Blog Spotlight: Mish’s Global Economic Trend Analysis

Another edition of our new series:  Blog Spotlight.

We put together a short list of excellent but somewhat overlooked
blog that deserves a greater audience. Expect to see a post from a
different featured blogger here every Tuesday and Thursday evening,
around 7pm.

Second up in our Blogger Spotlight:  Michael Shedlock and Mish’s Global Economic Trend Analysis.
Mike is one of the editors of The Survival Report, covering stocks and
the economy. He also writes for the Daily Reckoning, and co-edits
Whiskey & Gunpowder. He also runs stock boards on the Motley Fool,
Silicon Investor, and TheMarketTraders. He is an avid photographer,
when not writing about stocks or the economy, with over 80 magazine and
book covers to his credit.



A Mortgage Broker’s Synopsis

The following post is an email from Michael J. Dorff, a mortgage broker with Trans World Financial about the state of affairs in Orange County California. Monday evening I will have an update from Mike Morgan to share:


Here is a synopsis of the mortgage side of things here in Orange County and for that matter California in general.

What people don’t see, the NAR in particular, is the upcoming train
wreck. I am talking about all the sub prime loans for refinances as
well as purchases that were taken out 2 to 3 yrs ago and are now all
coming due to reset.  My guess is that 99% of all sub prime loans are
all done on a 2 or 3 yr fixed interest only type program. People
thought that it made no sense to take a 30 year fixed loan those homes
when the short term rates were a lot lower, but they were all wrong.

The time bomb is about ready to go off. All of the subprime loans
taken out 2 to 3 years ago have margins of at least 5% or higher and
usually based on the London LIBOR program. Those loans are starting to
reset now at fully indexed rates somewhere in the high 9% to 10% range.
When those loans were initiated 2 to 3 years ago, they all had start
rates of high 5% to low 6%. As of now, the LIBOR alone stands at 5.388
for the 6 month and 5.336 for the 1 year. Take those LIBOR indexes and
add the margins to see what is going to happen.

Here is a case in point. One of my clients who took out an interest
only subprime loan from another lender just received her reset notice.
Her current margin is 5.25% and her index for the 6 month LIBOR index
is 5.388%. This means her new interest rate will shoot up to 10.638%.
Her note states that her first adjustment cannot go higher than 9.2%.
So she will be at 9.2% for the next 6 months. With an initial loan
balance at $251,000 at 6.2% interest only, she had a monthly payment of
$1,296.83. In December her new payment will be $1,924.33 for the
following 6 months before it adjusts again. This is a $627.50 jump in
monthly payment. She simply can not afford this payment.

Given her low credit score near 550, she is fortunate to still have
equity that will allow her to refinance at all. Even still it is a
tough task because not only does she have a bad score, she also a late
pay on her record. The best option any sub prime lender would give her
was 8.5% but she can not even afford that. The only option left is a
Neg Am Option Arm Pick a Pay Loan where her payment is based on an
payment rate of 2% but with a fully indexed adjustable rate of 7.4%.
She will go negative if she cannot make the interest only portion of
this loan. She also needs cash, $75, 000.00 of cash. Mish, that is your
typical home ATM machine at work.

These Option Arm, Neg Am Pick a Pay Loan programs were one of the
things keeping the home building bubble and mortgage lending bubbles
going for the last 3 years. Without these products, the market (at
least in California) would have collapsed 3 years ago. Instead the
bubble just got bigger and bigger and we will see even a greater
collapse when it comes. Ninety percent of those who take an interest
only loan can only afford the interest only part and not only that,
there entire lifestyles are planned around that payment.

Lenders don’t really want people to pay the principle off anyway
unless there is a prepayment penalty on it. Prepayment penalties are
another scam in and of themselves. You can bet the lenders have made a
killing on these 6 month interest prepay penalties. Bear in mind that
once someone is subprime the odds of that ever being corrected are
slim. Refinancing on better terms is usually not an option. Average
credit scores for this group on the whole have not improved much if
indeed at all over the last few years. I would guess that 80 to 90% of
sub prime borrowers stay sub prime borrowers. Those borrowers are in a
hole so deep they will never cleanup their credit to get A-paper rates.
To top it off, many of them end up paying multiple prepayment penalty
each time they need more money. They simply can’t wait for their prepay
period to expire. Ultimately it is a death spiral to bankruptcy.

Ask any Realtor out there if they know or really care about the
types of loans there clients are getting. They may say yes but my
assumption is they just want to make the sale. Ask any mortgage loan
officer if he or she cares about what loan program they put their
client in. Many will say yes but the reality is that they just want to
close the loan and get their commission. First greed took over. Now it
is a matter of survival.

Here is another reason why these loans are pushed: Lenders pay a lot
of rebate on the back end on these loans which fuels the greed even
more. Mortgage professionals can make up to 3.5% back end points on
these loans while their client’s minimum payment stays the same. When
you are talking about the high loan amounts in California, the money to
be made by pushing someone into one of these programs is huge. So are
the temptations. Some lenders went so far as to put on their rate
sheets that the maximum a broker or mortgage loan officer can make is
$50, 000.00 on a given loan.

Initially investors and flippers loved these loans because their
payment was so low that by the time they could flip a home there out of
pocket expenses were nothing. It all works well when the market is
going up. When it stops or even falls, say good bye!

Everyone is in same box. Realtors need sales, homebuilders need
sales, and mortgage brokers need sales. Unfortunately those needs too
often come before their clients needs. In the end, the bankruptcies and
foreclosures that result from this mess will just keep adding to
inventory, ultimately forcing home prices lower. We are only in the
first year of decline. From where I sit things will get a lot worse
before they can get better.

Michael J. Dorff
Trans World Financial
Huntington Beach, Ca. 92646

Thanks Michael.

And thanks Mish!

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What's been said:

Discussions found on the web:
  1. blam commented on Nov 30

    Anyone who still thinks the federal government’s manipulation of the economy is benign should read this tale.

    But it’s all whistling in the wind. If half the gloom and doom we have been ranting about for the past six months comes true, the s**t will hit the fan.

    The stock market doesn’t seem worried. There is either a separate reality or the fundamental valuations of stocks have become meaningless. According to this blog, the end is near, again. I will watch with nervousness from the sidelnes. If we doomsters are wrong, great. We’ll get to keep our jobs. If doomsters are half right, bad. Everyone loses (except the bastards who are driving the market up before the short).

  2. Leisa commented on Dec 1

    The coal for this market engine appears to this amateur observer is liquidity and performance anxiety. Although I did read something interesting on Lex (FT) regarding Global Equities : “Is this the new, new paradigm? From corporate credit to commodities, assets are priced as if the cycle is dead. The stock market is not quite so convinced. Since the end of 2003, the S&P 500 is up 26 per cent, lagging behind the 47 per cent rise in rolling one-year forecast earnings. The prospective US price/earnings multiple has declined from 17.5 to 15 times. Globally, it has been compressed by 13 per cent, according to FTSE/IBES. This is unusual: in bull markets, both earnings and multiples tend to rise.”

    What do you have to believe is true to support your thesis? (Asked whether you or a bull, bear or just some stinky wolverine). While the market may be extended in technical terms, perhaps the valuations lack the frothiness that would precipitate an dramatic decline that many of us chicken littles have been expecting. Perhaps we will only see a stumble rather than a fall, as the underlying sentiment is not euphoria, but rather cautious optimism.

  3. rob commented on Dec 1

    I like the reports from Mike Morgan on Mish’s site.

  4. Bob A commented on Dec 1

    “In December her new payment will be $1,924.33 for the following 6 months before it adjusts again. This is a $627.50 jump in monthly payment. She simply can not afford this payment.”

    For those who aren’t aware, these borrowers were allowed to qualify based on the lowest payment allowed on these loans, even in the case of the negative amortization loans. They would NEVER have been given a loan based on their income if the payment had been what it’s going to be. It was all based on the pie-in-the-sky assumption that prices would appreciate or the people would magically be making that much more money if rates went up.

    A lot like “the Iraqi’s are going to greet our soldiers with flowers’ thinking.”

  5. Michael C. commented on Dec 1

    I’ve read similar reports from subprime lenders, and they have valuable opinions.

    But I take them with a grain of salt in that they are exactly that – subprime lenders. They represent a very small part of the market. (ie. what is Trans World Financial? they are not Wells Fargo, that much I know.)

    Subprime borrowers are bottom of the barrel. Everyone knows that. And during cycle tops they get hurt the most everyone knows that, as well. They take the riskiest loans to buy the cheapest homes which is why they represent the majority of foreclosures.

    But, I can tell you from living in the heart of Orange County, that it is not the dire atmosphere you would think from reading his perspective. Then again, I don’t live in a 200k neighborhood. But, I can also tell you from experience that those borrowers aren’t the big spenders at the mall, or at Best Buy, or at Home Depot.

    Yes, Orange County is one of the highest areas of ARM’s in the country. But, I know many financially capable who took on IO loans because rates were unbelievably low. When it comes time to refinance, they will be fully able to do so. Will their payments go up? Yes, but they’ve actually saved money believe it or not during that time since long term rates haven’t gone up all that much while some of them refinanced with a solid 5/1 ARM at 3% and change.

    FYI, I am a housing bear, I sold in summer 2005 (bought in 2000) and am renting, and inventory is very bloated here in OC. I would love to see the housing market tank, though I don’t desire ill will for anyone. It just struck me how negative his subprime comments were.

    Also, one very interesting commentary I read regarding the dollar and housing is below. Would be great to hear comments on this one. The full commentary is public here.


    “It’s also worth noting that since the dollar index bottomed out at $81 in December 2004, housing markets have mostly gone sideways. To me all of this does not seem like such a big deal. Only in a true deflationary environment will housing markets be in serious trouble.

    If the dollar starts going down again — and I think it will, because that’s what the Fed wants — then real estate will start going right back up. But again this price appreciation will mostly be an illusion. Housing values will again go up in some proportion to how much the dollar goes down. Owning a house is always going to be the best way to maintain relative purchasing power in the US economy.

    This is why I also purposely took out a big loan back in 2003, when I bought in San Diego County. I also did a much-maligned interest-only loan to boot. I just can’t see the point of spending even one dollar of today’s currency to pay down dollars that are due in 30 years. It doesn’t make any sense.

    I think the amount that comes due on my house in 30 years will be a laughably small amount in 2033 dollars. (I took the mortgage in 2003). If anything, inflationary trends like this tend to accelerate. Most of the damage to the dollar has occurred since 1987, when Alan Greenspan took over. I think the next 27 years will see this trend accelerate, beyond anything we can dream of today.

    I read lots of commentary from perma-bears about how the US economy is about to be destroyed by all of the refinancing and home equity loans taken out over the last 5 years. But I don’t get their logic. In an inflationary environment such behavior is rational. It makes sense to borrow today’s dollars and pay back tomorrow’s dollars.”


  6. Chris commented on Dec 1

    “The only option left is a Neg Am Option Arm Pick a Pay Loan where her payment is based on an payment rate of 2% but with a fully indexed adjustable rate of 7.4%. She will go negative if she cannot make the interest only portion of this loan. She also needs cash, $75, 000.00 of cash. Mish, that is your typical home ATM machine at work.”

    Can any body explain to me the $75000 cash?? Why does she need that? is it related to her mortgage?
    Thanks a lot!

  7. david foster commented on Dec 1

    Michael…”Owning a house is always going to be the best way to maintain relative purchasing power in the US economy”…why would this be the case? Doesn’t experience teach that some asset classes do better under some conditions and others under different conditons? Why would ownership of housing always be the best deal?

  8. john commented on Apr 21

    yes this is good informative blog. if you need more information and need loan in very low interest rate than is best for you.

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