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Tuesday, March 11, 2008

A Dose Of Reality

Okay, I was discussing the pending losses from HELOCs a long while ago, but now they are in the news. Fitch suddenly noticed the problem. Let me state with profound bitterness that any ratings firm which did not adjust for this very predictable result back in 2006 should be put out of business. For that matter, any bank which didn't try to adjust is also incompetent.

This is an example of the problem:

The effective collateral for sloppy seconds and HELOCs has been about 3/4s wiped out. This is where the worst losses will occur, and these losses will occur right across the banking board.

A sample of 12 month list price declines in various markets:
Tampa. Median decline 13.7%
Miami. Median decline 13.8%
Cape Coral. Median decline 20%
Orange County (CA). Median decline 15.5%
Portland, Oregon. Median decline 8.5%
Salt Lake City. Median decline 12.5%
San Diego. Median decline 15.9%
Sacramento. Median decline 22.5% (list prices have declined about 30% in 2 years)
DC metro. Median decline 19.3% (list prices have declined about 26% in 2 years)

First, note that the Case Shiller index for SD has declined more than list pricing. This is generally true in markets with a lot of bad loans.

What you are seeing is the result of changes in lending more than anything. The changes have been forced on the industry because the loans they were writing were defaulting at staggeringly high numbers. 2006 vintage was bad, but believe me, 2007 was worse. Okay, so these changes are very real. Nothing can reverse this trend. In areas in which prices didn't move up that much, I expect 5-10% average declines with no appreciation for years to come. Prices in every area will adjust to a pretty normal relationship with buyer incomes if we just let the market work.

The same methodology I used in 2006 to assess risk on HELOCs now tells me that some mortgage insurers should be assumed to go bankrupt, which adjusts my expected loss for later first lien defaults (2009) considerably higher, because I do not expect some of the MI companies to be able to pay off all their claims. This, btw, should affect the servicer's best decision about whether to work out or foreclose now if the loan is credit-enhanced.

We should start to see a pop in sales in a lot of these markets, because quite a few individuals realized the insanity and now have sweet REO pickings. They have money saved for downpayments, and can buy REO at 25-40% off. When that bulge wears off, individuals who are saving will begin to pick up in 2010. The housing affordability crisis is about over, because price declines will continue for years to come.

Under these circumstances, if the conforming loan limit were calculated as it has usually been, it would now be dropping. This is the second year that it hasn't been reduced to the level indicated by the formula. As it now stands, the conforming loan limit with a 10% downpayment would take care of the median home price in most of the erstwhile jumbo areas. The reason is that incomes vary much less across the country than home prices, and as mortgage underwriting returns to verifying ability to pay the mortgage, home prices are going to collapse in the areas in which pricing is utterly disproportionate to incomes.

From this you should draw several conclusions. The first is that I am really very good at what I do. Massively better than Fitch, Moody and S&P. But what you might not realize is that there are at least thousands of (let us call them "mature") people involved with banking who can do the same thing that I do, and that the ratings firms have failed to do. Tanta at Calculated Risk is a great example, but there are thousands of quiet others out there. Of course, none of these people will be saying what any politician wants to hear, and therefore we are effectively voiceless. We need you to join in.

The second is that adding a new category of jumbo conforming loans to the agencies is flat-out stupid. Especially when it is implemented like this. We should all put pressure on our legislators to make sure that this is indeed temporary. Let it expire at the end of the year. Let's try to save the agencies from bankruptcy while we still can. The taxpayers will be forced to bail these firms out if they fail, so let's not rack up our tab.

There is no way any measure at all can prevent the housing market from rerationalizing. Spending untold amounts of money to delay adjustments for six months or so is not sane. It does not support the overall economy. If people are struggling to pay unfeasible mortgages, they will not be spending in other areas. If they really cannot pay the mortgage, a DIL is the best solution. There is no way to wave a wand and create the ability to pay mortgages that are out of line with borrowers' incomes. Those mortgages will go bad regardless, and since the market is set by buyers, and since lending standards for purchasers are rapidly adjusting toward verifying ability to repay, stopping foreclosures will not stop home prices from adjusting.

Well said. I'm new to your blog. What is/was your occupation?
But MoM ... the name of the game isn't solve-the-economic-crisis; the name of the game is kick-the-can-past-the-elections. Seriously, doesn't that explain the actions taken in the last 8 months better? A lot of these actions make more sense as delaying tactics than as attempted fixes.
MAB,banking service from a techie/compliance side. Everything from risk assessment to calculations. Knotty problems. Last minute "Aggh, the examiners will be here on Monday and I don't even have a disaster plan."

John, the elections are not Bernanke's focus. He just doesn't understand mortgages. Greenspan didn't either, apparently.

Bernanke's proposal was clearly founded on the idea that if the creditors forgave enough principal to restore equity, foreclosures would halt and price declines would halt, thus saving the creditors more on down the road than they lost now. It is a bogus theory.
"The first is that I am really very good at what I do. Massively better than Fitch, Moody and S&P.

As a longtime reader/commenter (Reader Formerly Known as Frank), I DO know that you are very good at what you do.

Unfortunately, the second sentence is becoming almost laughably unsuitable as qualification. Pick the first 100 names in the phone book (with respect to William Buckley) and you'll find 100 people I'd trust collectively more than these "worthy" entities. They collaborated with the fraud (legal or simply operational) all the way up. Suddenly realizing when they were on the precipice that things didn't look that keen is too little, too late.
Frank, I agree. What normal people would figure out is what their models were used to disprove. Most head tellers know better.

It is an odd situation indeed.
Not as odd as what happened to me last night. I was meeting with my financial planner, and not only did he urge me to ditch my mutual funds for a purely defensive posture (money-market cash and tax-shelter munis), he starts saying "You know we are Living in the End Times..."

When your financial planner starts talking about End Time Prophecy, the economy has definitely gotten not only bad, but surreal.

The Headless Unicorn Guy
MOM, i have just one phrase to comment on..

" They .. can buy REO at 25-40% off "

Um, this REO is not off anything. If anyone buys a house before the year 2010, they're spending more money than they need to. In fact, the value of house X in 2010 would be the same whether you buy it now or then.. the only difference is that today your principal balance will be much higher.

I'm very frustrated with all the people who i hear saying "I got a deal on my house" -- um, no you didn't! The price you were quoted was discounted when compared to the list appraisal during a wildly inflated asset bubble.

There is no discount - prices are still higher than they "should" be - 3x median income. I live in Baltimore and see the for sale signs all over my neighborhood... in fact, I drive every day past a shuttered-up CRE location which used to house a Countrywide outlet!

Good luck with your ailments.. that sounds like it sucks.
Headless, I met with one last week, and the guy's eyes were rolling. At least he wasn't talking about the End Times.

Gavin, yes, prices will continue to go down! But they are down very substantially from peak in many areas.
Headless, I met with one last week, and the guy's eyes were rolling. At least he wasn't talking about the End Times.

I know. That was what made it so surreal. Like I'd stepped into The Simpsons or South Park for a moment.

"When the going gets weird,
the weird turn pro."
-- Hunter S Thompson

And financial planners talking out of the blue about End Time Prophecy qualifies as weird going.
Late here, but hope you feel better.

Agree, basic accounting and basic applied math without being a crook and knew the score.

Prices must come down to 3Xs income level top or .......

Places in S. CA are down 30%+ but don't state it. These regions are now for wealthy for ex. the ___ pro athletes with millions to destroy normal range.

Many places have 2-3 generations now living together to afford a place. Seniors are giving their old cheaply made style houses to heirs
who rent out for more bucks for selves.

These crooks are changing communities and quality of life.

Yes it is crooked. To me, most mortgages granted without verifying ability to repay are predatory.

Once a borrower is in a mortgage which he or she really cannot afford, getting out of it is the only thing that will fix their financial situation.
Places in S. CA are down 30%+ but don't state it.

I'm in SoCal (behind the Orange Curtain) and seeing a reaction, unstated or not. A lot of three-year-olds in sexually-active adult bodies are soiling their diapers and screaming in out-of-control rage about "MY PROPERTY VALUES!!!!!"

Die Yuppie Scum.
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