Sub-prime blues
March 5, 2007 11:05 AM Subscribe
For those of you who haven't been following The Mortgage Lender Implode-O-Meter and other purveyors of financial and real estate schadenfreude, the sub-prime mortgage market is in some serious trouble. The stock charts of the likes of New Century Financial and Fremont say a lot, although BusinessWeek and MarketWatch have been helpful in explaining. Is there really fraud in 70% of early payment defaults? I know traders are given to hyperbole, but Goldman Sachs and Merrill Lynch as "almost junk"?
The so-called subprime market (which changes yearly, what was subprime five years ago is now called Alt-A loans) is a disaster. Part of me says "Good, these fools need to be burned, and hard", but what will really happen is this.
1) A lot of people, who *never* should have gotten a loan of this size, are going to lose everything.
2) The lenders, who should be forced to collapse because of their mistakes in lending, will be bailed out.
So, the people who took the loans will take it in the teeth. The people who made the loans will be bailed out, probably with pious incantations along the lines of "they're too big to fail."
No-interest loans on primary residences are almost always wrong. No-documentation loans are *always* wrong. The vast majority of subprime loans should have never been given, a large slate of the Alt-A market is also bad, and in a just world, the lenders who made such loans should fail. They made bad decisions. The market is punishing them.
But this is America, where "free" markets are only allowed until the hurt the wrong people. We'll protect them -- they are, after all, the money class. They get protection. We couldn't let Chrysler fail. We couldn't let LTCM fail. We won't let Goldman Sachs and Merrill Lynch fail.
Those people in those loans? We can let them fail, and we will.
posted by eriko at 11:22 AM on March 5, 2007 [13 favorites]
1) A lot of people, who *never* should have gotten a loan of this size, are going to lose everything.
2) The lenders, who should be forced to collapse because of their mistakes in lending, will be bailed out.
So, the people who took the loans will take it in the teeth. The people who made the loans will be bailed out, probably with pious incantations along the lines of "they're too big to fail."
No-interest loans on primary residences are almost always wrong. No-documentation loans are *always* wrong. The vast majority of subprime loans should have never been given, a large slate of the Alt-A market is also bad, and in a just world, the lenders who made such loans should fail. They made bad decisions. The market is punishing them.
But this is America, where "free" markets are only allowed until the hurt the wrong people. We'll protect them -- they are, after all, the money class. They get protection. We couldn't let Chrysler fail. We couldn't let LTCM fail. We won't let Goldman Sachs and Merrill Lynch fail.
Those people in those loans? We can let them fail, and we will.
posted by eriko at 11:22 AM on March 5, 2007 [13 favorites]
And iTulip. Janszen's been harping on this subject for what seems like years. These are exciting times, that's for sure.
posted by saladin at 11:24 AM on March 5, 2007
posted by saladin at 11:24 AM on March 5, 2007
Wow. Casey's getting his salad tossed over there. Nice post. Liked the pigginton link. Lots of people fucked up out here in SoCal.
posted by phaedon at 11:26 AM on March 5, 2007
posted by phaedon at 11:26 AM on March 5, 2007
More reading.
And, though I like iTulip, I wonder if they're the proverbial stopped clock.
posted by Kwantsar at 11:26 AM on March 5, 2007
And, though I like iTulip, I wonder if they're the proverbial stopped clock.
posted by Kwantsar at 11:26 AM on March 5, 2007
No-interest loans
What's that? (Genuinely curious what you mean, not snarking)
posted by rkent at 11:30 AM on March 5, 2007
What's that? (Genuinely curious what you mean, not snarking)
posted by rkent at 11:30 AM on March 5, 2007
Does all of this mean I'll actually be able to afford a house in my lifetime?
posted by you just lost the game at 11:33 AM on March 5, 2007
posted by you just lost the game at 11:33 AM on March 5, 2007
you just lost the game: "Does all of this mean I'll actually be able to afford a house in my lifetime?"
Hear, hear. I hate that I have to hope for a major market to crash just so I can afford to buy my own place at a vaguely sensible age.
posted by Drexen at 11:37 AM on March 5, 2007
Hear, hear. I hate that I have to hope for a major market to crash just so I can afford to buy my own place at a vaguely sensible age.
posted by Drexen at 11:37 AM on March 5, 2007
I always liked sub-prime loans, and disliked lending at prime. Why? The risk of default to the lender is always the full price of the loan (and one could argue, by extension, of putting the money elsewhere). The risk itself is the same whether you have someone with great credit rating or someone with a terrible credit rating.
I've always felt that those on the prime were valued way out of whack and sub-prime was more correctly valued. That is one would use whatever distribution and the fact remains that the possibility of a prime borrower failing is very much in the realm of possibility (as is two planes flying into the WTC as much as that seemed unlikely) yet they received their money much more cheaply. As such I always felt that sub-prime loans included too much of a risk factor, as in they were too cautious in believing that the borrower would fail.
Now I haven't done any major research into the lending market, but I have done considerable amount of research into distribution and yield curves and had a feeling, somewhat implicitly, that the prime market was the one that didn't adequately value default. Especially considering new default laws.
Also LTCM was saved by the banks, the government just organized it (and I would argue the banks let it fail to the price where they could snatch it up). A lot of people lost money in LTCM but they weren't exactly the same type of people who are subprime lenders.
That said, morally, I think subprime loans take advantage of a certain class of people. LTCM used a foolish equation based on Brownian motion which works better in theory than in practice. There are no Platonic models for the stock market, and I don't believe there ever will be.
posted by geoff. at 11:38 AM on March 5, 2007
I've always felt that those on the prime were valued way out of whack and sub-prime was more correctly valued. That is one would use whatever distribution and the fact remains that the possibility of a prime borrower failing is very much in the realm of possibility (as is two planes flying into the WTC as much as that seemed unlikely) yet they received their money much more cheaply. As such I always felt that sub-prime loans included too much of a risk factor, as in they were too cautious in believing that the borrower would fail.
Now I haven't done any major research into the lending market, but I have done considerable amount of research into distribution and yield curves and had a feeling, somewhat implicitly, that the prime market was the one that didn't adequately value default. Especially considering new default laws.
Also LTCM was saved by the banks, the government just organized it (and I would argue the banks let it fail to the price where they could snatch it up). A lot of people lost money in LTCM but they weren't exactly the same type of people who are subprime lenders.
That said, morally, I think subprime loans take advantage of a certain class of people. LTCM used a foolish equation based on Brownian motion which works better in theory than in practice. There are no Platonic models for the stock market, and I don't believe there ever will be.
posted by geoff. at 11:38 AM on March 5, 2007
eriko writes "We couldn't let Chrysler fail."
Chrysler is a bad example of your point, all they needed was time to get their act together and they didn't cost the government anything. In fact, they payed their guaranteed loans back early. The granting of loan guarantees was a big old win-win-win for everyone.
posted by Mitheral at 11:38 AM on March 5, 2007
Chrysler is a bad example of your point, all they needed was time to get their act together and they didn't cost the government anything. In fact, they payed their guaranteed loans back early. The granting of loan guarantees was a big old win-win-win for everyone.
posted by Mitheral at 11:38 AM on March 5, 2007
Very interesting stuff, I like to think myself a student of economics but had no idea what was occurring in this realm. Thanks for elucidating me Adamchik and others.
posted by vito90 at 11:38 AM on March 5, 2007
posted by vito90 at 11:38 AM on March 5, 2007
Yeah, no kidding--where can I get a no-interest loan on my primary residence?
posted by DU at 11:41 AM on March 5, 2007
posted by DU at 11:41 AM on March 5, 2007
HSBC really screwed up here too. They dumped a bunch of execs over it, and has had to take big charges against earnings.
Locally, we have a sub-prime lender who managed to do even worse. Mortgage Lenders Network went bankrupt after they somehow got stuck with loans that they couldn't find anyone to finance.
posted by smackfu at 11:42 AM on March 5, 2007
Locally, we have a sub-prime lender who managed to do even worse. Mortgage Lenders Network went bankrupt after they somehow got stuck with loans that they couldn't find anyone to finance.
posted by smackfu at 11:42 AM on March 5, 2007
And for anyone interested, a good starting point, albeit technical for finding long-tail distributions. I do hate using the word "long-tail" as it is rather jargon based, but non-Gaussian isn't as catchy.
posted by geoff. at 11:43 AM on March 5, 2007
posted by geoff. at 11:43 AM on March 5, 2007
LTCM used a foolish equation based on Brownian motion which works better in theory than in practice.
That's awfully facile.
posted by Kwantsar at 11:45 AM on March 5, 2007
That's awfully facile.
posted by Kwantsar at 11:45 AM on March 5, 2007
Nice. The Implode-O-Meter is like the fuckedcompany.com of the housing bubble. But with less snark.
posted by Lazlo Hollyfeld at 11:48 AM on March 5, 2007
posted by Lazlo Hollyfeld at 11:48 AM on March 5, 2007
Kwantsar, I will not debate that it is a complex topic, but at its heart I believe LTCM's models were too reliant on that Brownian equation/Black-Scholes (which itself is a normal distribution of course). Indeed, if I remember correctly, towards the end they kept talking about how what occurred in the Russian markets was many deviations beyond what their models would expect ... which would translate it to such events occurring only once in many millions of years. Obviously that is not the case.
posted by geoff. at 11:50 AM on March 5, 2007
posted by geoff. at 11:50 AM on March 5, 2007
The Bloomberg article referenced by the last link is just silly...the default swap premiums on the big brokers have definately widened to reflect to risks of this bout of volatility but they aren't anywhere near junk pricing. Merrill's default swap premium for 5yr paper is somewere in the mid 30 basis points zip code. "Higher quality" junk companies like Lyondell or Harrahs Entertainment trade closer to 175 basis points for default protection making it 5 to 6 times more costly than the investment grade brokers. A real junk company with single B ratings or worse would require a premium in excess of 350 basis points and that assumes you could find a counterparty willing to do the trade.
Total headline horseshit...but I guess that sells newspapers...
posted by cyclopz at 11:51 AM on March 5, 2007
Total headline horseshit...but I guess that sells newspapers...
posted by cyclopz at 11:51 AM on March 5, 2007
geoff, someone's credit rating is basically a measure of how likely they are to default - so The risk itself is the same whether you have someone with great credit rating or someone with a terrible credit rating isn't accurate. The risk gets higher the lower the credit rating is.
posted by ny_scotsman at 11:51 AM on March 5, 2007
posted by ny_scotsman at 11:51 AM on March 5, 2007
Perhaps instead of "no interest loan" what was meant above is "interest only" loan? Those obviously bite the big one.
posted by Richard Daly at 11:54 AM on March 5, 2007
posted by Richard Daly at 11:54 AM on March 5, 2007
Part of the problem here is that credit has been sloshing around like beer at a college keg party: lots of credit and lots of greed means that someone, somewhere is going to get their teeth knocked in.
Starting the last month or so, the teeth are starting to get whacked. Risk in the housing market has been thinned by the use of 'securitized loans'. In laymans terms what this means is that HSBC, for example, can make mortgages to thousands of people. They then package up those mortgage notes and debt, securitize it, and sell it to Wall Street. Voila, the risk is now spread around and pushed off on someone else.
The problem for these mortgage brokers, especially the smaller ones, is that their lifeblood is the big brokerage houses and hedge funds who pour money into buying these securitized mortgages. When those capital flows get cut off, new mortgages cannot be written and service on debt becomes unmanageable.
But, the financial markets are only part of the problem here. The other part, as with any good asset bubble, is consumers and the related industries (Title Companies, appraisers, real estate agents, etc.). As the asset price increases exponentially, the only way to increasingly get people into mortgage products was to become more creative. That's where we got piggyback loans (one loan for 80% of the mortgage, another for the last 20%), short-term ARMs (1, 2, or 3year or even 6 month) and interest only mortgages (just 'lease' your house! the increase in value will offset any risk and you'll have more when you go to sell!).
Were we talking about financially sound and responsible people here, some of these mortgage products would make sense. For example, the average amount of time someone spends in their first home is between 5 - 7 years. Hence, for many responsible people a 5 - 7 year ARM loan may make legitimate sense as compared to a traditional 30 year note.
However, as the asset bubble grew and put more people out of reach (see: California, Arizona, Colorado, Md./Va./DC), these loans had to become more creative to keep the money flowing.
The result: tens of thousands of people in homes they never, ever should have gotten into. The sad reality is that home ownership is *not* for everyone, regardless what Fannie Mae, Home Depot and HSBC say. There are many people who may be able to afford the house, but the upkeep will kill them. Roof goes bad? $5000. New driveway? $10000.
It's going to be very interseting to see where this all winds up. If we're lucky it will just pop the real estate bubble and deflate slowly. If we're unlucky and there are large bankruptcies there is the potential for the entire market to become unraveled (old addage: housing rules the economy). As Americans increasingly have used their homes as ATMs, they're finding that the credit line is tapped and the bills aren't going away.
posted by tgrundke at 11:57 AM on March 5, 2007 [1 favorite]
Starting the last month or so, the teeth are starting to get whacked. Risk in the housing market has been thinned by the use of 'securitized loans'. In laymans terms what this means is that HSBC, for example, can make mortgages to thousands of people. They then package up those mortgage notes and debt, securitize it, and sell it to Wall Street. Voila, the risk is now spread around and pushed off on someone else.
The problem for these mortgage brokers, especially the smaller ones, is that their lifeblood is the big brokerage houses and hedge funds who pour money into buying these securitized mortgages. When those capital flows get cut off, new mortgages cannot be written and service on debt becomes unmanageable.
But, the financial markets are only part of the problem here. The other part, as with any good asset bubble, is consumers and the related industries (Title Companies, appraisers, real estate agents, etc.). As the asset price increases exponentially, the only way to increasingly get people into mortgage products was to become more creative. That's where we got piggyback loans (one loan for 80% of the mortgage, another for the last 20%), short-term ARMs (1, 2, or 3year or even 6 month) and interest only mortgages (just 'lease' your house! the increase in value will offset any risk and you'll have more when you go to sell!).
Were we talking about financially sound and responsible people here, some of these mortgage products would make sense. For example, the average amount of time someone spends in their first home is between 5 - 7 years. Hence, for many responsible people a 5 - 7 year ARM loan may make legitimate sense as compared to a traditional 30 year note.
However, as the asset bubble grew and put more people out of reach (see: California, Arizona, Colorado, Md./Va./DC), these loans had to become more creative to keep the money flowing.
The result: tens of thousands of people in homes they never, ever should have gotten into. The sad reality is that home ownership is *not* for everyone, regardless what Fannie Mae, Home Depot and HSBC say. There are many people who may be able to afford the house, but the upkeep will kill them. Roof goes bad? $5000. New driveway? $10000.
It's going to be very interseting to see where this all winds up. If we're lucky it will just pop the real estate bubble and deflate slowly. If we're unlucky and there are large bankruptcies there is the potential for the entire market to become unraveled (old addage: housing rules the economy). As Americans increasingly have used their homes as ATMs, they're finding that the credit line is tapped and the bills aren't going away.
posted by tgrundke at 11:57 AM on March 5, 2007 [1 favorite]
I think what geoff. means is that the total risked (the value of the house) is the same, not that the expected value of the risk is identical. In the next paragraph geoff states his belief that the actual expected value of the sub-prime mortgages is higher than the primes because the sub-primes more accurately reflect the chances of the borrower defaulting (if I read all that right).
posted by Richard Daly at 11:59 AM on March 5, 2007
posted by Richard Daly at 11:59 AM on March 5, 2007
Drexen writes "I hate that I have to hope for a major market to crash just so I can afford to buy my own place at a vaguely sensible age."
No need to hope, the vast majority of residential real estate in both Canada and the US is overvalued, in many cases wildly so. It's impossible to predict the exact popping of a bubble of course (how do you make a rational prediction of irrational behaviour) but I can't imagine things hanging on much longer and in fact some US markets are already coming down.
Real Estate tends to be cyclic (EG: someone has crunched the numbers for Vancouver) and we're cresting over what has been a very long run up.
posted by Mitheral at 12:03 PM on March 5, 2007
No need to hope, the vast majority of residential real estate in both Canada and the US is overvalued, in many cases wildly so. It's impossible to predict the exact popping of a bubble of course (how do you make a rational prediction of irrational behaviour) but I can't imagine things hanging on much longer and in fact some US markets are already coming down.
Real Estate tends to be cyclic (EG: someone has crunched the numbers for Vancouver) and we're cresting over what has been a very long run up.
posted by Mitheral at 12:03 PM on March 5, 2007
geoff. I've never met anyone running millions who claims that his model is true, right, correct, or the like. In fact, most desk quants or quant managers will say that their models are "wrong but useful." Like David Li does at the end of this interview
Given what LTCM said during their roadshow, I'd say that their failure was not due to a faulty model (which as I have implied is a redundant statement), but due to improper risk management.
posted by Kwantsar at 12:06 PM on March 5, 2007
Given what LTCM said during their roadshow, I'd say that their failure was not due to a faulty model (which as I have implied is a redundant statement), but due to improper risk management.
posted by Kwantsar at 12:06 PM on March 5, 2007
Kwanstar's right, the model itself worked fine. I'm led to believe that if LTCM had been able to stay in the game for only a few more months, they'd have made an absolute fortune. It was poor-risk management and severe over-leveraging, not fealty to the Black-Scholes model, that ultimately did LTCM in.
posted by saladin at 12:16 PM on March 5, 2007
posted by saladin at 12:16 PM on March 5, 2007
One of the (limited number of) joys of living in the heart of the rust belt is that we have had almost no housing bubble to speak of. I bought my house for 100K six years ago and while I'm only hoping to get a little better than inflation when I sell it this year, I'm also pretty sure that the value won't fall below 100K. You can't fall off the floor. Now if we only had a job market ...
posted by octothorpe at 12:17 PM on March 5, 2007
posted by octothorpe at 12:17 PM on March 5, 2007
More to the point, a realtor friend says that the easy-credit subprime system was seized upon by baby boomers, to purchase second homes as "investments". It was just a replay of the dot-com boom, only in overvalued real estate.
The bust is just beginning. 2008 is probably going to be ugly--especially for people who used subprime or adjustable-rate mortgages (usually with little or no collateral or down payment) to buy homes they can't afford. Personal bankruptcies will probably break all previous records.
The "system" bailed out the S&Ls in the 80s. They bailed out LTCM. It will bail out the lenders too. The working stiffs get stiffed.
Smile, it's a beautiful day!
posted by metasonix at 12:27 PM on March 5, 2007
The bust is just beginning. 2008 is probably going to be ugly--especially for people who used subprime or adjustable-rate mortgages (usually with little or no collateral or down payment) to buy homes they can't afford. Personal bankruptcies will probably break all previous records.
The "system" bailed out the S&Ls in the 80s. They bailed out LTCM. It will bail out the lenders too. The working stiffs get stiffed.
Smile, it's a beautiful day!
posted by metasonix at 12:27 PM on March 5, 2007
How will this affect those looking to get their first home (for someone planning on doing a 30 year mortgage with 10% down payment in the next two years or so)
posted by drezdn at 12:29 PM on March 5, 2007
posted by drezdn at 12:29 PM on March 5, 2007
I'm also pretty sure that the value won't fall below 100K
Well, that alone would be a 13% decline adjusted for inflation, which is worse than most of the coastal markets have done over the last year, so you wouldn't exactly be getting off scot-free if that happened.
posted by rkent at 12:35 PM on March 5, 2007
Well, that alone would be a 13% decline adjusted for inflation, which is worse than most of the coastal markets have done over the last year, so you wouldn't exactly be getting off scot-free if that happened.
posted by rkent at 12:35 PM on March 5, 2007
drezdn : even if housing prices do come down a bit, your situation probably won't change that much. You might be able to afford a bit more house, but it won't come down so much that you'll suddenly be able to put down 20% on the same house. The important thing with a 30 yr fixed is that you can afford the monthly payments plus, if you need it, insurance to cover you if you lose your income. If the market crashes right after you buy, as long as you can make your payments the only thing you lose is mobility. As a consolation prize, as inflation kicks in your payments will get easier to make over the years and eventually you'll break even.
posted by ny_scotsman at 1:01 PM on March 5, 2007 [2 favorites]
posted by ny_scotsman at 1:01 PM on March 5, 2007 [2 favorites]
The lenders, who should be forced to collapse because of their mistakes in lending, will be bailed out.
Maybe, maybe not. The big losers in the last subprime debacle (late 1990s, IIRC) most certainly were not bailed out. Assets and trade names ended up going for pennies on the dollar to other investors (arguably the correct price, as the major source of the problems was majorly-flawed, overaggressive book valuation.)
The risk of default to the lender is always the full price of the loan
No. The risk of default is, realistically, significantly less. That's before you even consider PMI (in reality required for conventional loans with LTVs over 80%) or FHA/VA insurance (most loans will carry one or the other.)
The risk itself is the same whether you have someone with great credit rating or someone with a terrible credit rating.
A better measure of "risk" for somebody making and keeping a large number of loans is a statistical measure that takes into account not only maximum possible loss but also the probability of default. Folks with low credit scores should (if the models are correct) be more likely to default - this means higher expectation of loss, all other things being equal. If you think the models are wrong you have a great arb opportunity here and you should definitely go for it.
As such I always felt that sub-prime loans included too much of a risk factor, as in they were too cautious in believing that the borrower would fail.
If this is correct then these guys should be making money hand-over-fist rather than all going down the tubes. A lot of people shared your view back in the day, and didn't take the time to look at the models carefully, or listen to reasoned opinion. They ended up hiring companies like my former employer to sell their asses to vultures after it all blew up.
Part of the problem here is that credit has been sloshing around like beer at a college keg party: lots of credit and lots of greed means that someone, somewhere is going to get their teeth knocked in.
This, and the rest of tgrundke's comment, is probably the smartest commentary so far in this thread.
Kwantsar may be right, maybe not about LTCM - I don't know enough about their particular model. But I've seen too many multiple-day runs of multiple-sigma movements in my day to have much comfort in stochastic, normal-distribution-based models. The problem is that things that should happen, in theory, very infrequently end up happening far more often than that.
But he's absolutely right that proper risk management should ameliorate model shortcomings (you insure against known flaws in the model as well as unknown flaws, but you do each differently.) The thing is if you believe in a flawed model too much, or don't understand its shortcomings, that makes it real easy to lose it all in a hiccup (Been there, seen it, in the mortgage biz though.)
posted by Opposite George at 1:06 PM on March 5, 2007
Maybe, maybe not. The big losers in the last subprime debacle (late 1990s, IIRC) most certainly were not bailed out. Assets and trade names ended up going for pennies on the dollar to other investors (arguably the correct price, as the major source of the problems was majorly-flawed, overaggressive book valuation.)
The risk of default to the lender is always the full price of the loan
No. The risk of default is, realistically, significantly less. That's before you even consider PMI (in reality required for conventional loans with LTVs over 80%) or FHA/VA insurance (most loans will carry one or the other.)
The risk itself is the same whether you have someone with great credit rating or someone with a terrible credit rating.
A better measure of "risk" for somebody making and keeping a large number of loans is a statistical measure that takes into account not only maximum possible loss but also the probability of default. Folks with low credit scores should (if the models are correct) be more likely to default - this means higher expectation of loss, all other things being equal. If you think the models are wrong you have a great arb opportunity here and you should definitely go for it.
As such I always felt that sub-prime loans included too much of a risk factor, as in they were too cautious in believing that the borrower would fail.
If this is correct then these guys should be making money hand-over-fist rather than all going down the tubes. A lot of people shared your view back in the day, and didn't take the time to look at the models carefully, or listen to reasoned opinion. They ended up hiring companies like my former employer to sell their asses to vultures after it all blew up.
Part of the problem here is that credit has been sloshing around like beer at a college keg party: lots of credit and lots of greed means that someone, somewhere is going to get their teeth knocked in.
This, and the rest of tgrundke's comment, is probably the smartest commentary so far in this thread.
Kwantsar may be right, maybe not about LTCM - I don't know enough about their particular model. But I've seen too many multiple-day runs of multiple-sigma movements in my day to have much comfort in stochastic, normal-distribution-based models. The problem is that things that should happen, in theory, very infrequently end up happening far more often than that.
But he's absolutely right that proper risk management should ameliorate model shortcomings (you insure against known flaws in the model as well as unknown flaws, but you do each differently.) The thing is if you believe in a flawed model too much, or don't understand its shortcomings, that makes it real easy to lose it all in a hiccup (Been there, seen it, in the mortgage biz though.)
posted by Opposite George at 1:06 PM on March 5, 2007
metasonix:
I think that 2007 will be very painful for many and 2008 may be outright disastrous.
I'm beginning to wonder how far things will have to go before we start seeing some extensions of help going out to those who are overstretched. Since Foreclosure is such an expensive, messy process, I can see a scenario whereby lenders turn to debtors and say, "okay, your ARM is going to readjust up and you're going to default - what say we split the difference and refi you into a fixed 30 year note for slightly more than you're paying now?"
If the foreclosures become too severe, it may be a way out.
posted by tgrundke at 1:09 PM on March 5, 2007
I think that 2007 will be very painful for many and 2008 may be outright disastrous.
I'm beginning to wonder how far things will have to go before we start seeing some extensions of help going out to those who are overstretched. Since Foreclosure is such an expensive, messy process, I can see a scenario whereby lenders turn to debtors and say, "okay, your ARM is going to readjust up and you're going to default - what say we split the difference and refi you into a fixed 30 year note for slightly more than you're paying now?"
If the foreclosures become too severe, it may be a way out.
posted by tgrundke at 1:09 PM on March 5, 2007
For an even better look at what's going on, take a look at these notes from New Century Financial's recent earnings report. Just to give you a flavor, here's the highlight:
Take out $1 billion in loans just before you report quarterly results so the cash shows up on your books.
...and nobody sees anything *wrong* with this practice?
posted by tgrundke at 1:12 PM on March 5, 2007
Take out $1 billion in loans just before you report quarterly results so the cash shows up on your books.
...and nobody sees anything *wrong* with this practice?
posted by tgrundke at 1:12 PM on March 5, 2007
To read about the origin of securitized loans in an entertaining manner, you need to look at Liars Poker by Michael Lewis.
posted by lalochezia at 1:18 PM on March 5, 2007
posted by lalochezia at 1:18 PM on March 5, 2007
I can see a scenario whereby lenders turn to debtors and say, "okay, your ARM is going to readjust up and you're going to default - what say we split the difference and refi you into a fixed 30 year note for slightly more than you're paying now?"
Aren't mortgages non-recourse loans in most/all states? You may be right that we see a lot of workouts, but I bet a lot of FBs are going to throw the keys to the bank, and live in their parents' garages until they can put something together.
posted by Kwantsar at 1:24 PM on March 5, 2007
Aren't mortgages non-recourse loans in most/all states? You may be right that we see a lot of workouts, but I bet a lot of FBs are going to throw the keys to the bank, and live in their parents' garages until they can put something together.
posted by Kwantsar at 1:24 PM on March 5, 2007
I'm so tempted to sell my house now, at the top of the wave, rent for a few years, and then pick up a nicer house at the expense of someone else's misery.
But then I remember that most of these overpriced houses are the McMansions that I can't stand anyway.
There will be some great photography of ghost 'burbs in the coming decades. Block after block of abandoned luxery homes.
posted by Eddie Mars at 1:30 PM on March 5, 2007
But then I remember that most of these overpriced houses are the McMansions that I can't stand anyway.
There will be some great photography of ghost 'burbs in the coming decades. Block after block of abandoned luxery homes.
posted by Eddie Mars at 1:30 PM on March 5, 2007
Is there really fraud in 70% of early payment defaults?
I believe it. You have to read that report carefully (and consider its intended audience.) In particular, I'd believe it's crooked loan originators and not the borrowers who are the direct source of most of the fraud.
Many (most? I've been out of the biz a while) home loans are originated by independent brokers who sell them to the ultimate source of funding or investor. The structure of the mortgage origination market results in them behaving more like car salesmen than the stereotypical lending officer (remember, they aren't lending their own money.) In a bad office the underwriters are in on it too (again, the business needs loans approved or it fails.)
Originators don't get paid unless they close loans. They have a real interest in "helping" borrowers get approval, especially hard-money borrowers. I wouldn't be surprised if a lot of the time this "help" occurs without the borrowers even knowing.
You'd think originators would be bound by a sense of ethics; well, yes, the good ones are but there are a lot of bad originators. Barriers of entry to the business are pretty low and you end up with a lot of less-than-scrupulous participants.
Yes, applications and loans get sold with buyback provisions in case of fraud, default or rapid refinance, but there are a number of reasons why calling the originator on issues like this happens far less often than it should. Not the least of this is the tremendous turnover in the industry - many origination shops are small operations that open to take advantage of a hot market. When the tide turns and writing loans gets more difficult these guys go back to, in the words of a former boss, "Selling Herbalife." Good luck tracking them down two years later when the loan blows up.
posted by Opposite George at 1:33 PM on March 5, 2007
I believe it. You have to read that report carefully (and consider its intended audience.) In particular, I'd believe it's crooked loan originators and not the borrowers who are the direct source of most of the fraud.
Many (most? I've been out of the biz a while) home loans are originated by independent brokers who sell them to the ultimate source of funding or investor. The structure of the mortgage origination market results in them behaving more like car salesmen than the stereotypical lending officer (remember, they aren't lending their own money.) In a bad office the underwriters are in on it too (again, the business needs loans approved or it fails.)
Originators don't get paid unless they close loans. They have a real interest in "helping" borrowers get approval, especially hard-money borrowers. I wouldn't be surprised if a lot of the time this "help" occurs without the borrowers even knowing.
You'd think originators would be bound by a sense of ethics; well, yes, the good ones are but there are a lot of bad originators. Barriers of entry to the business are pretty low and you end up with a lot of less-than-scrupulous participants.
Yes, applications and loans get sold with buyback provisions in case of fraud, default or rapid refinance, but there are a number of reasons why calling the originator on issues like this happens far less often than it should. Not the least of this is the tremendous turnover in the industry - many origination shops are small operations that open to take advantage of a hot market. When the tide turns and writing loans gets more difficult these guys go back to, in the words of a former boss, "Selling Herbalife." Good luck tracking them down two years later when the loan blows up.
posted by Opposite George at 1:33 PM on March 5, 2007
Aren't mortgages non-recourse loans in most/all states?
Not sure I understand your point, but there's always recourse to the borrower (except, in some states, in the case of bankruptcy.) A "non-recourse" loan is one that's sold to the investor in such a way that the servicer doesn't take a hit in a default - this used to be SOP for FNMA and FHLMC product (not GNMA - though their FHA/VA insurance mitigates this significantly.) For subprime loans, mostly securitized privately or non-securitized, the issue of recourse gets more complicated (and I don't know whether most of these loans are sold with or without recourse - again, it doesn't matter much to the borrower.)
It's true that a surrender of deed can be cheaper for the investor than a foreclosure, but they aren't required to accept it. Modeling the right thing to do gets especially complicated in a volatile market, with many unknowns related to all the costs involved. In the case of a recourse loan, the servicer or his attorney probably has more leeway to make the deal than for a non-recourse loan.
posted by Opposite George at 1:47 PM on March 5, 2007
Not sure I understand your point, but there's always recourse to the borrower (except, in some states, in the case of bankruptcy.) A "non-recourse" loan is one that's sold to the investor in such a way that the servicer doesn't take a hit in a default - this used to be SOP for FNMA and FHLMC product (not GNMA - though their FHA/VA insurance mitigates this significantly.) For subprime loans, mostly securitized privately or non-securitized, the issue of recourse gets more complicated (and I don't know whether most of these loans are sold with or without recourse - again, it doesn't matter much to the borrower.)
It's true that a surrender of deed can be cheaper for the investor than a foreclosure, but they aren't required to accept it. Modeling the right thing to do gets especially complicated in a volatile market, with many unknowns related to all the costs involved. In the case of a recourse loan, the servicer or his attorney probably has more leeway to make the deal than for a non-recourse loan.
posted by Opposite George at 1:47 PM on March 5, 2007
And also a refi rather than default means fee income for the servicer's origination department. All the better if they can write a loan they can sell out of portfolio, hopefully with no or limited participation/recourse.
posted by Opposite George at 1:51 PM on March 5, 2007
posted by Opposite George at 1:51 PM on March 5, 2007
Speaking of fraud, I wish I could conjur up the links, but I've recently come across many sites posting examples of how their mortgage origination was utter junk. Examples being those such as, "Mr. Smith, we know you only make $52,000 yearly, but surely you have investment income worth another $40,000 somewhere? Let's see...oh yes, in my ass we can find that income...."
Opposite George makes very valid points about how the mortgage origination business works. We've relaxed rules and opened the floodgates - and here my friends, is what we get.
posted by tgrundke at 1:56 PM on March 5, 2007
Opposite George makes very valid points about how the mortgage origination business works. We've relaxed rules and opened the floodgates - and here my friends, is what we get.
posted by tgrundke at 1:56 PM on March 5, 2007
Either I'm misunderstanding you, or vice versa. I'm looking at this from the perspective of the borrower.
A nonrecourse loan is a loan in which the borrower's liability is limited to the loan's collateral. So if a borrower is underwater on a nonrecourse mortgage, all he needs to do is put the collateral back to the buyer, walk away, and watch his credit get hit.
posted by Kwantsar at 1:59 PM on March 5, 2007
A nonrecourse loan is a loan in which the borrower's liability is limited to the loan's collateral. So if a borrower is underwater on a nonrecourse mortgage, all he needs to do is put the collateral back to the buyer, walk away, and watch his credit get hit.
posted by Kwantsar at 1:59 PM on March 5, 2007
drezdn writes "How will this affect those looking to get their first home (for someone planning on doing a 30 year mortgage with 10% down payment in the next two years or so)"
Cash is golden in a crash. Once the bust starts you'll be golden if you can put 25% down. 10% might be problematic but if values fall 50% (well within the realm of possibility) your 10% turns into 20%. Also in theory you'd want to wait until the cycle bottoms out. The numbers I linked to show that can happen in as little as six quarters.
posted by Mitheral at 2:01 PM on March 5, 2007
Cash is golden in a crash. Once the bust starts you'll be golden if you can put 25% down. 10% might be problematic but if values fall 50% (well within the realm of possibility) your 10% turns into 20%. Also in theory you'd want to wait until the cycle bottoms out. The numbers I linked to show that can happen in as little as six quarters.
posted by Mitheral at 2:01 PM on March 5, 2007
To what extent does all of what's being discussed here apply to Canada (more specifically, Toronto)? When the U.S. catches a cold, generally we do too, but no-one's talking about a downturn in housing prices up here, at least as far as I've heard.
posted by The Card Cheat at 2:19 PM on March 5, 2007
posted by The Card Cheat at 2:19 PM on March 5, 2007
A nonrecourse loan is a loan in which the borrower's liability is limited to the loan's collateral.
Yeah, we're speaking different tongues. My definition of "recourse" as it applies to home loans is from the funny language mortgage servicers use -- my bad. Mortage servicers being like other humans, they take perfectly-good words, apply their own screwed-up definitions and then forget the original definition ever existed.
Yours is the more common sense (and would probably be the definition most folks would take.) And you may be right that mortgages have to be nonrecourse by law in most states - in retrospect, I spoke too fast on that.
There are instances, though, where the insurer or investor can try to mitigate foreclosure-dependent losses through deficiency judgements, which means the deed-in-lieu decision is not always a no-brainer for either the borrower or the investor/insurer. This page explains the process from HUD's perspective.
posted by Opposite George at 2:28 PM on March 5, 2007
Yeah, we're speaking different tongues. My definition of "recourse" as it applies to home loans is from the funny language mortgage servicers use -- my bad. Mortage servicers being like other humans, they take perfectly-good words, apply their own screwed-up definitions and then forget the original definition ever existed.
Yours is the more common sense (and would probably be the definition most folks would take.) And you may be right that mortgages have to be nonrecourse by law in most states - in retrospect, I spoke too fast on that.
There are instances, though, where the insurer or investor can try to mitigate foreclosure-dependent losses through deficiency judgements, which means the deed-in-lieu decision is not always a no-brainer for either the borrower or the investor/insurer. This page explains the process from HUD's perspective.
posted by Opposite George at 2:28 PM on March 5, 2007
Fair enough, OG, and thanks.
Card Cheat: I think that the reason the US real-estate market is such a contentious issue is because the ratio of rents to prices is very low, the US consumer is (arguably) in a lot of debt, and many questionable mortgages have been issued. These factors, taken together, suggest that a downturn could be deep, severe, and prolonged, because the high prices, and the forces that support these high prices, are at risk of taking a big drop which could potentially be self-sustaining. The bull case is that as long as interest rates and employment are favorable, any correction will be contained and orderly.
Which is a long roundabout way of saying that if the three factors I have listed are in place in Canada, you're catching the same cold. Whether the cold is a bitch or not may depend on the job market and interest rates.
posted by Kwantsar at 2:42 PM on March 5, 2007
Card Cheat: I think that the reason the US real-estate market is such a contentious issue is because the ratio of rents to prices is very low, the US consumer is (arguably) in a lot of debt, and many questionable mortgages have been issued. These factors, taken together, suggest that a downturn could be deep, severe, and prolonged, because the high prices, and the forces that support these high prices, are at risk of taking a big drop which could potentially be self-sustaining. The bull case is that as long as interest rates and employment are favorable, any correction will be contained and orderly.
Which is a long roundabout way of saying that if the three factors I have listed are in place in Canada, you're catching the same cold. Whether the cold is a bitch or not may depend on the job market and interest rates.
posted by Kwantsar at 2:42 PM on March 5, 2007
Is GNMA considered a subprime lender here or are those mortgage pools and rates guaranteed by the US govt? Haven't mortgage-backed securities in some way predicted this fallout and started moving away from nontraditional loans? Why not more 40 year loans?
posted by mattbucher at 2:44 PM on March 5, 2007
posted by mattbucher at 2:44 PM on March 5, 2007
Mitheral, I think 50% is at the far end of the spectrum. The standard 20% deposit is supposed to address the worst-case short term shift in housing values - I think halving of house prices can only happen in very specific and vulnerable markets. I've seen numbers like 30% floating about that seem to be the worst-case scenario, but it seems like a lot of other things would have to go wrong with the economy to reach those levels.
mattbucher : GNMA is (unlike FNMA and FHLMC) backed by the US government... however, that doesn't mean they take excessive risk. Low income != subprime, and GNMA manages risk by charging a spread and being careful about property values. Also, since passthrough MBS are effectively callable every month, you don't need to worry about financing them to maturity.
posted by ny_scotsman at 4:13 PM on March 5, 2007
mattbucher : GNMA is (unlike FNMA and FHLMC) backed by the US government... however, that doesn't mean they take excessive risk. Low income != subprime, and GNMA manages risk by charging a spread and being careful about property values. Also, since passthrough MBS are effectively callable every month, you don't need to worry about financing them to maturity.
posted by ny_scotsman at 4:13 PM on March 5, 2007
Wow. HSBC went out and bought ANOTHER sub-prime lender after Household? There's a veritable brains trust at those board meetings...
There seems to be some seriously sub-prime thinking there.
posted by clevershark at 4:49 PM on March 5, 2007
There seems to be some seriously sub-prime thinking there.
posted by clevershark at 4:49 PM on March 5, 2007
Boy, I'm sure glad I've been in a rent-controlled apartment for the last 9 years and socking cash in the bank. In a couple years I should be pretty much golden to put a big chunk down and buy something nice, even here in Los Angeles.
That is, assuming the general economic crunch doesn't eliminate my income...
posted by zoogleplex at 5:29 PM on March 5, 2007
That is, assuming the general economic crunch doesn't eliminate my income...
posted by zoogleplex at 5:29 PM on March 5, 2007
50% is fairly extreme but I think there are lots of markets where we might see that kind of decline. Vancouver has done it before and they are especially bubbly. Calgary is just crazy, I've seen over a 150% "increase in valuation" in a mere five years and I didn't buy at the bottom of the market. If I'd managed to get a down payment together 2 years earlier I'd probably have realised closer to 200%.
posted by Mitheral at 7:23 PM on March 5, 2007
posted by Mitheral at 7:23 PM on March 5, 2007
Perhaps instead of "no interest loan" what was meant above is "interest only" loan?
Gaak. Yes, and I apologize for the mindo -- this one wasn't even my usual "hasty rewrite" -- you can tell those by the obviously missing words.
Interest-only loans do have a purpose -- you're not staying in a property long, and you basically have the capital to buy the property anyway. Instead of tying your capital up, you borrow the principle, pay the interest while you're using the property, and use the capital you have and the appreciation on the property to make money.
What they are not meant for -- purchase of a primary residence by a capital poor person.
posted by eriko at 4:49 AM on March 6, 2007
Gaak. Yes, and I apologize for the mindo -- this one wasn't even my usual "hasty rewrite" -- you can tell those by the obviously missing words.
Interest-only loans do have a purpose -- you're not staying in a property long, and you basically have the capital to buy the property anyway. Instead of tying your capital up, you borrow the principle, pay the interest while you're using the property, and use the capital you have and the appreciation on the property to make money.
What they are not meant for -- purchase of a primary residence by a capital poor person.
posted by eriko at 4:49 AM on March 6, 2007
Chrysler is a bad example of your point, all they needed was time to get their act together and they didn't cost the government anything.
But why should they have been given the time? They fucked up, repeatedly, and despite the bailout, in the end, they're still a mess. The (only) good part of it is we kept a large slate of workers working for a few more years, but...
I think the US Auto Industry might have been in better shape today if we had let Chrysler fail. It's very possible the lessons learned from the Chrysler failure would have made Ford and GM that much more competitive (and the former Chrysler workers may have found work with the reinvigorated Ford and GM.)
But the biggest harm from bailing out Chrysler is that we set a precedent -- that large companies have a safety net that other companies do not.
LTCM should have been allowed to crunch, and the companies that bet on them should have taken the hit -- even it if knocked us into a recession for a while, because that would have taught us a lesson.
It's a rehash of the old joke. If you owe $100,000 to the bank and lose your job, you have a problem. If you owe $100,000,000 to the bank and lose your job, the bank has a problem.
The proper market answer is "Yes, the bank does. They should have mitigated that risk. They did not. Too bad." The US market answer is "Save the bank, screw the small investors, give the former board huge golden parachutes."
The lesson has become "never gamble small. Small gambles are allowed to fail. Gamble big -- so big that if it does fail, people will be reluctant to take you down."
posted by eriko at 5:00 AM on March 6, 2007
But why should they have been given the time? They fucked up, repeatedly, and despite the bailout, in the end, they're still a mess. The (only) good part of it is we kept a large slate of workers working for a few more years, but...
I think the US Auto Industry might have been in better shape today if we had let Chrysler fail. It's very possible the lessons learned from the Chrysler failure would have made Ford and GM that much more competitive (and the former Chrysler workers may have found work with the reinvigorated Ford and GM.)
But the biggest harm from bailing out Chrysler is that we set a precedent -- that large companies have a safety net that other companies do not.
LTCM should have been allowed to crunch, and the companies that bet on them should have taken the hit -- even it if knocked us into a recession for a while, because that would have taught us a lesson.
It's a rehash of the old joke. If you owe $100,000 to the bank and lose your job, you have a problem. If you owe $100,000,000 to the bank and lose your job, the bank has a problem.
The proper market answer is "Yes, the bank does. They should have mitigated that risk. They did not. Too bad." The US market answer is "Save the bank, screw the small investors, give the former board huge golden parachutes."
The lesson has become "never gamble small. Small gambles are allowed to fail. Gamble big -- so big that if it does fail, people will be reluctant to take you down."
posted by eriko at 5:00 AM on March 6, 2007
The lesson has become "never gamble small. Small gambles are allowed to fail. Gamble big -- so big that if it does fail, people will be reluctant to take you down."
Perhaps unwise, but I'm thinking I might adopt this as personal credo - if it's all going to blow up, I might as well "Gamble big" - Now where's that form to cash in my 401K....?
posted by jalexei at 6:49 AM on March 6, 2007
Perhaps unwise, but I'm thinking I might adopt this as personal credo - if it's all going to blow up, I might as well "Gamble big" - Now where's that form to cash in my 401K....?
posted by jalexei at 6:49 AM on March 6, 2007
eriko writes "But why should they have been given the time? They fucked up, repeatedly, and despite the bailout, in the end, they're still a mess. The (only) good part of it is we kept a large slate of workers working for a few more years, but..."
Even if you discount the benefits of keeping 10s of thousands of people employed in good paying positions (something I think makes it worth it all by itself), having 3 major NA automotive manufacturers is at least 50% better competition wise than only having 2. Much innovative product came out of Chrysler exactly because they were both lean and hungry. For the cost of $0 the development of the minivan alone was worth the ticket price. The hope that GM and Ford would be more competitive when minus one competitor is laughable IMO.
Especially when we're talking about GM which was firmly in the grasp of money guys at the time and deep into Operation Foot-Bullet on every front. I'm reminded of the Pontiac Fiero which was both a platform that was sorely need and crazy cheap to make. GM cancelled it just as they had all the bugs worked out and much needed1 power steering developed for the platform. Why you ask? Because they were only selling 40,000 units a year. 40K! 40K units a year would have been a runaway success for Chrysler.
Stuff like the Prowler, Common Block Turbo, XJ, 4AOD, and Dakota would never have come from GM/Ford.
Also at least some of the customers no longer buying Chrysler would instead turn to the Japanese or Europeans thereby deepening the trade deficit.
[1] Much needed from a marketing point of view, the car drove and handled fine without it.
posted by Mitheral at 7:39 AM on March 6, 2007
Even if you discount the benefits of keeping 10s of thousands of people employed in good paying positions (something I think makes it worth it all by itself), having 3 major NA automotive manufacturers is at least 50% better competition wise than only having 2. Much innovative product came out of Chrysler exactly because they were both lean and hungry. For the cost of $0 the development of the minivan alone was worth the ticket price. The hope that GM and Ford would be more competitive when minus one competitor is laughable IMO.
Especially when we're talking about GM which was firmly in the grasp of money guys at the time and deep into Operation Foot-Bullet on every front. I'm reminded of the Pontiac Fiero which was both a platform that was sorely need and crazy cheap to make. GM cancelled it just as they had all the bugs worked out and much needed1 power steering developed for the platform. Why you ask? Because they were only selling 40,000 units a year. 40K! 40K units a year would have been a runaway success for Chrysler.
Stuff like the Prowler, Common Block Turbo, XJ, 4AOD, and Dakota would never have come from GM/Ford.
Also at least some of the customers no longer buying Chrysler would instead turn to the Japanese or Europeans thereby deepening the trade deficit.
[1] Much needed from a marketing point of view, the car drove and handled fine without it.
posted by Mitheral at 7:39 AM on March 6, 2007
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posted by delmoi at 11:18 AM on March 5, 2007