely won't get badly hurt if the deal goes bad - the dealmakers will still have a home to live in at least. It just doesn't really seem all that fair to me.

Some interesting housing stats

From today's WSJ:

Being stuck with little or no home equity is no longer a rare situation. Christopher Cagan, director of research at First American CoreLogic, a housing and mortgage data supplier in Santa Ana, recently found that nearly 7% of 32 million U.S. households studied as of December owed more than their homes were worth, based on computer estimates of the property values. An additional 4% had home equity of 5% or less. Since then, house prices have edged down in much of the country, erasing more home equity.

[...]

Partly as a result, foreclosures are surging. Moody's Economy.com, a research firm in West Chester, Pa., projects that lenders will acquire about 760,000 homes through foreclosure this year and 935,000 in 2008, up from an average of about 440,000 a year from 2000 through 2006.

Housing

Much more coming from me on this over the next few posts, but for now, I'd like to you join the NAR in clapping louder:

The National Association of Realtors again lowered its forecast for existing U.S. home sales in 2007, but said the market wasn't likely to suffer any further sharp downturns.

[...]

Lawrence Yun, NAR's senior economist, said the market was likely to be relatively stable going forward, suggesting that the worst drops in activity are behind the housing sector. "Existing-home sales should be relatively stable over the next few months, holding in a modest range, with some pent-up demand growing from buyers who've been on the sidelines," Mr. Yun said in a statement. Mr. Yun continued to forecast a relatively mild upturn in housing activity towards the end of this year and going into 2008. "A modest upturn is projected for existing-home sales toward the end of the year, with broader improvement to include the new-home market by the middle of 2008," he said.

I've got one question for Mr. Yun: where are these people going to get the financing? I can't see mobs of people storming into the real estate market right now. Or any time soon. Mr. Yun, you earn More Palaver's "Hack of the Day" award for Thursday, August 10. Congratulations!

Housing Ugliness Continues

This is really ugly:

American Home Mortgage Investment Corp. shares plunged 90 percent after the lender said it doesn't have cash to fund new loans, stranding thousands of home buyers and putting the company on the brink of failure. Investment banks cut off credit lines, leaving American Home without money yesterday for $300 million of mortgages it had already promised, the Melville, New York-based company said in a statement today. It anticipates that $450 million to $500 million of loans probably won't get funded today, and the lender may have to sell off its assets.

Having recently purchased a home, one of the biggest fears I had in the closing days before the closing was that my lender would somehow go belly-up. I can't imagine being in the position of some of these buyers.

At a median home price of about $225K, that's 2,000 home deals falling through due to lack of funding. It's unclear from the article, but that could just be TODAY'S American Home Mortgage fundings. Things are (sadly) getting more ugly every day.

Ha-ha-ha-ha-ha

Oh, it makes my stomach hurt:

Only a low credit score stood between Alipio Estruch and a mortgage to buy a $449,000 Spanish-style house in Weston, Fla., a few miles west of Fort Lauderdale... Instantcreditbuilders.com, or ICB, helped Estruch boost his score by arranging for him to be added as an authorized user on several credit cards of people with stellar credit who were paid to allow this coattailing. Parents also use this practice when they add their children to their credit cards to help them build solid credit. The pitch to those who are essentially renting their credit history for pay is seductive: You don't need to worry about users of this service receiving duplicate copies of your credit cards, account numbers or any of your personal information. It's essentially free money, they are told. Brian Kinney, 44, a retired Army officer in Glendale, Calif., pulls in more than $2,500 a month by lending out 19 credit card spots on two old Citibank cards with strong payment histories. Kinney, whose FICO score is above 800 on the scale of 300 to 850, quit his job working at a Farmers Insurance agency and uses the ICB income to tide him over until he starts his own insurance agency. Lenders are worried, however, that they're taking on greater default risks by unknowingly offering lower interest rates than they otherwise would to applicants who artificially boost their credit scores. Their trade group has complained to the Federal Trade Commission and is talking with the credit reporting bureaus in case the practice becomes more widespread. Estruch paid $1,800 in December for three credit card spots, and by January, his FICO score jumped from 550 to 715. In mid-March, he closed on his four-bedroom beige stucco house after obtaining a 30-year fixed-rate mortgage from a unit of American Home Mortgage Investment Corp. It carried a 7.5 percent interest rate and required no down payment.

And the punch line?:

"Everything now is score driven. I had a great mortgage history, but I got hurt because of my credit score," said Estruch, who also works as a mortgage broker, had bought and sold two houses previously, and currently owns another home in New York. Estruch said he's current on his mortgage payments.

HE'S A MORTGAGE BROKER!!!

So the mortgage industry is up in arms (pardon the pun) because they are issuing NINJA loans based on FICO scores and there may be people out there manipulating FICO scores? My heart bleeds for them.

Here's a question that I'll answer in a future post: Do mortgage brokers have a fiduciary responsibility to their clients? That is, when a mortgage broker is helping you find the financing for your house, whose needs are primary?

Housing now on the front pages

Two articles, one in the Washington Post the other in the Wall Street Journal, tell two sides of the same dismal story. WSJ first:

Her neighbors are losing interest in their lawns because they're losing their homes -- a result of the recent boom in "subprime" mortgage lending. Over the past several years, seven of the 26 households on the 5100 block have taken out subprime loans, typically aimed at folks with poor or patchy credit.

[...]

If events unfold as some predict, subprime lending could end up eliminating more homeowners than it created. One study by the Center for Responsible Lending, a nonprofit that focuses on abusive lending practices, forecasts that the subprime boom will result in a total of 2.4 million foreclosures nationwide, most of them on homes people owned before taking out the loans. That outweighs even the most optimistic estimates of the number of homeowners created, which don't exceed two million. (Emphasis mine)

Here is the first key quote:

"Individuals will resist reductions in their standard of living with everything in their power, including mortgaging their futures."

and how it manifests itself:

April Williams was feeling the pain of the downturn back in 2002, when she saw an ad from subprime lender World Wide Financial Services Inc. offering cash to solve her financial problems. At the time, production slowdowns at Ford Motor Co. were squeezing her husband's income from an assembly-line job, and they'd heard rumors that more cutbacks were coming. Still, after a loan officer from World Wide paid a visit, they became convinced they could afford stainless-steel appliances, custom tile, a new bay window, and central air-conditioning -- and a $195,500 loan to retire their old mortgage and pay for the improvements. The loan carried an interest rate of 9.75% for the first two years, then a "margin" of 9.125 percentage points over the benchmark short-term rate at which banks lend money to each other -- known as the London interbank offered rate, or Libor. The average subprime loan charges a margin of about 6.5% over six-month Libor, which as of Tuesday stood at 5.38%.

And the second key quote:

"You have two options -- to sell it or to refinance it," she says. "But if you can't do either, what can you do?"

Now the WaPo:

For a long time, Paul and Amy Woodhull's house on Capitol Hill was a honey pot. Through multiple refinancings over nearly a decade, they pulled out money to fix it up, buy a car, pay down credit cards, buy three other properties and improve them, too. Now the pot is dry. The Woodhulls are feeling squeezed by bills, but with interest rates up and home prices down, they're reluctant to touch their home equity again. They called their six children into a family meeting recently, and Amy laid down new rules: No more impulse purchases or frivolous shopping trips. "We're going to have to save our pennies," she declared.

The subprime market is where the most severe pain is going to be felt, but I don't for a second believe that problems will be exclusively (or mainly for that matter) in subprime. Alt-A and prime mortage borrowers will be put under pressure as well. Why? Because:

About a third of the free cash gained during this period was used to buy other homes, they calculated. About 29 percent was used to acquire stocks and other assets. About 12 percent went to home improvements. And nearly a fourth, 23 percent, went to consumer spending, including paying credit card bills and reducing other non-mortgage debts. The amount of free cash extracted has fallen sharply since the peak in 2005, to $217 billion in the last three months of 2006, down by almost half from a peak of nearly $400 billion in the third quarter of 2005. Analysts disagree about whether these changes will affect consumer spending. (Emphasis mine)

Analysts disagree? Sorry, but I don't see how this can't impact consumer spending. A major part of the nation's income - gains on home sales - that was used to fuel high-interest credit card spending is drying up. From where is this income going to be replaced?

How do the Woodhulls feel about this?

"Jeez, we've got all these payments every month," said Amy, 48, a radio network executive. "Now, when I look at sending my son to college in a year, I can't refinance again. Rates aren't falling. . . . I'm kind of stuck. What are my options? Sell a property into a down market? I'm really feeling quite caught -- like panicked caught."

But it's ok:

How consumers cope with these pressures will determine whether the economy stays on keel this year. In the case of the Woodhulls, they know they could sell their home if they really needed cash. For now, though, they're planning to hunker down until the housing market picks up.

So they could sell their home if they really become cash-strapped. But remember, if you can't sell it, and you can't refinance it, what are you going to do?

If you are the US economy, you are going to crash into a recession - hard.

Housing

Sales of new houses up huge in April (I'd be willing to bet big that the number will be revised down in future months) while the sale of existing homes continues to deteriorate and the median price fell again. The supply of existing homes on the market is now over 8 months. That's a really long time to have your house on the market.

The other shoe starts to fall

It's like watching a slow motion video of a car sliding into a wreck:

After years of piling debt on their homes, Americans are becoming more cautious about using them as a piggy bank. A cooling housing market and higher interest rates have made homeowners more reluctant to tap the equity they may have built up in their residences. The amount borrowers owe on their home-equity lines of credit has slipped in the past six months, to $561 billion at the end of March, the first such decline since 1999, according to new data from Equifax Inc. and Moody's Economy.com Inc. Although that decline was partly offset by a pickup in fixed-rate home-equity loans, total home-equity borrowing rose just 9% in the 12 months through March, well below the 21% average annual growth rate of the past five years.

That was from yesterday's WSJ. The last sentence is particularly amazing to me - the growth in equity extraction was 21% per year over the last 5 years?! This is bad news for the economy. Not unexpected, but bad news for sure. If people stop extracting equity from their homes, they will be unable to pay off their credit cards which is the funding mechanism they've been using to continue their consumption beyond any reasonable or rational limit (the current US savings rate in negative for the first time since the Great Depression). If they can't pay off their credit cards, they can't spend because they have no other method to pay for it. Net-net, the economy comes screeching to a halt.

This is from today's WSJ:

The U.S. economy slowed sharply in early 2007, retreating to its weakest pace in four years under the weight of the housing slump, while inflation accelerated... The surprisingly anemic pace lagged the fourth quarter's rate of 2.5% and reflected the slowest growth in GDP since 1.2% during the first quarter of 2003. Price-inflation gauges rose sharply in the first quarter. For instance, the price index for personal consumption expenditures rose by 3.4% after decreasing 1.0% in the fourth quarter. The PCE price gauge excluding food and energy grew 2.2%, after increasing 1.8% in the fourth quarter.

This is a double-whammy. With the economy slowing, job gains and income gains will likely cool as well, but at the same time the Fed, being laser-focused on inflation will feel some pressure to raise interest rates, which would ripple though the, yes, the housing market raising everyone's adjustable mortgages and lines of credit. It's a very tough place to be in when you simultaneously have a slowing economy and rising inflation because the levers that can help one will harm the other.

This is going to get really, really ugly.

The big question

In the housing implosion is this: who pays?

Lenders lent money like drunks buying drinks at a bar - no income? No problem! People bought houses they couldn't afford (whether they knew it or not). So, who pays?

Housing

There are two groups that are going to need support as the housing implosion unfurls: those subjected to predatory lendors and communites where much of the sub-prime and alt-a loans were made. Everyone else can (and should) crash and burn if they've taken on too much risk. I've got a few drafts on this working.

Housing and Spending

From today's WSJ:

With subprime mortgage lenders pulling back, some working-class Americans are already finding it harder to buy a new home or refinance the one they already own. The big question now for the nation's economy: Will it also get harder for these consumers to buy cars, shop at the mall and dine out?

The answer, of course, is yes. But don't worry:

Even if the poorest customers curtail their spending, it shouldn't be enough to shake the economy off of its trajectory of moderate growth. In the cold science of economics, rich people who have more to spend matter more to the economy than the poorer folks who don't. According to the Labor Department's 2005 consumer expenditure survey, the lowest 40% of earners represent about $1.1 trillion, just a fifth of total consumer spending.

I refer you to this.

Real Estate Implosion

There's a bunch here, so I'm going to take it in stages. Being a plain vanilla kind of mortgage guy, I really don't have any first-hand knowledge of mortgage products beyond the very boring 30-year fixed. There are some pretty exciting products out there right now. Here is a good rundown from the Washington Post:

Today's pop quiz involves some potentially exciting new products that mortgage bankers have come up with to make home ownership a reality for cash-strapped first-time buyers. Here goes: Which of these products do you think makes sense?
(a) The "balloon mortgage," in which the borrower pays only interest for 10 years before a big lump-sum payment is due.
(b) The "liar loan," in which the borrower is asked merely to state his annual income, without presenting any documentation.
(c) The "option ARM" loan, in which the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan.
(d) The "piggyback loan," in which a combination of a first and second mortgage eliminates the need for any down payment.
(e) The "teaser loan," which qualifies a borrower for a loan based on an artificially low initial interest rate, even though he or she doesn't have sufficient income to make the monthly payments when the interest rate is reset in two years.
(f) The "stretch loan," in which the borrower has to commit more than 50 percent of gross income to make the monthly payments.
(g) All of the above.
If you answered (g), congratulations! Not only do you qualify for a job as a mortgage banker, but you may also have a future as a Wall Street investment banker and a bank regulator.

All snark aside, I was pretty surprised by some of the practices in the mortgage market these days. Liar loans don't require any income verification, you tell the mortgage broker how much you make and the broker says, "OK with me, how much do you want?" Even better than liar loans are NINJA loans (No Income, No Jobs or Assets). How exactly does a person gain a house when they have no income, no job, and no assets? Well, the answer, as we're starting to see, is that they don't. Not for long anyway.