Real Estate Blog

Here’s another guest post, this one comes from Josh Lewis. Josh and I have sparred over many topics in the mortgage space and through that conversation I’ve learned a lot from Josh. I have tremendous respect for him and his understanding of the mortgage industry.

Josh Lewis has assisted California homeowners as a Certified Mortgage Planner, Certified Liability Advisor and licensed real estate broker since 1995. Josh is a recognized expert on mortgage planning, equity management and the cyclical trends in real estate. You can learn more at his website www.JoshLewis.net or contact him via email at info@JoshLewis.net.

Lost in all of the hoopla and back patting after the passage of the recent housing bill is an important provision that makes it illegal as of October 1 for sellers to fund the down payment for buyers of their homes by funneling the money through a non-profit third party. These down payment assistance programs (DAP’s) have been a huge support and source of liquidity in the current market. FHA originations are at their highest levels in over a decade an currently 2/3rds of all FHA loans make use of down payment assistance programs to effectively create an FHA 100% financing program.

Banning DAP’s has been on HUD’s radar for several years due to the fact that loans with seller funded assistance default at nearly 3 times the rate of traditional FHA loans where the buyer provides their own funds to close. This isn’t exactly an apples to apples comparison because HUD will continue allowing down payment assistance from 3rd parties not related to the transaction which can mean family members, employers and government entities among others.

When comparing FHA loans with 3rd party down payment assistance and seller funded down payment assistance the default rate is pretty similar. Seller funded assistance results in a 94% success rate while 3rd party assistance yields a marginally better 95% success rate.

At the end of the day, it’s great that the government is looking out for the bottom line and seeking to minimize losses from FHA loans in a declining housing market. However, there are a few important things to consider. First, we must recognize that this will have a further negative impact on an already weak housing market. Second, we must remember that the GNMA bonds that all FHA and VA loans are placed in have only resulted in a loss one time in their history when HUD made an ill timed attempt at a negative amortization program during a housing downturn.

These are full doc loans with a proven system of mortgage insurance that protects against losses even in periods like the early 90’s when home prices took a pounding. With that in mind a bill has already been introduced in Congress to authorize the use of seller funded DAP’s with some precautions. The new program will allow assistance to anyone with a credit score above 680 (which correlates to a higher likelihood of repayment mitigating the higher default rate of loans with seller assistance.) Borrowers with scores from 620 to 680 would also be able to use seller assistance but would be subject to higher mortgage insurance premiums to cover the losses from a higher default rate. The bill leaves open the possibility of opening the program to those with scores below 620 but doesn’t specifically authorize it.

The bottom line is that FHA currently funds nearly 20% of all loans in the US. If 2/3rds of those loans disappear with the banning of DAP’s you’ll see almost 15% of the liquidity sapped from an already credit starved market. If half of these borrowers manage to scrounge up a down payment from somewhere else, you are still looking at 7-8% of current buyers being taken out of the market.

If we’re going to outlaw DAP’s, how about we wait for a healthy market that can handle a punch to the gut. Until then, I recommend supporting HR 6694 to allow down payment assistance with proper safeguards to protect the long term viability of FHA loans.

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RIP FHA Down Payment Assistance Programs, Not So Fast

A new report out today by Goldman Sachs forecasts that half of the world’s economies are in or will be in a recession within one year.

So much for containment.  Care to comment Mr. Bernanke? (comment below from Bernanke’s testimony to Congress in May, 2007)

“We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system,” he said in remarks to a Chicago Fed conference.

From Bloomberg:

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Goldman Sachs Group Inc. said countries that account for half of the world’s economy face a recession a year after the credit crisis began.

The U.S., Japan, the 15-nation euro area and the U.K. are “either in recession or face significant recession risks in the months ahead,” Goldman’s London-based international economist Binit Patel said in a report to clients today.

A year since the U.S. housing slump sparked about $500 billion in credit market losses for banks globally, the world’s largest economies are all stumbling as rising borrowing costs combine with record commodity prices to sap growth. The U.S. is close to a recession and France, Germany and Japan all contracted in the second quarter.

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The FDIC is reducing mortgage payments and interest rates for delinquent borrowers at the federally-controlled IndyMac Bank. FDIC spokesperson Shelia Bair said that the FDIC hopes to keep nearly 30,000 delinquent borrowers in their home with the changes.

Must be nice though. If you’re in trouble with your mortgage I’m sure you’re rooting for an FDIC take-over. They seem to be far more willing to work with delinquent borrowers than traditional, private servicing companies.

More from Bloomberg:

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The Federal Deposit Insurance Corp. may lower mortgage interest rates for delinquent IndyMac Federal Bank FSB borrowers a month after suspending foreclosures on $15 billion in loans it’s managing as successor to a failed lender.

The FDIC, which is running IndyMac while seeking a buyer, may also extend repayment terms or base payments on reduced principal to help borrowers, FDIC Chairman Sheila Bair said today in a conference call with reporters. The program might serve as a “catalyst to promote more loan modifications for troubled borrowers throughout the country,” Bair said.

“We hope to keep tens of thousands of troubled borrowers in their homes and avoid the negative consequences that foreclosures can have on the broader economy,” she said.

Bair has led regulators in pressing mortgage-servicing companies to modify loans amid rising foreclosures in the worst housing slump since the 1930s. IndyMac Federal has about 740,000 mortgages that it owns or services for other companies, the FDIC said. The bank services $184 billion in mortgage loans.

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Can the FDIC take over my bank? Please?

Bloomberg is reporting that Lehman Brothers may take up to $4 billion in losses as a result of marking down $61 billion worth of mortgage-related assets. The losses would be announced in their 3rd quarter earnings. Lehman was the biggest underwriter of mortgage assets prior to the meltdown. They continue to be on the watch list as analysts wonder aloud if they can limit their exposure fast enough before suffering the fate of Bear Stearns.

I think we’re due to lose one more big I-Bank - and Lehman is as good a better as any.

From Bloomberg:

Lehman Brothers Holdings Inc. may write down about $4 billion in credit-related investments and other assets when it reports fiscal third-quarter earnings, JPMorgan Chase & Co. analysts said.

“The credit environment continues to be difficult,” New York-based analysts led by Kenneth Worthington wrote in a report yesterday. “It will be another difficult quarter for Lehman.”

Lehman may mark down some of its $61 billion of mortgage and other asset-backed securities after benchmark residential and commercial mortgage-related indexes declined by as much as 20 percent, the analysts wrote. The company may have already been selling some commercial mortgage assets, they added.

Lehman, the largest underwriter of mortgage bonds before the subprime market collapsed, has slumped 77 percent in New York trading as it struggles to pare its debt holdings. The bank has reported writedowns and credit losses of $8.2 billion in the past 12 months, according to data compiled by Bloomberg.

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Lehman may mark down $61 billion worth of mortgage assets

Fannie Mae and Freddie Mac are on the verge of government intervention, reports the Financial Times.  As credit worries continue to wreak havoc on the financial markets liquidity concerns at the two massive GSE’s sparked a stock sell-off that left both company’s stocks down nearly 25%.

Any government intervention or recapitalization would severely undercut the value of any current shareholder stock by diluting the living daylights out of it.  Many had hoped that the mere notion of the US Treasury backstopping the GSEs would put an end to the market unrest.  This drove Fannie and Freddie stock higher as investors gained confidence that the market would stabilize with the weight of a US government guarantee.  Now that it looks exceptionally likely that it will actually happen investors are once again spooked.

From FT.com:

Fears about the financial system grew on Monday as money market liquidity tightened and sharp falls in the share prices of mortgage financiers Fannie Mae and Freddie Mac led the US stock market lower.

Fannie’s and Freddie’s shares lost 22 per cent and 25 per cent, respectively, after an article in Barron’s suggested that the US government was considering recapitalising the companies on terms that would all but wipe out existing shareholders.

The concerns about Fannie and Freddie also spread to their debt, which fell in price. This threatened to push interest rates on mortgages backed by the two firms higher and put further pressure on the battered housing market.

The price of insurance against default on Fannie and Freddie subordinated debt hit record levels in the credit default swaps market, according to data from Markit. Risk spreads on their senior debt – which most analysts presume would be fully honoured by the government in any rescue – widened to levels last seen in the immediate run-up to the Treasury’s July 13 rescue plan, Credit Suisse said.

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Fannie and Freddie on Verge of Bailout

That can’t help matters. Wachovia has agreed to buy back $9 billion in auction rate securities as part of a wide-ranging SEC investigation of several Wall Street firms’ sales and marketing practices. UBS, Morgan Stanley and others are buying back ARS by the billions in order to avoid formal charges of securities fraud.

Will this be the death knell for Wachovia? The cash-strapped company has been raising capital through numerous debt and equity sales - where will the $9 billion come from, or what about next quarter’s losses? Spooky.

From Market Watch:

The Securities and Exchange Commission on Friday said Wachovia Corp. Wachovia Corp has agreed to a settlement related to sales of auction-rate securities, the market for which collapsed earlier this year. Under the settlement, Wachovia will offer to purchase roughly $5.7 billion of auction-rate securities held by individual investors, small businesses and charitable organizations, the SEC said. The bank will also offer to purchase the roughly $3.1 billion of securities held by all other Wachovia investors, according to an SEC press release.

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That’s gotta sting: Wachoiva to buy back $9 billion in auction rate securities

Existing home sales hit their lowest levels in a decade while price declines offered little to help stem the fall. Median home prices fell nearly 10%. Of course the biggest losses were seen in bubble areas such as inland California, Florida and Las Vegas.

From Bloomberg on the losses:

Existing U.S. home sales fell to a 10-year low in the second quarter and the median price for a single-family house dropped 7.6 percent as the real estate recession deepened.

The median price tumbled to $206,500 from $223,500 a year earlier, the Chicago-based National Association of Realtors said today. Sales of single-family houses and condominiums fell 16 percent to 4.913 million at an annualized pace.

Prices are declining with the U.S. on the brink of a recession, consumer prices rising and 30-year fixed mortgage rates at a six year high last month. A third of all sales in the quarter were foreclosures or “short sales,” in which lenders take a loss on a property, the Realtors said. Bank repossessions almost tripled in July from a year earlier, RealtyTrac Inc., a seller of foreclosure data, said in a separate report today.

“It’s getting worse,” Rick Sharga, RealtyTrac’s executive vice president for marketing, said in an interview. “The number of properties that have been foreclosed on by the banks and still haven’t sold is the highest we’ve ever seen.”

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Existing home sales hit decade low

It’s nice to see the mainstream media cover more of the voices outside of the bottom callers who keep tripping over each other to be the first one to call bottom. Merrill Lynch’s Chief Investment Strategist Richard Bernstein said that investors are “significantly underestimating” the risks still associated with the credit crisis and suggested that we are not even close to the end of the problems.

I couldn’t agree more - the more that the mainstream media gets this message out the faster we’ll precipitate the changes that will get us to that bottom, where we can actually start a recovery.

From Bloomberg:

Financial stocks fell, led by Bank of America Corp. and Morgan Stanley, after a limit on short selling expired and Merrill Lynch & Co. said the credit crisis is “far from over.”

Finance company stocks also fell after Merrill Chief Investment Strategist Richard Bernstein said investors are “significantly underestimating” the extent of the credit crisis.

“The problems are not confined to large institutions that are overexposed to U.S. subprime loans,” Bernstein wrote in a note to clients. He said banks and brokerages need “massive” consolidation to recover.

Analysts including Oppenheimer & Co.’s Meredith Whitney and Deutsche Bank AG’s Mike Mayo this week cut profit estimates and forecast further writedowns on mortgage-related bonds.

“You are going to see stresses continue for financial institutions,” said Stephen Wood, who helps manage $213 billion at Russell Investments in New York. “You’re beginning to see that macroeconomic slowdown ripple through.”

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Note: I’m very excited to introduce a series of guest articles by Anthony M. Freed.  This is his first.  Anthony is an analyst, researcher and freelance writer, and can be reached at anthonymfreed@gmail.com.  Please welcome him - I’m excited to get his take on the market from the analyst perspective.

So once again wild swings in the markets have unleashed the bullish cries of “Bottom!” by the guestimating industry cheerleaders like Jim Cramer, the NAR, and similarly minded government ilk who believe we can all collectively wish our way out of this mess. But the proverbial writing has long been on the wall, and we have yet to measure the depth of the losses.

What are the monsters are lurking in the nearby shadows? Well I am not going to tell you anything you have not already figured out if you have been following news posts and blogs about the mortgage industry with even a passing interest. It’s that illegitimate offspring of Sub prime and Prime called ALT A that is taking over the national spotlight. Now everyone in charge can throw up their hands in surprise that the golden child of the short lived post-sub prime era was a bad idea too. This from Housingwire.com’s Paul Jackson on Fannie’ mounting ALT A problems:

“,,,any changes purchase/underwriting criteria still clearly came far too late to prevent GSE (Fannie) from taking a direct credit hit, now that the Alt-A mortgage class is the latest area of mortgages to go through a meltdown, and many borrowers are defaulting at a seemingly parabolic rate each month and each quarter.”

This should not be not be news to anyone, especially those who should be in the know. As late as the spring of 2007, major national lenders were still aggressively marketing ALT A products with with ridiculously vacuous underwriting criteria: A borrower could secure a no income/no asset documentation cash-out refinance loan, with a simultaneous second mortgage up to 95% CLTV, on a non-owner occupied investment property, with only a 620 FICO, two months PITI reserves and a debt to income ratio up to 60%. Whah?

So even as executives were in the midst of struggling to explain how they were blindsided by the rapid demise of their sub prime divisions, they were also racing to expand ALT A criteria to cover all but those borrowers with the very worst credit ratings. And they did not stop there, they pressed on with the development of other exotics Iike Near Prime and Expanded Approval, And it was all done to maintain market share and the record origination levels they had grown addicted to. But who will they blame in the media for their greed driven and fiscally irresponsible business practices? Why, all the lying cheating borrowers who did this to them, of course! Also from Jackson’s article:

“The strategy isn’t all that surprising, as nearly anyone in the mortgage business these days is looking for a reason to push the bad loans — and the losses associated with them — off of their books, and onto someone else’s. And in the case of Alt-A, there’s likely to be more than a just a fair amount of income misrepresentation, among other sorts of fraud.”

I am in love with this line of reasoning: The average American homebuyer- be they plumber or grocery clerk or postal worker – collectively conspired by the millions to defraud the financial industry out of 3 trillion dollars in about a five year period. And now, they are cleverly concealing their new found fortunes by going through the motions of being foreclosed upon and thrown out on the street just to cover their tracks. Truthfully, how much can you be lying about if you only need to get yourself to a 60% DTI?

I know if they look at enough liar loans, they will find some liars. But that is missing the fundamental issue at hand here, that it was lax underwriting and low down payments initiated by the lenders, not the borrowers, that are responsible for this mess, I can remember as a little boy, asking my dad why someone would bother putting up a chain link fence that was only four feet tall. “Little fences are only for keeping good people out of trouble,” he told me. And that is exactly what the lenders did not do when they developed and marketed these and other more complicated products like Pay Option Arms, they built them without the little fences that would have kept them and us out of trouble.

Let’s pretend for a moment that borrower overstatement of income on ALT A loans really was so greatly overstated on average as to be responsible for 50% of all defaults on the books. Imagine what the effect a simple underwriting requirement like a signed T4506 – the authorization to review tax returns – could have made. They do not inherently prevent default on stated income and asset loans, but they certainly would have made borrowers who might be tempted to stretch the truth think twice about the consequences. Instead, there was a culture were no one felt they had to be really honest with anyone else. The hunters set the traps, and now they want to blame the animals for getting snared, and the media just eats it up.

So don’t be fooled by those who need you to stick your money into those raucous markets. The time will come, but it’s not here yet. And it should not be this difficult for the big brains to figure it all out. The underwriting is on the wall, the deals are closed, and the resets are coming like clock work. Let’s all just accept that it is really no surprise to any of us.

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ALT A is Broken? Really?

Portfolio.com asked it’s readers to vote on the least trustworthy Wall Street CEO. The results are not surprising and macabre in their own way. As we’ve thoroughly documented here, Wall Street CEOs have had a problem with drinking their own kool aid or lying throughout the housing, credit and mortgage bust.

Below are the results with their most choice quote about the strength of their company or the impact of the mortgage mess on their business.

The higher the percentage the less trustworthy. As Barry asks at The Big Picture, where’s Tangelo? And the answer

of course is, he’s no longer a CEO.

From Portfolio.com:

The Final Tally:

Alan Schwartz, Bear Stearns : “Capital … remains strong.” 26%

Martin Sullivan, AIG: Chance of a loss? “Zero.” 22%

Ken Lewis, BofA: There’s “value in Countrywide.” 12%

Ken Thompson, Wachovia: We’re in “a great market.” 11%

Dick Fuld, Lehman Bros.: “The worst is behind us.” 8%

John Thain, Merrill Lynch: “We have tackled the problem.” 8%

Vikram Pandit, Citi: We are “well-capitalized.” 7%

Kerry Killinger, Washington Mutual: “Profitability” in 2008. 4%

John Mack, Morgan Stanley: “Comfortable” with the risks. 3%

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Courtesy of the Big Picture:

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Friday Funnies

Fannie Mae posted a $2.3 billion loss for the quarter as the mortgage and housing bust keeps chipping away at the liquidity of the mortgage giant. At this rate, I can’t imagine it being too much longer before the treasury pumps its first infusion of capital in to the company.

At least the company cut the dividend to a nickel for investors (from 35 cents).  In my opinion as long as the government is explicitly guaranteeing the debt of this company, and using taxpayer funds to prop them up all dividends should be eliminated and corporate pay packages should be brought in line with other public officials.  How pissed are you that your tax dollars are going to pad the salary of Fannie’s CEO?

From Market Watch:

Fannie Mae reported Friday a wider-than-expected loss for the second quarter and cut its dividend as the biggest U.S. buyer of home mortgages said the struggling housing market and credit expenses again hurt its performance, sending the company’s shares lower.

Fannie Mae lost $2.3 billion, or $2.54 a share, a reversal from the $1.9 billion, or $1.86 a share, earned in the year-ago second quarter.

Daniel Mudd, Fannie’s chief executive, said that credit conditions are getting worse and that the company expects to have to resort to further increases in its loss reserves.

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Fannie posts $2.3 billion quarterly loss

Wow, this keeps getting more and more interesting by the minute.  The latest in the mortgage market meltdown is the news that Citigroup and now UBS will buy back a combined $32 billion worth of auction rate securities that were sold fraudulently.  This is just another blow for cash-strapped mega-banks that have gone to great lengths to raise and maintain capital in this credit crunch.

Billion-dollar buybacks sure don’t help.  Shareholders rejoice! Not really.

From Bloomberg:

UBS AG, Switzerland’s biggest bank, may pay more than Citigroup Inc. or Merrill Lynch & Co. to settle state and federal claims that it fraudulently sold auction-rate securities, a person briefed on the negotiations said.

UBS is close to resolving those claims and may make a promise to retail and institutional clients to buy back the securities, valued at $25 billion by regulators, the person said. Merrill Lynch offered yesterday to buy back about $10 billion in auction-rate securities from individual investors, claiming that was the amount its customers held.

Citigroup agreed yesterday to buy back $7.3 billion of the debt from individual investors to settle state and federal regulators’ claims and to pay $100 million in fines, setting a framework for talks with other banks including UBS. Citigroup also promised to help institutional customers unload another $12 billion in the securities.

“We reach settlements that are appropriate for the circumstance,” New York State Attorney General Andrew Cuomo said yesterday at a press conference announcing the deal with New York-based Citigroup, the largest U.S. bank by assets, that also requires it to help more than 2,600 institutional investors unload $12 billion of the securities. “UBS would be a different circumstance.”

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Auction Rate Securities = Bank Desperation

The worst over?  Not so much.  AIG took a whopping $5.4 billion dollar loss last quarter related to, you guessed it, mortgage losses and write downs!  I’m one big broken record these days, but there’s not much else to say here.

AIG quickly took a nice chunk out of its recently-raised $20 billion as writedowns on mortgage hammered its business.

From Market Watch:

American International Group reported a $5.36 billion second-quarter net loss late Wednesday as the insurance giant was hit again by write-downs and impairments on mortgage-related exposures.

The quarterly net loss included $5.57 billion of unrealized market valuation losses on AIG’s super senior credit default swap portfolio. It also included $6.08 billion of net realized capital losses from its investment portfolio, the company disclosed.

“Our second quarter results were adversely affected by the severe conditions in the housing and credit markets and a very difficult investment environment,” AIG’s new Chief Executive Robert Willumstad said in a statement. “We have a lot of work to do to restore AIG’s profitability to where it should be.”

AIG reported a record quarterly loss earlier this year after suffering huge write-downs on credit exposures. The company quickly raised roughly $20 billion selling new shares and other securities.

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AIG takes $5.4 billion 2nd quarter loss

Thank goodness for that explicit guarantee!  Freddie Mac posted losses of $821 million and said that there is “no possible way” to predict the end of the housing bust.  The company also doubled it’s loan loss reserves to $2.8 billion - which sounds reassuring until you realize that $2.8 billion is only good for about 3 quarters of similar losses.  Freddie Mac is going to need lots of cash - my paycheck awaits!

From Bloomberg:

Freddie Mac, the U.S. mortgage-finance company hobbled by record foreclosures, slashed its dividend at least 80 percent after posting a quarterly loss that was three times wider than analysts’ estimates.

… Freddie doubled its reserves for future home-loan losses to $2.8 billion, signaling Chief Executive Officer Richard Syron sees no end in sight to the worst housing slump since the Great Depression.

Freddie has 22,000 properties in foreclosure, more than ever before, and it now anticipates losing 26 percent on each loan, up from 22 percent. McLean, Virginia-based Freddie has plunged 76 percent this year on concern the company may not have enough capital to overcome delinquencies on the $2.2 trillion of mortgages it owns and guarantees, prompting Treasury Secretary Henry Paulson to step in with a rescue plan.

“Neither we nor anyone else can predict when the housing market will recover and it will be folly for anyone” to try, Syron said on a conference call with analysts today. “There’s still a large amount of inventory to work through the system and record foreclosures.”

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Freddie Mac loses $821 million for the quarter