The fed lets it be known through a "leak" they will NOT be inclined to bail out falling asset prices.And
WSJ Fedwatcher Greg Ip said in an article published today that Bernanke is trying to break the market's association with market convulsions and rate cuts. Ip said that Bernanke is showing signs of a break with Greenspan by distinguishing between the Fed's two main roles of maintaining financial and economic stability.We'll see.
Source.
25 comments:
The fed is already propping up asset prices. They did so when they changed the terms of discount rate loans to banks a week and a half ago making "overnight" loans essentially indefinite and allowing banks to offer mortgage securities as collateral for those loans (not to mention a rate cut). This will take some time to flow through the market fully (it took nearly 18 months for the crap Alt-As to become a problem), and we are still likely to see more fallout for institutional investors that are going to get burned for owning securities without any idea of what they were (which will of course fuel the MSM's about face on the topic of Real Estate - now everything is bad), but don't think for a minute that they aren't protecting asset prices (maybe not underlying securities) but no way they want to see a wholesale crash in home prices... easing access to credit will be key to cushioning the reversal of supply and demand issues in the market - or at least buffering the wild on/off switch nature of home price volatility (in Marin at least)...
I don't know how to read the Fed's intent, which I'm sure is part of their game plan to keep the markets a bit unsure. Waaaaaaay too much focus on the Fed and the Fed's actions right now, which means all things economic must be precarious indeed on Wall Street..
I am disgusted however with all the puking going on over CNBC and Bloomberg etc regarding the need for rate cuts and how it is almost un-American to keep the rates where they are... Those Wall Street bankers sure have their posy of credit junkies fully junked up and selling their dope to the masses.
Hell, let the rates fall to 0% and see if that holds home prices up. It will slow the down-bound train, but I doubt seriously it will stop it. All it will do is inflate the hell out of the dollar. Bottom line, median income in Marin still cannot afford a fully amortized load for the median home in Marin, whatever the rates are.
Besides the Fed's fund rate is not the only factor that affects the mortgage market...
What's really scary is Bernanke is talking to the lending industry to come up with more creative products to help strapped borrowers to refinance into something they can afford.
It's almost as if Bernanke doesn't understand that the problem was exotic products that allowed house prices to get further out of whack.
It's as if Bernanke doesn't understand that "affordability products" just make houses more unaffordable.
It's as if Bernanke doesn't understand that houses are way too over priced.
It's as if Bernanke doesn't understand.
It's as if Bernanke doesn't understand.
Surgeons recommend surgery. That simple.
I don't see how the markets are going to become any less focused on rates as a primary driver of equity prices... First off, with the CMO meltdown, a bunch of easy, "safe" return just disappeared - this will put even more pressure on money managers to extract return from the equity markets - so interest rates will become more and not less important to them - which means more emphasis on what the fed does not less.
"It's as if Bernanke doesn't understand."
He was an academic Ivy-league professor. Maybe that is the problem.
Japan dropped their interest rates to 0% and it didn't save their housing market. And they're an island...talk about not making any more land -);
It seems like tighter standards are here to stay now that the secondary market for mortgage junk has disappeared. A small cut in short term rates won't magically enable folks to qualify for a mortgage.
We all know it takes years to save for a downpayment. And if prices are flat or falling, I think there will be a lot less interest in stretching to buy a home. What's the point?
Prices are going to come down. A lot, I think. The MSM and politicians can dance around this, but if we are back to more conventional standards, we will go back to more conventional home prices.
lisa,
I fully agree with you it really doesn't matter what Bernanke does. He is just playing the same script every Fed chairman before him has played and it won't end any better this time around. But what irks me is that we could get the unavoidable pain out of the way sooner and faster if they just stop meddling and mucking around in our supposedly "free" market. What sort of country are we? The sort that pulls off bandaids quickly or slowly.
Bernanke came out today and said the fed stands by to do "whatever is necessary". So far it's all just talk. And Bush came out saying he has a bail out plan for the FBs. If it's anything like the Katrina Plan or the Iraq Plan or the Health Care Plan, then I think we will be digging ourselves into a deeper hole than the one we already find ourselves in.
Well, as I understand the press on this today, the Administration proposals would loosen requirements and raise the ceiling on FHA loans -- permitting refinancing to better terms, permitting FHA loans without ANY equity.
Unless I am reading this wrong, it looks like we shift the ultimate expected default loan losses from the brokers, banks, and hedge funds to the US public. A bailout camouflaged is still a bailout. Thank you, Mr. Bush & Company.
Let's see what additional subsidies the Democrats can come up with to compound the negative aspects of this move.
I have a proposal: remember tax "surcharges" during the Nixon era (perhaps others)? I suggest a surcharge on all reported earnings from mortgage origination and placement fees at every level of the churning of residential mortgage paper since, say, 2004. Some percentage of the billions in profits that are reported for income tax purposes (before accounting tricks to masquerade these profits). Let's apply THAT money to solve the "crisis" we find ourselves facing.
Thank you class -- please comment in an essay for tomorrow's session.
Regarding Bush's speech today on helping mortgage owners I was glad to see this (from cnn article);
One thing the president promised not to do was a direct bailout of homeowners facing foreclosures or of lenders with financial problems traced to portfolios of defaulting subprime loans.
Such bailouts, he said, "would only aggravate the problem."
It seems like tighter standards are here to stay now that the secondary market for mortgage junk has disappeared.
I don't think that is correct at all. At least if what you mean is that by tighter standards you mean what the mortgage market is experiencing today. It's as wrong as those that were saying "its all differnt this time" before the bubble popped.
The reason is that the underlying conditions that were a pre-cursor to and enabled mortgage brokers to make these bad loans haven't gone away. Partially, because the concepts of collateralized mortgage derivitives is a sound idea, the liquidity that they provide to the real estate industry will continue to be in demand, and the information that is available about the home equity market continues to grow.
Yes, the recklessly loose standards that marked the last 2 years or so are likely gone for good (a good thing), but to think that we are going back to 20% down and 30 year fixed owned by your local S&L is silly.
Specifically, there is still a tremendous amount of money looking for return and not enough good ideas to fufill that need. This will continue to put pressure on the institutional market to find a way to profit from CMOs because the value of the U.S. housing stock is too big to ignore.
Secondly, the derivitave structures that led to CMOs aren't going away. We can't roll back to world to 1990 when these instruments didn't exist.
There seems to be a sense, perhaps even a rooting for, things to return to the way they were "back when." The good ol' days when banks made everyone put 20% down and held the mortgages and you had to "work hard to own a home" what ever that means... but that's just fantasy.
Today's lack of ability to sell any CMO's is a reaction to the market on two fronts by the investors that were willing to underwrite the home equity market. 1.) they don't know or understand what they own, and 2.) if they do understand or know what they own, its really unlikely that they will want to buy any new paper based on the old models and thinking with regard to asset and risk pricing. The result has been a freezing of the market - an overreaction where liquidity concerns dominate the market rather than rational risk pricing.
This, however, is a temporary environment, home assets are good assets, the investors and banks will get smarter about what makes a good or bad product, they will figure out how to improve transparancy and liquidity and when they do we will start see the market for CMO's begin to flow again.
What those standards will look like at the homeowner end, I can't tell you. But I can tell you that it won't be as conservative as the 20% down 30 year fixed rate mortgage of old. There is too much info available, too much money flowing in the home equity market for large specialized mortage firms to disappear like the dodo and the mere ability to structure derivitives allows for more flexible, and ultimately safer ways to assign risk than if you ran the First Bank of Marin and held all the mortgages you made on your own books.
This is why I find it hard to believe the dire predictions of home prices falling as drastically as some here predict based on historical precedent of a world where there was far less information and liquidity and the mortgage business was straight out of "It's a Wonderful Life".
The world has changed, just not as drastically as the boosters would have had you believe - but its not going back to the pre-derivitave world that those on the other side of the bubble would like you to believe either.
As for the idea that Bernanke's urging for the financial institutions to come up with innovative products to keep people out of forclosure is indicative of the problem that got us to this mess, I think that misses the point as well.
Yes products based on innovative structures artificially stimulated the market - but it was bad product, not the structures that enabled those products, that is to blame. Blaming the idea of a CMO for the the bad loan practices is like blaming a road engineer for accidents caused by reckless driving or negligent auto design.
Loans that get paid back and where investors are willing to fund because they feel are being fairly compensated for the use of their money are good loans - even if they don't hew to traditional ideas of what a mortgage might be.
I can't think of a worse way to bring the supply/demand issue into balance than allowign forclosures to spike. All that does is artificially transfer large amounts of wealth to those that already have the liquidity, wealth and access to capital necessary to capitalize on individual misfortune, not to mention collect a large number of innocent bystanders in the process by swinging the market too hard in the other direction.
Mass forclosures will have the mirror effect on the market of what the loans that caused the current crisis did on the upside. Depressing prices well below fair value. Mass forclosures, however, are more nefarious than an overheated market. The difference is that while you don't necessarily HAVE to buy if the market is overheated, there are times when you do HAVE to sell through no fault of your own.
Excess downside volatility injects a bad luck factor into the market that doesn't exist on the other side and makes housing less stable overall as sellers try to time the market to avoid getting stuck in a HAVE to sell situation - causing even more volatility and all sorts of collateral problems - the proverbial "run on the bank." Its the same reason we have the FDIC to prevent runs on bank assets - not because we want bail out banks - but because we want to make the banking business stable enough to allow folks to trust it.
Innovative products to help bridge an artificially constrained liquidity market, provided they were sound in their design, would help lower pricing volatility - which is the true goal of sensible policy. Because stability allows for rational financial planning by individuals and higher trust and certainty with regard to the right price to buy and sell a home.
If the median around that lower volatiilty occilates around a higher income to debt ratio than what it was traditionally because the nature of changes associated with information about home equity, markets for equity ownership and products that tap equity for investors of equity , so be it.
Debt is debt after all, no matter how people try to spin it. Yes, there is tremendous amount of global liquidity looking for higher returns. However, I have noticed the "hot" money have been flowing to Asia more than here.
Why? Most Asian countries have high saving rates and huge reserves. Their financial systems are in much better shapes than ours. Plus, I heard that China has lost more than $10 billion dollars by investing in the US sub-prime market. You think they will continue to invest in this money losing market or cut losses and bail out?
If the Fed decides to cut rates, the US dollars will tank and consequently the long-term treasury yield will shot up. Maybe these US debt holding countries mainly China and Japan will look for other alternatives to put their money.
There is no denial that the shifting power from here to the Asia countries, especially China, has been taking place for several years. People here should start waking up and learn how to save and work hard in order to compete and survive. The so-called "easy" money does not come easy after all. We all have paid huge prices for it.
mrlmv,
Well, I was with you (for the most part) all the way up to the end, but then you lost me…
I disagree that given current home prices, the US housing market is a good asset class to invest in.. it is simply not... not anymore.. in fact, I'd classify it as a terrible asset class to invest in right now and will remain as such until prices come down significantly to historic norms.. same as the high tech asset class being a terrible asset class to invest in in the late 90's..
I disagree with you as well in that mass foreclosures are needed and a good thing for the long term health of the US housing market.. Nothing beats excess quite like excess and this market needs a massive correction to remove the huge excesses of the past 5-6 years... yes, a few liquid investors will capitalize on this situation while this thing unwinds… oh well, pick your poison… your comments indicate that the current housing market was a reaction (mostly to) fundamentals... not so sir.. home prices were artificially inflated due to many false external factors which I can name 5-6 very easily; one being an unregulated and irresponsible lending environment… again, for the long term health of the market and health of our communities require a painful correction…
I also don’t think this initial round of foreclosures will bring housing prices down to “fair value” yet as you say…. There is still far too much fear and greed imbedded in this market for that to unwind over a few months of foreclosures… Nope, people buying foreclosures now are STILL not buying fair value… the reason I know this is contained in all the graphs and data showing the historic value of homes… they will be the FB’s in a few years perhaps..
Your intelligent positions are noted however, but they look at this market from the high (investor) side and not from the lower and more pragmatic (buyer) side… I say all the posturing being done right now by Shummer, Clinton, Bush and BB are all being done to keep the bankers in business and profitable and have very little to do with helping out the average taxpayer… just the opposite in fact… but is sure sounds good to the average voter and TV reporter..
Matt
I disagree with you as well in that mass foreclosures are needed and a good thing for the long term health of the US housing market..
matt,
I don't think "mrlmv" was arguing that foreclosures are a good thing. Please look again at what he/she wrote.
mrlmv,
Thank you for taking the time to write a very informative comment. Really. I will try to return the courtesy.
I had to re-read what you wrote four or five times before I felt like I understood what you were saying. You make a lot of points and it's not always clear to me how they connect. If I could paraphrase, it sounds like what you are saying is (1) CMOs and derivatives are in theory sound ideas and because of that they are not going away, (2) recently (say, over the last five ot six years or so), risk assessments (on both the lender side and the borrower side) became progressively more unrealistic, (3) and so we see a "freezing up" of liquidity and pricing volatility as natural consequences of the transition from a "free-wheeling, anything goes" environment to one that is more realistic, (4) foreclosures are bad not only because they hurt homeowners but because they cause house prices to overshoot the mean on the downside.
I am not certain that I completely understood all that you wrote. I don't know about anyone else here on this board but I for one would really like to better understand the products and processes involved in today's world of mortgage financing and I am perfectly willing to admit that I am mistaken on some or many points and so I am open to the idea that a higher income-to-mortgage-debt ratio makes sense or, to put it another way, that a more traditional income-to-mortgage-debt ratio is now obsolete.
I guess what I take exception to is the consequences of point 3, above, and that prices returning to some mean value, in point 4, above, is some how a bad thing. With regards to point 4, I am going to dismiss the overshooting the mean thing as it is a time-tested behavior of most any market. That is, markets are nothing more than human psychology in action and on the downside markets almost always over shoot the mean on the down side. It is bad for some and good for others.
But what I really don't understand about your comment is how returning to a 20% down payment (or a little more or a little less) requirement and the like is "unrealistic". Would you please explain that to us in more detail in the context of CMOs and the like? Certainly, I think your equating 20% down payment requirements and all the rest with the claim that people are arguing for/hoping for a return to the 'good 'ol days of "It's a Wonderful Life" and S&Ls' is wrong and somewhat of a cheap-shot. But I can understand how one might get that impression. So no harm done at least as far as I am concerned.
But how can returning to a 20% down payment and the like requirement be unrealistic? If I understood you correctly and if I understand what I read in the MSM and elsewhere, a big part of the problem in the mortgage financing, CMO, etc world is due to mis-assessments of risk. The risk was introduced, to a large extent, by allowing people to make 0% down (no skin in the game so to speak), stated income (stating whatever was needed to get the loan), low teaser rates with severe adjustments later on, ever growing debt burdens due to neg am sorts of loans, and the irresponsible instilling of the attitude that "houses never go down in price", "buy now or be priced out forever" fear mongoring, etc, etc, etc. Sure, an investor can be compensated for that risk by paying them ever greater sums for the use of their money. But that is just an argument for the continued existence of CDOs and their buyers and the like and is just looking at one side of the equation.
But what about the other side of the equation? On the one side you can always in theory compensate an investor for growing risk by paying them increasingly more. On the other side of the equation you can lower the risk and so can compensate the investor with less. Isn't requiring down payments, accurately stated incomes, and realistic demonstrations of ability to service debt a legitimate way to reduce that risk?
And if down payments and all the rest are legitimate, does it really matter that it is "traditional"? What's wrong with traditional? It's not a bad word and some things become "traditional" for sound reasons. The basic principles are the same ones that have been around for thousands of years... there's a buyer on one side, a seller on the other, someone with money, and someone without. Debt is debt and the burden of debt is the same burden it has always been.
Further, if down payments and all the rest are legitimate and come back in vogue as they seem to be, how can recent housing prices be maintained given that recent housing prices were justified primarily under faulty assumptions of risk? Joe Median Income still has to be able to service his debt obligations and if he is now required to actually make a significant down payment he will not be able to buy at today's prices. Some people still can but more and more cannot. The buy-sell-buy-sell-... chain breaks. The inevitable result is that either prices come down to the level justified by the "new" reality or the house doesn't sell. In truth it will be a combination of the two with the prices for those houses that don't sell being set behind the scenes by those that do sell.
A third possibility is that Joe Median Income's ability to pay increases to compensate for the new lending requirements and that is what I am really interested to hear what you have to say. One way for that to happen is that salaries/wages hugely increase. I think that is very unlikely. Another way is through fancy financing/derivatives/etc and which is what I am interested in hearing more about from you. But it seems to me we just went through a period of failed fancy financing/derivatives/etc.
mrlmv,
Sorry, but something else just occurred to me. I may be falsly anticipating your response to my previous comment and if so please don't take it the wrong way. I am just trying to get my head around this...
But anyway, one could argue that there is no prima facie need to reduce risk on the buyer side of the equation if you can always compensate for that elevated risk by paying an investor of a CDO or whatever with an ever increasing rate of return. Further, if I understood you, there is currently (and likely to continue) a market for that because there is so much "money in search of return" now. If that is right, when does that fall apart or can it continue indefinately? Also, aren't there many other ways for that money to find its return?
I think the swing towards more traditional standards is already happening....even the IJ has run articles about the credit crunch impacting our precious Marin....lenders are requiring 20%+ downpayment on big Jumbo loans ($1MM+). Anything less is seen as too much risk and there's no market for that right now.
The cat's out of the bag at this point. Foreclosures are increasing substantially, and we haven't even seen most of the ARM resets yet. CDO's may be alive and well, but investors will want appropriate compensation for the risk. This means higher rates and stricter standards before loans can be sold off to investors.
Even requiring 10% down will put a big wrench in our market, especially for first time buyers given current home prices. And at some point, I bet lenders will go back to looking at safer multiples of household income (e.g. buy at 3x or 4x annual gross income). And they'll want cash reserves in the bank and little or no other consumer debt.
BTW, these "traditional" standard kept home prices in line with income. Once the need for a downpayment went bye-bye along with PITI / income ratios, that's when prices went to the moon.
Exotic financing only served to make homes less affordable during the boom, as it allowed people to stretch to an extent they would not have been allowed to under traditional metrics. Give people enough rope to hang themselves, and some people will take it.
mrlmv and marinite.....
Thanks to both of you for spending the time and energy to bring light to this subject.
I'm more confused now than I was before.
I don't want anything to crash.
I just want to buy a nice home in Marin for a rational price.
The rollercoaster in the simulation seems to indicate that we are way over the fundamentals.
Is there some way to get back to fair prices?
"Exotic financing only served to make homes less affordable during the boom, as it allowed people to stretch to an extent they would not have been allowed to under traditional metrics. Give people enough rope to hang themselves, and some people will take it. "..,
Exactly Lisa… agree completely…
Although he's obviously has some inside perspective on these matters, I don't think mrlmv's position on the current state of housing and lending is spot on... at all...
Marinite's next blog showing historic home prices is all one needs to see with respect to this market...
Marinite... I'm afraid you didn't read mrlmv's post too carefully, or my post was not that clear... we differ in that I believe massive foreclosures are good and necessary given the massive excessives of the past 5-6 years... mrlmv does not... that's one area where we differ..
Amongst many other benefits that massive foreclosures will bring will be massive price corrections and a change to the overall housing market (and buyer) psychology... we need to exorcise the excessive hype and greed out of this market and massive foreclosures and the resulting media outflow is the best means that I can think of to do this...
Oh by the way, I predict 70-80% price corrections in some of the worst bubble areas (inland empire, central sacto valley) where incomes are dwarfed by home prices and the locations themselves are are dust bowls of heat and congestion with extremely long commutes to employment centers like SF...
Marinite - Sorry it took me a few days to get back - I was away from the computer this weekend.
I appreciate the care on your post. Let me see if I can elaborate on your points and questions. It may take me a few postings to get through them all.
1. As for your first point I guess what I take exception to is the consequences of point 3, above, and that prices returning to some mean value, in point 4, above, is some how a bad thing.
-- I don't disagree that prices are returning to a mean. The question is - "what is the mean?" You could look at the mean on a historical basis - look at the housing downturn that occured in the late 80's for instance - and extrapolate where the housing market "mean" - or even the low point - should be based on other data - such as income or savings rates. But that assumes that a.) the market for homes and mortgages is pretty much the same as it has been in the past, and b.) the data from which you extrapolate hasn't undergone significant changes either. Personally, I don't think either are the same as the last downturn (and I haven't even delved into b.) and as such predictions of where prices "should be" based on that "historical" view will be incorrect.
The 64 thousand dollar question - and for which I don't have an answer - is what is the correct way to "predict" the new market? What I do know is it's not what the mortgage brokers and real estate agents would like you to believe, but nor is it what "traditionalists" that see a world of 20% down fixed mortages would have you believe either. Since we are in agreement that the RE and mortage folks are wrong - I'll focus on why the traditionalist are wrong too.
Since the last market downturn for housing prices, the market for financing home equity has changed structurally (not just price-wise) from what we have seen historically.
At the same time we have seen a big imbalance in the market due to events set in motion by some of those structural changes - an imbalance which is unstainable and has created a market where prices will either need to level off for sometime (best case) or fall to some degree to come back into balance with what rational lending policies would dictate.
The question is how much of the current change in prices is ascribed to the structural change in the mortgage market and how much is ascribed to the stupidity that has been spawned by those changes.
When you strip away the stupidity factor you will have what the new mean is... and it should be higher than the old mean.
The reason that it should be higher is the following. The structural changes associated with CMO's permanently changed who buys mortgage debt and how investors in mortgage debt look at the risks associated with that debt. Those changes have drastically increased the size of the pool of dollars chasing mortgage debt as well as how investors in debt look at the risks associated with that debt. Both of these factors have created an environment that is permanently less risk adverse (on a rational basis) than the historical market for residential debt. Which has a permanent effect on prices (on long term rational basis) by increasing the pool of potential buyers for properties because lenders will be willing to lend more to any one individual and lend to more individuals.
As a result of those changes - the risk premium that might be applied by an investor in mortgage debt has changed - it has been lowered permanently.
In the "old days" meaning prior to the CMO explosion - the 20% down and high credit requirements were imposed as protection for the investor in a mortgage - which was almost always your local bank. It wasn't some moral standard of good behavior imposed by banks - it was meant to protect the bank's principal investment in the debt of any particular mortgage in the case of default on that mortage - it covered the costs associated with forclosure, made it easier to sell forclosed properties (they had 20% of your money to burn through before they began to feel pain), and provided protection from pricing compression in their market. 20% equity was a margin of safety.
That margin of safety, was also pretty big - or conservative. It was conservative for several reasons - 1. the local banks didn't sell their mortgage obligations - they held them - so they held the risks associated with that loan directly. 2. they rarely held enough loans to have significant diversity in the portfolio - meaning that there were significant risks associated with the bank's clientele based mostly on the geography of where the bank operated 3.) The banks had the law of small numbers at work - they didn't have enough loans for them to have any statistical certainty as to how many loans would fail - so whether or not you had defaults made a big difference on the success or failure of the institution's lending practice - meaning that they had to be conservative to avoid defaults at all cost. This is why there were prepayment penalties in the "old market" as well - because it was expensive to process these loans and the banks didn't want you to go get a new mortgage - leaving them with all the costs of finding someplace new to put the principal that used to be invested in your house. All in all it was an inefficient market that had significant disadvantages for individual homeowners in the form of lack of choice and costs.
By collateralizing the debt, and then "packaging" debt into products for investors that had different "traits" the investment banks that did the collateralizing changed the risk profile for any one loan - meaning that if there was a market for high rate high risk loans (at least compared to historical norms) - then the brokers of mortgages could sell a high risk loan at a high rate to an individual. The reason investors put up with this was that they could buy the kind of risk they wanted (a part of a larger portfolio investment plan), avoid the risk they didn't want (someone else would buy that risk instead) and get exposure to so many mortgages in one instrument that there was some statistical certainty (at least they thought) as to the rate of failure of loans and pre-payments of loans - and that was factored into the expected yield for that investment.
Between the growing competition for those loans - meaning investors willing to invest with less and less margin of safety, brokers willing to process loans for less and less in the way of fees (or to shift the fee burden onto the buyers of the debt) and the globalization of mortgage obligations which genericized the home mortgage market we now have a market which on a normal day will have far more access to capital for a borrower than the old way - and that has an impact on pricing by growing the pool of dollars chasing homes. This BTW is before you get to the demographic changes of accellerating population growth and the urbanization of the U.S. population.
So what happened? The biggest problem is that Wall Street got too smart for itself - and in the process made faulty assumptions about property prices, equity growth rates for property, borrower income requirements - pretty much everything associated with getting a good read on the value of a CMO. They also, in some cases, way overleveraged themselves to buy these loans (jacking up their rate of return to their investors - which in the case of most hedge funds is directly linked to the rate of pay for the managers)- meaning just like a homeowner with an exploding ARM rate - some investors don't have the luxury of waiting out a market correction even if they wanted to.
So right now we have a lock down - even good borrowers can't get loans because those that buy loans won't until they feel more comfortable with what they already own and how those derivitives are priced in the future. Not to mention that the smart investors are waiting for the dumb investors to get nailed so that they can pick up good debt at a discount price - increasing their return at the expense of the other guy.
As such prices for those that HAVE to sell their obligations are in free fall. This wouldn't be a problem if it restricted itself to the professional class of investors - they should get what's coming to them. The problem is that there is no incentive for those with capital to help their competitors out by bailing them out of dumb loans - especially if those competitors have been making their lives more difficult by squeezing them out of the market by making the CMOs either too expensive or to risky for them to be investors.
The reason that the gov't. needs to get involved is that the lock of capital access has real consequences for individuals - many of which have no choice to be selling (and not necessarily because they were greedy and overbought based on stupid loans - though there certainly are those in the mix)... The reason they should step in to protect these people - even if they have to "bail out" the professional investors in the process is that if they don't then there are two risks to the economy. 1.) People stop buying homes because there is too much risk associated with selling that home should you need to move for some reason down the road - which will further depress housing prices and undermine the middle class by turning them back into renters, 2.) The situation is temporary caused by a lack of liquidity and not a lack of value - and not reflective of what the market would normal reflect in a more steady state. In that situation those that have to sell a home (which aren't the independently wealthy) will get taken to the cleaners by those in the investor class that have the capital to put to work right now, and for the most part have contributed to this mess by pulling their capital (wisely in a self interested way) to the sideline. This is just bad social policy.
By introducing normalcy back to the market - even if its less conservative than the historical past - the gov't. insures that individuals don't get penalized, for the most part, for things outside of their controll when buying a home - lowering the risk that you will lose sizeable amounts of real money. This is different than encouraging people the make "bets" on making sizeable amounts of money - even if the mechanisms might look the same.
So to your point that you see the "freezing up" of the market as a natural consequence of the new way that the mortgage obligation market works - you are right. But that doesn't mean that its good policy to allow that to happen.
In fact, historcally its exceptionally bad social policy when that happens. The biggest example of what happens when markets allow liquidity rather than value dictate price is the great depression. If the gov't. allowed liquidity rather than fair value to be the mechanism by which prices corrected, and let that liquidy crunch to run out of control - its not hard to see similar results as what happened when they let a liquidity crunch happen to the equity markets in 1929.
Today, there numerous checks on the system to protect the equity markets from such liquidity crunches - from the rules set down in the 30's and 40's that make up the backbone of securities rules to more modern rules such as the downtick rule or curbs on electronic trading. The result is that the equity markets, over time, have become less and less volatile (on a pct. basis), making them more and more "safe" for rational players - encouraging economic growth and meritocracy.
The result is that over time, as information has become more transparent in the equity market - the mean prices for equities has risen - well above historical basis - but that should make sense. When Ben Graham was an investor he could invest in companies at a huge discount (thereby guaranteeing a return given enough time) because the market didn't have the information to properly price those equities. Today the information age has made those kind of investments much, much harder to find, pricing equities better at any one point in time than in the past. Better transparancy and forcasting means that investor dollars are willing to have a lower margin of safety than Ben Graham - yet still be acting rational given the new mechanics of the market.
The key here with mortgages is for the gov't to not just make a stop gap "bail out" but instead look hard at the new realities of the market in order to create rules that protects the integrity of the market against the volatiilty of large, avoidable and temporary liquidity concerns without meddling with the underlying values of the market.
Unfortunately, is that unlike the 30's and 40's when much of this work was done for the equities business, gov't. is far less likely to take a long view on an issue like this - which is a pre-requisite in my mind for getting the right solution - rather than the right political solution.
I'll tackle the rest of your comments later...
matthew - Your intelligent positions are noted however, but they look at this market from the high (investor) side and not from the lower and more pragmatic (buyer) side…
.. You are right. And to a degree I am sure it has injected some bias in my personal views. Though I try to keep my opinions focused on those things that I feel quailfied to opine on - such as why markets have changed and the impact that will have on pricing rather than what is the new fair value.
I think your point is important though, because Wall Street and the investor class are far more important to understanding the market than in the past - something that is in my opinion unlikely to change in the future for very sound reasons.
Many here on this board, however, seem to be blind to this with the exception of the bad consequences of some of those changes - basing their opinion, in my opinion, on only part of the story - assuming that the world goes back to the past - basing predictions and sense of value on that historical perspective - because the current is unstainable (something that I agree with as well) - rather than considering the impacts of a rational new market may have on pricing - even if its not the same as what it is today.
There is nothing pragmatic about a buyer being paralyzed by fear based on faulty reasoning - thereby paying more in real terms for property in the future (if they buy at all) because their view of "fair value" is artificially low based on a historical view that is no longer valid and staying out of the market while it rises rationally.
Its essentially the opposite of being overly optomistic - except that over time if the overly optomistic buyer that hasn't hung themselves with a loan they can't repay - will likely benefit from increased values (if they don't have to move) regardless of short term volatility (and if you never move again... its moot).. they may not make as much as someone that times the market perfectly (which is in my mind just luck) but they will be better off than doing nothing - because there are few more useful places for your equity in than in your home because even if you make no money in the home - you still get to use that asset for a useful purpose... Rents on the other hand will continue to rise in keeping with the market - unless artificially constrained by rent control... meaning overtime those that are paralyzed will lose out as inflation erodes their buying power relative to homeowner - even those that buy poorly.
The Marin Heat Index is 0.40 as of today. I have seen at least 10% price reductions for the houses I have been tracking for the month of August.
Rents may not go up because there are a lot vacant homes available for rents. People were buying 2nd, 3rd homes during the boom time. If they can not sell them in time, then, renting them out might be a solution.
Lisa - I think the swing towards more traditional standards is already happening....even the IJ has run articles about the credit crunch impacting our precious Marin....
You are right - though I would stress that there is a difference between standards swinging toward "traditional" standards - which would imply going back to the old regime for loans and swinging toward more conservative terms - which would be completely in keeping with my argument that the loan market had gotten irrationally loose. Of course any tightening of credit will have an impact on our housing market... so the IJ is right on there as well. Still that's not an endorsement of a return to locally held loans by local banks with highly conservative terms dictated by the nature of that market.
lenders are requiring 20%+ downpayment on big Jumbo loans ($1MM+). Anything less is seen as too much risk and there's no market for that right now.
Again you'll get no argument from me on this. The reality is that investors - not trusting the newer models that just failed have defaulted to the old model (which was tried and true) until they feel comfortable with the manner in which CMO obligations are valued - and even then there are other investor market-specific issues associated with the liquidity crunch that are overhaning the market - its likely to stay conservative for some time. How long it takes for liquidity to return is the key question - and it won't return until there is more transparency in CMO products.
The cat's out of the bag at this point. Foreclosures are increasing substantially, and we haven't even seen most of the ARM resets yet. CDO's may be alive and well, but investors will want appropriate compensation for the risk. This means higher rates and stricter standards before loans can be sold off to investors.
Again I agree with this. My point is that properly valued CMO's will support a more liberal mortgage origination market than the "traditional" regime - so there is a bias toward more financing flexibility long term - and therefore more capital chasing homes over time. When we get back to the new stasis is a question mark. How housing prices react to that will be dictated to a large degree by when liquidity reappears - the longer it takes the more those ARMs and forclosures become impactful on the price market. At first, however, the marginal seller (e.g.,someone that wants a bigger home, but could stay pat) will disappear from the market - offsetting some of the pressure from ARMs and forclosures. If liquidity returns quickly - say 6 or 12 months - the impact on housing prices may be minimal as prices lag the market - particularly if sellers aren't motivated. Much of it will come down to specific properties, subsegments of the market and individual circumstances. If liquidity doesn't come back for some time - pricing resets may be severe.
Even requiring 10% down will put a big wrench in our market, especially for first time buyers given current home prices.
This is a blanket undefined statement that is of little use in analyzing the market - how much of the Marin market is dictated by 10% down mortgages? What is the definition of big? What is the impact of higher downpayments on prices and how do you ascribe what part of price impact is associated with requiring higher down payments v. other tightening credit critera? When will requiring 10% down have an impact - and is it a permanent or temporary change in the market?
Requiring 10% down certainly will have limited impact on the most expensive properties - as the buyers are highly liquid folk.
I am not saying that it won't have an impact (again it may be part of a rationalization of the market) I am just saying that saying your comment provides me with no supporting information to gauge whether 10% is the tip of the iceberg - or a temporary market abberation.
And at some point, I bet lenders will go back to looking at safer multiples of household income (e.g. buy at 3x or 4x annual gross income). And they'll want cash reserves in the bank and little or no other consumer debt.
Again, you won't get any argument from me on the first part of this. However, I don't think you, or anyone for that matter, really knows what investors are going to deem as "safe multiples" of household income. Part of the problem is that investors - and not the originators of loans - will dictate those terms in the future - and those will be constantly in flux given the global capital markets, analysis tools available to investors and demand for mortgage paper. What is certain is that whatever model they use, it will be far more sophisticated than some basic multiple of household income like what banks used to use. The reason for this is that the market will continually drive investors to innovate in order to identify excess risk premium - in order to capture it for themselves. However, once that inefficiency is exposed by more than one or two players, the market will stamp it out by using that efficiency to lower prices to capture marketshare - to the benefit of consumers. The old S&L's had no incentive to do any of that. This means that investors will look at forcasted equity value growth rates, the underlying value of the property, other asset coverage and maximum default rates across various slices of the market when making loan decisions in order to gain an edge over their competitors - this means that themarket might be more conservative than "traditional terms" over some periods of time or segments of the market (as I would suspect it is right now due to liquidity issues that didn't necessarily exist to the same degree in the traditional mortgage regime) but over time I would argue it will be systematically lower than a traditional definition of "safer income multiples". BTW this should help Marin over time on a relative basis as the true unique value of Marin properties is identified relative to other markets.
BTW, these "traditional" standard kept home prices in line with income. Once the need for a downpayment went bye-bye along with PITI / income ratios, that's when prices went to the moon.
Yes, and keeping those prices in line with incomes wasn't necessarily a good or fair thing. What traditional standards did was artificially constrain the growth of the housing market in certain areas by limiting access to capital to buyers and depressing values by overwieghting the income risk of the buyer when determining access to capital. That those prices stayed in line with wages is not surprising because all the banks used similarly safe numbers when calculating the loan-worthiness of potential buyers - numbers driven by a highly inefficient way of assigning risk relative to a collateralized market.
Since there is less variability in wages than true property values - its not surprising that prices would be flat from one market to the next and in line with wages. When the regime changed, investors looked through those arbitrary standards in an attempt to more properly asses risk of the investment than what the banks had done. Part of this was due to their having a differernt risk profile than your local S&L and part of this was due to competition for loan originations and the fee stream that went with it - since part of a proper equation of risk in this changed market is the value of the property based on its desirability, demand and potential for appreciation rather than merely the income of the owner - values changed to reflect that on a market by market basis. This is why some properties have gone up 10 fold in the last 10 years and some, such as upstate NY, for instance have been stagnant despite looser loan standards.
Exotic financing only served to make homes less affordable during the boom, as it allowed people to stretch to an extent they would not have been allowed to under traditional metrics. Give people enough rope to hang themselves, and some people will take it.First off "exotic" financing is a misnomer - almost every mortgage today is collateralized. So the concept of collateralization can hardly be considered "exotic." The impacts that collateralization has on the market cannot be considered exotic either - to do so is to stick one's head in the sand with regard to the reality of the market structure today and in the future. Certainly certain types of loans that were made could be considered "exotic" but the implication that all "exotic" loans are bad or the root cause of the mortgage crisis is just flat out wrong. The root cause is too many stupid loans - and stupid loans can take all kinds of forms - not just "exotic".
For example... if you were precient enough to understand what would happen with home prices in Marin in 2000 based on the dynamics of the changing capital markets you could have made loans at a 150% LTV with whatever crazy structure you wanted and made smart loans - the reason was that prices were going to go up in order to reflect a market that had been constrained by a lack of captital access - when making loans in 2000 in Marin the financial profile of the buyer is essentially moot because owner income had almost no impact on whether your principal was safe - at the same time you could have made some very stupid loans by investing in "traditional" mortgages in rural upstate New York and even worse if you were doing Alt-As for that market - because the reality is almost all of your margin of safety was in the buyer's ability to maintain the mortgage payments and not in the appreciation of the property or your ability to sell that asset in order to recoup your principal should a borrower default.
Certainly excess capital overheated our market - as well as many other markets as well. But I am not certain that is worse than an artificially constrained market where access to home ownership is overly expensive and owners aren't paid the true value of their homes because of a lack of access to capital.
As for giving people enough rope to hang themselves... well that's ultimately the individual's responsibility to purchase what they can afford. Of course gov't has an obligation to insure that lenders are upfront about the nature of what people agree to and that selling practices are fair and truthful. But it doesn't have a responsibility to make sure that an individual makes a "safe" choice or that an investor makes "safe" loans. The problem occurs when the market is allowed to hang enough of those people that it impacts the rational pricing of the market - thereby unfairly penalizing rational players at the expense of the irrational - on both the up and downside of the market.
Marinwatcher - Yup its a bitch... I feel for you.
Marin is particularly tough because we are talking about large amounts of leverage to play. Leverage that you are ultimately responsible for.. a 10% correction here is real pain v. suburban Cleveland should the unforseen occur.
I struggled mightily with the problem as well, and made a huge mistake when buying our first home (mostly on the heels of the dot com insanity)... but we made up for it buying our second home and remodelling it - partially because we had had enough time in the market to identify the right property, in an improving neighborhood, at a price that seemed sensible. Learning the market goes a long way - and there are thankfully far more sources of information about the market today than in the past to help with that.
The challenge will be reconciling Marin with other markets - Marin has had different dynamics than other markets for some time now - some are systemic (e.g., access to land creating scarcity) and some are cyclical or temporal - e.g., the structural change in the capital market for mortgages untapped more pent up equity value in Marin than many other markets - but that's a one time event so it would be a mistake to think that growth rates driven by that are sustainable, or the flip side, which is that values will completely retreat to match metrics in other markets that may have different dynamics than Marin or historical norms...
I am sure that doesn't help much. My sense is that there will be more bargains over the next 18 months to be had with some segments fairing better than others - and then who knows.
Matthew - Now that I have made it to the bottom of the comments and I see your second posting I better understand your investor v. buyer comment.
I think its wrong to ascribe the market's pricing strength to buyer psychology as if that alone could propel higher prices - and that by dampening enthusiasm we can get back to rationality.
This also makes my point about the importance of the investor in the equation - and the complexity of today's investor market v. the old buy and hold local banks a very, very important distiction.
Buyer psychology and the excesses associated with it and home equity driven displays of wealth may be annoying, but don't make the mistake of thinking that buyer's drive the bus in setting price in the housing market. Its access to capital plain and simple. If investors do a better job of matching risk to capital access to buyer - then buyer sentiment will fall in line with the true demand for housing in Marin... which is likely lower than it is today (well lower than it was before this mess occured) and higher than what it was in the old "traditional" lending regime.
Without access to capital - no one can buy a home. So buyer sentiment become moot. And if forclosures spike - investors aren't going to lend money to anyone - which will further and artificially restrain access to capital for home buying. The consequences of which are universially bad to anyone except those that are independently wealthy and liquid and thereby able to use that capital to capitalize on the misfortune of those that have to sell in a capital locked market. Yes a handful of cheap bastards will finally see home prices drop to what they think is fair - but at what cost? Meanwhile the biggest winners will be those that are already rich as they scoop up properties at artificially low prices only to sell them back whe normalcy returns to the market.
Higher forclosures - especially if driven by a lack of liquidity (which is by its nature a temporary situation) will merely serve to line the pockets of those that don't need it and impose real pain on those caught by what is ultimately a temporary market condition. A steady return to a rational norm (a soft landing) is far more desirable - no growth while waiting for other metrics to catch up, thereby stamping out speculation and the marginal buyer counting on appreciation as an "asset" in determining property suitability, is far better than a market where forclosures beget more selling as prices spiral downward through fair value and real buyer's that want to own and live in a home stay on the sidelines (rationally) to preserve capital - further accelerating the price depression cycle.
Marinite - With regards to point 4, I am going to dismiss the overshooting the mean thing as it is a time-tested behavior of most any market. That is, markets are nothing more than human psychology in action and on the downside markets almost always over shoot the mean on the down side. It is bad for some and good for others.
I don't disagree with your point about markets that swing from under to over valued and back - it is natural.
My point is that allowing forclosures to spike as a mechanism for encouraging that swing - even if needed - is the difference between orderly and disorderly markets. In disorderly markets - liquidity concerns - and not value rule the day. Those that can wait out the liquidity crunch can get fair value for their property - those that cannot are stuck selling in a market where values don't reflect the true value of a home - just the value at that moment in time. In that disorderly market - innocents get slaughtered through no fault of their own.
Consider two neighbors with identical properties. One plays by the rules has built up equity from 20% to 40% over a period of time. The second has no earthly right to be able to afford their mortgage - but through luck has built their equity from 0% to 20% over the same time. Both now need to sell, owner A. because they have to move and need the money to buy another home in a different location, and owner B because they can no longer make payments on the mortgage. Both put their homes on the market for $1MM (hey its Marin) but no one is biting because forclosure rates are beginning to spike and properties are too expensive by 10% to fair value. After 3 or 4 months the bank takes over owner B's property and promptly lowers the price to $800 K to recover their principal as fast as possible (it wipes out owner B's equity - but hey its not their money, they aren't interested in making any equity gain on the property and they want their money back as fast as possible - this is not orderly at all), meanwhile now owner A's property is worth 10% less than fair value based on that sale, destroying 10% of Owner A's equity merely because he had the misfortune of living next to someone who was forclosed.
Instead, were Owner B able to refinance on some nasty terms in order to sell in an orderly fashion - he might have to wait a long time to sell that home based on the market - and he might have to use the "luck" equity gained to pay interest on the bridge loan to do that - but 1.) he is incented to save as much of his equity as rationally possible - putting that property on equal footing with the neighbor that did everything right, and two the pain felt is restricted to the owner that made the mistake and not the innocent by stander.
There is a difference between forcing owners out of homes they cannot afford - which will drive the prices toward the mean because they are motivated sellers - and turning those properties over to the bank which will then sell at any price they can (even below their principal exposure) to recapture capital - as they are irrational actors relative to other non-forclosed sellers. As a result allowing lots of forclosures means that we are encouraging liquidity driven volatility - which is the opposite of what we should be trying to acheive in the housing market - better transparency in real value and less volatitlity - both in good times and bad - so that individuals can buy a home with the confidence that if they don't do something stupid they won't be penalized irrationally for being an owner.
That's my point about the right and wrong way to get to rational prices. If the gov't needs to step in to facilitate that - then they should - because the alternative is punitive to many that had nothing to do with prices going beserk. Of course, the gov't can screw it up by removing moral hazard for the irresponsible individual - thats a careful line they must walk when weighing public good of a home market with lower volatility - even if prices are flat or declining v. the cost of putting those supports in place - both in real and psychological terms.
But that's a whole nother kettle of fish.
But what I really don't understand about your comment is how returning to a 20% down payment (or a little more or a little less) requirement and the like is "unrealistic".
Hopefully my points in some of the other posts have cleared this up but if not, let me say that its not the 20% that is unrealistic... hell it could be 50% (unlikely - but it could be). Its that the 20% was predicated on a market structure that was far less efficient in a number of ways than today's post-collateralization market.
If you believe that good collateral loans are good loans - meaning made on sound principals just then chopped up and sold in slices rather than held by your local bank - then it stands to reason that going back to 20% down on a permanent basis is unlikely - because the emergence of loan collateralization has changed what the meaning of "safety" is for any one loan - and that margin is less than in the old regime. That's all.
If the CMO market can do a better job with pricing and transparency there should be better terms than the traditional 20% down tight credit environment that was a functional requirement for banks that held loans, were more sensitive to any one default, had far less diversity, and had to manage the risk profile of every loan because they couldn't lay off the risks that they didn't want - short of not loaning to that borrower at all.
If that is true - than making blanket predictions based on that historical perpsective are likely to be wrong. They may be right or even overly optomistic for the short term while the CMO market is closed down - but over time that will change and a more rational and more liberal regime that is less volatile should emerge.
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