One of my favorite SNL bits of all time was a game show parody called What's The Best Way with Adam Sandler, Glenn Close and Phil Hartman. It was about driving directions in Boston with the accents in full-on mode.I had the You Cahn't Get There From Here thought (think thick Yankee accent) as a I read a very gloomy post from Bill Cara that a reader pointed out to me.
Bill sees a depression coming to the US and based on how I read the post he lays a lot of the cause at the feet of the sub prime market. He has a zillion charts and tables to help make the case.
I tend to view this sort of thing in terms of probability. Any outcome could be possible I suppose but what is the realistic probability of any particular outcome?
One thing I don't think I saw in Bill's post was how many people are impacted by all of the loans made that are part of the problem. What I mean is (making numbers up here to make a point) if 50% of every loan written last year was sub prime and half of those sub prime loans default; well how many people are impacted. If 1000 loans were made and 250 of them default who cares? Obviously more than 1000 loans were written but does this issue effect even 1% of homeowners? I really don't know but the number of people facing default is either significant or it is not and per the post by Bill we don't know the number.
Bill is worried about rates going up causing adjustable mortgages to reset causing people to lose their homes. Again how many families does this effect? Are there 3 million of these loans out there, or 1% of the US population? How many of those 3 million (or whatever the real figure) are impacted? One chart shows that in 3Q 2006 4.8% of sub prime mortgages are 90 days or more delinquent.
Five percent of 3 million (again a number I made up) is 150,000. Is this enough for a depression?
He could be right, but again I don't agree with him, but this discussion is not complete with out knowing how many people are impacted. He cited that 20% of 2006 originations were sub prime but again how many people is that?
To me the bigger threat is sub prime as one small-ish piece of global liquidity constraint.
I am not saying that real estate and lending are not facing some problems but I do question that a depression has as high a probability as Bill gives it.
13 comments:
I personally do not view the "sub-prime" issue as just a sub-prime issue. While you are looking at the the mortgage originations against the backdrop of all homeowners, when you look at these types of originations against the backdrop of current lending activity it provides a view of the magnitude of our current economic recovery funded by these specious loans. Accordingly, if the faucet starts to get turned off, then this provides for potential liquidity issues--contraction of liquidity and increased costs as assets (loan receivables) get written down. Already states, beginning with Ohio are promulgating loan doc requirements--this could spread to other states, and it could extend to the a Federal reach.
So if these loans were a high proportion of all loans and the real/perceived risks of these loans increases, and availability of funds to buy excess home inventory and or fund MEW declines, then these issues clearly spill over into the economy. Remember, selling an existing home does not provide economic growth. Building new homes provides economic growth through a very long food chain. That food chain is going to get very ravenous for there are fewer and fewer tiers to gorge upon.
Further, what we have not seen is the increase in the loan loss reserves at the major banks (WFC, WB who acquired GoldenWest) and other places. WB has 140B in ARM loans that it has purchased as part of its acquisition of GW. These loans on a % basis are concentrated in the trouble spots (CA, VA, AZ, FL).
FRED publishes the loan loss data monthly, the loan losses are at historical lows. My guess it that they will become parabolic once we have a full percolation of the effects of these negative amortization loans, decrease in collateralization should real estate prices fall etc.
I don't think that the above view is overly hand-wringerish, but merely realistic in understanding, proportionately, how these loans figure into our current environment.
Will that provide a depression/recession. HEck, I don't know, nor does anyone else. But if the consumer is 70% of the economy....well, it's a pretty good chance that what I outlined below will percolate through in a way that consumers will be hit and respond in their purchase patterns accordingly.
So my quibble (respectful quibble!) with your post is that your area of focus seems to incorrect. Mortgage resets are a small part of the issue--upfront liquidity loss is the larger issue insofar as my humble and inferior understanding of the issues goes!
Roger, You're our normal guy on wallst. Why: you don't live there. You can do community work without being tethered to your lap top. You know your own limitations without relying on neurotic forms of compensation. So when Bill Cara writes life as we know it is about to end, it's you that we look to translate. I like Cara's attitude..sort of screw the man and willingess to say the emperor wears no clothes, but I don't have a clue as to a psychic baseline from which to judge his seemingly thoughtful commentary.
Leisa,
great stuff; according to one of bill's tables WFC is the largest, you have a tangible number of $140 billion, so if the average mortgage is $300,000 That works out to 465,000 loans which based on another table implies about 4 million sub prime loans total (i was not that far off,wow). What is a normal default rate? what if the normal rate triples, how many loans is that.
That this dominoes into something ugly but short of a depression seems reasonable but for now I have trouble with "life as we know it ending" at the 910 comment cleverly notes.
In a way the markets almost seem to be coming back to a kind of normalcy; e.g., one of the things that felt weird the past couple years was the way second and third-tier stocks were being bid up, in some cases even higher than first-tier stocks in their sector that were clearly superior companies. When there is too much money chasing too-few assets that can happen I guess but those lower-tier names are starting to roll over, pretty much as they did in 1998, and w/ more divergence (and volatility) long-short strategies are starting to make sense again.
On the larger question, while I have made some profit shorting subprime lenders the evidence their collapse is directly infecting other markets is not particularly strong as far as I can tell (which is not to say they couldn't); TomG at Accrued Interest kindly provided one of those rarities, an intelligible description of CDO structure (http://tinyurl.com/yqu4gb), that partially allayed some concerns I had regarding mortgage backed securities generally but also made it fairly obvious that accurately predicting how some of these securities will perform under greater market stress may not be possible (shades of "portfolio insurance" perhaps but who knows).
To add to Leisa's comment, what may be more to the point is that the falling off in the mortgage, real estate, home building/improvement, asset-backed security complex is affecting a lot of folks in one way or another nationwide and, taken as a whole, appears to be having a noticeable impact on market psychology (at least as I read the tea leaves). As Japan demonstrated, deflation can be thought of as a psychological as well as an economic condition: You can make money freely available, at zero interest even, but if people are worried about their economic future and refuse to consume there is nothing you can do; that's a 'depression' if you will.
Don't think we're going there, Americans do love to buy, buy, buy, but regardless that scenario is in the long tail where it has lurked for a long, long time and, god willing, that tail will grow no fatter.
PS: As a semi-humorous aside, I had to go to my second bank safety-deposit box a month or two ago -- holds long-term docs and such and I rarely access it -- and noticed a couple bags in the back that I hadn't opened in years: My stash of Krugerrands and old silver coins that I had set aside nearly three decades ago in the 'bad old' days; that's money that hasn't been doing any real work for a long time ...but maybe I should hold on to them (now where did I stash that 12-gauge) ;-)
funny about the safety deposit box; maybe the shot gun is with the freeze dried food and MREs.
lol
Is there a beans/ammo ETF yet? I'm long survivalist compounds and moonshine producers.
Cara is an interesting dude and I learned a lot from his RSI stuff. But sometimes there's a bit of a survivalist compound vibe.
http://theperplexedinvestor.blogspot.com/2007/03/loan-losses-all-banksrelease-031207.html
I've provided a link to my modest little blog not to promote my blog in any way, but rather it easily shows the FRED schedule for loan losses. I'm not sure that it answers Roger's excellent question about was the average....at it's height, it was more than 1.5% and we are currently less than a third of that. PLUS, we have odder vehicles. Could that historical rate get blown out of the water? Yep. Remember too, that these beauties have been re-packaged and sold, so you have a much wider radius of folks affected.
I do not pretend to be anything but an amateur thinker on any of this. But I'm quite confident that the majority of folks haven't done any kind of thinking which makes a full vetting of the issue impossible. I think that we will begin that important vetting and winnowing through the crap and the fact to help solidify our understandings and quantify risks.
Well, the market is doing a bit of "vetting" today - LOL! I think that lost in the noise today is the 1.2% decline in sales at bars and restaurants - yikes!
last savings and loan crisis was bad. Hundreds of billions in losses and no one could agree how much exactly. Everyone was saying the sky was falling. We got a recession followed by a great bull market.
How bad will this housing mess end up being - who knows, but I certainly do not expect a depression or anything else from the sky is falling crowd.
I have sold off about 13% of my portfolio and will look to reinvest when the time is right.
Do not let the FEAR crowd scare you to much. For all the criticism of the fed since Volker took over they really have done an excellent job and Bernanke seems to be continuing just fine (and with as much criticism).
This correction will be over when the mass of us throws in the towel, giving up forever. And not a minute sooner. When the economic world really does fall apart, your money is no good anyway, so you can't really lose it. So we have a soft, losing real estate market for three years, the homes will end up in stronger hands, just like the stocks.
What you are ignoring is that those who bought those mortgages then levered that money 5-30X and then put that money back into the markets. Similar situation with the yen carry trade. If the principal gets pulled out from under you the margin calls begin and the asset bubble pops.
309 pm, are you saying people who buy the mortgages in the secondary market as investments then lever up to buy equities?
That trade I have not heard about, at least not with the magnitude you say. If you are correct that does sound bad unless these same folks have swaps to mitigate some portion of the potential impact.
Without the MEW I don't see how the US consumer can carry on. This recovery has been very low grade and now that liquidity is drying up I think you will be surpised at how quickly it unravels. Subprime, Alt +, some of the primes, a falling dollar unwinding carries and a massive blow up in CDO's, painful as all the profits have allready been booked. I think the DOW might go to new highs down the line but the dollar will be worth half what it is now to do it.
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