In light of the current crisis in our financial system, I am re-running a series from last February, looking back at how we got here. I will have a different piece on Oct. 3.
Part II
We continue with our discussion of Ben Bernanke’s tenure at the Federal Reserve and the housing crisis, utilizing the archives from my “Week in Review” columns. Frankly, I’m taking a bow, as you’ll see from my own comments in covering the topic, plus StocksandNews is above all the rest in incorporating the thoughts of the leading experts in the industry.
WIR 2/17/07
I kept up on events as much as I could the past week, but aside from the ongoing real estate story it doesn’t appear there is too much to discuss. Fed Chairman Ben Bernanke gave his semi-annual state of the economy message to both Houses of Congress and he basically told everyone what we already knew, at least readers of this space. Inflation is not an issue, for crying out loud. Of course he threw in the obligatory verbiage that if the economy heats up too much the Fed may have to raise rates anew, but this is all garbage. Sorry to repeat myself, but, again, Bernanke, who has obviously done a masterful job thus far, knows it would be financial suicide to hike rates, though that doesn’t mean he’s about to lower them either.
Of course where a surprise rate hike would hurt the most is in the housing sector. Lord knows there is enough suffering already, and now actual employment in the residential construction market is about to take a dive as builders wrap up their last projects that they insisted on completing. They’ll then begin to take a collective time out, hand out pink slips, and let demand catch up again with supply. Just how long this takes is anyone’s guess.
But with this week’s release of the worst housing starts figure in 10 years for the month of January, down 14% and far worse than expected, I’m taking a bow for being bang on throughout housing’s slide from Mt. Olympus, even if I was a few years early.
For every indicator that flashes a signal we may have hit a bottom, another one or two come around to slap us in the face in the form of a further reality check. And aside from the abysmal number on starts, the subprime market continues to take it on the chin as one lender after another goes under.
Even in the six-county Southern California market, where median prices have remained surprisingly stable, foreclosure rates are soaring, as Josh P.’s latest data confirmed is the case in once white-hot San Diego County.
Here’s what it comes down to. You have a large player like KB Home issue a statement that it was “encouraged” its cancellation rate of 48% in the fourth quarter was an improvement from the 53% logged in the third. Now that is truly pitiful and not even worthy of being called ‘spin.’
Even the National Association of Realtors, whose own chief economist just last year wrote a rosy book on investing in the real estate boom, had to admit sales were down 31% in Florida for the fourth quarter and off 27% in Arizona. I keep thinking back to what I saw in the Tucson market last October during a trip there; mile after mile of empty developments, as I reported to you at the time. Scary stuff if you’re on the wrong side of that trade.
WIR 3/3/07
So let’s look at our three-legged stool for clues as to where we’re headed; housing, the consumer, and capital spending.
The housing sector is nowhere near a bottom, a fact reinforced by sliding equity markets that further impact confidence. As the subprime market (those who had no right buying in the first place) craters, lending standards are tightening quickly. The Federal Reserve warned banks on Friday to be more transparent when it came to disclosing risks and earlier mortgage giant Freddie Mac said it would no longer buy the riskiest types of subprime paper, with CEO Richard Syron adding:
“The steps we are taking today will provide more protection to consumers and enhance the level of underwriting standards in the market” and, as of September, Freddie would stop buying “no income, no assets” mortgages in which borrowers are not asked to provide financial information; “stated income, stated assets” products, for which borrowers’ incomes are not easily verifiable; and certain kinds of mortgages offered with teaser rates.”
“It’s a tough situation,” said Syron. “There’s a very delicate and difficult balance between getting as many people into houses as you can, and at the same time not putting them into houses they can’t keep unless home prices are appreciating or interest rates are very low.” [Financial Times, USA Today]
Countrywide Financial, the largest U.S. home mortgage lender, said late payments on its loans were rising rapidly, to 2.9% of prime home-equity loans, up from 1.6% a year earlier; while 19% of its subprime mortgage loans were now late, up from 15.2% at the end of 2005. Not a disaster for Countrywide, yet, but you can’t ignore trends that are only going to worsen.
And then you throw in the derivatives angle. Years ago, Lewis Ranieri basically created the mortgage market. [He is best known to others for his central role in the 1989 book “Liar’s Poker.”] Ranieri was the man who came up with the idea of pooling mortgages, then slicing and dicing them to be resold as bonds to pension funds and institutional investors. It was the start of the derivatives market, in many respects.
So last weekend Ranieri told the Wall Street Journal’s James Hagerty that the business has changed so much that if the housing market goes down much further, no one will know where all the bodies are buried, which has been my point on derivatives for years, frankly. Ranieri said “I don’t know how to understand the ripple effects through the system today.” If Lew Ranieri doesn’t, do you think some fresh-faced trader does? I think not; let alone the fact there are two sides to every trade. Actually, in the derivatives market that’s part of the problem. Often there isn’t another side; it just floats out there in the Kuiper belt.
As talk increased this week of problems in housing and derivatives thereof, I couldn’t help but think of how we are also seeing a worsening of the haves vs. the have nots. Many of the have nots are seeing their dreams go up in flames, while the haves, battered, are nonetheless still in fine mettle, overall. If a rising tide lifts all boats, some higher than others, a receding one carries out the dead, while leaving the rich still sipping pina coladas from their decks on shore .
But if you needed to be cheered up this week, take heart from Fed Chairman Ben Bernanke who said the markets were working well and the economy was just Jim Dandy.
He certainly wasn’t looking at the revision on fourth quarter GDP, up only 2.2% from the first estimate of 3.5%. This is the progression in growth for the four quarters of 2006; 5.6% (Q1), 2.6%, 2.0%, 2.2%. If we have now settled into a 2%-3% pace, then, yes, that’s happyland. Slow growth, low inflation, low interest rates. Even with decelerating earnings, any damage would be limited.
But 2%-3% is not what we’ll see. Try 1%-2%, possibly worse. It will sure begin to feel like a recession.
[Ed. note first quarter GDP would come in at 0.6%, but then reaccelerate to 3.8% in the second.]
WIR 3/10/07
So what should you care about these days? Let me put it to you this way. You know how Lucy Van Pelt told Charlie Brown the only thing she wanted at Christmas was real estate? She was last seen huddling with her real estate expert and accountant on how much further she needed to slash the sales price of the 600 condos she was intending to flip in order to stay solvent. It was a fun ride for Lucy on the way up .but there is hell to pay on the way down, and lord knows Lucy isn’t handling it well. [As for Charlie Brown he’s chuckling over Lucy’s problems, after all she did to him. The kid who once gave a home to a scrawny little tree put the standard 20% down on his first and only home years ago and is sleeping soundly today. Yes, good things do happen to good people.]
You see, today’s crisis in the subprime market continues. In fact it’s almost comical how some just a few weeks ago, let alone months, were trying to convince you the bottom was in. As John Wayne would say, gaze fixed on an unknowing target, “Well hold on there, pilgrim. You see a bottom?” “Ah, no, Mr. Wayne. Sorry I brought it up.”
You know you have problems when the nation’s second-largest subprime mortgage lender, New Century Financial, may have filed for bankruptcy by the time you read this. Or when every developer, like Hovnanian, or a bank such as HSBC, continues to speak of serious issues in the housing sector, overall, and not just subprime.
In fact as you’ve undoubtedly heard, but which I would be remiss in not mentioning at least for the archives, Donald Tomnitz, CEO of builder D.R. Horton, told investors in New York that “2007 is going to suck, all 12 months of the calendar year.”
3/17/07
In their earnings reports this week, Goldman Sachs, Bear Stearns and Lehman all said their exposure to the subprime mortgage market was small and any interest they maintained well hedged. Good for them. But some of their own analysts aren’t as sanguine when it comes to the rest of those holding the paper.
Jan Hatzius, chief U.S. economist for Goldman, said in a research note, “Mortgage credit-quality problems go well beyond the subprime sector. The underlying problem is not the subprime market per se, but the reset of large quantities of adjustable-rate debt – some of which is classified as subprime some as prime – to higher interest rates in an environment of flat or falling house prices in most of the United States.” Hatzius adds that there is still a large segment of prime buyers with ARMs who are about to experience their own reset issues. [Wall Street Journal]
Adam Topalian, fixed income strategist at Lehman, told a CFA Society of Seattle dinner that the greatest risk facing investors is for the troubled subprime lending sector to lead to a spiral of falling home prices and further defaults. While Topalian added there isn’t enough evidence this is happening yet, the risk of a broader market impact is “very real.”
$900 billion in adjustable-rate mortgages is resetting over the next two years, he allowed. “Any kind of sharp pullback in lending could lead to a vicious spiral of continued housing price depreciation and defaults. This does have the potential to feed on itself and it’s a real concern.” [Reuters]
Merrill Lynch chief economist David Rosenberg, who has been warning of housing’s difficulties for quite some time, says tighter credit standards finally being implemented by mortgage lenders could lead to a 10% decline in home prices. He worries about the “knock-on effect” in sectors such as appliances and furniture; which of course can severely impact employment.
A former Federal Reserve chairman (I said last week I wouldn’t use his name anymore) weighed in on the side of Rosenberg this week, even as current chairman Ben Bernanke last insisted there will be no “spillover” from rising delinquencies. But the Fed meets this week and we await the language in the statement accompanying the certain move to continue to hold the line on rates.
Speaking of delinquency rates, this week it was announced that a staggering 13% of all subprime mortgage payments were late, while the rate of foreclosure for all classes of mortgages hit an all-time high.
Credit Suisse analyst Ivy Zelman, another who has been bang on in calling the problems in real estate, sees another issue; a 20% drop in new-home sales. Her argument is if you can’t sell your entry level home, you can’t move up. Inventory levels will thus continue to soar.
As for the homebuilders themselves, last week it was D.R. Horton CEO Donald Tomnitz who told investors “2007 is going to suck, all 12 months of the calendar year.” This week Toll Brothers CEO Robert Toll said the start of the spring selling season was “pretty much a bust,” adding “When will the market rebound? Who knows? The Shadow knows. I have no idea. I would’ve thought that it would’ve rebounded by now and I would’ve been dead wrong, and I was.” [Bloomberg News]
Actually, with their recent choice of words, some of these CEOs are beginning to lose it. And you’re still not hearing enough about their tremendous exposure to land that they remain on the hook for (and/or their banks).
All of the above spells ongoing troubles for the collateralized mortgage sector, or CDOs; the packaging of which hit $918 billion last year. According to JP Morgan, $173 billion of this paper was backed mainly by subprime mortgage bonds and related derivatives. Well, remember the old mantra around here. Many of those responsible for the coming debacle just aren’t that smart.
In the end, though, it’s the little guy who is still the biggest loser. As Countrywide CEO Angelo Mozilo told CNBC, his company being a diversified operation and not subprime heavy, the “concern is for the country.” The “rush to judgment in cutting off programs first-time buyers have used” could be crippling. The have nots lose another round to the haves, and the full carnage has yet to be felt during this developing credit crunch.
3/24/07
The Housing Sector
Two weeks ago, March 10, I wrote that I was incredulous that some actually thought what former Federal Reserve Chairman Alan Greenspan had to say at a speaking engagement or two moved the markets.
“The man is irrelevant and I see zero reason to bring him up in the future, unless it’s about his earlier forecasts as chairman which fell woefully short of being accurate.”
Well, Randall Forsyth had a terrific column in the March 19 edition of Barron’s and on the issue of Greenspan, Forsyth writes:
“In a speech to the Fed’s Community Affairs Research conference in April 2005, The Maestro sang the praises of ‘technological advances’ that ‘have resulted in increased efficiency and scale within the financial services industry. Innovation has brought about a multitude of new products, such as subprime loans,’ he continued, adding that technology had allowed lenders to size up the creditworthiness of borrowers more cheaply.
“ ‘Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today, subprime mortgages account for roughly 10% of the number of all mortgages outstanding, up from just 1% or 2% in the early 1990s.’
Forsyth:
“Since then, subprime mortgages have burgeoned to about twice that level, to around 20% of the total, according to most estimates. And the results are becoming apparent .
“Yet among the avalanche of coverage of the subprime debacle, the deterioration of adjustable-rate mortgages – even of prime quality – is still more dramatic. But three years ago, Greenspan was touting ARMs for Everyman. ‘American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage,’ he told the Credit Union National Association in 2004. ‘To the degree that households are driven by fears of payment shocks, but are willing to manage their own interest-rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.’
“As Greenspan spoke, the Fed’s key interest-rate target, the overnight federal-funds rate, stood at a mere 1%. Just over four months later, however, the Fed began tightening its monetary policy, eventually raising the funds rate 17 times, to the current 5.25% level.
“The impact on those who took Mr. G’s advice has been dramatic. The latest data from the Mortgage Bankers Association show a sharp jump in delinquencies and foreclosures in the fourth quarter. People with ARMs with low ‘teaser rates’ at the beginning are getting into trouble once they adjust up to prevailing market rates .
“But this latest fiasco goes beyond mortgages. ‘Subprime is today’s dot-com – the pin that pricks a much larger bubble,’ writes Stephen Roach, Morgan Stanley’s chief economist ‘the actors have changed, but the plot is strikingly similar,’ he continues. ‘This time, it’s the U.S. housing bubble that has burst, and the immediate repercussions have been concentrated in a relatively small segment of the market – subprime mortgage debt.
“ ‘As was the case seven years ago, I suspect a powerful dynamic has been set in motion by a small mispriced portion of a major asset class that will have surprisingly broad macro consequences for the U.S. economy as a whole,’ Roach concludes.”
James Grant, in an op-ed for the Washington Post:
“The top man at the Treasury Department urged calm last week in the face of losses on Wall Street brought on by fears of defaults on the riskier kinds of mortgages. Really, he said, the damage is easily containable.
“But of all people, Henry M. Paulson Jr., former head of the New York investment banking house of Goldman Sachs, should know just how reasonable this near-panic was. Easy credit has long been the American financial lifeblood. Anything resembling stringency on the part of our formerly carefree lenders would tend to set the economy on its ear.
“Easy credit financed the bull market in houses and the flood of home refinancings. Americans felt richer and spent as though they were. It stands to reason that the withdrawal of this manna will lead them to spend less – with substantial collateral damage to the housing-centered U.S. consumer economy, and, perhaps, well beyond. Our captains of industry owe as much to their lenders’ leniency as does any subprime, or high-risk, home buyer. They, too, have been able to raise money on terms unimaginable only four years ago.
“All this sounds scary enough, and it is. But financial history offers some solace. The U.S. economy excels in the art of facing up to error – of identifying it, reappraising it and then repricing it. Loans, especially the risky kind, have been mispriced. They were, and are, too cheap. They will be repriced – as they were, for example, in the aftermath of the junk-bond and real estate troubles of the late 1980s and early 1990s. Borrowing costs will go up, and the value of the things that debt financed will tend to go down. In an attempt to ease the pain, the Federal Reserve will print more money .
“But the ripples from this cold bath go even further than the $8 trillion mortgage market. The truth is that the no-down-payment, no-documentation, interest-only mortgage loan has its counterparts in most branches of American finance.
“The date of the last ceremonial burning of an American mortgage is lost in the mists of time. Outright, unencumbered ownership of a house, a building or a corporation is no longer an ideal that most Americans embrace. The new goal is to borrow as much as possible, as soon as possible, against any asset that could be financed. And these days – thanks to Wall Street’s ingenuity – all manner of assets pass as good collateral for a loan .
“Nowadays, loans rarely rest on the balance sheets of the lenders who make them. Rather, they are scooped up and fashioned into securities – ‘asset-backed securities.’ And these are gathered up and refashioned into still other securities – ‘collateralized debt obligations.’ And the CDOs, many of them dizzyingly complex, are sold to investors the world over. No bank regulator watches over these financial sausage-making operations. As the Federal Reserve has receded in importance in this worldwide financial system of ours, so has the U.S. banking system. A parallel kind of banking system has come into existence. Wall Street calls it the ‘CDO machine.’ .
“In a speech two years ago, Federal Reserve Chairman Ben Bernanke pointed to a curious coincidence: Growth in U.S. mortgage debt tracks closely with the growth in the trade deficit – that is, the difference between what we consume and what we produce. ‘Over the past two decades,’ he said, ‘major innovations in the United States have improved the availability and lowered the costs of home mortgages. These developments likely spurred homeowners to tap increasing home equity to finance consumer expenditures beyond home purchase. In contrast, mortgage debt is not so readily available among our trading partners as a vehicle to finance consumption expenditures.’
“If I were the head of state of one of our trading partners, I would be asking myself if these ‘major innovations’ were as wholesome as they used to seem. Deciding not, I would command my minister of investments to unload U.S. mortgage holdings. And I would imagine that I would not be the only head of state to whom this thought had occurred.”
You’d be hard-pressed to find someone who has written more than I have on the real estate bubble, and I’m continually amazed by those who offer we’ve already hit a bottom. Robert Froehlich of DWS Scudder went so far as to say the subprime mortgage crisis “will be the most hyped disaster that never occurred since Y2K.” Right, Bob, but then you have mutual funds to hump so I’d expect nothing less. How the heck can you compare Y2K, which indeed proved to be nothing (though I was taken in by it myself) to a real estate debacle that has caused real pain to a broad class of Americans; those who can least afford it? It’s that kind of irresponsible shillery (my word of the week) that gives Wall Street a bad name.
Every few weeks I have to repeat myself on a key point. When we do hit bottom in the real estate market, it is not just going to bounce right back up. Think of the plight of the Kansas City Royals baseball team. They last won 90 games in 1989 (92-70). They then stair-stepped down the next four seasons before flat-lining, with the worst period being the last five-year stretch, 2002-2006. Or, since Detroit’s housing market is suffering as bad as any these days, think the Detroit Lions. We will bottom and stay there.
But we aren’t close to that bottom yet. I also have a confession to make. Until recently I didn’t know what the definition of an “Alt-A” mortgage was, the class between subprime and prime. You know, for Alt-A, I’m told, lenders are finally demanding 5% down! This isn’t even subprime, and yet you can still get one without little documentation and basically no money down. So doesn’t that make Alt-A really the same as subprime?
Andy Laperriere of ISI Group in an op-ed for the Wall Street Journal.
“According to Credit Suisse, the number of no or low documentation loans – so-called ‘liar loans’ – increased to 49% last year from 18% of purchase loans in 2001, a nearly three-fold increase. The investment bank also found that borrowers put up less than a 5% down payment in 46% of all home purchases last year.”
That’s staggering. Laperriere:
“The Alt-A market .has increased sevenfold since 2001 and accounted for 20% of home-purchase loans last year. Fully 81% of Alt-A loans in ‘06 were no or low documentation loans. Why have borrowers employed this kind of risky financing? Because it was the only way many of them could afford a home in some of the hottest housing markets, where prices more than doubled in five years.”
There are some idiots out there, snug in their castles, who go on the air and say ‘It serves them right.’ That’s simply cruel and my heart goes out to those who made some very bad mistakes in judgment, or were flat out swindled.
I also am not one of those free marketeers who say the government needs to stay out of this mess. Wrong! Think back to the Tech Bubble. What was one thing Alan Greenspan could have done that would have without a doubt lessened the pain? Raise the margin rate. What one thing could the Fed, the FDIC, or the Comptroller of the Currency have done during the real estate boom? Insist that mortgage documents be written in plain English and spell out the risks.
You think that is hard to do? Ask my old mutual fund buddies. Years ago, when I was still in the business and before the market-timing scandals that hit the industry, we were forced to come up with simpler prospectuses that spelled out as plainly as possible the impact of expenses on shareholders. Regulators also insisted that past performance be laid out for all periods (and adjusted for applicable sales charges), not just the hottest one.
So it can be done. It doesn’t mean the government is interfering in the ability of Mr. and Mrs. Jones to buy their first home, but at least some of the homebuyers may have realized that when their mortgage resets, the payment goes up $500. It’s been shown time and time again that in many instances this wasn’t explained to them. No doubt, there is the principle of individual responsibility, but there is also accountability.
I don’t feel in the least bit sorry for speculators who were flipping Miami or Las Vegas condos and finally got burned. They should have known the risks and if they didn’t, tough.
But it makes me sick how some of the ‘little people,’ and I use the term affectionately, were burned when all they thought they were doing was pursuing the American dream.
So, no, we haven’t hit bottom and while I’m at it, let me tell you what is really on my mind, something that Barron’s Randall Forsyth and countless others in the financial press want to write but can’t because they have editors standing behind them. Alan Greenspan was not a great Fed chairman. He was a fraud, as history is increasingly revealing.
WIR 5/19/07
Believe it or not, each week I try to avoid bringing up real estate, but for the archives I do have to note that housing starts for April were up 2.5%, a mild positive, but building permits (future starts) were down 9%, the worst such figure in 17 years. The median price across the country was also down, 1.8%, in the Jan.-Mar. period, the third such quarterly decline in a row. And an index of homebuilder confidence hit a new low.
But fear not, for Federal Reserve Chairman Ben Bernanke said “the financial system will absorb the losses from the subprime mortgage problems without serious problems.”
Of course just a little while ago he was acting as if subprime would create zero problems, but who am I to argue with a man whose intelligence dwarfs all mortals’?
WIR 6/9/07
It was all about the 10-year Treasury as it rocketed through 5% and finished the week at 5.11%, the highest level in about a year. In a speech, Federal Reserve Chairman Ben Bernanke reiterated comments from the Fed’s minutes of its May 9 meeting, admitting that housing will be a “drag on economic growth for somewhat longer than previously expected,” while inflation was “somewhat elevated.” Overall, though, Bernanke is optimistic the economy will pick itself up off the floor after a lousy first quarter and those looking for a rate cut will be deeply disappointed.
Last week we talked about how the second quarter could be solid for the simple reason that store shelves needed to be replenished after inventories were run down in the first. Certainly we’ve seen a rebound in recent manufacturing data. The consensus among economists is that growth in the second quarter will be 2.6% after just a 0.6% rise in the Jan.-Mar. period. On Friday, Morgan Stanley took it a step further and said growth would accelerate to 4.1%. In either case, if this kind of growth were to carry through into the second half of the year, there is obviously no way the Fed is lowering rates. But, again, if they were to raise instead, as I have consistently said all year, it would be the death-knell for the U.S. economy. As it is, the bond market is already doing the Fed’s work in taking rates higher without Bernanke’s crew having to worry about acting itself and this alone can help dampen inflation.
Globally, rates continue higher across the board with the European Central Bank hiking its key lending rate to 4% this week, the highest since Aug. 2001, while New Zealand captured some attention when its banking officials raised their benchmark rate to 8%, second highest in the developed world next to Iceland. Where this comes into play is in perpetuating the yen carry trade; borrowing yen at 0.5% and buying 8% Kiwi paper, for example.
But what do I think is really going to happen? With the action in the bond pits this week, we are one step closer to flipping rolling over. Maybe the inventory rebound leads to a solid current quarter, but the developing headwinds are too strong to ignore.
For starters, real estate. I love the comment of Richmond Fed President Jeffrey Lacker, who reiterated his view that the economy will rebound as housing recovers.
“The housing market is likely to find a bottom some time this year and no longer be a drag on top-line growth.”
Were this true, though, it doesn’t mean we’re back off to the races, as I’ve pounded home all year. Some analysts conveniently ignore the fact that when the average American’s #1 asset is no longer rising, an asset that was the source of cash in the form of home equity loans and cash-outs, it doesn’t make you want to go out and buy a new car.
And, anyway, I don’t know how Mr. Lacker et al can claim we’re going to find a bottom just yet when housing inventories continue to rise, long after they were to have leveled off. In most parts of the country inventories are up 30% year over year. Even the National Association of Realtors, the industry’s mouthpiece, has lowered its forecast on home sales and prices for the balance of 2007.
WIR 7/21/07
Wall Street / Housing Debacle, Part XXVI
There are basically two schools of thought out there. The first says that the problems in the domestic housing sector will be contained and that the U.S. consumer will keep spending, even as their number one asset shrivels up, while the second says that housing and all the pieces of paper attached to it is far from bottoming and that eventually this will impact the health of the overall economy.
It’s pretty funny how Federal Reserve Chairman Ben Bernanke, a bright guy with a lot of brainpower, just a few weeks ago was saying that the problems in housing would indeed be contained. But this week in his semi-annual congressional testimony he was far less sanguine, saying that housing “could get worse before it gets better,” and that conditions in the subprime mortgage market “have deteriorated significantly.” As the line from Meatloaf’s “Paradise By The Dashboard Light” goes, “What’s it gonna be, boy?”
Well, you certainly know where I’ve stood on this topic, consistency being one of my virtues, I’d like to think, so I’ll let others do the talking first today; such as Freddie Mac CEO Richard Syron, who knows a thing or two about mortgages. In predicting the subprime crisis would deepen, Syron said in an interview with Bloomberg that “Unfortunately I don’t think we have hit bottom. I think things are going to get worse,” though Syron adds the crisis doesn’t threaten “the stability of our financial system.”
But noted fixed income manager Robert Rodriguez, who has been all over the mortgage debacle, told U.S. News & World Report, “We’re set up for a storm that could be much larger than Long-Term Capital,” referring to 1998’s meltdown. “The elements are all there. The tinder is there. The question is: What will be the match to set it off?”
Of course the answer is contained in the subprime market itself and the $1.8 trillion in paper that was issued, including collateralized debt obligations, or CDOs. Fed Chairman Bernanke, when asked by a senator to quantify the potential losses, said $50-$100 billion. But he doesn’t have a clue. In fact I can guarantee all he was doing was parroting a story he saw in Bloomberg or the Wall Street Journal. I’ve passed along that number, too, as well as another one that said the losses would be up to $200 billion. Of course I don’t have a clue either what the actual number will be; except for the archives I’ll say it exceeds $200 billion when all is said and written off.
We already know of $1.5 billion being wiped out in the two Bear Stearns hedge funds specializing in this crapola (the actual total is far higher, though as yet incalculable), as Archie Bunker would have opined, and the contagion has spread to London and Sydney as hedge funds are beginning to report large losses there due to investments in our mortgage paper.
But Bear Stearns added that part of the problem in their offerings was losses in AA and AAA securities, as well. In other words, yes, the problem is far from contained and we’re beginning to see emerging signs of a true credit crunch, as the likes of Washington Mutual, for example, slam the door on some of their more generous, and egregious, lending practices.
And it’s not just mortgages. Josh P. passed along a Bloomberg story I had missed that sums up the issue in the loan market, as in:
“Goldman Sachs, JP Morgan Chase and the rest of Wall Street are stuck with at least $11 billion of loans and bonds they can’t readily sell.
“The banks have had to dig into their own pockets to finance parts of at least five leveraged buyouts over the past month because of the worst bear market in high-yield debt in more than two years.
“Bankers, who just a few months ago boasted that demand for high-yield assets was so great that they would have no problem raising debt for a $100 billion LBO, are now paying for their overconfidence. The cost of tying up their own capital may curb earnings and stem the flood of LBOs, which generated a record $8.4 billion in fees during the first half of 2007, according to Brad Hintz, the former chief financial officer at New York-based Lehman Brothers .
“ ‘The private equity firms, being very tough negotiators, are unlikely to let the banks off the hook,’ said Martin Fridson,” a leading expert in the high-yield sector.
The bottom line is there are a ton of highly-leveraged deals out there that have yet to close and are relying on investors of all shapes and sizes to step up. Will they?
But back to real estate, the CEO of KB Home said on Thursday that he didn’t expect the U.S. home market to bottom until the end of next year, 2008, and that he didn’t envision any real price increases until well into 2009. You can take this to the bank. If Jeffrey Mezger is correct, as I believe he is, we have serious problems. It’s comments like Mezger’s that reaffirm my outlook of last December that it’s not 2007 when the market and the economy crater, but rather ’08.
WIR 8/4/07
I’m starting to write this segment around 3:00 p.m. on Friday and I just watched Jim Cramer on CNBC almost explode through the television set as he went ballistic over how bad it is out there on Wall Street and how Federal Reserve Chairman Ben Bernanke needs to cut interest rates immediately.
Here’s what I know. We had another week where the economic releases were less than expected, including on both manufacturing and consumer spending, we had another punk jobs report, and the rate on home mortgages, even for ‘prime’ candidates, is suddenly skyrocketing, irrespective of where the benchmark 10-year Treasury sits.
On top of this there was a slew of bad news on the mortgage originators’ front, as well as with the investment banks and anything housing related, and as reflected in July auto sales, the consumer appears to finally be pulling in their horns in earnest.
Plus there were further stories from overseas, such as with IKB, a German bank with a heavy exposure to subprime bonds, or Australian giant Macquarie, the world’s largest private manager of infrastructure (ironically) that is also in the investment game. Two of its funds lost 25% in value the past month.
The great trader/strategist Jim Rogers said this week that the U.S. subprime market rout has “a long way to go. This was one of the biggest bubbles we’ve ever had in credit.” I didn’t see his comments for Bloomberg include the fact it is a global phenomenon.
Economist Larry Kudlow, the unofficial Mr. Sunshine for the White House, said “the rest of the world is rising” so stop worrying. Economist David Hale wrote in an op-ed for the Wall Street Journal that we were witnessing the “best economy ever.” It’s all about globalization and corporations maxing out productivity, he wrote.
No doubt hundreds of millions worldwide have emerged from poverty and moved into the middle class a great thing.
But I also recall similar statements were made before the Asian currency crisis of 1997, after which many an Indonesian went back to eating insects.
Bond expert Tony Crescenzi gave a number of reasons why today’s credit crisis is nothing to be concerned about. Crescenzi noted record international reserves, record corporate cash levels, improved balance sheets at even the state level, and a strong banking system.
But that has little to do with Mr. and Mrs. Jones being able to meet their mortgage payment. And I repeat, the real estate bubble is global. Talk to any Londoner, for example. It’s about “affordability,” and a growing gap between rich and poor.
It’s the same story in China and Brazil, Russia and Spain. The rich are thriving, while the little guy is struggling mightily to just make ends meet. Before this cycle plays out you will see massive protests outside the United States, of this I’m sure.
And the pretty budget or balance sheet picture that Tony Crescenzi and others paint will lose its luster as tax revenues and profits dry up. But that’s been my 2008 scenario, though it’s kind of looking like I may need to move up the timeframe a bit.
Where the likes of Kudlow and Hale are correct, however, is in their dire warnings on protectionism, which is where Congress is headed.
Lastly, as if there wasn’t already enough bad news, throw in the fact the U.S. stock market is rigged, though on this I need to be very clear.
Over time, the average investor doesn’t have to worry. Good companies will perform like good companies, while bad will perform like bad. But the intra-day activity in many stocks, as well as the broader action at the close of trading, the last half hour, was clearly rigged this past week. The hedge funds and investment banks controlled the activity, totally irrespective of fundamentals, especially Wednesday and Thursday.
WIR 9/22/07
Wall Street...Give me 50!
The Federal Reserve met this week and in a surprise move lowered the key short-term funds rate 50 basis points, not the expected 25, to 4.75 percent after holding the line at 5.25 percent since June 2006. In its accompanying statement the Fed offered:
“Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.”
Wall Street took the rate cut bait and ran with it, back into its den, or up in some secure branch, and devoured it like a mongoose that’s just strangled a cobra. But wanting more, frothing at the mouth, and finding no road kill, traders began to do the next best thing; bid up stocks for a second straight week.
It didn’t matter that the U.S. dollar was hitting mega-year or all-time lows against other currencies, such as the euro and the Canadian dollar, the latter now at parity for the first time since the 1970s.
And it didn’t matter that gold, normally a harbinger of all things bad when it takes flight, soared to its highest levels since January 1980, or that crude oil hit a high of its own, touching $84 before finishing the week near $82 still it’s first weekly close at this
level.
It didn’t matter that the crisis in commercial paper, worldwide, is still a factor, even if a diminished one for the time being, or that the leveraged buyout premium that had helped propel stocks the first half of the year was officially kaput.
And it certainly didn’t matter that everyone’s number one asset, outside of those on the Forbes 400 list of billionaires, their home, is no longer rising 8% a year; more likely than not it’s falling.
Yet Fed Chairman Ben Bernanke told a congressional committee on Thursday that “Global financial losses have far exceeded even the most pessimistic estimates” for the mortgage sector.
Speak for yourself, Bennie Boy. Some of us were bang on, especially compared to your prior musings.
If nothing else this column is consistent. It’s gets a little repetitive, for sure, and I’m early with many of my bigger themes, such as the Nasdaq Bubble, concerns over Russia’s political situation, or real estate. But it’s been about a key word regarding this last one, “affordability,” around the world.
[Ed. I then cited past comments.]
WIR 5/29/04
“Yes, since World War II, nationwide, housing values haven’t declined in any single year, but tell that to California homeowners during the period 1989-1997, or Houston residents during the oil bust of the 1980s. No doubt, many parts of the country have more diversified economies than they once did, as in the above two cases, but the watchword is ‘affordability’ and in large swaths of America, folks are either stretching beyond their means or simply can’t make the move.
“Housing was the prime source of the wealth effect that helped carry the economy through the post-2000 bubble period, as people saw their #1 asset appreciate at 8%+ a year and then borrowed against it. And heck, I know I’m a broken record on this topic and have zero credibility by now, but the big gains are in and now we wait to see if the next move is down or sideways. Either way, many won’t feel as wealthy a few years hence, if not sooner, unless there is a spectacular rally on Wall Street, and consumer spending is bound to suffer.”
WIR 4/2/05
“Remember, the bubble isn’t just a U.S. story, it’s global; whether we’re talking Britain, Spain, Australia, or China.”
WIR 5/27/06
“Ask anyone who’s been to Europe in the past few years, chatting up a few blokes in a pub, and you’ll find everyone is buying a second home in Spain, to cite but one prominent example; thanks in no small part to the prevalence of low-cost airlines that make it far easier to jet away for the weekend. But these same communities are going to slide like the rest.”
WIR 5/12/07
“So pray the rest of the globe doesn’t catch the cold we appear to be developing, though of course it will because it is suffering from the same chief symptom we have a real estate bubble. Ours has popped. The rest are in the early stages of doing so; whether it’s Britain, Ireland, out of control Moscow, Spain, or Australasia. And you can take that to the bank.”
This week, for the first time that I can remember (at least it’s not in any of his ‘monthly outlooks’ this year), PIMCO’s Bill Gross specifically mentioned real estate bubbles in “Ireland, the UK, and Spain.” And in my daily reading I saw these headlines in just the past few days.
From the Sydney Morning Herald:
“Housing affordability has worsened (in Australia) as the pace of house price growth has outstripped increases in disposable income, said the report by Fujitsu and JP Morgan .
“ ‘It is really quite difficult now for many people to afford to buy property. There is huge demand, huge drive to own your own property,’ said the consultant at Fujitsu.”
The New Zealand Herald:
“A bank survey of residential real estate sector sentiment has presented a pessimistic picture, with many professionals saying the market has turned down fast .
“A valuer [appraiser] said some prices were ‘easing backwards’ and valuation work was very slow
“Property investors said the market had turned and the peak had been reached.”
Call this the popping of the “Lord of the Rings” bubble, in actuality.
London Times
“House prices across much of Western Europe have stalled or begun to fall as spiraling borrowing costs and fears of over-supply take their toll on markets from Ireland to Spain, an industry survey has revealed.
“The German housing market has been hit hardest. A glut of property for sale in former East Germany dragged down price inflation countrywide, leaving the national average down 6.9 percent over the 12 months to the end of June.”
Ben Bernanke may not really know what the heck is going on, but while the focus this week was to some extent on the dollar, gold and oil, when it comes to the Big Picture, globally, it’s still about real estate by my way of thinking, linked with massive debt loads.
The thing is, as I’ve noted on countless occasions, the picture is unfolding at various rates of speed, as proved yet again in the above anecdotes. I said long ago there would be no recession in 2007, but I’ve been focusing on 2008 because I felt by then it would all come to a head when the decline in a chief asset’s value finally begins to impact consumer spending and thus earnings. Frankly, some of the other items we’ve been concerning ourselves with the past two months are noise.
None of this means stocks can’t still rally. I’ve almost given up trying to predict the market. I also said the past few weeks the Federal Reserve was irrelevant, outside of a few days’ response to a change in interest rate policy, and I stand by that. The Fed, as Bernanke and former chairman Alan Greenspan both said this week, can’t be totally blamed for the housing bubble. But accomplices? Yes.
For now, I agree with Yale Professor Robert Shiller’s statement to a Senate committee.
“The decline in house prices stands to create future dislocations, like the credit crisis we have just seen.”
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Wall Street History
09/29/2008
The Fed Blows It, Part II
Bull/Bear reading, 10/1...33.7 / 47.2
In light of the current crisis in our financial system, I am re-running a series from last February, looking back at how we got here. I will have a different piece on Oct. 3.
Part II
We continue with our discussion of Ben Bernanke’s tenure at the Federal Reserve and the housing crisis, utilizing the archives from my “Week in Review” columns. Frankly, I’m taking a bow, as you’ll see from my own comments in covering the topic, plus StocksandNews is above all the rest in incorporating the thoughts of the leading experts in the industry.
WIR 2/17/07
I kept up on events as much as I could the past week, but aside from the ongoing real estate story it doesn’t appear there is too much to discuss. Fed Chairman Ben Bernanke gave his semi-annual state of the economy message to both Houses of Congress and he basically told everyone what we already knew, at least readers of this space. Inflation is not an issue, for crying out loud. Of course he threw in the obligatory verbiage that if the economy heats up too much the Fed may have to raise rates anew, but this is all garbage. Sorry to repeat myself, but, again, Bernanke, who has obviously done a masterful job thus far, knows it would be financial suicide to hike rates, though that doesn’t mean he’s about to lower them either.
Of course where a surprise rate hike would hurt the most is in the housing sector. Lord knows there is enough suffering already, and now actual employment in the residential construction market is about to take a dive as builders wrap up their last projects that they insisted on completing. They’ll then begin to take a collective time out, hand out pink slips, and let demand catch up again with supply. Just how long this takes is anyone’s guess.
But with this week’s release of the worst housing starts figure in 10 years for the month of January, down 14% and far worse than expected, I’m taking a bow for being bang on throughout housing’s slide from Mt. Olympus, even if I was a few years early.
For every indicator that flashes a signal we may have hit a bottom, another one or two come around to slap us in the face in the form of a further reality check. And aside from the abysmal number on starts, the subprime market continues to take it on the chin as one lender after another goes under.
Even in the six-county Southern California market, where median prices have remained surprisingly stable, foreclosure rates are soaring, as Josh P.’s latest data confirmed is the case in once white-hot San Diego County.
Here’s what it comes down to. You have a large player like KB Home issue a statement that it was “encouraged” its cancellation rate of 48% in the fourth quarter was an improvement from the 53% logged in the third. Now that is truly pitiful and not even worthy of being called ‘spin.’
Even the National Association of Realtors, whose own chief economist just last year wrote a rosy book on investing in the real estate boom, had to admit sales were down 31% in Florida for the fourth quarter and off 27% in Arizona. I keep thinking back to what I saw in the Tucson market last October during a trip there; mile after mile of empty developments, as I reported to you at the time. Scary stuff if you’re on the wrong side of that trade.
WIR 3/3/07
So let’s look at our three-legged stool for clues as to where we’re headed; housing, the consumer, and capital spending.
The housing sector is nowhere near a bottom, a fact reinforced by sliding equity markets that further impact confidence. As the subprime market (those who had no right buying in the first place) craters, lending standards are tightening quickly. The Federal Reserve warned banks on Friday to be more transparent when it came to disclosing risks and earlier mortgage giant Freddie Mac said it would no longer buy the riskiest types of subprime paper, with CEO Richard Syron adding:
“The steps we are taking today will provide more protection to consumers and enhance the level of underwriting standards in the market” and, as of September, Freddie would stop buying “no income, no assets” mortgages in which borrowers are not asked to provide financial information; “stated income, stated assets” products, for which borrowers’ incomes are not easily verifiable; and certain kinds of mortgages offered with teaser rates.”
“It’s a tough situation,” said Syron. “There’s a very delicate and difficult balance between getting as many people into houses as you can, and at the same time not putting them into houses they can’t keep unless home prices are appreciating or interest rates are very low.” [Financial Times, USA Today]
Countrywide Financial, the largest U.S. home mortgage lender, said late payments on its loans were rising rapidly, to 2.9% of prime home-equity loans, up from 1.6% a year earlier; while 19% of its subprime mortgage loans were now late, up from 15.2% at the end of 2005. Not a disaster for Countrywide, yet, but you can’t ignore trends that are only going to worsen.
And then you throw in the derivatives angle. Years ago, Lewis Ranieri basically created the mortgage market. [He is best known to others for his central role in the 1989 book “Liar’s Poker.”] Ranieri was the man who came up with the idea of pooling mortgages, then slicing and dicing them to be resold as bonds to pension funds and institutional investors. It was the start of the derivatives market, in many respects.
So last weekend Ranieri told the Wall Street Journal’s James Hagerty that the business has changed so much that if the housing market goes down much further, no one will know where all the bodies are buried, which has been my point on derivatives for years, frankly. Ranieri said “I don’t know how to understand the ripple effects through the system today.” If Lew Ranieri doesn’t, do you think some fresh-faced trader does? I think not; let alone the fact there are two sides to every trade. Actually, in the derivatives market that’s part of the problem. Often there isn’t another side; it just floats out there in the Kuiper belt.
As talk increased this week of problems in housing and derivatives thereof, I couldn’t help but think of how we are also seeing a worsening of the haves vs. the have nots. Many of the have nots are seeing their dreams go up in flames, while the haves, battered, are nonetheless still in fine mettle, overall. If a rising tide lifts all boats, some higher than others, a receding one carries out the dead, while leaving the rich still sipping pina coladas from their decks on shore .
But if you needed to be cheered up this week, take heart from Fed Chairman Ben Bernanke who said the markets were working well and the economy was just Jim Dandy.
He certainly wasn’t looking at the revision on fourth quarter GDP, up only 2.2% from the first estimate of 3.5%. This is the progression in growth for the four quarters of 2006; 5.6% (Q1), 2.6%, 2.0%, 2.2%. If we have now settled into a 2%-3% pace, then, yes, that’s happyland. Slow growth, low inflation, low interest rates. Even with decelerating earnings, any damage would be limited.
But 2%-3% is not what we’ll see. Try 1%-2%, possibly worse. It will sure begin to feel like a recession.
[Ed. note first quarter GDP would come in at 0.6%, but then reaccelerate to 3.8% in the second.]
WIR 3/10/07
So what should you care about these days? Let me put it to you this way. You know how Lucy Van Pelt told Charlie Brown the only thing she wanted at Christmas was real estate? She was last seen huddling with her real estate expert and accountant on how much further she needed to slash the sales price of the 600 condos she was intending to flip in order to stay solvent. It was a fun ride for Lucy on the way up .but there is hell to pay on the way down, and lord knows Lucy isn’t handling it well. [As for Charlie Brown he’s chuckling over Lucy’s problems, after all she did to him. The kid who once gave a home to a scrawny little tree put the standard 20% down on his first and only home years ago and is sleeping soundly today. Yes, good things do happen to good people.]
You see, today’s crisis in the subprime market continues. In fact it’s almost comical how some just a few weeks ago, let alone months, were trying to convince you the bottom was in. As John Wayne would say, gaze fixed on an unknowing target, “Well hold on there, pilgrim. You see a bottom?” “Ah, no, Mr. Wayne. Sorry I brought it up.”
You know you have problems when the nation’s second-largest subprime mortgage lender, New Century Financial, may have filed for bankruptcy by the time you read this. Or when every developer, like Hovnanian, or a bank such as HSBC, continues to speak of serious issues in the housing sector, overall, and not just subprime.
In fact as you’ve undoubtedly heard, but which I would be remiss in not mentioning at least for the archives, Donald Tomnitz, CEO of builder D.R. Horton, told investors in New York that “2007 is going to suck, all 12 months of the calendar year.”
3/17/07
In their earnings reports this week, Goldman Sachs, Bear Stearns and Lehman all said their exposure to the subprime mortgage market was small and any interest they maintained well hedged. Good for them. But some of their own analysts aren’t as sanguine when it comes to the rest of those holding the paper.
Jan Hatzius, chief U.S. economist for Goldman, said in a research note, “Mortgage credit-quality problems go well beyond the subprime sector. The underlying problem is not the subprime market per se, but the reset of large quantities of adjustable-rate debt – some of which is classified as subprime some as prime – to higher interest rates in an environment of flat or falling house prices in most of the United States.” Hatzius adds that there is still a large segment of prime buyers with ARMs who are about to experience their own reset issues. [Wall Street Journal]
Adam Topalian, fixed income strategist at Lehman, told a CFA Society of Seattle dinner that the greatest risk facing investors is for the troubled subprime lending sector to lead to a spiral of falling home prices and further defaults. While Topalian added there isn’t enough evidence this is happening yet, the risk of a broader market impact is “very real.”
$900 billion in adjustable-rate mortgages is resetting over the next two years, he allowed. “Any kind of sharp pullback in lending could lead to a vicious spiral of continued housing price depreciation and defaults. This does have the potential to feed on itself and it’s a real concern.” [Reuters]
Merrill Lynch chief economist David Rosenberg, who has been warning of housing’s difficulties for quite some time, says tighter credit standards finally being implemented by mortgage lenders could lead to a 10% decline in home prices. He worries about the “knock-on effect” in sectors such as appliances and furniture; which of course can severely impact employment.
A former Federal Reserve chairman (I said last week I wouldn’t use his name anymore) weighed in on the side of Rosenberg this week, even as current chairman Ben Bernanke last insisted there will be no “spillover” from rising delinquencies. But the Fed meets this week and we await the language in the statement accompanying the certain move to continue to hold the line on rates.
Speaking of delinquency rates, this week it was announced that a staggering 13% of all subprime mortgage payments were late, while the rate of foreclosure for all classes of mortgages hit an all-time high.
Credit Suisse analyst Ivy Zelman, another who has been bang on in calling the problems in real estate, sees another issue; a 20% drop in new-home sales. Her argument is if you can’t sell your entry level home, you can’t move up. Inventory levels will thus continue to soar.
As for the homebuilders themselves, last week it was D.R. Horton CEO Donald Tomnitz who told investors “2007 is going to suck, all 12 months of the calendar year.” This week Toll Brothers CEO Robert Toll said the start of the spring selling season was “pretty much a bust,” adding “When will the market rebound? Who knows? The Shadow knows. I have no idea. I would’ve thought that it would’ve rebounded by now and I would’ve been dead wrong, and I was.” [Bloomberg News]
Actually, with their recent choice of words, some of these CEOs are beginning to lose it. And you’re still not hearing enough about their tremendous exposure to land that they remain on the hook for (and/or their banks).
All of the above spells ongoing troubles for the collateralized mortgage sector, or CDOs; the packaging of which hit $918 billion last year. According to JP Morgan, $173 billion of this paper was backed mainly by subprime mortgage bonds and related derivatives. Well, remember the old mantra around here. Many of those responsible for the coming debacle just aren’t that smart.
In the end, though, it’s the little guy who is still the biggest loser. As Countrywide CEO Angelo Mozilo told CNBC, his company being a diversified operation and not subprime heavy, the “concern is for the country.” The “rush to judgment in cutting off programs first-time buyers have used” could be crippling. The have nots lose another round to the haves, and the full carnage has yet to be felt during this developing credit crunch.
3/24/07
The Housing Sector
Two weeks ago, March 10, I wrote that I was incredulous that some actually thought what former Federal Reserve Chairman Alan Greenspan had to say at a speaking engagement or two moved the markets.
“The man is irrelevant and I see zero reason to bring him up in the future, unless it’s about his earlier forecasts as chairman which fell woefully short of being accurate.”
Well, Randall Forsyth had a terrific column in the March 19 edition of Barron’s and on the issue of Greenspan, Forsyth writes:
“In a speech to the Fed’s Community Affairs Research conference in April 2005, The Maestro sang the praises of ‘technological advances’ that ‘have resulted in increased efficiency and scale within the financial services industry. Innovation has brought about a multitude of new products, such as subprime loans,’ he continued, adding that technology had allowed lenders to size up the creditworthiness of borrowers more cheaply.
“ ‘Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today, subprime mortgages account for roughly 10% of the number of all mortgages outstanding, up from just 1% or 2% in the early 1990s.’
Forsyth:
“Since then, subprime mortgages have burgeoned to about twice that level, to around 20% of the total, according to most estimates. And the results are becoming apparent .
“Yet among the avalanche of coverage of the subprime debacle, the deterioration of adjustable-rate mortgages – even of prime quality – is still more dramatic. But three years ago, Greenspan was touting ARMs for Everyman. ‘American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage,’ he told the Credit Union National Association in 2004. ‘To the degree that households are driven by fears of payment shocks, but are willing to manage their own interest-rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.’
“As Greenspan spoke, the Fed’s key interest-rate target, the overnight federal-funds rate, stood at a mere 1%. Just over four months later, however, the Fed began tightening its monetary policy, eventually raising the funds rate 17 times, to the current 5.25% level.
“The impact on those who took Mr. G’s advice has been dramatic. The latest data from the Mortgage Bankers Association show a sharp jump in delinquencies and foreclosures in the fourth quarter. People with ARMs with low ‘teaser rates’ at the beginning are getting into trouble once they adjust up to prevailing market rates .
“But this latest fiasco goes beyond mortgages. ‘Subprime is today’s dot-com – the pin that pricks a much larger bubble,’ writes Stephen Roach, Morgan Stanley’s chief economist ‘the actors have changed, but the plot is strikingly similar,’ he continues. ‘This time, it’s the U.S. housing bubble that has burst, and the immediate repercussions have been concentrated in a relatively small segment of the market – subprime mortgage debt.
“ ‘As was the case seven years ago, I suspect a powerful dynamic has been set in motion by a small mispriced portion of a major asset class that will have surprisingly broad macro consequences for the U.S. economy as a whole,’ Roach concludes.”
James Grant, in an op-ed for the Washington Post:
“The top man at the Treasury Department urged calm last week in the face of losses on Wall Street brought on by fears of defaults on the riskier kinds of mortgages. Really, he said, the damage is easily containable.
“But of all people, Henry M. Paulson Jr., former head of the New York investment banking house of Goldman Sachs, should know just how reasonable this near-panic was. Easy credit has long been the American financial lifeblood. Anything resembling stringency on the part of our formerly carefree lenders would tend to set the economy on its ear.
“Easy credit financed the bull market in houses and the flood of home refinancings. Americans felt richer and spent as though they were. It stands to reason that the withdrawal of this manna will lead them to spend less – with substantial collateral damage to the housing-centered U.S. consumer economy, and, perhaps, well beyond. Our captains of industry owe as much to their lenders’ leniency as does any subprime, or high-risk, home buyer. They, too, have been able to raise money on terms unimaginable only four years ago.
“All this sounds scary enough, and it is. But financial history offers some solace. The U.S. economy excels in the art of facing up to error – of identifying it, reappraising it and then repricing it. Loans, especially the risky kind, have been mispriced. They were, and are, too cheap. They will be repriced – as they were, for example, in the aftermath of the junk-bond and real estate troubles of the late 1980s and early 1990s. Borrowing costs will go up, and the value of the things that debt financed will tend to go down. In an attempt to ease the pain, the Federal Reserve will print more money .
“But the ripples from this cold bath go even further than the $8 trillion mortgage market. The truth is that the no-down-payment, no-documentation, interest-only mortgage loan has its counterparts in most branches of American finance.
“The date of the last ceremonial burning of an American mortgage is lost in the mists of time. Outright, unencumbered ownership of a house, a building or a corporation is no longer an ideal that most Americans embrace. The new goal is to borrow as much as possible, as soon as possible, against any asset that could be financed. And these days – thanks to Wall Street’s ingenuity – all manner of assets pass as good collateral for a loan .
“Nowadays, loans rarely rest on the balance sheets of the lenders who make them. Rather, they are scooped up and fashioned into securities – ‘asset-backed securities.’ And these are gathered up and refashioned into still other securities – ‘collateralized debt obligations.’ And the CDOs, many of them dizzyingly complex, are sold to investors the world over. No bank regulator watches over these financial sausage-making operations. As the Federal Reserve has receded in importance in this worldwide financial system of ours, so has the U.S. banking system. A parallel kind of banking system has come into existence. Wall Street calls it the ‘CDO machine.’ .
“In a speech two years ago, Federal Reserve Chairman Ben Bernanke pointed to a curious coincidence: Growth in U.S. mortgage debt tracks closely with the growth in the trade deficit – that is, the difference between what we consume and what we produce. ‘Over the past two decades,’ he said, ‘major innovations in the United States have improved the availability and lowered the costs of home mortgages. These developments likely spurred homeowners to tap increasing home equity to finance consumer expenditures beyond home purchase. In contrast, mortgage debt is not so readily available among our trading partners as a vehicle to finance consumption expenditures.’
“If I were the head of state of one of our trading partners, I would be asking myself if these ‘major innovations’ were as wholesome as they used to seem. Deciding not, I would command my minister of investments to unload U.S. mortgage holdings. And I would imagine that I would not be the only head of state to whom this thought had occurred.”
You’d be hard-pressed to find someone who has written more than I have on the real estate bubble, and I’m continually amazed by those who offer we’ve already hit a bottom. Robert Froehlich of DWS Scudder went so far as to say the subprime mortgage crisis “will be the most hyped disaster that never occurred since Y2K.” Right, Bob, but then you have mutual funds to hump so I’d expect nothing less. How the heck can you compare Y2K, which indeed proved to be nothing (though I was taken in by it myself) to a real estate debacle that has caused real pain to a broad class of Americans; those who can least afford it? It’s that kind of irresponsible shillery (my word of the week) that gives Wall Street a bad name.
Every few weeks I have to repeat myself on a key point. When we do hit bottom in the real estate market, it is not just going to bounce right back up. Think of the plight of the Kansas City Royals baseball team. They last won 90 games in 1989 (92-70). They then stair-stepped down the next four seasons before flat-lining, with the worst period being the last five-year stretch, 2002-2006. Or, since Detroit’s housing market is suffering as bad as any these days, think the Detroit Lions. We will bottom and stay there.
But we aren’t close to that bottom yet. I also have a confession to make. Until recently I didn’t know what the definition of an “Alt-A” mortgage was, the class between subprime and prime. You know, for Alt-A, I’m told, lenders are finally demanding 5% down! This isn’t even subprime, and yet you can still get one without little documentation and basically no money down. So doesn’t that make Alt-A really the same as subprime?
Andy Laperriere of ISI Group in an op-ed for the Wall Street Journal.
“According to Credit Suisse, the number of no or low documentation loans – so-called ‘liar loans’ – increased to 49% last year from 18% of purchase loans in 2001, a nearly three-fold increase. The investment bank also found that borrowers put up less than a 5% down payment in 46% of all home purchases last year.”
That’s staggering. Laperriere:
“The Alt-A market .has increased sevenfold since 2001 and accounted for 20% of home-purchase loans last year. Fully 81% of Alt-A loans in ‘06 were no or low documentation loans. Why have borrowers employed this kind of risky financing? Because it was the only way many of them could afford a home in some of the hottest housing markets, where prices more than doubled in five years.”
There are some idiots out there, snug in their castles, who go on the air and say ‘It serves them right.’ That’s simply cruel and my heart goes out to those who made some very bad mistakes in judgment, or were flat out swindled.
I also am not one of those free marketeers who say the government needs to stay out of this mess. Wrong! Think back to the Tech Bubble. What was one thing Alan Greenspan could have done that would have without a doubt lessened the pain? Raise the margin rate. What one thing could the Fed, the FDIC, or the Comptroller of the Currency have done during the real estate boom? Insist that mortgage documents be written in plain English and spell out the risks.
You think that is hard to do? Ask my old mutual fund buddies. Years ago, when I was still in the business and before the market-timing scandals that hit the industry, we were forced to come up with simpler prospectuses that spelled out as plainly as possible the impact of expenses on shareholders. Regulators also insisted that past performance be laid out for all periods (and adjusted for applicable sales charges), not just the hottest one.
So it can be done. It doesn’t mean the government is interfering in the ability of Mr. and Mrs. Jones to buy their first home, but at least some of the homebuyers may have realized that when their mortgage resets, the payment goes up $500. It’s been shown time and time again that in many instances this wasn’t explained to them. No doubt, there is the principle of individual responsibility, but there is also accountability.
I don’t feel in the least bit sorry for speculators who were flipping Miami or Las Vegas condos and finally got burned. They should have known the risks and if they didn’t, tough.
But it makes me sick how some of the ‘little people,’ and I use the term affectionately, were burned when all they thought they were doing was pursuing the American dream.
So, no, we haven’t hit bottom and while I’m at it, let me tell you what is really on my mind, something that Barron’s Randall Forsyth and countless others in the financial press want to write but can’t because they have editors standing behind them. Alan Greenspan was not a great Fed chairman. He was a fraud, as history is increasingly revealing.
WIR 5/19/07
Believe it or not, each week I try to avoid bringing up real estate, but for the archives I do have to note that housing starts for April were up 2.5%, a mild positive, but building permits (future starts) were down 9%, the worst such figure in 17 years. The median price across the country was also down, 1.8%, in the Jan.-Mar. period, the third such quarterly decline in a row. And an index of homebuilder confidence hit a new low.
But fear not, for Federal Reserve Chairman Ben Bernanke said “the financial system will absorb the losses from the subprime mortgage problems without serious problems.”
Of course just a little while ago he was acting as if subprime would create zero problems, but who am I to argue with a man whose intelligence dwarfs all mortals’?
WIR 6/9/07
It was all about the 10-year Treasury as it rocketed through 5% and finished the week at 5.11%, the highest level in about a year. In a speech, Federal Reserve Chairman Ben Bernanke reiterated comments from the Fed’s minutes of its May 9 meeting, admitting that housing will be a “drag on economic growth for somewhat longer than previously expected,” while inflation was “somewhat elevated.” Overall, though, Bernanke is optimistic the economy will pick itself up off the floor after a lousy first quarter and those looking for a rate cut will be deeply disappointed.
Last week we talked about how the second quarter could be solid for the simple reason that store shelves needed to be replenished after inventories were run down in the first. Certainly we’ve seen a rebound in recent manufacturing data. The consensus among economists is that growth in the second quarter will be 2.6% after just a 0.6% rise in the Jan.-Mar. period. On Friday, Morgan Stanley took it a step further and said growth would accelerate to 4.1%. In either case, if this kind of growth were to carry through into the second half of the year, there is obviously no way the Fed is lowering rates. But, again, if they were to raise instead, as I have consistently said all year, it would be the death-knell for the U.S. economy. As it is, the bond market is already doing the Fed’s work in taking rates higher without Bernanke’s crew having to worry about acting itself and this alone can help dampen inflation.
Globally, rates continue higher across the board with the European Central Bank hiking its key lending rate to 4% this week, the highest since Aug. 2001, while New Zealand captured some attention when its banking officials raised their benchmark rate to 8%, second highest in the developed world next to Iceland. Where this comes into play is in perpetuating the yen carry trade; borrowing yen at 0.5% and buying 8% Kiwi paper, for example.
But what do I think is really going to happen? With the action in the bond pits this week, we are one step closer to flipping rolling over. Maybe the inventory rebound leads to a solid current quarter, but the developing headwinds are too strong to ignore.
For starters, real estate. I love the comment of Richmond Fed President Jeffrey Lacker, who reiterated his view that the economy will rebound as housing recovers.
“The housing market is likely to find a bottom some time this year and no longer be a drag on top-line growth.”
Were this true, though, it doesn’t mean we’re back off to the races, as I’ve pounded home all year. Some analysts conveniently ignore the fact that when the average American’s #1 asset is no longer rising, an asset that was the source of cash in the form of home equity loans and cash-outs, it doesn’t make you want to go out and buy a new car.
And, anyway, I don’t know how Mr. Lacker et al can claim we’re going to find a bottom just yet when housing inventories continue to rise, long after they were to have leveled off. In most parts of the country inventories are up 30% year over year. Even the National Association of Realtors, the industry’s mouthpiece, has lowered its forecast on home sales and prices for the balance of 2007.
WIR 7/21/07
Wall Street / Housing Debacle, Part XXVI
There are basically two schools of thought out there. The first says that the problems in the domestic housing sector will be contained and that the U.S. consumer will keep spending, even as their number one asset shrivels up, while the second says that housing and all the pieces of paper attached to it is far from bottoming and that eventually this will impact the health of the overall economy.
It’s pretty funny how Federal Reserve Chairman Ben Bernanke, a bright guy with a lot of brainpower, just a few weeks ago was saying that the problems in housing would indeed be contained. But this week in his semi-annual congressional testimony he was far less sanguine, saying that housing “could get worse before it gets better,” and that conditions in the subprime mortgage market “have deteriorated significantly.” As the line from Meatloaf’s “Paradise By The Dashboard Light” goes, “What’s it gonna be, boy?”
Well, you certainly know where I’ve stood on this topic, consistency being one of my virtues, I’d like to think, so I’ll let others do the talking first today; such as Freddie Mac CEO Richard Syron, who knows a thing or two about mortgages. In predicting the subprime crisis would deepen, Syron said in an interview with Bloomberg that “Unfortunately I don’t think we have hit bottom. I think things are going to get worse,” though Syron adds the crisis doesn’t threaten “the stability of our financial system.”
But noted fixed income manager Robert Rodriguez, who has been all over the mortgage debacle, told U.S. News & World Report, “We’re set up for a storm that could be much larger than Long-Term Capital,” referring to 1998’s meltdown. “The elements are all there. The tinder is there. The question is: What will be the match to set it off?”
Of course the answer is contained in the subprime market itself and the $1.8 trillion in paper that was issued, including collateralized debt obligations, or CDOs. Fed Chairman Bernanke, when asked by a senator to quantify the potential losses, said $50-$100 billion. But he doesn’t have a clue. In fact I can guarantee all he was doing was parroting a story he saw in Bloomberg or the Wall Street Journal. I’ve passed along that number, too, as well as another one that said the losses would be up to $200 billion. Of course I don’t have a clue either what the actual number will be; except for the archives I’ll say it exceeds $200 billion when all is said and written off.
We already know of $1.5 billion being wiped out in the two Bear Stearns hedge funds specializing in this crapola (the actual total is far higher, though as yet incalculable), as Archie Bunker would have opined, and the contagion has spread to London and Sydney as hedge funds are beginning to report large losses there due to investments in our mortgage paper.
But Bear Stearns added that part of the problem in their offerings was losses in AA and AAA securities, as well. In other words, yes, the problem is far from contained and we’re beginning to see emerging signs of a true credit crunch, as the likes of Washington Mutual, for example, slam the door on some of their more generous, and egregious, lending practices.
And it’s not just mortgages. Josh P. passed along a Bloomberg story I had missed that sums up the issue in the loan market, as in:
“Goldman Sachs, JP Morgan Chase and the rest of Wall Street are stuck with at least $11 billion of loans and bonds they can’t readily sell.
“The banks have had to dig into their own pockets to finance parts of at least five leveraged buyouts over the past month because of the worst bear market in high-yield debt in more than two years.
“Bankers, who just a few months ago boasted that demand for high-yield assets was so great that they would have no problem raising debt for a $100 billion LBO, are now paying for their overconfidence. The cost of tying up their own capital may curb earnings and stem the flood of LBOs, which generated a record $8.4 billion in fees during the first half of 2007, according to Brad Hintz, the former chief financial officer at New York-based Lehman Brothers .
“ ‘The private equity firms, being very tough negotiators, are unlikely to let the banks off the hook,’ said Martin Fridson,” a leading expert in the high-yield sector.
The bottom line is there are a ton of highly-leveraged deals out there that have yet to close and are relying on investors of all shapes and sizes to step up. Will they?
But back to real estate, the CEO of KB Home said on Thursday that he didn’t expect the U.S. home market to bottom until the end of next year, 2008, and that he didn’t envision any real price increases until well into 2009. You can take this to the bank. If Jeffrey Mezger is correct, as I believe he is, we have serious problems. It’s comments like Mezger’s that reaffirm my outlook of last December that it’s not 2007 when the market and the economy crater, but rather ’08.
WIR 8/4/07
I’m starting to write this segment around 3:00 p.m. on Friday and I just watched Jim Cramer on CNBC almost explode through the television set as he went ballistic over how bad it is out there on Wall Street and how Federal Reserve Chairman Ben Bernanke needs to cut interest rates immediately.
Here’s what I know. We had another week where the economic releases were less than expected, including on both manufacturing and consumer spending, we had another punk jobs report, and the rate on home mortgages, even for ‘prime’ candidates, is suddenly skyrocketing, irrespective of where the benchmark 10-year Treasury sits.
On top of this there was a slew of bad news on the mortgage originators’ front, as well as with the investment banks and anything housing related, and as reflected in July auto sales, the consumer appears to finally be pulling in their horns in earnest.
Plus there were further stories from overseas, such as with IKB, a German bank with a heavy exposure to subprime bonds, or Australian giant Macquarie, the world’s largest private manager of infrastructure (ironically) that is also in the investment game. Two of its funds lost 25% in value the past month.
The great trader/strategist Jim Rogers said this week that the U.S. subprime market rout has “a long way to go. This was one of the biggest bubbles we’ve ever had in credit.” I didn’t see his comments for Bloomberg include the fact it is a global phenomenon.
Economist Larry Kudlow, the unofficial Mr. Sunshine for the White House, said “the rest of the world is rising” so stop worrying. Economist David Hale wrote in an op-ed for the Wall Street Journal that we were witnessing the “best economy ever.” It’s all about globalization and corporations maxing out productivity, he wrote.
No doubt hundreds of millions worldwide have emerged from poverty and moved into the middle class a great thing.
But I also recall similar statements were made before the Asian currency crisis of 1997, after which many an Indonesian went back to eating insects.
Bond expert Tony Crescenzi gave a number of reasons why today’s credit crisis is nothing to be concerned about. Crescenzi noted record international reserves, record corporate cash levels, improved balance sheets at even the state level, and a strong banking system.
But that has little to do with Mr. and Mrs. Jones being able to meet their mortgage payment. And I repeat, the real estate bubble is global. Talk to any Londoner, for example. It’s about “affordability,” and a growing gap between rich and poor.
It’s the same story in China and Brazil, Russia and Spain. The rich are thriving, while the little guy is struggling mightily to just make ends meet. Before this cycle plays out you will see massive protests outside the United States, of this I’m sure.
And the pretty budget or balance sheet picture that Tony Crescenzi and others paint will lose its luster as tax revenues and profits dry up. But that’s been my 2008 scenario, though it’s kind of looking like I may need to move up the timeframe a bit.
Where the likes of Kudlow and Hale are correct, however, is in their dire warnings on protectionism, which is where Congress is headed.
Lastly, as if there wasn’t already enough bad news, throw in the fact the U.S. stock market is rigged, though on this I need to be very clear.
Over time, the average investor doesn’t have to worry. Good companies will perform like good companies, while bad will perform like bad. But the intra-day activity in many stocks, as well as the broader action at the close of trading, the last half hour, was clearly rigged this past week. The hedge funds and investment banks controlled the activity, totally irrespective of fundamentals, especially Wednesday and Thursday.
WIR 9/22/07
Wall Street...Give me 50!
The Federal Reserve met this week and in a surprise move lowered the key short-term funds rate 50 basis points, not the expected 25, to 4.75 percent after holding the line at 5.25 percent since June 2006. In its accompanying statement the Fed offered:
“Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.”
Wall Street took the rate cut bait and ran with it, back into its den, or up in some secure branch, and devoured it like a mongoose that’s just strangled a cobra. But wanting more, frothing at the mouth, and finding no road kill, traders began to do the next best thing; bid up stocks for a second straight week.
It didn’t matter that the U.S. dollar was hitting mega-year or all-time lows against other currencies, such as the euro and the Canadian dollar, the latter now at parity for the first time since the 1970s.
And it didn’t matter that gold, normally a harbinger of all things bad when it takes flight, soared to its highest levels since January 1980, or that crude oil hit a high of its own, touching $84 before finishing the week near $82 still it’s first weekly close at this
level.
It didn’t matter that the crisis in commercial paper, worldwide, is still a factor, even if a diminished one for the time being, or that the leveraged buyout premium that had helped propel stocks the first half of the year was officially kaput.
And it certainly didn’t matter that everyone’s number one asset, outside of those on the Forbes 400 list of billionaires, their home, is no longer rising 8% a year; more likely than not it’s falling.
Yet Fed Chairman Ben Bernanke told a congressional committee on Thursday that “Global financial losses have far exceeded even the most pessimistic estimates” for the mortgage sector.
Speak for yourself, Bennie Boy. Some of us were bang on, especially compared to your prior musings.
If nothing else this column is consistent. It’s gets a little repetitive, for sure, and I’m early with many of my bigger themes, such as the Nasdaq Bubble, concerns over Russia’s political situation, or real estate. But it’s been about a key word regarding this last one, “affordability,” around the world.
[Ed. I then cited past comments.]
WIR 5/29/04
“Yes, since World War II, nationwide, housing values haven’t declined in any single year, but tell that to California homeowners during the period 1989-1997, or Houston residents during the oil bust of the 1980s. No doubt, many parts of the country have more diversified economies than they once did, as in the above two cases, but the watchword is ‘affordability’ and in large swaths of America, folks are either stretching beyond their means or simply can’t make the move.
“Housing was the prime source of the wealth effect that helped carry the economy through the post-2000 bubble period, as people saw their #1 asset appreciate at 8%+ a year and then borrowed against it. And heck, I know I’m a broken record on this topic and have zero credibility by now, but the big gains are in and now we wait to see if the next move is down or sideways. Either way, many won’t feel as wealthy a few years hence, if not sooner, unless there is a spectacular rally on Wall Street, and consumer spending is bound to suffer.”
WIR 4/2/05
“Remember, the bubble isn’t just a U.S. story, it’s global; whether we’re talking Britain, Spain, Australia, or China.”
WIR 5/27/06
“Ask anyone who’s been to Europe in the past few years, chatting up a few blokes in a pub, and you’ll find everyone is buying a second home in Spain, to cite but one prominent example; thanks in no small part to the prevalence of low-cost airlines that make it far easier to jet away for the weekend. But these same communities are going to slide like the rest.”
WIR 5/12/07
“So pray the rest of the globe doesn’t catch the cold we appear to be developing, though of course it will because it is suffering from the same chief symptom we have a real estate bubble. Ours has popped. The rest are in the early stages of doing so; whether it’s Britain, Ireland, out of control Moscow, Spain, or Australasia. And you can take that to the bank.”
This week, for the first time that I can remember (at least it’s not in any of his ‘monthly outlooks’ this year), PIMCO’s Bill Gross specifically mentioned real estate bubbles in “Ireland, the UK, and Spain.” And in my daily reading I saw these headlines in just the past few days.
From the Sydney Morning Herald:
“Housing affordability has worsened (in Australia) as the pace of house price growth has outstripped increases in disposable income, said the report by Fujitsu and JP Morgan .
“ ‘It is really quite difficult now for many people to afford to buy property. There is huge demand, huge drive to own your own property,’ said the consultant at Fujitsu.”
The New Zealand Herald:
“A bank survey of residential real estate sector sentiment has presented a pessimistic picture, with many professionals saying the market has turned down fast .
“A valuer [appraiser] said some prices were ‘easing backwards’ and valuation work was very slow
“Property investors said the market had turned and the peak had been reached.”
Call this the popping of the “Lord of the Rings” bubble, in actuality.
London Times
“House prices across much of Western Europe have stalled or begun to fall as spiraling borrowing costs and fears of over-supply take their toll on markets from Ireland to Spain, an industry survey has revealed.
“The German housing market has been hit hardest. A glut of property for sale in former East Germany dragged down price inflation countrywide, leaving the national average down 6.9 percent over the 12 months to the end of June.”
Ben Bernanke may not really know what the heck is going on, but while the focus this week was to some extent on the dollar, gold and oil, when it comes to the Big Picture, globally, it’s still about real estate by my way of thinking, linked with massive debt loads.
The thing is, as I’ve noted on countless occasions, the picture is unfolding at various rates of speed, as proved yet again in the above anecdotes. I said long ago there would be no recession in 2007, but I’ve been focusing on 2008 because I felt by then it would all come to a head when the decline in a chief asset’s value finally begins to impact consumer spending and thus earnings. Frankly, some of the other items we’ve been concerning ourselves with the past two months are noise.
None of this means stocks can’t still rally. I’ve almost given up trying to predict the market. I also said the past few weeks the Federal Reserve was irrelevant, outside of a few days’ response to a change in interest rate policy, and I stand by that. The Fed, as Bernanke and former chairman Alan Greenspan both said this week, can’t be totally blamed for the housing bubble. But accomplices? Yes.
For now, I agree with Yale Professor Robert Shiller’s statement to a Senate committee.
“The decline in house prices stands to create future dislocations, like the credit crisis we have just seen.”
