For some insight into this issue, let’s pull some data from a fascinating discussion in Barron’s this past weekend. Lon Witter puts forth a different and intriguing notion. Witter observes that we don’t have a Housing bubble, what the U.S. has is a lending bubble. His evidence is how loose the lending standards have become, and why not? The banks ultimately just flip the loans to the Fannie Mae (Federal National Mortgage Association, on the NYSE: FNM), where foreclosures and defaults become the headache of buyers looking for greater risk and return.
Witter claims his careful look at the reasons for the rise in housing give a good indication of the impact housing may have on the stock market. He observes the causes (in chronological order) of the rise and ultimate fall of Housing: “The collapse of the Internet bubble, which chased hot money out of the stock market; rock-bottom interest rates; 50 years of economic history that suggested housing never goes down, and creative financing.”
More specifically, Witter’s expectations are colored by rather disturbing data:
• 32.6% of new mortgages and home-equity loans in 2005 were interest only, up from 0.6% in 2000;
• 43% of first-time home buyers in 2005 put no money down;
• 15.2% of 2005 buyers owe at least 10% more than their home is worth (negative equity);
• 10% of all home owners with mortgages have no equity in their homes (zero equity);
• $2.7 trillion dollars in loans will adjust to higher rates in 2006 and 2007.
Traditionally, Mortgages have been low risk lending, as the loan is securitized by the underlying property. When banks were lending less than the value of the property (LTV), to people with good credit, who also were invested in the property (substantial down payments) you had the makings of a very good business: low risk, moderate, predictable returns, minimal defaults.
That model seems to have been forgotten. THIS IS REMINSCENT OF THE S&L CRISIS — where lenders did not have any repercussions for their bad loans!
As bad as the above numbers look, the thinking behind them is worse:
“Lenders have encouraged people to use the appreciation in value of their houses as collateral for an unaffordable loan, an idea similar to the junk bonds being pushed in the late 1980s. The concept was to use the company you were taking over as collateral for the loan you needed to take over the company in the first place. The implosion of that idea caused the 1989 mini-crash.
Now the house is the bank’s collateral for the questionable loan. But what happens if the value of the house starts to drop?”
A good example of how this is unfolding at lending institutions comes from Washington Mutual: You may recall Washington Mutual laid off 2500 employees in their mortgage broker department earlier this year. As LTV went above 100%, and then as property values decayed from recent peaks, the collateralized aspect of these mortgages suddenly is at risk.
Here’s how this has played out over the past few years via WaMu’s ARM loans (data via Washington Mutual’s annual report):
– 2003 year end, 1% of WaMu’s option ARMS were in negative amortization (payments were not covering interest charges, so the shortfall was added to principal).
– 2004, the percentage jumped to 21%.
– 2005, the percentage jumped again to 47%. By value of the loans, the percentage was 55%.
So each month, the borrowers’ debt increases; Note there is no strict disclosure requirement for negative amortization — Banks do not have an affirmative obligation to disclose this to mortgagees.
Thus, a large part of our housing system have become credit cards. And according to Witter, “WaMu’s situation is the norm, not the exception.”
Even worse, Witter notes that negative amortization is booked by the banks as earnings. “In Q1 2005, WaMu booked $25 million of negative amortization as earnings; in the same period for 2006 the number was $203 million.”
This situation is unsustainable. Witter’s housing and market forecast is rather bearish:
“Negative amortization and other short-term loans on long-term assets don’t work because eventually too many borrowers are unable to pay the loans down — or unwilling to keep paying for an asset that has declined in value relative to their outstanding balance. Even a relatively brief period of rising mortgage payments, rising debt and falling home values will collapse the system. And when the housing-finance system goes, the rest of the economy will go with it.
By the release of the August housing numbers, it should become clear that the housing market is beginning a significant decline. When this realization hits home, investors will finally have to confront the fact that
they are gambling on people who took out no-money-down, interest-only, adjustable-rate mortgages at the top of the market and the financial institutions that made those loans. The stock market should then begin a 25%-30% decline. If the market ignores the warning signs until fall, the decline could occur in a single week.”
As we saw yesterday, the housing data has begin that downside surprise. We have yet to see if July’s downard acceleration was a one off or the start of something much more ominous.
Anecdotally, a friend who is a Real Estate attorney in Virginia emailed the following after yesterday’s discussion:
‘We’re seeing substantial increases in foreclosure volume, with more loans going to sale and being bought back by noteholders. Most are loans which have originated since 1/1/05. many are conventional ARM loans. Foreclosure investors are now sitting on the sidelines.
Huge increases in available real estate up and down the i-95 corridor with stuff sitting for extended periods, even in resort areas.”
Thus, our Housing driven Economy has now moved into the next phase: the long glide downwards in prices, sales volume, and foreclosures.
And, we have new Home Sales today at 10am
More on this later . . .
The No-Money-Down Disaster
Barrons, MONDAY, AUGUST 21, 2006