That’s the whole point of the CDO’s behind the growth of the subprime market. By splitting the mortgages into difference tranches, the senior ones are then safe enough for AAA funds. The remaining tranches are riskier and higher yielding, which is more appealing to other investors. That kind of specialization adds value and is how the IB make money.

Where it went wrong is that the sudden infusion of that money that CDO’s made available then created short-term problems related to driving costs up because now everyone can afford granite countertops. The builders saw the sudden demand and charged above the equilibrium price. Nothing wrong with that, but Wall Street didn’t take account of the fact it was a one time event, and that costs would soon revert normal. So now replacement costs are back down by 10% or so, taking existing home prices down with them.

I also think the markets and the public have an increasingly short memory for scandalous financial events. In less than half a decade Enron is little more than a catch phrase and a business school case study. Long Term Capital Management, Russia’s default, Asian stock meltdown? Mere hickups in the chase for the almighty dollar, err, euro.

I’m not sanctioning such political ingenuity, simply pointing out the new (or not so new) reality.

The difference being that junk bonds pay extraordinary yields comparatively, and cannot be purchased by most large investment funds. I would be pretty surprised if anyone could make money selling mortgages to deadbeats at credit card rates, which is what they will have to do to sell the securities, especially on a depreciating asset. The market may not disappear completely, but it will be about 1/10000th the size it is now.

Let’s say selling prices in Issaquah/Redmond (in that price range) are about 7-10% higher right now compared with the end of summer 2005. The link above (http://www.nationalcity.com/corporate/EconomicInsight/HousingValuation/default.asp?WT.mc_id=100206) shows about 18% during that time (from $343K median to $406K). The bubble numbers reported seem to be a lot higher than house prices have actually appreciated. 7-10% could just be 3-4% annual inflation. From memory, gas prices have risen about 40% since then.

While some fools bankrupt themselves at the grocery store, I will sit on the sidelines. When the crash comes, I’ll use my savings to feast on filet, (down 45%).

Jon – you may be right, but I suspect major changes (like improved transparency) have got to occur before investor’s trust securities like CDO’s again, and I do not see that happening overnite.

Stay away from Seattle Real Estate; too risky.

Back in the 80’s the big scare was over junk bonds. They too went below 20 cents on the dollar (source), and that market is alive and well (under some stress under the current correction of course). The innovations behind how that market works were carried over into the mortgage market, so not only did that market survive, but it spawned a new one.

“If these IB’s were forced to actually mark these assets to their fair market value, all of them would be INSOLVENT.”

That’s true only if you assume the fair market value is very lower than the model, which it may or may not be.

When paper money was first introduced, there were plenty of abuses…

Man, it’s a good thing that isn’t happening anymore.

The ABX indexes (http://www.markit.com/information/products/abx.html) disagree with your assertion that subprime is going to be around forever. BBB rated stuff is getting 20 cents on the dollar, with AAA rated getting 76 cents on the dollar. NOBODY is going to want to touch this stuff again.

For some further reading on why these 10b here, 10b there writeoffs are a big deal see http://www.rgemonitor.com/blog/roubini/224871.Most of these IB’s have level 3 (aka mark to made up) assets that are much larger than their capital base. If these IB’s were forced to actually mark these assets to their fair market value, all of them would be INSOLVENT. Let that sink in for a minute. This is why our corrupt Treasury secretary tried to create the super SIV, to help fraudulently hide these assets with made up values until a bailout can be created. Fortunately that plan seems to be DOA because everyone knows a "chocolate" sandwich when they smell it.

If you look at how weak the dollar is, and how it is basically dropping like a stone every day, you can see what the rest of the world thinks of our market right now. The game is over, the only question now is how much you and I will pay in taxes and inflation to bail out Wall Street.

So back to the graph, the new line will remain at a different level than it was before once the crooks are uncovered and the market gets back into a steady state.

Jon – that’s a rather sanguine view. I’m not sure it is shared by many of the former employees of these guys .

I think your definition of “steady state” is very different than mine, cuz the last 3 years have been anything but.

Sure $10B is a lot of money in terms of profit to companies that sell identical products and compete solely on price, and hence have very narrow margins, but to the underlying market it’s not that big a deal. So losing $10B out of a year’s profit sucks, but compared to $1T of deposits it can be handled.

The reason the subprime market isn’t going away is because it provides a valuable service. It’s just that it was introduced so fast that it created distortions in the market that Wall Street’s pricing models didn’t account for. After this initial wave goes through (by no means the first wave of overbuilding in history), adjustment and refinements will be made, but mainly the market will again be stable but at a higher level that is supported by the new way of financing.

When paper money was first introduced, there were plenty of abuses, but the concept survived. The same will be true with tranches. In this case low lifes at WaMu ran scams, and builders overcharged, and that caused big problems, but in tamer markets, possibly including Seattle (only time will tell) the market may be able to absorb the sudden change.

So back to the graph, the new line will remain at a different level than it was before once the crooks are uncovered and the market gets back into a steady state.

And of course, both Merrill and Citi fired their CEOs. And their stock prices are down (MER from ~$90 to $56 in six months, C from ~$55 to $35). No big deal. Happens all the time.

Now GM has written down $39B of assets today. yawn.

Easy loans are going away –

Fed: Mortgage standards tightening

……The Fed survey, which was conducted in early October, found that 41 percent of banks responding said that they had tightened loan standards either “considerably” or “somewhat” for prime residential mortgages, those offered to borrowers with strong credit histories
The 41 percent figure was up from about 15 percent of banks who said they were tightening standards on prime mortgages in the last survey in July. The Fed’s survey covered 49 banks, including many of the nation’s largest. These banks account for about 75 percent of all residential real estate loans on the books of commercial banks.

The Fed’s quarterly survey of senior loan officers found that 60 percent of the banks that offered nontraditional mortgages had tightened lending standards, up from 40 percent in the July survey. The Fed’s definition of nontraditional mortgages covers such products as interest-only loans and “Alt-A” mortgages that require limited verification of income.
The survey found that 56 percent of banks still offering subprime mortgages tightened standards in the latest survey. However, the survey said that 40 of the 49 banks surveyed said they are no longer offering subprime mortgages. Of the nine banks that are still providing such loans, five said they had tightened standards while four said lending standards were basically unchanged…..

————————————–
Below is a link to Citigroups 3rd quarter 2007 financial statement

Citigroup 8K

I claim to be no expert on reading financial statements, but it appears that Citigroup is carrying $40B of delinquent securitized receivables (loans held for sale) in 3rd Q of 07, $36B of same in 2nd Q of 07, yet held zero of these type loans in 3rd Q 06. Are these the now legendary “junk” status mortgages that nobody will buy in the secondary mortgage market?

http://seattletimes.nwsource.com/html/businesstechnology/2003997361_webhomesales06.html

Prices fell about 1% YOY in KC.

Citigroup Inc. (C) Total Cash (mrq): 987.98B
Merrill Lynch & Co. Inc. (MER) Total Cash (mrq): 730.58B

Drop in the bucket. And where did all the water in the bucket com from? Competitive loan products.

Wow. do you really think comparing a write off (which is INCOME) to the total BALANCE SHEET position of a bank (which includes the money that their customers have with them in their accounts) makes any sense at all?

Take a look at their market caps:
MER Market Cap (intraday)5: 48.22B
C Market Cap (intraday)5: 174.51B

Drop in the bucket?

This is exactly what has already happened. Keep in mind the Fed does not “print” money. It encourages an increase in credit, which inflates the money supply. The inflation we have seen in the past few years is a direct result of the increase in the money supply caused by the housing boom. The low CPI is just a result of tampering with the evidence by the government, we all know inflation has been rampant on the items they no longer include in the CPI.

The problem for the Fed is that it doesn’t have any more cards up its sleeve. How are they going to prevent a contraction of this huge credit bubble that has been growing for probably about 20 years but the last few years have been the worst? The sub prime crisis is the beginning and by the end we will see how the upward spiral of the RE boom can turn around and spiral down and the credit (or money supply, or at least a significant part of it) will evaporate into the place from which it came (nowhere) along with all the “wealth”, which really means added debt, that people had from their housing ATM’s, except that people who don’t default will still have the debt but not the wealth. This is deflation. Lowered home prices and lower prices on other things, but not everything, should be the result, along with a lot of problems for the government.

How is the Fed going to encourage lending with so many defaults? When perceived risk is higher, then either no one will lend, or the rates have to go up, and the Fed can’t change that. If the bond market says higher rates, and I think at some point during this RE bust it will, the Fed will follow, just like it has been following the bond market in lowering rates lately.

Patient, maybe this kind of analysis does work if the data gets down to a more local level. But I’m looking at those numbers and thinking, how does Seattle fit in? $317K (the “top” number in the graph, the June 2007 figure) still barely gets you in the door anywhere in the city of Seattle or across Lake Washington. That value reflects the state median—half of prices are higher, half are lower—so pretty much all of Seattle and the Eastside are on the top side.

The question becomes, what happens to the values along the X axis if you only focus in on Seattle and/or the Eastside? Hard to say off the cuff—cost of living is higher, but all stats say that KC, Seattle, and the Eastside all have higher earnings than the rest of the state, too..

Just idly wondering. Anyone want to crunch the numbers, knock yourself out.

Citigroup Inc. (C) Total Cash (mrq): 987.98B
Merrill Lynch & Co. Inc. (MER) Total Cash (mrq): 730.58B

Drop in the bucket. And where did all the water in the bucket com from? Competitive loan products.

I’ll believe teaser rate ARMS are gone when I stop getting advertisements for them in the mail. Sure, it’s down to several a week instead of several a day, but I’m still getting them. (I have a interest-only ARM, so even though it’s fixed rate for eight more years, all the marketing computers think I need to refinance)

I sold a house on the Eastside at the end of 2005, and follow the market there very closely right now, in similar neighborhoods.

In my view, the prices are still higher. I would estimate that a house that sold for 450K back in 2005 would likely sell for somewhere in the mid to high 400s. It would probably even be seen as a bargain, assuming a buyer could actually get a loan for it and “afford” the payment. I’m *guessing* that selling prices there (in that price range) are about 7-10% higher right now compared with the end of summer 2005. Listing price is another matter entirely. The listing price for a similar house would likely be 499 to 525K right now.

Only the least expensive places sell right now, and it seems VERY infrequent that I see anything sell for more than 500K. Properties for less than this sell pretty quickly, as long as they’re not total dumps, or tiny.

That’s what I’ve been seeing anyway… As I say, I watch this particular market (Issaquah, Samammish, Redmond) pretty closely.

Inventory is seasonal and always declines during the winter months then goes back up in the spring. Prices will not increase because demand also follows the same seasonal pattern.

What inflation, the 1980+ type CPIs running 2-3%….that foreign deficit you talk about is filling Walmarts with $19 DVDs and the Chinese Chery is about to put Toyota out of business with $2500 luxury cars next year.

Couple that with Seattleites/Americans making about $44K average household income stagnant since 1999 and there’s plenty of buyers for hey, $200K homes, if all the banks don’t go broke in the next few years trying to bail out the $300K loans and more outsourcing doesn’t lower our wages to $22K per household……

I can just see Washington Mutual approving $400K home loans lickety-split with all this inflation in housing? Not.

How do you guys do the hyperlinks in this blog?

It seems hard for me to believe that prices in, say, Weed or Yreka, directly paralelled what was going on in San Diego. Or, in Wash state, if Washtucna saw the same kinds of price changes as Bellevue.

And, total disposable income in the state? Probably a lot more in the big cities than the rural burgs…

The lines are pretty, but I’m skeptical about how robust the conclusions are. Location, location, location…

The most likely way for the fallout to be mitigated is that the feds print money as fast as they can; otherwise the US would default on its debt and all hell would break loose. That means massive inflation, which house prices should keep pace with in the long run. In the long run we should expect to see a big spike in house prices due solely to inflation.

The government can work all they want to restrain inflation, but that’s not going to happen when two wars are in quagmire status, a third is being planned, and NASA is readying a $trillion mission to pick up a few rocks from Mars.

Here in Seattle we’re just coming over the top and starting the downward slope. What many can dismiss now will be much more obvious and generally acknowledged by Spring ‘08. Reality always wins out over wishful thinking, and the facts do count.

Upton Sinclair

“It is difficult to get a man to understand something when his salary depends on his not understanding it.”

I think this valuation increase is comaprable to a tax increase for the majority of buyers. This is what the fed and the government should be really concerned about, think ~20-50% added tax on the working and middle class. ( Housing is the main expense for these segments ). This is what will be devestating to the consumer and economy in the longterm.
Their main focus should be to encourage rapid price deflation of homes if they want to save the economy long-term.

as for this comment…

A straight line for Disposable Income/Long-terms rates is just saying there used to be a rule that your mortgage payment could be no more than 28% of your income. When they changed that rule the line moved. The graph doesn’t really say where the line should be.

and this one

so, if the available loan product hasn’t reverted to the historic state, why would the prices revert to their historic state?

I think they miss the point. There is no “new norm” on lending. It was a fallacy – like the new valuation models that Wall St pushed in the dot-com boom. Easy loans are gone, and I doubt they return. That’s why Citi and Merrill are writing off $10B each, more to come…

I know, it’s hard to accept that the perfect storm of circumstances is bearing down on the dear old NW along with the rest of the country but those here are ones who have looked beyond the emotions of their own situations and seen the inevitable.

Remember, “it’s hard to persuade a man whose living/dreams/beliefs depend on his NOT understanding the facts” (paraphrased from somebody)

1) To drive prices up to create revenue for the states and the fed…i.e…war is coming.

2) To raise the bar on what is expected of people to pay for housing per a percentage of their paycheck.

It’s worked. They’ve driven up housing prices so far that there is no hope of return to what is should be. Even when prices come down, and all dust settles, the graph you’ll see is a step style graph…where this era will show up as a large step up from what the linear graph should have us at.

The best form of slavery is the economic kind…where people have no room to breath and have to work all the time to support themselves. Poor people in this country are well aware of that. It’s the douche bags driving around in their Escalades, Hummers, Expeditions with stickers of “Support the Troops”, who have 2, 3 kids, live in the dull, drab, and over-rated areas such as Simi Valley, Moorpark, Santa Clarita in their McMansions paying $2500, $3000 per month, big screen TVs, no life…just clean their kids diapers, etc who think they’ve got it made. The douches don’t know they’re stuck where they are and are buried up to their eyeballs in debt. But hey…they drive an Escalade.

http://www.nationalcity.com/corporate/EconomicInsight/HousingValuation/default.asp?WT.mc_id=100206

Seattle and Olympia: 38% overvalued.
Tacoma: 42% overvalued.
Bellingham: 51% overvalued.
Mount Vernon: 46% overvalued.
Bremerton: 35% overvalued.

There’s almost no savings cash in Seattle or America to speak of. The 401Ks don’t count, no one’s cashing them in before retirement.

Imagine when the savings cash that’s out there dries up after the recent foreclosure sales dry up even part of this small cash pot, in a few years.

35-50% reductions at the auctions I predict, from today.

During the Great Depression almost new used cars were going for 10 cents on the dollar. Have you tried selling a Harley Davidson or a small plane lately, without reducing last year’s price 50%?

LOL. Ostrich investors said the same in FL, CA, AZ, NV, MA, etc etc etc a short year ago. All wrong.

Wishful thinking indeed.