The Mortgage Crisis - Another Ripoff from Wall Street?

The mortgage meltdown has been front page news for the past couple of months. I've tended to ignore most of the news, thinking it related mostly to subprime borrowing and overheated and overbuilt Sunbelt markets. But this past Sunday there were 2 eye opening articles in the Sunday Times. On the front page, there was an article "In a Spiraling Credit Crisis, Large Mortgages Grow Costly." That report discussed the impact of tighter credit on "jumbo" mortgages — loans above $417,000 that don't confirm to Fannie Mae's guidelines and therefore can't be sold to the Federally chartered mortgage enterprises, Fannie Mae and Freddie Mac. "Jumbo" mortgages are traditionally packaged into mortgage backed securities that are sold to investors, but don't have the government's backing. Investors are running for the exits on these riskier, non-government backed securities. As a result, the rates on these jumbo mortgages have been climbing sharply. This week, the spread between the rate on conventional conforming mortgages and non-forming "jumbo" mortgages has risen to .75 to 1%, up from a spread of .25 to .375. And that spread could grow. And as investors are requiring much more stringent lending guidelines on these non-government backed mortgages, the spread could get much greater. If the availability of mortgage money for large home loans becomes tighter, and the rates higher, this could have a significant impact on buyers — and demand — in the upper end market, particularly in the more discretionary second home sector.

The more disturbing news was buried deeper in the paper, in the Week in Review section. An article there, "Zero Down: The Loan Comes Due" and a companion piece, "Housing Busts and hedge Fund Meltdowns" delved into the ramifications and mechanisms of mortgage backed securities. Its a sobering article about how riskier loans with little down were made to borrowers who couldn't afford them, how Wall Street packaged those loans into mortgage backed securities, and in the cruelest turn, how Wall Street financiers repackaged the riskiest slices to resell them as higher rated "collateralized debt obligations." The big winners in this, or course, were the investment bank wizards who figured out how to do it and skimmed off huge fees for doing so. The mechanisms are too involved to detail here, and unfortunately the archived articles are in the Times Select paid section of nytimes.com, so I can't link to them from here. But if you still have last Sunday's Times and didn't read the article, dig it out of your recycling bin. It will certainly make you wonder, "Where was the government and the regulators in all of this?" I expect that, in the end, the mortgage 'crisis' will take its place next to Enron and Worldcom as yet another poster child of the "business run amok" legacy of this laissez faire, pro business adminsitration.

(Correction Aug. 17: I just had a long talk with a friend who is very familiar with the structure of mortgage backed securities and the mechanisms of that market. He commented that the NY Times article wasn't technically correct, that the 'Collateralized Debt Obligations" derived from mortgage backed securities don't whitewash the risk of subprime mortgages that are packaged into them. His take is that the purchasers of C.D.O.'s and the riskier slices of mortgage backed securities are were sophisticated investors, well aware of the risks --- and were paid higher rates of return for assuming higher risk. That, frankly, is the basis of risk-based pricing, to offer higher returns for higher risk. And sometimes those riskier investments tank, like mortgage backed securities backed by subprime mortgages. And the investors in those securities knew what they were getting into, and agreed to assume that risk in exchange for a higher rate of return.)

For the past few months, I've looked at the real estate market through a traditional lens of supply, demand and affordability — and from that perspective things looked pretty good in New York. But this recent shift in the ground in mortgage availability and pricing adds a whole new wild card to the mix. I don't have a crystal ball about what the ultimate impact will be. But we could end up with a very divided market — split at that magic $417,000 threshold for conventional conforming loans that come with Fannie Mae's blessing and backing. If availability continues to tighten and money becomes more and more expensive, for larger, non-conforming "jumbo" loans, that could have a more pronounced negative impact on more expensive properties at the upper end, over $500,000. 

Comments

[Tony Ritter]

"Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. . . . With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . .

Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending . . . fostering constructive innovation that is both responsive to market demand and beneficial to consumers." (emphasis added)

-Remarks by Chairman Alan Greenspan on Consumer Finance
At the Federal Reserve System’s Fourth Annual Community Affairs Research Conference, Washington, D.C. April 8, 2005

Source:
http://bigpicture.typepad.com/comments/2007/03/quote_of_the_da.html
=================
Tony Ritter
Narrowsburg, NY
www.delawareriverfishing.com

[John]

http://www.rgemonitor.com/blog/roubini/210688

This will sum it all up with real research backing. NY Times is more lay-man terms.

We are looking at the worst housing decline in American History
Even if core inflation remains low, many products that have involved cheap money will sky rocket (leases, auto loans, etc). Home Sellers and Auto manufacturers will get hit the hardest.

[Tony Ritter]

Today at:

http://www.marketwatch.com/news/story/housing-starts-fall-10-year-low/story.aspx?guid=%7BF3D19719%2D465F%2D44E1%2D806C%2D37758D194B05%7D

ECONOMIC REPORT
Housing starts fall to 10-year low in July
New construction drops 6.1% to 1.381 million annual rate
By Rex Nutting, MarketWatch
Last Update: 8:31 AM ET Aug 16, 2007Print E-mail Subscribe to RSS Disable Live Quotes WASHINGTON (MarketWatch) - U.S. home builders cut back again in July, starting construction on the fewest number of new homes in more than 10 years, the Commerce Department reported Thursday.

Housing starts fell 6.1% in July to a seasonally adjusted annual rate of 1.381 million, the lowest since January 1997. The decline was larger than the expected fall to 1.40 million.
Authorized building permits dropped 2.8% in July to a seasonally adjusted annual rate of 1.373 million, the lowest since October 1996 and less than the 1.40 million pace expected by economists surveyed by MarketWatch.
Housing starts are down 21% in the past year, while permits have fallen 23%.
The data show builders are still struggling to bring supply and demand back into balance.
The decline in building was more pronounced for single-family homes. Single-family starts fell 7.3% to a 1.070 million annual rate, while single-family permits fell 1.6% to 1.003 million, the lowest since June 1995.
The housing market has been battered by high prices that have reduced affordability as well as a glut of homes on the market. Foreclosures have jumped, pushing more houses on the market. And many would-be borrowers are finding it more difficult or more expensive to get a mortgage.
In the past weeks, the credit crunch has worsened, with even the most qualified borrowers denied credit. If the credit squeeze persists, the housing slump could get worse.
The government cautions that its housing data are volatile and subject to large sampling and other statistical errors. In most months, the government can't be sure whether starts increased or decreased. In July, for instance, the standard error for starts was plus or minus 7%. Large revisions are common.
It can take five months for a new trend in housing starts to emerge from the data. In the past five months, housing starts have averaged 1.45 million annualized, down from 1.48 million in the five months ending in June.
In the first seven months of the year, starts and permits are down 25% from the same period a year ago.
Almost all analysts agree that housing won't recover until the overhang of unsold homes is worked off. For that to happen, builders must slow the pace of new construction.
On Wednesday, the National Association of Home Builders said builders grew increasingly pessimistic in August. The builders' monthly sentiment gauge fell to its lowest level in 16 years.
Starts fell in three of four regions, with the Midwest showing a 2.6% rise reflecting robust construction of apartment buildings. Starts dropped 11% in the South, 3.7% in the West and 1.3% in the Northeast.
Housing completions fell 0.1% in July to a 1.512 million annual rate, the lowest in six years.
Rex Nutting is Washington bureau chief of MarketWatch.

[Chuck]

Hey David - on a slightly different note, at the beginning of the summer you blogged about 'does Sullivan County have a million dollar market' and listed a few houses as examples. Any chance on getting an update on what happened to thoses houses?

Additionally, my company has 3 deal pendings at the moment, all at very different stages of the process (one is closing next week, one is closing next month, and one is just starting the application process). I'll keep you posted as to what the impact of all these 'high finance sky is falling scenarios' have on real life, well-qualified buyers. They are all putting down 20%, and buying houses that easily appraise.

Similarly, I have not found a panic mode in the buyers. And am receiving multiple inquiries from serious buyers each week.

I'll keep you updated on real-life examples of ground-zero, i.e. - qualified buyers getting (or attempting to get) mortgages.

[David Knudsen]

Chuck, good question about those million dollar plus lakefront houses. Of the 4 I mentioned in that post, only 1, MLS 20176 in Black Lake listed at $1.3M has moved to contract. (Happy to say, our deal, closing in the next couple of weeks.) The other 3 - MLS 19089 in Chapin, 19541 in Forestburgh and 19586 in Tennanah, have not sold and to my knowledge do not have a deal on them (or, at least in the MLS, they don't show as "Pending" or "In Contract.") Interestingly, only 1 of those - MLS 19541 in Forestburgh - has had a modest price reduction, from $1.4M to $1.3M.

Regarding your houses in contract, a key factor in their ability to get mortgage funding is whether 1) they already have a mortgage commitment and 2) whether the loan amount is under the conventional-conforming ceiling of $417,000. The problems seem to be much more in the Jumbo loan category, for loans above $417,000.

[Chuck]

Hey DK - thanks for the update.

I think the biggest keys to getting financing at the moment are to have good credit, have 20% money to put down, and to buy a house worth what you are paying - funny how this sounds old-fashioned.

From the conversations I have had over the last few days with local banks, they are not scared of lending, and just as they have in the past, will presently lend to qualified candidates on houses that appraise.

Like you said, the banks that played fast and loose with lending criteria are probably the banks to avoid presently. Possibly the more local banks will pick up some market share while the cowboys are licking their wounds (or being laid to rest).