"The most valuable truths are the ones most people don't believe. They're like undervalued stocks. If you start with them, you'll have the whole field to yourself. So when you find an idea you know is good but most people disagree with, you should not merely ignore their objections, but push aggressively in that direction." Paul Graham
He makes a lot of assumptions in this analysis, but if he’s right about the increasing number of foreclosures and the slim number of non-REO sales taking place, the California housing market will continue to be a scary place for quite some time.
Take a look at the debate going on at his Web site if you want to see other people’s perspectives on his video.
Delinquencies for Alt-A mortgages rated between 2005 and 2007 are climbing, with total delinquencies rising as high as 17 percent in some cases, more than 6 percentage points higher than previous estimates, the ratings agency said in a report.
Alt-A mortgages are considered higher-quality than subprime ones because Alt-A borrowers have high credit scores, often better than 700. However, most of these loans were made with little or no documentation of the borrowers’ income. Now the market is beginning to show what a risk these loans really are.
Lower-quality subprime mortgage delinquencies soared as high as 37 percent for mortgages originated in 2006, 4 percentage points higher than previous estimates, S&P said.
Subprime mortgages originated in 2007 saw delinquencies climb to almost 26 percent, 6 percentage points higher.
That’s a staggering delinquency rate. Banks’ loss mitigation departments are overwhelmed and understaffed.
“The 2007 issuance year continues to be the worst-performing vintage in terms of cumulative losses,” S&P said, regarding subprime mortgages. “Serious delinquencies” of payments 90 days late or more and foreclosures also are rising, S&P said.
Things may be bad now, but the Alt-A crisis hasn’t even fully begun. The housing market is going down before it comes back up.
Investors who are prepared for this will profit. Everyone else will get slaughtered.
Fannie Mae has reported a loss of more than $2 billion in the first quarter and expects severe weakness in the housing market throughout the rest of the year….
The government has increasingly looked to Fannie Mae to restore stability in the market by buying up mortgages and selling them as securities. Three-quarters of mortgage-backed securities are issued by Fannie Mae and its smaller sibling, Freddie Mac.
To raise capital, the company said it would cut its dividend and offer $4 billion in an immediate share offering. It intends to raise another $2 billion later in the year.
The government is relying on Fannie Mae to reduce the problems we’re facing on the mortgage market. In order to help Fannie Mae do this, investors will have to buy Fannie Mae’s stock.
The company (1) reported a loss of more than $2 billion last quarter, (2) cut dividends, and (3) is planning to package up and sell more loans in a troubled secondary market. In addition, the company is (4) lowering its down payment standard to 3 percent in areas with falling home prices.
(5) Fannie Mae’s stock is down 25 percent this year, and (6) its own chief executive doesn’t think the U.S. housing market will recover until 2010.
If you were considering purchasing its stock, what would you do?
One of the members of our team ran across this article from the Bank Wage-Hour and Personnel Report (No. 7, Vol. LVIII). My emphases are in bold.
The FDIC is warning banks to prepare for the increased workload that will come as more and more loans default. It’s advising banks to bring on the staff necessary to work these problems out with the borrowers.
The banking crisis is not going away. Don’t be caught off guard.
Shore Up Loan Workout Staff, FDIC Advises
April 15, 2008
The Federal Deposit Insurance Corporation (FDIC) is urging insured financial institutions with significant commercial real estate (CRE) concentrations, including concentrations of construction and development (C&D) loans, to immediately undertake a number of risk management actions. Such actions include bolstering the institution’s loan workout infrastructure and staffing to handle the increased workload associated with problem loans….
According to the FDIC, institutions with CRE and/or C&D concentrations should ensure that they have sufficient staff with the appropriate skill sets to properly manage an increase in problem loans and workouts.
Staffing decisions may involve hiring, making internal staffing changes, and training. Human resources strategists may also entail entering into arrangements with third-party experts on a temporary outsourcing basis. The FDIC suggests that management should develop a ready network of legal, appraisal, real estate brokerage, and property management professionals to handle additional prospective workouts.
If your institution’s management is currently adopting risk management strategies to contain the damage from subprime loan losses and the associated financial repercussions, you should insist on a place at the planning table. No risk management strategy can be successful without adequate staff who are appropriately trained to handle the potential wave of problem loans.
In my article about the Foreclosure Summit, I said that Vena Jones-Cox and Lucy Brenton gave us some interesting insights about the mortgage market. The real estate bubble is bursting, creating opportunities for distressed property investors to make money.
Here’s an article on the cause of the subprime crisis.
Rozeff echoes what Vena and Lucy said at the Foreclosure Summit: the problem is not high interest rates. They’re already historically low. The problem is a lack of liquidity, and that lack of liquidity is the result of the credit contraction that always follows a period of credit expansion.
In other words, the Fed can lower interest rates as much as it wants, but this action has to result in an expansion of credit to have an impact on the subprime crisis. It doesn’t matter whether the interest rate is 6% or 8% if I can’t get a loan.
At the root of the crisis is Federal Reserve monetary policy. Bernanke is not expanding the money supply, which is the ultimate source of credit, so the credit needed to refinance bad loans is not available.
Rozeff believes that the markets will become very regulated. This is bad for the average real estate investor but very good for us as note buyers, since we’ll be buying notes and working with the homeowners as a lender, not as a pre-foreclosure investor. Since we’ll be buying at large discounts, we’ll have room to make concessions to the borrowers if necessary.
Thanks for posting that, Cory. I ran into the same video from another source. It seems that many of the experienced investors are talking about how bad Alt-A is going to be, but this sort of thing never seems to hit popular media until after it becomes a big problem.
Alt-A [and option ARM] resets will peak in 2011. Things will remain bad for quite a while. Bad for everyone else, that is, and good for those who help bring liquidity to the markets through short sales, REO purchases, and note purchases.
Addition: It typically takes about six months after an adjustable-rate mortgage resets for the bank to repossesses the property. It may then take another six months for the property to sell and six more months before the property is no longer used as a comp to lower the values of the houses around it.
There’s a year and a half between an ARM re-set and the time when the house is no longer used as a comp. The fallout from the mortgage crisis is going to be around for a couple of years.
The Fed currently isn’t doing much to “save” the markets. The swaps for T-bills aren’t inflationary (yet), since the assets have to be swapped back every 28 days. I think swaps will become inflationary when the paper stops performing while it’s being held by the Fed.
I think Bernanke is more concerned about the value of the dollar than he is with bailing out the markets. I’ve written about this before:
The rumor going around today is that the Federal Reserve is inflating the money supply and that this is causing the dollar to fall rapidly in value. The common advice has been to be in commodities, since commodities rise against the dollar. A lot of people are running to gold and oil in anticipation of future inflation.
The other rumor being circulated is that we’re looking at a severe credit crunch, which is bringing us into a recession. The International Monetary Fund has recently said that this is the worst financial crisis to hit the United States since the 1930s.
There’s a problem here. The rumors contradict each other. The expectation of future inflation is inconsistent with the claim that we’re in the middle of a credit crunch.
Forecasting the Future
This is not just a theoretical problem. Your investments succeed or fail based on how successful you are at planning for the future.
If there’s going to be future inflation, gold and oil will rise. If we’re in a credit crunch, gold and oil will fall. Gold mining shares and oil companies will follow suit.
In order to anticipate the direction of future price inflation, it’s important to look at the Fed’s present policy of monetary inflation. That is, if the Fed is producing new money today, we should expect prices to rise in the future. If the Fed is holding to a policy of stable money in the middle of a credit crunch, we can expect prices to fall later.
The best indicator of Fed policy today is the adjusted monetary base, a measure of the total amount of physical currency (dollar bills, etc.) in circulation plus commercial bank deposits held by the Fed as reserves. The Fed controls this directly by creating and destroying currency.
Notice how the chart has been almost flat for the past two years. (This has also happened to M1.) The Fed has been creating hardly any money relative to its activity in the past. This is one of the sources of the credit crunch we’re facing today.
Rising Prices Today Do Not Point to Inflation Tomorrow
Yes, certain prices are going up - but remember that price inflation is a result of monetary inflation. Price changes lag behind the Fed’s activity. The cost of housing went up because the previous Fed Chairman, Alan Greenspan, expanded the money supply several years ago. The new mortgage credit created as a result of Greenspan’s policies artificially increased the demand for housing, driving up its price. The price of oil, copper, and other commodities rose because of the demand for materials created by the housing bubble.
Ben Bernanke, who is Greenspan’s successor as Fed chairman, slowed down the rate of monetary expansion. That’s why the adjusted monetary base is almost flat. The credit which had been created under Greenspan’s bubble then disappeared. Many people were no longer able to refinance out of their high-interest and adjustable-rate loans. This led to a higher rate of foreclosures, which lowered the value of mortgage paper, which made it even harder for banks to make new loans.
The credit crunch we’re seeing today is a result of Fed policy just as much as the housing bubble was.
Money is still moving into gold, oil, and other commodities, partly because people don’t want to put their money into the stock market or into real estate. However, we can expect the prices of those commodities to fall if the Fed continues its policy of stable money and allows the credit crunch to play out naturally. Inflation will return, but only after the Fed has started to expand the money supply again.
What We’re Investing In
Our investment group is not moving our money into commodities. I expect commodities’ prices to fall due to the Fed’s policy of stable money. We expect the credit crunch to be as exciting for investors as the housing bubble was; we just have to make sure we’re on the right side of the fence.
The credit crunch will force business to sell their assets in order to pay off their debts and try to avoid bankruptcy. When everyone starts to sell at the same time, prices will fall to the floor.
Get ready to pick up defaulted mortgage paper, foreclosed property, and business equipment at fire-sale prices. We’re already doing a lot of short sales. We recently got one approved in Edmond, Oklahoma. We’re also getting ready to buy mortgage notes at large discounts. Stay tuned for more updates on our investment strategies.
If you’d like to share your own investment plans or publish a success story on our site, let us know by posting a comment here.
By now, many people are starting to recognize that the housing crisis is causing job losses. This goes both ways: job losses reduce the supply of ready renters for apartment units, driving down the prices of apartments, which are valued based on the buildings’ income. Lost jobs also drive down the prices of homes and condos, since fewer people have the income to qualify to buy them.
Real estate is starting to have problems in Manhattan now. Up until this point, jobs at Wall Street have helped the prices of apartments continue to rise. Now sales are starting to slow down. Take a look at this article:
Manhattan apartment sales plunged the most in 18 years in the first quarter as buyers faced the prospect of a recession and job cuts at Wall Street securities firms.
Sales fell 34 percent from a year earlier and inventory rose 4.6 percent to 6,194 units, New York-based real estate appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate said in a report today. The median price of a Manhattan co-operative apartment or condominium increased 13.2 percent to a record $945,000.
Note that this is the largest drop in Manhattan apartment sales since 1990. (2008 - 18 = 1990) Sales are down, but condos are still appreciating. Will prices continue to rise?
“If it continues along this pattern, we’re in a period of transition to a weaker market,” Miller Samuel President Jonathan Miller said in an interview. “You typically see a slowdown in sales activity precede a slowdown in pricing.”
Financial companies have cut at least 34,000 jobs in the past nine months as losses and writedowns related to mortgage- backed securities climbed to at least $230 billion. Wall Street drives Manhattan real estate, with the median apartment price roughly tracking bonuses paid by investment banks since 1997, Miller said….
Brokers are waiting for any fallout from job losses on Wall Street or from JPMorgan Chase & Co.’s takeover of Bear Stearns Cos.
When the housing bubble started to pop, we felt the reverberations in Wall Street. This took Countrywide and Bear Stearns down. Now brokers in Manhattan are expecting to see job losses in Wall Street cause price declines in real estate.
It’s a downward spiral.
About 30 percent of all first-quarter closings were for apartments in new developments that went into contract before turmoil hit the credit market, said Gregory Heym, chief economist for Terra Holdings.
“They are pre-credit crisis, pre-Wall Street worries, pre- new mortgage standards,” he said in an interview. “You see a delay in impact in these numbers.”
Read that last sentence again. There’s going to be a delayed reaction to what happened to Bear Stearns. We haven’t felt its full impact yet.
20-30% of the homes in the San Francisco/East Bay area have negative equity, meaning that homeowners owe more on their houses than the houses are worth.
Click below to see a full-size version of the map:
There’s a method of selling a house that helps the homeowner get out of a situation. It’s called a short sale and involves negotiating with the bank to sell the house for less than the loan balance.
According to this friendly map, there are lots opportunities for short sales in most parts of the country. We’re currently doing this in the San Fracisco Bay Area as well as Oklahoma City.
Bring me a lead and I’ll pay you $600 if we buy the house.
In my article about the 
