Saturday, February 18, 2006

American Dream to Become a "Roach Motel Nightmare"?

I've written about the "reset problem" before and how, if for no other reason, it does make it "different this time". Of course, other bloggers before me have also put the spotlight on this issue; the best discussion IMHO can be found at this blog where it is pointed out that the interest payment rates on about $360 billion worth of "exotic" loans will reset in 2006 and in 2007 it is roughly a staggering $1.2 trillion (that's $1,200,000,000,000!). This article says it's $330 billion in 2006 and just $1 trillion in 2007. And this one says it's $2.5 trillion that will be resetting. What ever the exact amount turns out to be, if these 2007 figures are even close to being accurate, then I think it is going to be a complete "show stopper" if a way to lesson the shock of the reset is not found. And it has been pointed out before that going to 40 or 50 year mortgages will not have a significant effect on monthly mortgage payments as such terms only decrease the monthly payment by about $100 or so.

And remember, house sale prices are "set at the margin". So all house owners who think they might want to sell within the next 10 or 15 years or so will feel the fallout of this reset problem.

This fun, made-up site isn't too far from the truth.

Anyway, here is another article ('Coming Home to Roost' By Jonathan R. Laing, February 13, 2006, Barron’s) that discusses the problem. Thanks to the reader who sent this in.

Some choice quotes:
THE RED-HOT U.S. HOUSING MARKET MAY be fast approaching its date with destiny. Indeed, inside the mortgage trade, much anxiety is being focused on a looming "reset problem." Over the next two years, monthly payments on an estimated $600 billion of mortgages to borrowers with checkered or no credit histories -- the "sub-prime" market -- may zoom as much as 50% higher, as the two-year teaser rates on hybrid adjustable-rate loans expire and interest payments hit their fully indexed levels.

In the past, such resets caused little disruption. For one thing, the sub-prime market was strikingly smaller. Only $97 billion of such mortgages were originated in 1996, compared with a mammoth $628 billion last year and $540 billion in 2004, according to the trade publication Inside B&C Lending. Sub-prime loans outstanding now account for more than 10% of the total U.S. mortgage debt of $8.4 trillion. Moreover, the reset triggers on sub-prime mortgages have dramatically shortened, with the loosening in underwriting standards.

Surging property values in much of the country in the past four years helped bail out many sub-prime borrowers, letting them refinance their loans as painful resets loomed. Many borrowers not only refinanced old debt at attractive teaser rates, but also sucked additional equity out of their homes with cash-out refinancings, to pay off higher-rate credit-card debt. Meanwhile, delinquency rates and credit losses remained artificially low. A tapped-out borrower always could sell his home into a soaring real-estate market to pay off his mortgage debt and regroup.

But now the refi window may be closing for the sub-prime crowd. The Fed's hikes in short-term interest rates have pushed up fully indexed ARM rates. At the same time, evidence is mounting that home-price appreciation is slowing or, in a few areas, reversing. And the secondary market in mortgage-backed securities, which provides some 90% of the liquidity in the sub-prime market, is starting to balk at the easy lending practices in this sector.

"The implication of all this is that many sub-prime borrowers who took out loans in recent years may not be able to refinance unless their income increases or interest rates drop significantly," he [Xu] observes dryly. In other words, the American Dream of home ownership could turn into a Roach Motel nightmare.

Richard DeKaser, senior vice president and chief economist of Cleveland-based National City (ticker: NCC), has more than an academic interest in what's happening in housing. National City is not only a top-10 originator and servicer of prime mortgages, but it also owns a major sub-prime lending concern, First Franklin. These days, his attention is riveted on National City's quarterly survey "Home Prices in America." As of 2005's third quarter, the latest period for which data are available, it showed 38% of the U.S. housing market at an "extreme" overvaluation level of 30% or higher. The champ, or chump: Naples, Fla., where National City believes homes are 84% overvalued.

Experience in the 299 metropolitan areas covered in the survey shows that such levels of overvaluation are typically followed by price declines of about 15% that take an average of three years to unfold. If systemic and not merely localized, he asserts, any correction this time around could have nasty side-effects: "Individuals will suffer a wealth decline and spend less freely. Lenders will suffer elevated loans losses and credit conditions will tighten. Mortgage-backed securities will lose value and consumer confidence and home building will decline."... "Thus, loss severities in key, overheated markets like California and New York could skyrocket by eight-to-10 fold even if home prices growth just moderates markedly rather goes negative."

The Bottom Line

Cause or effect? Sub-prime mortgages have helped to push up home prices, which in turn have boosted sub-prime lending. This virtuous circle may be about to turn vicious.


Blogger marine_explorer said...

If systemic and not merely localized, he asserts, any correction this time around could have nasty side-effects: "Individuals will suffer a wealth decline and spend less freely.

Systemic could be a valid descriptor for future far-reaching consequences of income contraction on the heels of a record credit binge. Maybe I'm just kidding myself this will be a huge problem, but how many are leasing their future for the "good life" today?

Speaking of "roach motels," one future consequence may be where financially stressed homeowners are barely able to make their mortgages, and in consequence, neglect the care of their homes and neighborhoods.

Consequently, an abundance of fixed-income (retirees), stressed homeowners (own at any cost), and rental properties (neglectful "investors") could further erode the overal condition, desireability, and property values of communities. Dare I say this could happen even to Marin?

Feb 18, 2006, 5:00:00 PM  
Blogger Marinite said...

Thanks reskeptic for pointing that out as I agree that is yet another potential pitfall of this housing bubble for our communities.

Feb 18, 2006, 5:42:00 PM  
Blogger Rob Dawg said...

Welcome to the Condotel California?

And you didn't even reitterate the changes in bankruptcy law. IMO however the two biggest problems with the subprime mortgage market aren't even being considered yet. First, the vast majority of sub borrowers are stupid. They aren't able to deal rationally with what's coming. They'll stop all other saving, investment, whatever and run up any consumer credit they have BEFORE they see a problem. By then it will far too late. A maxed out consumer that has been ignoring routine mantainence, scrimping on healthcare and insurance, has a now old car with still sizable balance and nearly maxed credit cards is going to miss their property tax payment or something and then just stop paying everything, thinking they are hoarding against the inevitable losing their "stuff" and starting out clean all over again. Like I said, stupid.

The real stupidity is the lenders. They have been counting neg-am balance accruals as current income and when late pays and those penalties start to pile up they'll call those current income as well. By the time they realize they have nowhere near the reserves against loses it'll be too late for them as well. Like the stupid borrower the banks will wish to prop up shareholder value until the elephant in the corner is too big. The write-downs and stock hits are going to be frightening.

Feb 19, 2006, 7:39:00 AM  
Anonymous Anonymous said...

Reskeptic, I would say that the future you describe is now...

Based on my unscientific analysis of my southern marin cul-de-sac, here is what we have. In a total of 12 homes.

3 - "investor owned" rental homes - one is long term vacant

5 - retirees, probably on fixed income, but realatively equity rich

4 - homes with one wage earner each. All have owned homes more than 10 years.

To my midwestern eyes, it looks like a decaying suburban tract. Lots of junk in some of the yards, many houses with multiple junky mid-80s cars parked on the street (a couple being mine). No desparate, pining yuppies here, but the neighborhood is wanting and looks to not have much of a future.

Feb 19, 2006, 9:43:00 PM  
Blogger Athena said...

since when did owning a home become a profession?

does it seem like that to anyone else?

I look around at the people living "the life" one income earner, brand new SUVs, a house that can't have a 30yr.fixed on it, and a go go go gotta have it, we must have a bigger everything kind of mentality... I know what the working spouses do for a living, and I know what they likely make...I know darn well they don't make enough to live their lifestyle.... and it is like having a mortgage has become a stay at home venture... a profession all its own.

when did getting into debt start to be a high paying job?

Feb 21, 2006, 2:55:00 PM  
Blogger Marinite said...

when did getting into debt start to be a high paying job?

When people stopped worrying about ever repaying it? Just a guess.

I think being a social anthropologist in, say, 15-20 years studying the present will likely be a fascinating career.

Feb 21, 2006, 8:16:00 PM  
Blogger Athena said...

Oh the social critique that will be written about this ten year stretch... LOL

But you are right... it became a job when people stop worrying about paying it back... this is a lot like playing crack the whip. Remember that game and how someone always goes flying off the end and cracks their head open on the black top?

Same game... just we are the yard duties watching...

Feb 21, 2006, 10:36:00 PM  

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