Seattle Bubble

The Wall Street Journal is reporting that a major industry-wide agreement to work-out issues with sub-prime mortgages coming up for resets will be announced next week.

http://online.wsj.com/article/SB119638615868608863.html?mod=hps_us_whats_news

If this kind of concerted industry action occurs, it would seem to greatly change the curve of the reset wave many analysts have been watching. Couldn't this provide a boost to the real-estate market? Far fewer people will be forced into foreclosure by a sudden rise in their payments. Fewer foreclosures would have to be positive.

On the other hand, I don't see how this would make the underlying securities backing these mortgages any more attractive. If anything, investors might want to discount mortgage securities even more if they feel the terms governing them can arbitrarily change.

And let's forget about this kind of plan re-kindling interest in new mortgage securities.

Still, on the whole such a massive re-work program might slow down price declines in the next year or so.

Interesting topic. On the one hand, it seems like a bailout would help stabilize prices, but I've just about convinced myself that I don't believe it. Ignoring conventional wisdom, here's what I see.

Supply is already at nearly 1 year, which is just ridiculously high. I believe consensus is that this has happened prior to the largest wave of defaults. Say a bailout was highly successful and prevented 1/2 of all defaults which would otherwise occur. I don't see how this number will be too different from what we saw in 2007, and there was a significant rise in supply against demand for 2007.

Taking foreclosures off the market might stabilize price declines a little, but it would also stabilize rental prices. You're taking people who would have been forced to rent and locking them into a house instead. This effects rent-vs-buy calculations.

How will this make loan originations easier? We all know that it was the easy money more than anything else that drove this bubble. The easy money is drying up. You hear the words credit crunch thrown around, but I don't think they are accurate. The point is if you need 20% to buy, there will be no buyers in NYC, San Fran, San Diego, Seattle, etc. So if the entire industry is subsidizing bums who can't pay their real rent, why would they go back to loaning to those people again?

I think this whole thing is just a boondoggle now. If it happens, maybe nationwide prices decline only 7% next year instead of 9%. If that's what the industry has to look forward to, they'd better start drinking the crazy juice today.

When the government gets involved in trying to fix or regulate an industry, at least two things happen:

1) the politicians go back and forth and back and forth so many times that by the time they're ready to pass the legislation, it's usually been watered down to a level where the impact will be less than hoped for.

2) Politicians often fails to see the big picture consequences of their grand plans, beyond the immediate impact on their chances for re-election. If they try to fix things the way their proposing, the consequences outlined by sniglet will be severe for the existing residential mortgage market. We don't want the result of what they're trying to do.

This is what I see: The foreclosure problem nationwide must be so bad that we don't even yet fully realize what we're in for. The government regulators and politicians must be seeing something we don't see such as a decline in revenues and tax dollars used to fund programs that keep the government sector jobs and win re-election for the politicians.

Where will the money come from to pay for their proposal? It better not come from our tax dollars. This problem was created by business so business ought to take the brunt of the pain. Government ought not try to save a failing business idea (adjustable rate loans). The lenders should foreclose and the homeowners should re-enter the market as renters.

Let business and industry take care of this. Let a new company spring forward that is willing to help these homeowners and refi them out of their adjusting loans. Oh, wait a minute, I forgot. President Bush already did that. He gave the world FHA Secure. Like I said months ago, this program will be largely ineffective.

If there is any significant government program that goes in place which requires lenders to hold their rates constant, I think you can kiss most new lending goodbye.

From the sketchy stories on this plan (I just saw another on Bloomberg) it seems as if the government isn't putting any money into the bail out. In similar fashion to the Super-SIV bail-out proposal, the Treasury and Fed is merely getting a lot of private parties together in a room to agree on a joint plan of action.

So far, the result seems to be that the major mortgage servicers (Citigroup, Countrywide, etc), and banks feel that it is better to extend the teaser rates of subprime loans in the hope that prices might recover and allow SOME recovery of money rather than force a massive wave of foreclosures in which the banking and investment community get wiped out altogether.

This is the hail-Mary school of business theory: your investment is toast already so you'd might as well let your bad assets ride for as long as possible just in case a miracle occurs. What do you have to lose?

Of course, the details on this bail-out are extremely vague right now, so we should be a little cautious about jumping to conclusions just yet. Remember that when the Treasury department announced the plan for a SIV bailout that the markets counced up, and a lot of ink was spread about how everyone was going to be saved. A week or so later, however, it became apparent that the SIV bail-out proposal had massive holes and it was unclear how it could actually work in the real-world. Now the SIV bail-out proposal is a running joke.

Sometimes I get the impression that political and business leaders are just trying to calm the markets through PR, and are hoping that they can come up with some wacky theoretical proposal that will allow the markets to think happy thoughts for a month or so and recover on their own. It's not like there is really an intention to follow-through with an actual bail-out after all...

According to WSJ:

"Treasury officials say financial institutions are likely to set criteria that divide subprime borrowers into three groups: those who can continue to make their payments even if rates rise, those who can't afford their mortgages even if rates stay steady, and those who could keep their homes if the maturity date of their mortgages were extended or the interest rates remained at the teaser rates. ONLY THE THIRD GROUP WILL BE ELIGIBLE FOR HELP."

Questions, why would group 1 continue to pay? I'll just play dead and be group #3. Who decide these groups? On what criterias? Most people are in group #2 anyway and that doesn't help. Who take the loses of teaser rate for all these time? Cause teaser rate does not turn a profit. What happen to the investor guarantee rate? It better not be coming out of taxpayers money. This thing is a cluster f*** in the making and wave of lawsuits waiting to happen.

Lately, I've been getting this feeling that we have no idea what we're in for and all Eleua's dark predictions are going to start staring us in the face.

To me, it seems like this entire debacle has the potential for being bigger than the S&L bailout and the Enron crisis. I feel like we're living through something historic.

I don't see how delaying the adjustment of the ARM is going to do anything but postpone the inevitable foreclosure or forced sale of these homes. If they can't afford the adjusted payment now, what makes any of us believe that they'll be able to afford the adjusted payment a few years from now, or that prices will be back up at that time so the homeowner could sell?

Any delays would seem to reward the corporate CEOs and executives by hiding the inevitable, long enough so they can collect their bonuses and check out.

Isn't that exactly what happened in Japan in the early 90's? The banks wouldn't write off loans, even though they knew they were bad. The net result being, the banks just quit lending and the economy ground to a halt.

Check this article from back in July. Seems like it may have been prescient

Hidden U.S. subprime losses may mirror Japan bank crisis

Breathtakingly cynical as well as apocalyptic in back to back posts, Jillayne! A woman after my own heart.

I think they are simply trying to spread out the losses over a longer time period so that they won't all smack he economy in the face at the same time. This conveniently allows a lot of execs time to get while the gettin's good, however.

Whether it works, I don't know. Subprime seems to be the least of our problems, so if that's all they are focusing on, this is all just hand-waving.

Slightly off topic but....

All these plans are dilatory tactics whether it's the super-SIV or freeze ARM.

These are political tactics to make sure the pain does not start next year while you know who is still in office. Call me a conspiracy theorist or whatever, but everything that's going on in DC or gov't is pure PR spin.

Don't underestimate the stupidity of citizenry of this country. They bought I-wreck bait, hook, and sinker they'll buy anything just let them switch the channel back to American Idol.....

The Repukes know they probably won't win in 2008 so what a great gift to the next admin

This is a common refrain, but I don't believe it's really all that true. The Iraq debacle really came about as a perfect storm of assumptions. People's willingness to go along with Iraq was based on a number of assumptions which turned out to be true. Everyone thinks about the WMD deal as being the only false assumption.

However, citizens (by enlarge) assumed they could trust reports coming out of the CIA, and the government at large. People assumed a new war would go as 'wonderfully' as the last Iraq war. People assumed that the federal government had already worked out a reasonable plan, and would carry it out. People assumed that most Iraqis toiled under the tyranny of Hussein's regime, and that they would welcome our soldiers as France did during WWII. Finally, they assumed that by toppling one more dictator, the world would become a slightly less dangerous place.

Since then, every American has learned that they can't trust what the government reports (WMDs), can't trust the government to act when they are in distress (New Orleans), and can't expect any solutions to our problems from the government in general.

Will this administration try to pull some strings to make sure we don't fall in to a great depression during their watch? Undoubtedly they will try. But don't expect it to fool the people. And here's one piece of proof. There are probably 6 republicans with an outside chance of getting their nomination, and probably 5 democrats. That is an extremely wide selection considering the first primaries are only a month away. People are looking for change, and people are looking for solutions, and they seem to be willing to look past Clinton, Romney, Obama, and Guilliani to get them.

Seth hits it again.

Paulson's Plan to Punish the Public
http://www.fool.com/investing/general/2 ... ublic.aspx

Seth Jayson
November 30, 2007

If you don't learn from the past ...
If the mortgage crisis and housing bubble have taught us one thing, it should be to watch out for the unintended consequences of greed. Unfortunately, our nation's legislators and political appointees haven't learned that lesson. Recent plans for housing and mortgage bailouts generally run from dumb to dumber. Today, The Wall Street Journal reported on yet another scheme, reportedly being spearheaded by Treasury Secretary Hank Paulson. It's an idea so naively populist and antimarket that you would think it came from Hugo Chavez, Evo Morales, or Mahmoud Ahmadinejad, if not for its cringe-inducing, Beltway-wonk moniker: the Hope Now Alliance.

In short, bankers and loan servicing outfits are going to lower interest rates on strapped borrowers so they don't lose their houses. How much and how long, and who qualifies are all still up in the air. No doubt, this will sound good to those folks who signed on for mortgages they can't actually afford. It will also look good to politicians angling to score points before the next election, and to bleeding hearts everywhere. It will also look good to select mortgage-industry players -- like Countrywide Financial (NYSE: CFC) and Citigroup (NYSE: C), which could really use a government-led bailout.

Unfortunately, this ill-conceived salve will ultimately punish the silent majority of Americans, people who didn't go out and make bone-headed financial decisions over the past half decade. Let's take a look at why.

A history of the housing Ponzi scheme
Since 2001, too-cheap financing pumped up housing prices to ridiculous levels. This was enabled by speculative lending from Wall Street to Main Street: Big banks like Goldman Sachs (NYSE: GS), Bear Stearns (NYSE: BSC) and others were providing the lending capital to outfits like deathwatch candidate Countrywide, mostly dead NovaStar Financial and Impac Mortgage Holdings, along with dozens of completely dead lenders. They did this by purchasing mortgage loans from these lenders so that they could chop them into mortgage-backed securities of dizzying complexity and dubious credit quality, which were, in turn, sold to suckers ... err, "investors," all over the world.

This provided a musical-chairs-like situation in which lenders produced as much volume as they could, no matter how bad the loans or credit risk, because they got paid to pass that risk along, through Wall Street's Wise bankers, to whatever "investor" ended up with the loans, in the form of stuff called MBS, CDOs, CDO-squared, R2D2, and so on. There was a flood of money to the lenders, which stimulated excessive demand, in-turn, stimulating excessive price appreciation. (You will note that there was no Paulson-led "Hope Now Alliance" coming together at that point to try and rein in this dangerous orgy of greed, though the consequences were plain to anyone who bothered to examine it.)

Greedy flippers and naive homebuyers resorted to gimmicky loans, like interest-only and "option" adjustable-rate mortgages, because it was the only way they could pay inflated prices for the properties they wanted. They got a few years of artificially low payments, thanks to artificially low teaser rates. The catch was that when the loans reset after a few years, they'd jump up several points, to 9%, 10%, 11%.

This may not sound like a big deal, until you run the math on the payments to see that many people would be facing twice the mortgage bill they were used to. Now that those mortgages are resetting and home prices are dropping like rocks, they can't make their payments, and they can't flip the houses for a profit, so loans are defaulting. The fancy securities -- what I call Wall Street dog food -- have become nearly worthless, and the music has stopped, without any chairs for anyone. Ironically, stupid, leveraged bets on these lousy securities have crippled the banks themselves, and CEOs and other execs have been getting the boot at places like Citigroup, Merrill Lynch (NYSE: MER), and Morgan Stanley (NYSE: MS).

Hank to the rescue!
Hank Paulson's latest plan to protect homebuyers from their own mistakes is simple: Lenders extend those teaser rates for a few years. It's a win-win, right? What's the harm, especially when there's no bill to pay? You just reset those interest rates to low levels, and everything will be fine, right? Who could be against a policy that would keep Americans in their homes? One negotiated with the private sector itself?

This Fool, for one.

Making the credit crunch crunchier
Remember, the only reason those teaser-rate loans were made in the first place was because lenders (and thus the investors buying the mortgages from the lenders) could count on a much larger, contractually guaranteed payoff in the future, when those interest rates were due to reset. Take away that payoff and you take away any incentive to loan to borrowers of marginal credit quality. Usher in an era when government and banks reset loan rates at their whim, and you can be sure that investors will never again buy securities based on adjustable-rate mortgages.

If you think credit is tight now, just wait until you yank away potential returns from the people putting up the capital for all those loans.

And let's not forget that Paulson's plan introduces an incredible moral hazard. By rescuing greedy and naive borrowers from their mistakes, our government encourages others to take big, stupid, bankruptcy-inducing risks, secure in the knowledge that the government will bail them out when times get rough. That means trillions of dollars in capital will be ill-invested yet again, something that's much less likely to happen when speculators are made to suffer the consequences of their behavior.

No free lunches
Here's another problem. Someone is going to have to foot the bill for this. Banks and associated entities that will, over the short term, finance this homeowner bailout are not going to do it out of the goodness of their hearts. Reported Hope Now Alliance honchos like Countrywide and Citigroup (NYSE: C) are, I'm certain, only doing this because they hope it will be cheaper than having to pay up for their lending sins all at once. Moreover, it gives them a chance to look like good guys who care about the commoners -- never mind the fact that they were quite happy to fleece borrowers with gawd-awful mortgage "affordability products" for years.

Still, this will sting some of these banks and mortgage servicers, so you can bet they're going to pass along the costs. They're going to do it by firing employees. (Countrywide and Citigroup are already doing that.) They're going to do it by moving offices to offshore tax havens, outsourcing, closing branches, lowering deposit rates, hiking fees, and whatever else it takes. (Golden parachutes for Wall Street failures are pricey.)

Worst of all, they're going to do it by soaking future borrowers -- people like the majority of us, who didn't do something stupid -- with higher rates than we would have otherwise paid for mortgage loans, credit cards, and commercial loans. They'll have to. They've got their own lenders to pay, and those lenders aren't going to simply hand over-stretched Americans a pile of money.

Foolish final thought
There's another reason that Paulson's latest plan will punish the public. It will have the effect of artificially supporting a home-price bubble that desperately needs a correction. Historical rent-to-purchase data show just how far home prices need to come down in order to return to mean. That requires a painful drop, and it will happen sooner or later.

Paulson's plan means fewer homes dumped back on the market at lower prices, where they belong. Now that he's a politician and not the CEO of Goldman Sachs, Paulson apparently believes that the market shouldn't be allowed to correct on its own. He's wrong about that, and he's wrong to support any plan that will only delay the inevitable. Better the quick, painful correction than the decades-long, slow bleed that he's nurturing now. For evidence of how ugly things get when policy-makers try to coddle the financial industry rather than let the market apply its harsher, faster, medicines, just take a look at how long the banking mess continued in Japan.

Of course, a decade from now, if the economy is still suffering because of an ill-conceived housing bailout plan designed to win favor with the public and cover the economic hind-end of his boss, George Bush, Paulson won't have to issue any gomen nasai. He'll already be long gone, retired to his millions.

You and I will pay the bills.

Well, if no bail-out takes place then MOST Americans are going to suffer terribly as housing prices collapse, and bring despair to all existing home-owners (which is the majority of families these days). Yes, it's ludicrous to expect that political leaders and business men are going to stand aside and allow house prices to crash, appearing as if they aren't doing anything about it.

It is far better to put together crazy schemes to save struggling home-owners, even at the risk of making problems worse, if the pain can be pushed off just a wee bit longer. When the housing crash comes the business leaders and politicians are all toast anyway, so why not just try to prolong things some more in the hope that a miracle will bail us out? So what if all these bail-outs make things worse in the end? The politicians and bankers are already going to be shot against the wall in the revolution, so whether the depression is a little deeper or not is irrelevant.

Furthermore, it is much better to be percieved as helping the common man than to do nothing, even if that "help" makes matters worse. Look at how much FDR is revered even though most of his policies likely only deepened the depression? Instead society looks back on all the government efforts to "help" people in the depression with a great nostalgia and fondness.

[quote="rose-colored-coolaid"]

However, citizens (by enlarge) assumed they could trust reports coming out of the CIA, and the government at large. People assumed a new war would go as 'wonderfully' as the last Iraq war. People assumed that the federal government had already worked out a reasonable plan, and would carry it out. People assumed that most Iraqis toiled under the tyranny of Hussein's regime, and that they would welcome our soldiers as France did during WWII. Finally, they assumed that by toppling one more dictator, the world would become a slightly less dangerous place.

[/quote]

Ergo, stupidity on people's part. Assumptions piled upon assumptions (sounds a lot like what made CDO such wonderful financial product). I would not contribute to it being a perfect storm...too easy a cop-out. A perfect storm almost sounds like uncontrollable circumstances came together in some random fashion. But what we have is a willful, calculated act. Leaders at the top knew what they wanted except they did not think through.

Iran and Iraq were in power equilibrium after the 1st gulf war. By taking away one, a power vacuum is created and we are seeing remifications of that today; moreover, why do the dirty work yourself by replacing Iraq with the US to confront Iran? This is not a hindsight analysis, thousands of historical data points from recent European history to ancient history could have foretold that.

Anyway, now I'm really off topic......

Mish opines on the topic here

"temporary" mortgage freeze is doomed