Thursday, September 06, 2007

Subprime Time

I found this graphic here.

What is interesting about this graphic is that the states with the highest use of so-called "affordability products" also have the lowest home ownership rates. Furthermore, according to the article, home ownership rates are not significantly different from those of the mid-1960s (before the securitization of mortgages came into existence). So it would appear that the securitization of mortgages has little benefited the home owner but has benefited Wall Street (except for the fact that by being highly liquid securitized mortgages sow the seeds of their own panics and crashes).

Thanks to a reader for sending me the graphic.

Some choice quotes:
In the golden age of American home buying — the years after World War II — savings-and-loan institutions or government agencies supplied returning G.I.’s with fixed 30-year mortgages. Home prices appreciated, steadily but at modest rates, and lending fiascoes were rare.

The world began to change in the late 1970s, when Salomon Brothers, in the person of a banker named Lewis Ranieri, pioneered the mortgage security. This showed a flash of genius. Even though each unit of real estate continued to be a slow-moving, illiquid asset, Ranieri perceived that the underlying mortgages could be traded as rapidly as stocks and bonds.

Salomon and other institutions would take the mortgages sold by banks and stitch together bonds backed by the payments of many mortgagees, which they sold to investors. Voilà! Ranieri had knitted a group of inert mortgages into a tradable security. The mortgage market thus obtained liquidity, which, according to Wall Street, made mortgages cheaper and benefited us all.

The [resulting] distancing of the borrower from the lender has contributed to the development of lax underwriting standards... investors in the securities, being remote from the actual real estate, could hardly be expected to scrutinize the underlying mortgages loan by loan. Most delegated the task to ratings agencies, and in time the agencies, intoxicated by the booming market, also grew lax. Meanwhile, Wall Street, sensing the appetite of investors, devised exotic ways of repackaging mortgages.

What happened over the last generation is that housing was turned from a market that responded to consumers to one largely driven by investors. Liberal mortgage financing pushed home prices higher — and younger, first-time buyers were effectively priced out of the market. Rates of homeownership are scarcely any higher than in the mid-1960s.

It was John Maynard Keynes who observed the paradox of securities markets: their very liquidity, which investors perceive as a safeguard, creates the conditions for disaster. “Each individual investor flatters himself that his commitment is ‘liquid,’ ” Keynes wrote, and the belief that he can exit the market at will “calms his nerves and makes him much more willing to run a risk.” The catch is that investors, collectively, can never exit in unison. Whenever they try, panic and losses are the sure result. Once, you had to be a hedge-fund player to experience such a trauma. Now, thanks to the dubious wonders of financial engineering, home buyers are exposed to the very same risks.

3 Comments:

Blogger mrlmv said...

That's an interesting point about the difference (or lack thereof) about homeownership rates in states where loans are more likely to be riskier...

I wonder why. I suppose price increases might have offset the number of buyers... e.g,. the pool of capital wasn't spread across any more buyers - so you had more dollars chasing homes without a big increase in the number of buyers chasing homes...

Perhaps, and I don't have any data to work with here, its something systemic - NY and CA have high home prices on a relative basis historically anyway and highly urbanized populations which tend to higher percentages of renters than non-urban areas. That DC is at the bottom of the is would seem to make sense given that theory - though that place is kinda whack so it could just be that much of the city is too poor or too under/un-employed to get a mortgage...

California also has the warping of its market associated with prop 13 which discourages efficient utilization of the housing stock... artificially restricting supply and keeping historically high prices higher...

What does it say about the higher rate markets - did those places increase post securitization? That might make sense - more liquidity in a market that can spread out would lead to more home ownership by growing the housing supply. In markets where housing is already constrained - all it does is drive up prices in certain markets where there was already excess demand...

Sep 7, 2007, 2:24:00 PM  
Blogger sf jack said...

As I posted on Ben's blog this morning:

Comment by sf jack
2007-09-08 08:48:42
Gap down!

G
a
p

d
o
w
n
!

Friend reports an acquaintance 30ish public servant couple residing in a wealthy East Bay (Alt-A Bay Area) enclave are trying to sell their townhouse…. having tapped the Bank of Mom & Dad two years ago for a downpayment.

As 2007 dawned, they decided to try to keep up with the Joneses by selling said townhouse and moving to a nearby bigger ‘burb with larger houses. Townhouse was listed for sale.

No lookers for 8 months. Reduced a measly amount to ~$580K.

Bad news Thursday - neighbor on one side just listed for $20K below already reduced listing price.

Worse news yesterday - neighbor on other side, single mom HELOC partier type (~$200K spent) just SOLD her place for $100K under their list (at $479K) to avoid foreclosure.

Yes, that equity flushing sound and fist pounding you heard last night was emanating from the Alt-A Bay Area!

[Note to MSM: Save everyone the bleeding heart single mom “thrown out on the street” angle on this one; instead, educate by focusing on the fact that renting is a very good option for the single mom (this will be especially true as outer Bay Area rents moderate or drop) and who may have learned the best lesson of her life which she could pass on to little Timmy and Janie.]

Sep 8, 2007, 9:26:00 AM  
Blogger Matthew said...

SF Jack,

Now, that's what I'm talking about.. Thanks for that anecdotal story... excellent stuff and so very predictable.

I'm sure that is a very common occurrence going on in many neighborhoods right now. Your story reminded me that one of the many (many) casualties of this housing bubble popping is neighborhood good will and community spirit. Nothing like a few empty houses, foreclosures and price undercutting to dampen that block party enthusiasm.

I think this would be a good subject for Marinite at some point.. We could extend it to SF districts as well… I know around my neighborhood, the crashing of the housing market is like a silent presence at all gatherings nowadays. I love the fact that housing prices are not the number one discussion topic at social gatherings. What will some of these HELOC’d owners talk about now ?

Sep 9, 2007, 8:09:00 AM  

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