The economy may be flat, but it’s boom time for investors who know how to buy houses at fire-sale prices, fix them up and sell or rent them out.
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Investor Report: Home Investors Booming
A lot of people assume that the federal bailout law is all about helping banks and buying toxic mortgage portfolios. That’s true, but Congress included some important tax items in the Emergency Economic Stabilization Act that could be of immediate use by owners and developers of investment real estate.
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Investor Report: Bailout to Aid Investors
There has been some joy in the real estate marketplace during the past few days, in large measure because the National Association of Realtors announced that home sales rose in May.
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Why Shun Investors?
Like he did for the relationship between mortgage brokers and appraisers, the three major bond-rating firms reached an agreement with Cuomo, the New York Attorney General that creates more independence for ratings agencies. Cuomo has been one of the only public official currently in office that hasn’t simply tried to slap more regulations on all parties, pointing the finger and saying don’t do bad things.
Give me a break.
Like him or not, Cuomo has done is to fix systemic flaws within the financial system by following the mortgage.
Rating agencies were one of the weakest links in the integrity of the lending system.
Today’s WSJ article Bond-Rating Fee Overhaul Looms in Settlement, discusses the potential agreement.
many critics claim has been a chronic problem with bond ratings: They are paid for by the entities being rated. That financial dependence has been blamed for the industry’s failure to predict that risky subprime mortgages would crumble, resulting in losses and shaken confidence.
If the firm gave too low a rating, it wouldn’t get hired by the investment bank who would simply go to the next agency to get the rating they needed:
Under the Cuomo settlement, which would cover the hardest-hit portions of the mortgage market, the firms would get paid for their review, even if they didn’t end up getting hired to rate the deal. This would mean the firms would get paid even if they were tough. The plan, which requires final agreement by Mr. Cuomo’s office and the rating firms, wouldn’t dictate the exact fees rating firms could charge. But the firms would be required to charge more than a nominal fee for their preliminary work.
It still doesn’t fully separate the rating agencies for preferential treatment from bond issuers but it sure is a good start.
Cuomo seems to be less abrasive that Spitzer, his predecessor was. At the very least, the bond agencies were guilty of gross negligence for using the wrong data to understand the potential default rates for the securitization of subprime, alt-a and for that matter prime loans. Last summer they suddenly downgraded highly rated mortgage bonds claiming the models they had didn’t work.
Cuomo seems to be more interested in fixing investor confidence than playing hard ball with the agencies. It’s refreshing to think there is a light at the end of the securitization tunnel.
Speaking of stirring things up, take a look at these videos of the recent Parkersburg Iowa tornados: [bank security camera] [house] (hat tip to Market Power)
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[Cuomo Recipe] Ratings Agencies Take Hand Out Of Cookie Jar
Pirates of several hundred years ago have been getting a lot of attention of late via the 3 Johnny Depp/Disney movies.
Well, apparently pirates formed some of the first petri dishes of modern economics and democracy according to a new book “The Invisible Hook: The Hidden Economics of Pirates” written by an economics professor at George Mason (hat tip to Freakonomics).
The book caught me eye, arrgh, as someone who fancies the likes of (sorry, I digress) Talk Like A Pirate Day each September 19th as well as my friend Chris Miles’ site TalkLikeAPirateDay.com. The “founders of International Talk Like a Pirate Day acknowledge that there is, in people who love to say “Aargh,” a yearning for a certain kind of freedom.”
Aargh!
Presidential candidates, take note: Long before they made their way into the workings of modern government, the democratic tenets we hold so dear were used to great effect on pirate ships. Checks and balances. Social insurance. Freedom of expression.
The pirates who roamed the seas in the late 17th and early 18th centuries developed a floating civilization that, in terms of political philosophy, was well ahead of its time. The notion of checks and balances, in which each branch of government limits the other’s power, emerged in England in the Glorious Revolution of 1688. But by the 1670s, and likely before, pirates were developing democratic charters, establishing balance of power on their ships, and developing a nascent form of worker’s compensation: A lost limb entitled one to payment from the booty, more or less depending on whether it was a right arm, a left arm, or a leg.
Aside from walking the plank analogies, what the heck does this have to do with housing?
I’m getting to that.
If you think about it, one of the arguments against anything in the form of a bailout, is that we let the free markets decide (aka “Aargh”). Good honest hard working people should not be asked to foot the bill for other’s greed. I agree.
But all the “help” done so far is explicitly presented as anything but a “bailout” which is not true. That’s because any “fix” is essentially a bailout.
In a pure sense, the “anti-bailout” sentiment is based on the idea that people took advantage of the lending system to their own personal gain at other’s expense so they should suffer their free market fate.
If people broke laws, they should be punished. But what if they didn’t and gamed the system to its full advantage because there were no regulations or significant repercussions?
My entry into blogging in 2005 was born out of frustration that people around me were gaming the system “legally” (definitely not ethically) and seemingly nothing could be done about it or no one in government was willing to or understood what the problem was. Until now.
Which brings me to my next point.
Free markets don’t work if there aren’t guidelines (remember that quote from Pirates of the Caribbean?). The problem with the lending environment of the past 5 years was the lack of approperiate regulation, oversight and enforcement. There was not a level playing field and risk could be shifted off to unwitting (misinformed, naive or stupid) investors.
In other words, it was a systemic problem.
Yet a business enterprise made up of the violent and lawless was clearly problematic: piracy required common action and mutual trust. And pirates couldn’t rely on a government to set the rules. Some think that “without government, where would we be?” Leeson says. “But what pirates really show is, no, it’s just common sense. You have an incentive to try to create rules to make society get along. And that’s just as important to pirates as it is to anybody else.”
Unless all parties have skin in the game, whether it is lenders, investors, borrowers, appraisers, mortgage brokers, mortgage bankers, investment banks, government, regulators, GSEs, ratings agencies, there is no financial democracy and we will have another systemic breakdown.
In other words, we need a workable regulatory structure.
The pirates were a lot more innovative than we probably give them credit for - you do need to lose an arm or a leg if you do something wrong.
Aye…
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[Bailing Out The Housing Ship] Pirate Economics And Democracy
Spring brings optimism to our economic senses, and that’s probably a good thing. Pessimism as it relates to the housing market usually becomes a self fulfilling prophecy. After all, what is property value but an intangible feeling about a property compared to others based on future expectations (and of course, a lot of other things, but bear with me).
I was invited to speak to a group of successful real estate professionals yesterday and mingled with many before I spoke. I was struck by many comments along the lines of: “in the last week and a half, the market seems to have woken up…”
After all, it is spring. It is sunny outside. Optimism encroaches on judgement and sensibilities. Buyers venture out of their winter hibernation and sellers want to move on. It is a good feeling.
I also have observed the same optimism in the past few weeks covering the reporting of economic conditions which has been confusing. The economic numbers continue to show trouble ahead, but the interpretations are clearly more optimistic than just a month ago.
David Leonhardt has a very good article in today’s New York Times called Fearing Red Herring In the Data.
Only a month ago, a recession looked inevitable. Job cuts were picking up speed, and stock prices were falling. The Federal Reserve was cutting its benchmark interest rate rapidly, in an effort to keep the downturn from snowballing. But the notion that the economy could avoid a recession altogether seemed fanciful.
It looks less fanciful today. The economic news hasn’t exactly been sunny lately, but there also haven’t been any nasty new surprises. If anything, the economy seems to have stabilized. The pace of layoffs has eased a bit, stocks have risen and the Fed has signaled that the rate cuts are over for now.
Apparently the sunny side perspective is based on the reduced amount of economic catastrophes that are being announced each day. In other words, the bad news has stabilized and therefore we are approaching some sort of bottom.
The article mentions InTrade, which scored a PR coup a few days ago by being the feature story on ABC News’ 20/20. I was going to write a post about InTrade during the broadcast but the web site was overwhelmed by traffic and I couldn’t load it.
InTrade is a consumer based trading market that allows anyone to bet on the outcome of events like whether the economy is in recession or who will win the Democratic presidential nomination. Leonhardt mentions that investors now only give a 29% chance that the ecoomy will go into a recession. I believe we are actually in a recession or flirting on the edge of one.
For the life of me, I am not aware of any current economic condition that is going to stimulate new demand for housing in the immediate future above and beyond current levels. No tangible benefits have been introduced by the government to soften the damage the housing market has inflicted on the economy. It’s a tough nut to crack.
At least on a federal level, I do find solace in the fact that everyone seems to have woken up to the condition of the housing market.
Two types of housing bottoms:
Bottom 1 — The point where the decline in real estate markets is not accelerating
Bottom 2 — The point where both real estate market prices and activity stop declining
They both represent very different conditions and once the first bottom is reached, there is no telling how long the lag to the second bottom will be.
Still, it is spring.
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[Spring Fishing] Getting To The Bottom Of It All
Ok, let me get this straight. Fannie Mae:
Actually Fannie Mae’s stock dropped 5.7% yesterday so maybe it’s not love afterall.
Ok, what am I missing here? It seems to me that the GSEs can not be the housing market’s sole saviours and we risk serious damage to our financial system if housing drops sharply this year and Fannie & Freddie get taken over by the government and assume the liabilities…
But some financial experts worry that the companies are dangerously close to the edge, especially if home prices go through another steep decline. Their combined cushion of $83 billion — the capital that their regulator requires them to hold — underpins a colossal $5 trillion in debt and other financial commitments.
The companies, which were created by Congress but are owned by investors, suffered more than $9 billion in mortgage-related losses last year, and analysts expect those losses to grow this year.
More regulation is need to protect the GSEs from faltering. OFHEO lowered their capital requirements in exchange for making Fannie Mae go out and borrower $6B to help protect against further housing market declines.
“Regulators need all the tools they can get to make sure these companies don’t fail, especially since we’re talking about entities that have over $5 trillion in financial commitments and debt,” said Senator Richard C. Shelby of Alabama, the senior Republican on the Senate Banking Committee. “Six billion dollars looks like a pretty paltry sum, and if we get into a further housing downturn, that capital can go pretty fast.”
The dilemma (although its not really a dilemma because there few other options) is whether to entrust the GSE to get the nation out of the mortgage problem that is keeping housing from stabilizing.
Increased roles for Fannie and Freddie could be just what the doctor ordered to maintain confidence and liquidity in the mortgage markets at a crucial time and stave off a far greater crisis. However, if the crisis continues to deepen, these companies could go under and possibly push the worldwide financial system into turmoil.
William Poole, a former Federal Reserve Bank president, said that Fannie and Freddie are “at the top of my list of sources of potentially serious trouble.” And according to Senator Mel Martinez, a former secretary of housing and urban development, the companies “could cause an economywide meltdown if they got into real trouble and leave the public on the hook for billions.”
It seems to me like this is one small solution of many others that are needed. It’s going to be a long time to ride out this downturn and common sense says that the GSEs can’t weather it alone. FHA lost money last year too. I am starting to think we are making things worse by trying to fix the problem.
Here’s a great piece by Randall Forsyth of Barrons called Show Me the Monet where he says more than half of all homeowners who bought in ‘06 are underwater and that’s the tipping point for foreclosures. He wonders how the worst of the credit crisis can be behind us.
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[GSE Pin Cushion] Will The Saviours Of Housing Need Saving?
Getting Graphic is a semi-sort-of-irregular collection of our favorite BIG real estate-related chart(s).
Click here for full sized graphic.
In the It’s Newer Homes That Stand Empty as Vacancies Rise by Floyd Norris the sharp increase in vacant houses are more heavily weighted toward new construction.
The Census Bureau reported that 2.9 percent of homes intended for owner occupancy were vacant at the end of the first quarter. That figure had begun to rise even during the housing boom, a little-noticed byproduct of the aggressive construction of homes encouraged by easy credit. Before 2006, that figure had never exceeded 2 percent.
The ease of credit combined with limited underwriting resulted in an excessive level of new construction to enter the market. That’s why the rental market is as weak as the sales market in those areas that were characterized by new development. The speculation drove development beyond the level of reasonable absorption causing investor units to enter the market as competitors to existing rentals.
Credit:
[Getting Graphic] Empty And New And More Of Them
Lost a reliable Internet connection at home for the past 3 days so my posting has been non-existent (but I did change a few lightbulbs with my free time)
Back in the day, I loved to read books like Barbarians at the Gate, Den of Thieves and Liars Poker covering the truth and mythology of Wall Street (now I read books like Pontoon). Michael Milken was directly or indirectly connected to many of those stories, as well as the firm he worked for Drexel Birnham Lambert because of the financial vehicle he championed, the fabled junk bonds.
When the subprime crisis first became kitchen table talk last summer, initially there was discussion that it was another “junk bond” crisis. I cringed because junk bonds weren’t bad in and of themselves. The investors that used or purchased them got into trouble, because didn’t appreciate the risks associated with them. Higher returns, equals higher risk. Sounds a lot like subprime market participants doesn’t it?
Andrew Ross Sorkin’s excellent article in the New York Times today called Junk Bonds, Mortgages and Milken addresses this issue:
“The financial crisis we’re in today stems from the invention by Drexel Burnham Lambert of the junk bond,” Martin Lipton, the superlawyer who co-founded Wachtell, Lipton, Rosen & Katz, said derisively at a conference last month. “You can draw a straight line from Drexel Burnham to the financial world today.”
Miliken disagrees:
Critics who compare the subprime debacle to the bubble in high-yield, high-risk corporate bonds that Drexel helped inflate two decades ago are “people who don’t understand markets very well,” Mr. Milken said. He suggests that “their rationale is that both types of financial instruments are risky.”
And he says junk bonds, or those rated below investment grade, “have little in common with mispriced subprime mortgages,” which he says are the real culprits.
“Having financed several of America’s largest home builders, I know a few things about the housing industry,” Mr. Milken said. “What happened to housing was not a failure of securitization, but rather a disastrous lowering of underwriting standards and other unfortunate practices.”
Criticizing securitization — the slicing and dicing of debt that he helped popularize — is “like condemning scalpels because a few unqualified surgeons have injured patients,” he said.
With the introduction of new financial instruments, users tend to go overboard at the end of the cycle and then new regulation is introduced that tends to go to far (ie mortgage current underwriting standards will become a self-fulfilling prophecy).
Ultimately what junk Bonds and subprime mortgages really had in common, were the people that used them. They didn’t reflect adequate risk into their pricing. A more pro-active SEC might keep that in check, but then squash innovation.
I need to change some more lightbulbs.
Read more here:
[Indebtor’s Ball] Subprime Discussion Without The Junk
Real Estate Investors E-Book, How to Talk with Sellers: Learn to Pre-screen Sellers and Negotiate a Fabulous Price!
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Http:WillBuyAnyHouse.com.
There is an absolutely spot-on article in the New York Magazine called Triple-A Failure: The Ratings Game
I highly recommend that everyone read the article from start to finish.
In 1996, Thomas Friedman, the New York Times columnist, remarked on “The NewsHour With Jim Lehrer” that there were two superpowers in the world — the United States and Moody’s bond-rating service
Essentially in their quest for profits, the agencies’ relationship with Wall Street changed from a mysterious and powerful ratings entity to a firm working closely with their clients.
Rating agencies (Moody’s, S&P, Fitch are the biggies) sought fees from investment banks to rate securities. If the ratings were too conservative, the bank could simply go to one of the other agencies to get the rating they wanted to. The agencies were essentially behind the curve in understanding the sophisticated new products being introduced at a rapid rate.
A few years ago, as I was getting more and more frustrated at the lack of neutrality in the mortgage lending process and the shaft given to good appraisers in the form of pressure, even an outsider like me could see that something was wrong with the relationship. The system can’t allow a ratings agency to be at the mercy of fee driven investment banks. The proverbial hand in the cookie jar.
Rating agencies were the enabler of securitization much like appraisers were the enabler of shady lending practices. Search hard enough and long enough and anyone can find someone to make the deal work.
By providing the mortgage industry with an entree to Wall Street, the agencies also transformed what had been among the sleepiest corners of finance. No longer did mortgage banks have to wait 10 or 20 or 30 years to get their money back from homeowners. Now they sold their loans into securitized pools and — their capital thus replenished — wrote new loans at a much quicker pace.
Mortgage volume surged; in 2006, it topped $2.5 trillion. Also, many more mortgages were issued to risky subprime borrowers. Almost all of those subprime loans ended up in securitized pools; indeed, the reason banks were willing to issue so many risky loans is that they could fob them off on Wall Street.
The search for new profits and their close relationship with Wall Street placed them in a non-neutral position yet investors were relying on the ratings.
Thus the agencies became the de facto watchdog over the mortgage industry. In a practical sense, it was Moody’s and Standard & Poor’s that set the credit standards that determined which loans Wall Street could repackage and, ultimately, which borrowers would qualify. Effectively, they did the job that was expected of banks and government regulators. And today, they are a central culprit in the mortgage bust, in which the total loss has been projected at $250 billion and possibly much more.
The agencies have a very big credibility problem right now with investors. It’s all about the lack of activity in the credit markets right now.
It’s certainly telling that the three ratings agencies and four major mortgage related associations took the position with Congress that the current administration’s suggestions for fixing the problem were flawed. The Real Estate Roundtable, Mortgage Bankers Association, Commercial Mortgage Securities Association and the National Association of Realtors basically took the position not to do anything but teach investors how to, well…invest.
Are they kidding?
The credit markets are currently frozen because of the lack of neutrality in the rating and mortgage process, not because investors are ignorant. Next thing we will start hearing is that the agencies and associations will simply self-police.
Fear of change, living in denial.
Over rated.
Here’s something that’s not overrated: Joe’s Gizzard City, my favorite college hangout (note the Michigan State jersey).
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[AAA] Ratings Agencies And The New Culture Of Partnership
