Wednesday, November 28, 2007

How's This For "Contained Meltdown"?

I heard one economist recently refer to the current credit markets situation as "well-contained. Sure, contained on Planet Earth..."

A large part of the reason the markets are so erratic lately is because there is so much uncertaintly as to how much damage has been done and not yet acknowledged. How much more money will be lost, and by who? Financial engineering has helped build layers upon layers of cloaking around the bad investment eggs, and the unwind is coming in baby steps (which is good, time helps the markets digest what is clearly a big rotten meal...)

So here's a story from a colleague of mine, which highlights the defensive posturing by creditors who are clearly fearing this "unknown risk" in the market. It also signifies a huge leap in terms of the webbing between "subprime" mortgage issues and areas of other financial concern. This is one way how the virus is NOT being contained...

"How far will this reach into credit cards? One fellow I know received a letter from American Express, dramatically lowering his available credit limit. Our analysis of the credit risk associated with customers who have residential loans from the creditor(s) indicated in your credit report." He has two loans: one from ING Mortgage and a HELOC from JPMorgan Chase. He called Amex and they said: "We were told by Experian that your mortgages are with 'risky lenders". They also said that "information received from a consumer credit reporting agency was factored into the decision." (He has no delinquencies. They listed standard reasons, inquiries, balances, etc.) He wrote, I have never seen credit being denied or reduced for something 100% out of the borrower's control."

Something to keep a watch on as the market feels for a bottom, those in position to lend money for any reason are proceeding with extreme caution...

Tuesday, November 27, 2007

Conforming Loan Limits For 2008 Set By OFHEO


OFHEO has announced the 2008 conforming loan limits - the limit stays at $417,000. Read the details at the OFHEO website. Were it not for the fear of widespread consumer damage from falling prices and tightening credit, the 2008 limit would likely have been reduced. They have made an exception to the general price-setting methodology to avoid adding insult to injury in the housing market. I discussed that here.

This number is based on national median home value info. For those of us in California, where median prices are higher than other states, hopes of a state-by-state limit are dashed with this latest release. OFHEO’s is not in the position to issue state-by-state guidance unless Congress enacts legislation directing them, which has not happened. And the last news on this was that Governor Schwarzenegger has issued a letter to the leaders in the U.S. Senate and the House of Representatives urging them to support legislation that would raise the loan limit for conforming loans. The median price for a home here is more than $586,000. "This disparity makes these products practically irrelevant in California. This means that for the majority of California homebuyers, the only option is to obtain a larger 'jumbo' loan and pay higher interest rates and fees," said the governor. I'd say that the conforming loans have a shorter reach, but they are hardly irrelevant. In any event, most mortgage professionals say that raising the limit would be the biggest boost for the real estate market possible here in the Golden State.” Unfortunately there is probably not much taxpayer support in the rest of the nation for this…

With rates hitting 2 year lows yesterday, anybody with a rate above 6.500% (on any type of loan) should consider refinancing. Thankfully the conforming limits are staying at 417k, as the Jumbo market is still pricing at a significant premium to conforming products.

Monday, November 19, 2007

A Great Place To Shop For Foreclosures

Its called Catanzaro Way in Antioch, California... take your pick...

There will undoubtedly be some money made by the bottom-feeders of the real estate market. And by bottom feeder, I mean opportunistic investors who use market conditions as a lever to snag inventory on the cheap. They feed off the market at its bottom. Because lets face it, what goes up must come down, but when it comes to housing, or just about any other investment, what comes down goes back up ... eventually.

We'll see a deluge of infomercials hosted by "real estate gurus", featuring average looking folks sitting poolside in a Hawaiian shirt at some resort in Orlando, and talking about their bounties in terms of monthly incomes. For $99 or $599 or 3 easy installments of $129, you can buy the books and tapes that unleash the secrets of how to get your own Aloha shirt and two tickets to the Radisson Disneyworld. We've seen it all before... These guys who make a living selling the recipe instead of baking the cake are arguably the real bottom feeders, but I can't tell you who is/isn't legitimate in that world...

But timing the markets is the challenge. Once you hear its time to get back in, it might be too late. So understanding how to find a good home, a good investment deal, and manage it safely without exposure to excessive risk will be the key until the market booms again. We'll definitely be keeping an eye on this...

Sunday, November 18, 2007

Tightening Guideliens In Mortgage Lending

The Economist has a great visual tool this week showing the trend in guideline tightening by mortgage lenders. It looks back almost 20 years, and you can see where guidelines tighten into tougher housing markets - and where they tend to get more loose (below the zero mark) during booming markets. This is quite a spike, with nearly 50% of lenders reporting that they are tightening guidelines right now.

This is why many of the borrowers who have loans entering an adjustable rate period are going to be caught between a rock and a higher payment, as many will be unable to qualify for the same loan they had, let alone a better one.

To some extent, the tightening guidelines are an over-reaction by lenders, who are trying to fix a problem after the damage has been done. Some adjustment is clearly needed, as the liberal guides can be blamed for contributing to the run-up in housing mania. But we are seeing it difficult in some cases to fit some very sensible deals together, as lenders are hyper-sensitive and picking apart every aspect of the file. Some cases, not all.

Like the housing market itself, the lender guidelines will balance out again. Markets have crossed from the manic side of balance to the panic side, and we will stay here until the participants themselves are convinced that a bottom has been reached.

Wednesday, November 14, 2007

Fragments Of Recent Market Commentary Related To Subprime Contagion

At this point, there has been a deluge of financial press about the implications of a "Mortgage Meltdown", how the Subprime problems started a Credit Crisis, (or Liquidity Crunch, Credibility Crunch, etc), and about speculation into the US Economy's chances to enter a recession. I don't think you can turn over a rock anywhere and find anybody who hasn't 'heard the news'.

In the Mortgage world, this has made everything a little more challenging. Fewer loan programs exist, fewer borrowers qualify, and fewer deals work. Its an over-reaction to the 'easy money' days we saw on the run-up in the housing market. But it will normalize. Just watch...

In the meantime, here are some snippets from articles I've recently read. Each is telling, descriptive, or interesting in the context of this changing economy and shifting housing market (my own interjections are beneath each quote where applicable):

  • In an era of spread compressuion and search for yield, the rising tide of amle liquidity covered up a profusion of jagged and dangerous rocks. As the tide now goes out, the rocks now get uncovered. The subprime crisis is a classic example of what can be unmasked at low tide. -Stephen Roach, "A Subprime Outlook For The Global Economy"
    • As a side note (John here again) This sentiment has already been famously expressed by Warren Buffett as follows: " It's only when the tide goes out that you learn who's been swimming naked", but it was spoken in relation to an entirely different issue - evidence of history repeating itself yet again...
  • Starting in 1991, the US financial sector began contributing more and more to total US corporate profits as our universities began matriculating relatively more financial engineers (modern day alchemists?) compared to mechanical engineers. -Paul Kasriel, Northern Trust
    • CDOs, CLOs, SIVs, anybody?
  • The central banks have a difficult balance to strike. If policy is too tight, they will be held responsible for creating recessions. If it is too loose, their grip on inflation could slip, as markets and the public cease to believe that prices will remain stable. The great paradox is that the central banks' mastery of inflation has made the task of keeping financial markets safe all the harder. When people are confident that inflation is low and will remain so, they may be more prepared to take on debt.That leads to an expansion of credit and the pursuit of more exotic rewards by lenders. It feeds price rises in assets such as housing and securities. It encourages excessive risk taking. If so, how can you contain inflation without sparking occasional but dangerous bouts of insanity in asset markets? That is a riddle likely to test central bankers for a long time to come. -The Economist, "Only Human"
  • The Fed is anxious to calm the credit markets, so that the economy's funds are allocated in line with risk and reward. But even if it succeeds, risky assets are likely to hold much less appeal than they did. The central banker's task is to unscramble price signals distorted by panic, not to protect the markets from a signal that they do not like. -The Economist "Paper Losses"
  • Borrowers found that such creditors, in their hunger for higher yields at a time of low interest rates, were quite willing to drop safeguards altogether, leading to a surge of "covenant-lite" loans. Because banks held on to fewer loans, they relaxed their guard. -The Economist, "Switching off the lites"
  • Providing greater short-term liquidity might ease the taking back of assets on to banks' balance sheets and hence bring down interbank rates. But it would also undermine the efficient pricing of risk by providing insurance, after the event, for risky behavior. -The Economist, "CSI: Credit Crunch"

Friday, November 09, 2007

More Signs Of A Topping Market - From Luxury Alternative Investments, And Some Market Chatter


It has been well publicized that asset markets have cycled higher in value in recent quarters, largely attributable to strong economic growth worldwide, and cheap and easy access to cash, credit and liquidity. Low rates from the US Federal reserve, as well as other countries like Japan (where the Fed Funds equivalent was at 0.000% for 8 years... 0%!! .... 8 years!!!) encouraged investors and consumers to borrow and invest and save, and economies boomed and everything got more expensive. We have seen it in the stock markets, bond markets, housing, commodities, precious metals, corporate buy-outs, you name it.

But there is another set of asset markets that tend to receive a little less publicity, and whose cycles often signal the peaking of exuberant money. In July 06, John Mauldin writes:

"Art, Wine & Horses

One of the recurrent themes of our research has been that it has "never been so expensive to be rich" and that this situation will only likely deteriorate. But even with that in mind, we have to admit that we have been floored by the recent activity at the high end of the market. Take wine, art & horses as examples. As most of our readers will know, modern art, fine wines, & horses, are assets that tend to peak just before the start of a pronounced downturn of the economic cycle. And interestingly, over the past couple of months, these assets have really been shooting up, breaking several records on the way:

* The US$16 million horse. A few months ago, a two-year-old colt who has yet to run a race drew a world record sale price of US$16 million at an auction in Florida, after a furious bidding war between Englishman Michael Tabor and Sheikh Mohammed bin Rashid al Maktoum of Dubai (could he be thinking that horses will run better than Dubai stocks?). The sale broke the previous record of US$13.1 million paid in the mid-1980s for Seattle Dancer. Considering that very few horses ever reach winnings of US$1 million and that the all-time leading earner, Cigar, took home close to US$ 10 million, this is a truly mind-boggling price to pay for a horse that has yet to race a single race (incidentally, Seattle Dancer, the previous record holder, went on to win a paltry US$150,000, racing only five times in his short career).

* The unbottled 2005 Bordeaux. In the world of wine investments, Bordeaux is king, with up to US$3.7 billion worth of wines changing hands every year. Over the past twelve months, much to Charles' chagrin (who likes to say that he is now too old to drink cheap wines), the price of top vintages have surged more than +45%. Much of this latest rally can be attributed to the - yet to be bottled - 2005 vintage. The 2005 vintage from some of the top chateaux are reportedly selling for around US$9,000 per case; as a comparison, in 2003, the same wines went for about US$3,800 per case... While investing in wine can be a very risky business, there is one undeniable advantage: if all else fails, it is a liquid asset...

* The US$135 million portrait. A few weeks ago, Robert Lauder bought a portrait by Gustav Klimt for a staggering US$135 million, the highest sum ever paid for a painting, eclipsing a Picasso sold for US$104 million in 2004. While we (by no means) would pass for art connoisseurs, prices do seem to have reached stratospheric heights. In his latest Gloom Boom Doom report, our good friend Marc Faber, describes his visit to the June Basel Art Fair, where one pure black canvas had a price tag of US$1.5 million... "

Sotheby's International, pedaler of all such things luxury is one good barometer of these markets. Look at a Sotheby's share price 2 year chart. Look like the peak has been reached? The company got kicked by shareholders today after a staggeringly poor auction result. Implication? Money is dried up. Sellers think the peak has been reached.

Paul McCulley of Pimco recently described liquidity as follows:

"... liquidity is not a pool of money but rather a state of mind. ... liquidity is about borrowers and lenders collective appetite for risk, a function of: The willingness of investors to underwrite risk and uncertainty with borrowed money and the willingness of savers to lend money to investors who want to underwrite risk and uncertainty with borrowed money..."

So with all that has been going on along with this subprime virus, and its mutating its way through our credit markets right now, its no wonder everyone is getting a tight grip on their wallets. As new stories about financial loss break daily, the confrontation with reality becomes more real. The reason for the lag between the rising rates (the Fed started raising rates in 2004) and the realization of a liquidity crisis is because, as McCulley puts it, liquidity has more to do with psychology than it does with capital.

Likewise, it will take some time for the recent Fed cuts (and the coming ones as well) to work their way through the markets and translate to brighter attitudes and expectations. Banks - who have tightened up guidelines after-the-fact, will not un-pucker until after a bottom in housing is evident. Great quote from Pimco's Bill Gross, who describes the current situation as "closing the barn door after the subprime mortgage horse has escaped from the barn."

Pretty much. Going to be some bumps in the road, but I would not underestimate the mortgage industry to come up with some creative ways to work through some of the problems, and rescue the good deals from distress; not everybody facing pain in the housing market right now deserves to be there. We shall see...

Thursday, November 08, 2007

Considering A Short-Sale?


If you are in a situation where you can no longer make your mortgage payments and your home is now worth less than you owe on it, foreclosure may not be your only option.

A "short sale," in real-estate terms, is a sale of a house in which the sale price is less than what the owner still owes on the mortgage. It is a procedure sometimes agreed to by lenders who often would rather take a small loss than go through the lengthy and costly foreclosure process.

While there are some significant negative consequences to a short sale, an ever-increasing number of properties are being advertised with that label. Proponents say, arguably, that they can be a “win-win-win” situation for seller, buyer and lender. Here's how: the seller gets out of the mortgage liability without facing bankruptcy, the buyer gets the home at a reduced price, and the lender agrees to a loss it considers minimal without going through a foreclosure and being saddled with an unsalable property.

While it may seem surprising that lenders would agree to accept less than what they are owed, they benefit from the process, too, since they don’t have to go through the lengthy foreclosure process and then having to put the property on the market and go through the whole marketing process.

I'm not sure this is a win-win-win, but maybe a win (buyer); lesser-of-two evils (lender); better-than-nothing (seller); business-as-usual (realtor).

Friday, November 02, 2007

How To Get Out Of An Option ARM

Thoughts go out to those affected by fires in Southern California.....