Re: Housing Crash. Wallstreet meltdown. Reprise of last year's thread...
- From: DDobrjansk@xxxxxxx
- To: fptalk@xxxxxxxxxxxxx
- Date: Sat, 27 Sep 2008 00:11:51 EDT
As someone who has spent time as a credit analyst and has a a fair knowledge
of credit default swaps, EDF (expected default frequencies) and credit
underwriting, a very large portion of what David Isaacson says is spot on.
While I concur that the bail out is imperfect there needs to be shoring up
of some of the neutron bombs because their 'detonation' could escalate an even
worse situation.
The main reason why Lehman Brothers and Bear Stearns were allowed to "fail"
and AIG bailed out is because AIG held and still holds a significant paper on
credit default swaps and other 'exotic' derivatives across a broader spectrum
of clients. It is the magnitude of the client base that motivated the
federal law makers to bail out AIG. Because Lehman and Bear were actually
clients of AIG their 'failure' was deemed less detrimental to the economy as a
whole. If the entire book of AIG's credit default swaps was worthless this
could
cause a China Syndrome meltdown far worse than the Great Depression.
Now while I am no expert on real estate lending, having done it for a little
less than a year in the nascence of my career I do know that the biggest
flaw was that certain mortgages securitized were ones that would have been
termed 'non-conforming' (due to absence of income verification, lower down
payments etc.) and that when they went into default the mortgages that
replaced them
(within the pool secruitized) were no better. Jumbos and Alt A mortgages
were not as risky as sub-prime they were nevertheless of different risk class
and their EDF (expected default frequency) was higher (but not as high as
sub-prime) than a prime.
The whole domino theorem became evident when investors (the large IBs) began
seeing that they had paper which they could not move and that meant less
mortgage money out there not only for the UNQUALIFIED buyers but for the
qualified ones. That also sent a seizing of credit throughout other markets and
placed doubt on securitizations - some of which were pools of sub-prime debt
like
credit cards and auto loans.
I too oppose the bailout because it basically acknowledges shoddy
underwriting standards but does not address the issue of oversight. This is
where the
entire financial constituency of banks, brokerage firms, accountants and
local and federal regulators all "dropped the ball" with safeguarding
investments.
SOX (Sarbanes-Oxley) was an outgrowth of Enron, and WorldCom and the
excesses of the executives who felt no need for control (or accountability).
What
is needed is a re-regulation of the CMBS industry and in fact all
securitization products. We also need to see where external auditors failed
in applying
the correct concepts of valuation and marking-to-market the paper that was
readily being sold on the street.
The first step in risk management is identify the risk; second is quantify
and third is mitigate it. Pity that something so simple was never applied to
the CMBS markets.
Additionally I feel the current crisis has it roots back in 2000, when the
Fed Chairman Greenspan pushed the ubiquitous "panic button" because he
"thought" he saw inflation. His inflation fear is what tanked the markets
then and
today it is still affecting us . Perhaps we need to give less power to the
Fed Chairman and make him responsible to someone or some legislative body; for
the life of me I do not know to whom the Fed Chairman is accountable.
Anyway that is my take on the subject...observed from the trenches.
Although I am a current 'refugee' from the financial industry I hope to be back
working soon and in a credit risk supervisory capacity challenging questionable
underwriting standards and being a gate keeper for invested funds.
- Dan Dobrjanskyj
In a message dated 9/26/2008 11:28:44 A.M. Eastern Daylight Time,
isaacson@xxxxxxxxxxxxxxx writes:
Last year on FPTALK, a chat brewed up over the "will happen/can't happen"
housing crash. I was the "will happen/ IS happening" view ;)
We live in interesting times.
This has been a pet research area for me the last few years.
I am opposed to the current "bail out" for variety of reasons, even whilst
conceding imperfect understanding of every nuance of "credit default swaps"
and some other Wall Street Neutron Bombs (economically speaking). I suspect
several levels of scam with the Wall Street for Wall Street nature of the Bail
Out request, as in who is requesting it and why... suspicious. I am amazed
and gratified (though not yet reassured) that it is Republicans, no doubt
bolstered by wave upon wave of anti-bailout clamor from constituents, who are
quashing the Bailout... so far.
Previously I argued that overt lack of regulation and pseudo free market
(privatize gains, socialize losses. money for the "free market" ultimately
coming from the Fed, credit bubble from Ayn Randian Al Greenspan) would give
disaster, with the Housing Bubble (representing actually a gov't sponsored
credit
bubble) leading the way, but also with that Housing issue being symptom as
much as cause.
I noted that housing prices could fall 50-80% in hottest areas (cali,
phoenix, florida, etc) and that even the "first to rise last to fall"
Manhattan
would plummet, though that last point has not happened... yet. Latest data
cites
40% drop in parts of Cali. I note that aside from Wall Street issues, the
core forces (macro economics, not personal views) behind the now at least
recognized by most folks housing crash... well, those core forces are still
revving up. The Alt-A and Jumbo markets (far bigger than "it's all contained"
Sub-Prime) have not yet even peaked on resets, never mind finished resetting.
Foreclosures should continue to accelerate through 2010 perhaps, and
continuing
for years after.
The core issue on Housing (now blossoming due to Wall Street's betting ON
Housing) is affordability, measured by couple parameters.
1) Mortgage + fees (tax, hoa, etc) should be less than equivalent rent in a
"stable" market'
2) Median House should cost in any area (some areas richer than others) 3x
Median Income. In California in which towns have median household income of
50k, housing median should be around 150k (there are some tweaks, but let us
start there). In many such towns Median blew by 500k. Go figure
3) Houses should cost about 120x the stable monthly rent (with some spread
not huge spread for highly desirable areas)
There are more, but that's a start.
I have quoted below some of the chat from FPTALK last year. Yanked most of
the names as I'm more interested in the content and in the "what's next" than
in who said what when. I left my own quotes named (i'm the second one down in
the quoted stuff below and more below that).
The verbiage from "economic leaders" the last year has paralleled (not that
correlation equals future outcome) 1929.
I am curious to hear fellow penfolk views of housing, the economy, where
this is headed.
Anyway.... here is some of the chat from last year, triggered by a fellow
list member's move to Arizona.
The quotes below recede in time as one scrolls down. The first quoted post
is a response to me.
regards
david
-----------------------
On Oct 14, 2007, at 3:05 AM, wrote:
All this palaver over whether a nice pen-collecting/selling veteran should
join his kids in Tucson and go semi-communal? I thought I was reading posts
to the Fountainpencollecting group for a while there. My FPtalk list
sub-mailbox was aglow with more pro and con on what our Northwestern friend
should
do, than I have seen since Max found a new cache of pen nibs and ink bottles
for sale. Be careful what you listen to as most of the real-estate and
relocation advice given...well just consider the source. And I am only
getting
involved because I began to see some of the best econ-jibberish Ive seen since
the word investment came up in the context of pen purchases!
Now, I am not smart enough nor did I study hard enough to be a doctor, but
if I were I bet I could probably bone up on all this in my spare time, and if
I could get a few quiet night shifts, well, I might find enough time to
study the matter pretty thoroughly...or at least read Business Week I guess.
I
just wish I could turn my 30 plus years in banking and finance into a
medical career! (tongue firmly in cheek and elbow in ribs here) After all we
are
friends right?
But since I got into this, I thought I might point a few things out.
There are 2 variables you might want to consider, and the variables make all
the difference:
1) The irrepressible ingenuity (read profit incented creativity) of the free
enterprise system and its myriad of independently simultaneously operating
buinesses and similarly incented business people
and
2) the historical business economics truth is that if you can predict a
disaster (one that is not unalterably controlled by forces of pure
mathematics,
physics or chemistry) it will not occur.
Oh and there is a 3rd: An Economist is someone who has no better idea about
what will happen in the future than you or I but he has a degree to prove it.
Anyway...The unstoppable forces of number1 will almost always intervene to
determine the final outcome that takes place in number 2 work.Each new problem
or financial difficulty only provides opportunities to "sell" the new remedy
for the new problem.
But more importantly, the financial world and the real estate finance world,
in spite of recent overzealous mortgage brokers squeezing the wrong folks
into the wrong loans, and the securitizing of real estate finding their way
(wrongly) into hedge funds, is pretty well regulated and some of the behavior
attributed to the actions or lack there of that banks will or wont take as
predicted in Dr. i's scenario, simply should not happen that way. And that
will tend to shorten the length of the crunch. I can not fault his logic as
applied to the facts listed but there are many variables unaccounted for in
those facts. There are significant rules about what banks assets must be
"written off" and what may not be. In general a bank can not simply choose
when to
write something off or not. There is a very formal thing called "n
on-performing asset" which can not be hidden. Simply put it is a loan (loans
are bank
assets) that is 90 days past due. At that point the loan is placed on
non-accrual which means it is not to be counted as a bank asset nor is any
accrued
income coming from that asset to be counted in the banks income. "Writing it
off" is not like doing you taxes and deciding to take a business loss...it
is a mandatory thing that can not be delayed other than the loan being brought
current. One more thing...Reserves. Every bank must set aside reserves for
bad loans long before any real losses are on the horizon. These reserves
are created by a charge to income. These reserves are set aside in
preparation/anticipation for/for loan failures. These funds are already
"written off".
Thus banks do not hurt themselves by taking the loss on a loan unless the
loss is greater than the reserve already set aside. REO (real estate owned -
the name for properties foreclosed on by banks) will be fixed up and sold at a
market price and only the difference between what was the loan loss and what
is the funds recovered on sale will stay written off, all the rest will come
back to the bank as "recovery" of reserves. As a banker for the past 30+
years and bank management team member for the past 15 years, I can attest to
the day in day out (read constant) discussions, planning and design of new
products to satisfy current and predictable (or not) future possibilities so
as
to protect shareholder value. Shareholder value is NOT to prop up false
financial information in the very short run, especially at the risk of certain
precipitous backfiring at many times the current loss in the not too distant
future...not to mention the great possibility of running afoul of many
punishing regulations (Sarbanes-Oxley, for example), which punish faulty
financial
reporting that might tend to mask problems and to present a rosier-than-normal
view of financial performance.
And don't be alarmed that the long list of acronyms that stand for low-down,
low cost loans was done without the full knowledge that if the borrower
failed to pay that the property would be foreclosed on. That WAS the plan
from
the beginning of that type loan. And do not confuse these loans as a class
with "sub-prime". Sub-prime refers to the borrower and not the loan category.
There are plenty of prime borrowers and loans in the categories mentioned.
Of course there are many sub-prime borrowers who have taken advantage of
these easier-to-qualify for-loans, too.
This adjustment process has already begun. Among them are early conversions
to reasonable fixed rate loans already being offered today to avert the
crunch Dr i mentions. Some of the new terms are in my mind bad in general but
good in some cases (40 year fixed rate mortgages, for example) but they do
smooth out the differences between the monthly payments on the old low monthly
cost loans that Dr i mentions will be coming due soon, and the fixed rate
mortgages that at 40 years is more affordable as an alternative.
Having said all that (and I apologize for it not being as coherent as I
would like - that would take a book ), I do agree with Dr. i that there is and
will likely be a continuing decline in some property values, I do not believe
it will be as severe as to see prices falling 50% nor long lasting as
2+years... By that time the ingenuity of the business world will come to the
"rescue"
with their own innovative, profit driven solutions to avoid the worst...as
it always has.
_isaacson@xxxxxxxxxxxxxxxx (mailto:isaacson@xxxxxxxxxxxxxxx) wrote:
I hear you. :-)
I will take stab at predicting major decline over next few years, especially
in inflation controlled (never mind international-currency controlled in
fact of our plummeting Dollar, thanks Ben Bernanke), buckerooties.
I will dig up links another day, but the Sub Prime debacle often cited of
late (often called "contained" which might be true if contained means
contained
in an open system with no time limit LOL) is but tip of iceberg just on the
front of loan resets. The zero-am, neg-am, zero-down, cash-back,
heloced-to-death, alt-a and most of sub-prime is set to re-set during the next
three
years. To degree that current drop in prices (note, the median price for house
is
underestimating the fall. more on that next paragraph) is due to the
"re-sets", well... the resetting is just warming up and will peak (NOT end) in
couple years yet from now. Forclosures, Short Sales (devastating to owner d/t
1099
hit) are waaay up, in some parts of country more frequent than actual
regular sales. FC's drive down the comps. And, the process is slow and drawn
out
as bank-owned (REO) properties are being held back and not "marked to market"
and sold at actual demand prices, as it behooves Banks in short term to not
sell at loss (keeps up numbers for stocks and bonuses) even if the long term
loss on such properties will be greater than if hit taken now. This is the
horror of publicly owned companies- short term trumps long term goals. An
unsold house not marked to market *seems* less loss on paper... for now. Many
of
these houses are rotting physically.
Median is bad indicator. In any credit crunch housing crunch, high end tends
to hold out bit longer than entry level. Thus, currently, more pricey houses
are trading at relatively greater rate than lower priced houses, skewing up
the median while not reflecting the crash in total units traded. Better
indices are median price-per-square foot (down much greater than the NAR's
claims about median price per whole house) . Better still the Case-Shiller
index
which tracks individual houses and does number crunches relative to prior
sales.
My guess (this i'd have to research before making hard claim) is that Tucson
Phoenix are down about 20% during last 16 months, the warm up (not the end)
of the housing smoosh.
Of course what with being a poor dumb doctor, i keep open mind when taking
stand on business issues ;-) Always more to learn.
david
> No disagreement on facts. Credit is national -- and has been for
> some time. In general, not many product demand and supply
> determinants are completely local anymore in the US. No doubt
> housing market outcomes have a strong component of local
> determinants. I don't know anyone who would argue that only local
> conditions determine "all real estate" making that "old myth" a bit
> of a straw man. The housing market price outcome in any particular
> locality has lots of determinants, including other national
> conditions and decisions (such as national income, inflation
> expectations, Fed decisions, etc.) plus important local conditions
> --e.g. demand based on income, population, local taxes, weather,
> neighborhood, prices of heating, cooling, expected future house
> value--the list could go on. Agree that these favor soft prices and
> slower sales for awhile in Tucson. Hard to predict how long, but
> personally doubt that prices will decline for more than 2 additional
> years. Also depends on how fast they fall, which is really hard to
> predict.
>
> Hmm, If the prediction of a MAJOR price decline were to occur, I
> would consider buying a retirement house in Tucson! Indeed,
> interesting few years :-) .
>
>
> Quoting David:
> The fundamentals of affordability (median per SQUARE FOOT) for
> housing relative to median income favors a major slow leak/crash in
> Arizona.
> An old myth (myths are not untrue, just believed true whether true
> or not) is that all real estate is local. However, today, all credit
> is national.
>
> Should be interesting few years ;-)
>
> david
>
> Quoting
>
> > No disagreement
> > about the past, Tucson had a big increase in housing prices since
> > 2004 or so. In the weak mortgage market, that clearly makes Tucson
> > vulnerable but it doesn't guarantee big price declines by any means.
> > Although the mortgage markets are national, home construction and
> > sales are predominantly local and depend heavily on local
> > conditions. As far as I can tell, Tuscon also continues to have
> > strong population growth and that is predicted for many years into
> > the future. Condo prices in one area of Ora Valley I'm familiar with
> > rose strongly in 2005, dropped a lot (over 10%) last year but look
> > steady or even stronger this year. Hard to tell anything from one
> > example. I saw some research report that prices are still
> > increasing in Tucson but that quantity of sales is slower--a
> > different form of soft market. Personally, if I were moving to
> > Tucson, I might rent for a short time and watch for a few months or
> > a year to see if prices will get softer. However, given the
> > population and other growth and history if the area, I suspect that
> > anyone who waits several years to buy a house will be paying more,
> > particularly in growth areas of Tucson. The predictions from
> > researchers on this are quite varied right now, so take under
> > advisement anyone who sounds like he or she *knows* what will happen
> > (and that includes me :-) . Business cycle timing is quite
> > difficult to predict and is seldom the same from one downturn to the
> > next.
> >
> > I wonder if anyone has studied how fountain pen sales behave over
> > the business cycle. I'm sure they follow the fluctuations in
> > income, but no idea to what extent. Interesting.
> >
> >
> >
> >
> >
> >
>
>
=
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