Why It Helps To See Things In Perspective

Check out this chart from Barry Ritholtz. There was a lot of recent media coverage about the anniversary of the 1987 stock market crash. Black Monday. It happened on October 19, and the Dow Jones was off by 22.6% There was also a lot of comparison to today's market environment. Coincidentally, the Dow had another big dip on October 19 2007, but a couple hundred points off of an index value of 14,000 is rather different than a couple hundred points from 2,000. On 10/19/07, the index lost 2.6%. Weird, but coincidental.


It was devastating at the time, but notice the "crash" in the red circle, and then in the context of the next 20 years in the market. Would you have bought the day after the crash?

Sub-prime Meltdown - Visual Tool

I think its fairly understood at this point that there has been a "meltdown" in the sub-prime lending world for home loans. The degree to which it would spill over into normal housing markets and prime home financing has been the subject of debate. I don't know why it wouldn't spill over, as the problem in the sub-prime lending was a spill-over of problems in the prime lending arena in the first place. Namely, money got too cheap and easy to get.

But take a look at this chart. Another great one from The Big Picture. It shows the delinquency rate for various recent 'vintages' of non-prime paper. 2006 and early 07 is being regarded as the worst 'vintage' because it was underwritten and funded at the peak of the lending mania.

14% of those loans are delinquent 20-24 months after origination, compared to a 3-7% delinquency rate on vintages recent previous years. 14 percent!!

It stands to reason that the Q307 paper and onward will be some of the best quality paper on the secondary market going forward, as these borrowers were scrutinized by the currently tough underwriting guidelines. I'll discuss this more in future posts...

Changes To Conforming Loan Limits?

If it were not for the current stress in the housing sector, the OFHEO would likely lower conforming loan limits for 2008 based on a decreasing value of median home prices. Many are speculating that they may raise the limit to help ease the situation... here is the latest word directly from the OFHEO...

FOR IMMEDIATE RELEASE October 16, 2007
	NO DECLINE IN 2008 CONFORMING LOAN LIMIT
	Additional Comments Sought on a Revised Loan Limit Guidance; New Mortgage Market Note on Historical Trends in Conforming Loan Limit
Washington, DC – The Office of Federal Housing Enterprise Oversight (OFHEO) announced today three actions regarding the calculation of the conforming loan limit, which establishes the maximum mortgage loan value eligible for purchase by Fannie Mae and Freddie Mac. OFHEO Director James Lockhart announced that, based on provisions in the proposed guidance, the current conforming loan limit will not be reduced for 2008. If the index used to calculate the maximum loan level should increase, the amount of the increase in 2008 would be reduced by the decline calculated in 2006 of 0.16%. Under no circumstance, however, would the maximum loan level for 2008 drop below the 2006 and 2007 limit of $417,000. OFHEO Director Lockhart also announced that OFHEO has transmitted to the Federal Register a revised Examination Guidance for procedures relating to the calculation of the conforming loan limit and implementation of increases or decreases in the limit. A proposed guidance was subject to public comment earlier this year and OFHEO has made changes to the proposed guidance in several areas. OFHEO is seeking additional comment on the revised guidance within 30 days of its publication in the Federal Register. Key provisions of the revised Examination Guidance entitled Conforming Loan Limit Calculations proposed for public comment are the following: -- As previously proposed, any decreases in the limit would be deferred one year. -- Decreases would have to total cumulatively more than three percent before a decrease would be implemented, a change from the proposed one percent de minimis amount. -- As proposed and clarified, if a loan is conforming at the time of origination, it remains conforming regardless of declines in the conforming loan limit, providing greater certainty for markets and asset securitization. -- As proposed, for simplification, the conforming loan limit will be rounded down to the nearest $100. The Guidance, as transmitted to the Federal Register for publication, may be found on OFHEO’s website at www.ofheo.gov/media/guidance/CLL101607FR.pdf. The notice for the Federal Register contains a summary of the proposed and final guidances, the revised guidance as well as an Appendix setting forth various scenarios relating to possible loan limit decreases. OFHEO also announced the publication of a new Mortgage Market Note on the conforming loan limit. The Note provides background information on the history of the conforming loan limit. It traces the growth in the loan limit relative to other key economic variables, such as household income. The Note also describes how the national loan limit has changed as compared with regional and state-level measurements of home price appreciation. The Mortgage Market Note is available on OFHEO’s website at www.ofheo.gov/media/mmnotes/MMNOTE072.pdf ###
OFHEO's mission is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac.

Government Taking Steps To Ease The Bubble Burst

On the docket in the US Senate right now is a piece of legislation designed to help take some of the sting out of the current burn many are experiencing in the housing arena. With lending standards being raised so suddenly, and values starting to come down on a national level, there is increasing concern of a snowball effect from the segment of homeowners who cannot re-qualify for a mortgage to replace the one they currently have. Problems arise when the homeowner's loan terms change for the worse, and they cannot sell the home or refinance the debt. Stuck between a rising payment and a hard place (to sell)...

This proposal just passed the House with 89% approval. There are three points of significance. To understand the first point, it helps to understand the "Phantom Tax". Phantom Tax is a cost incurred by somebody who has a debt that is forgiven. If a borrower owes 250k on a home, but the home is worth only 200k, and that borrower agrees into a Short Sale of the home for 200k, the borrower is receiving a benefit of 50k in forgiven debt. The IRS views this as income, and taxes the borrower accordingly... This legislation currently before the Senate seeks to eliminate this tax. Its a huge gift to homeowners caught upside-down in housing.

The legislation also calls for an extension of the mortgage insurance deduction through 2014. It is otherwise set to expire at the end of the year, making mortgage interest non-deductible to all filers.

On the other side of the equation, there needs to be a way for Uncle Sam to make up for these expected short-falls in tax revenue. So the legislation also changes the current homeowner exemption rules. Currently, the tax law allows you to live in a second home as a primary home for 2 of the last 5 years, and then take the $250k capital gains exclusion ($500k for married couples). The proposed change would require filers to pro-rate the number of years that you have lived there as your primary home when taking the exemption. For example, if you have owned the home for 4 years, but lived there for 2 as a primary home, you would only get 50% of the exclusion. There is a grandfathering provision, but it will affect anyone selling a 2nd home eligible for this exclusion for sales beginning in 2008.

If you have questions about any of this, please consult with your tax advisor, or refer to the official language in the legislation for interpretation.

Credit Market Changes Visualized

I found a few charts recently that are very useful in conveying magnitude of the recent changes we have seen in the mortgage market. The first two are courtesy of the Weldon Financial Monitor, and the last one is an excel chart from a market analyst colleague of mine. Let's take a look.

Chart 1: 30 percent of lenders across all types of credit are reporting a tightening of lending standards - over the previous year, there had been a net easing of standards for the most part. Notice the spike corresponding to the news in early August... Tougher to get financing for just about anything...

Chart 2: Specifically for home financing, the lenders report the concerns that are influencing their decision to tighten standards. Housing market woes are topping the list.


The bar for qualification has been raised, as evidenced in the charts above. Somewhere between "qualified" and "not qualified" there is a spectrum of, "qualified, but paying a premium". This spectrum, and the premiums paid has always been there, but it is much broader now, and again, the bar is lower. So more mortgage borrowers are flopping into the "qualified, but paying a premium" category.

Chart 3: Just one example of this expanded spectrum can be seen by looking at the historical spread between conforming and non-conforming (jumbo) interest rates over time. The spike in 07Q3 matches up with the charts above.


The good news is that we are seeing this spread slowly trickle back down. The markets do not expect this spread to flatten back as far as it had been in recent years, but we saw the pendulum swing from one extreme to the other, and we are in the process of returning to a more neutral ground.

Stock Market Cheatsheet

I found this on Barry Ritholtz's Big Picture blog. It seems to sum up the recent stock market sentiment pretty well:

This is circulating via email around trading desks:

>

Cheat sheet: reacting to data and market releases

weak data = Fed ease, stocks rally

consensus data = lower volatility, stocks rally

strong data = economy strengthening, stocks rally

bank loses $4bln = bad news out of the way, stocks rally

oil spikes = great for energy companies, stocks rally

oil drops = great for the consumer, stocks rally

dollar plunges = great for multinationals, stocks rally

dollar spikes = lowers inflation, stocks rally

inflation spikes = will inflate all assets, stocks rally

inflation drops = improves earnings quality, stocks rally

More Making Fun Of The Mortgage Industry

Never Take Yourself Too Seriously.