Are FHA Loans the New Subprime?

I just ran into another tenant in my office building this morning - he is a mortgage broker specializing in sub prime lending. He just moved his office to his house due to the fall off in these types of loans. I asked him how the business was and he mentioned something about the growing popularity of FHA loans, referring to loans either made or guaranteed by the Federal Housing Administration. And then he made a chilling statement with a slight grin on his face:

"You know, FHA is the new sub prime."

He then waltzed out the door, safe in the knowledge that his capital wasn't at risk.

I have to do more research on this type of loan. I know a little bit about it - only 3% down payment required I believe. If anyone knows something about this type of lending, please comment and tell me we are not about to make the same mistakes again.

It's Official, Securitization Sucks

It took them long enough to prove what we all knew in our heart, but four members of academia just published a paper on it. This excerpt is from the conclusion:

"The goal of this paper is to empirically investigate whether securitization had an adverse effect on the ex-ante screening activity of banks. We exploit a specific “rule of thumb” in the subprime lending market to generate an instrument for ease of securitization. Comparing characteristics of the loan market above and below the ad-hoc credit threshold, we show that securitization does indeed weaken the screening incentives of financial intermediaries."

"An 80% increase in securitization volume is on average associated with about a 20% increase in defaults. These defaults are being driven by characteristics of the loan or the borrower that are unobservable to both the researchers and the securities market. That we find any effect on default behavior in one portfolio compared to another with virtually identical risk profiles, demographic characteristics, and loan terms suggests that the ease of securitization may have a direct impact on incentives elsewhere in the subprime housing market, as well as in other securitized markets."

Full Paper

Commercial Mortgage Delinquencies Head Up

Delinquency rates on Commercial Mortgages steadily increased during 2007, according to recent reports from several different groups. According to Foresight Analytics, rates were:

4Q-07 - 1.7%
3Q-07 - 1.4%
2Q-07 - 1.1%

These rates are still very low and not a worry yet, but they are sure to head higher in 2008.

The Federal Reserve also reported a 1.94% delinquency rate in the fourth quarter of 2007.


Commercial Mortgage Delinquencies

Countrywide Earnings

Countrywide Financial (CFC) just reported what will probably be its last quarter as an independent company. I won't rehash all the losses and write offs that were detailed in the press release, but I did notice one thing that scared me a little.

CFC reported a delinquency rate of 5.76% in its servicing portfolio for Conventional 1st liens. This is up from 4.41% and 3.05%, at the quarters ending September 30, 2007, and December 31, 2006, respectively.

The delinquency rate for sub prime was a sky high 33.64%, but that did not come as a surprise to me.

Foreclosure City

A great heat map of foreclosures by county courtesy of Mathhew Yglesias and a blog called Grasping Reality with Both Hands.




It's a little too small and hard to read but I think you get the point.

Thrift Report

The Office of Thrift Supervision (OTS) just released its third quarter report on the state of the thrift industry. While the market and the media have been focused on the travails of the large cap banks and brokers, the thrift industry is just as important to our financial system as it has $1.57 trillion in assets and originated 30% of all mortgages in the most recent quarter. The full report is available here:

Thrift Industry

Highlights include:

1) Loan loss provisions increased to 0.92 percent of average assets in the third quarter, an increase from 0.22 percent in the third quarter one year ago and from 0.38 percent in the prior quarter.

2) Troubled assets (noncurrent loans and repossessed assets) were 1.19 percent of assets, up from 0.95 percent in the prior quarter and 0.64 percent a year ago.

Loan loss provisions as a percent of average assets are now at the highest level as far back as the report goes (1991).

Although these metrics are high, it can get a lot worse. If you look at page 11 of this report, entitled troubled assets, you can look at the peak back in the early 1990's.

Also, as the report notes, if you exclude the top ten thrifts who are active in originating loans for sale, the industry return on assets would have been much higher.

Lennar Earnings Call - No Bottom Yet

I just got off the Lennar call and wanted to share these highlights regarding the housing markets. Management has not yet seen the bottom in the markets they build in.

During the call, Lennar said that they would need to see three things before there is a recovery or stabilization in the market:

1) Inventories of both new and existing homes will have to stabilize first and be absorbed.

2) Mortgage markets will need to settle.

3) Consumer confidence is going to have to be restored.

Lennar said that there was no sign during the quarter that any of these occurred, and that in fact they had deteriorated further during the quarter.

General Market Conditions

“These continue to be very difficult times for the homebuilding industry”

“Current market conditions are primarily defined by the overhang of inventory in those markets which is comprised of completed homes on the ground, spec homes that are back on the market and owned homes that are up for sale. The overriding sentiment in our reviews is that the market has continued to become more and more competitive as inventories are managed and there continues to be a great deal of downward pricing pressure through the use of incentives, price reductions and incentivized brokerage fees."

On Signs of the Bottom

“Overall the supply of homes to sell continues to climb in many of our markets and we are not able to get a good reading how quickly this inventory will be absorbed or whether it will continue to increase as foreclosures increase and add to inventory.”

Mortgage Markets

“Adding to the sluggishness on the demand side is the continuing deterioration of the mortgage market as an additional component of demand has been sidelined.”

“We have not yet seen stability in the mortgage market either.”

On the Arrival of Helicopter Ben

“While the recent cut in interest rates by the federal reserve will began a process of rebuilding confidence it will most certainly not be a panacea for conditions as they exist.”

Wilbur Ross Speaks and You Damn Well Better Listen

I just listened to a great interview with Wilbur Ross on Bloomberg which was brought to my attention by the people at Vinvesting


Wilbur Ross Bloomberg Interview

The interview is 25 minutes long and goes into good detail on the issues of the day, including the sub prime lending fall out, brokerage earnings, the growth of the hedge fund industry and the inherent weakness of quantitative "black box" investing.

Jackass of the Day - August 31, 2007

"The program could play a very important role in saving from foreclosure American homeowners who have been taken advantage of by unscrupulous subprime lenders and brokers,"

Senate Banking Committee Chairman Christopher Dodd, D-Conn

And how will you tell them apart? Can you distinguish between greed and stupidity?

Quote of the Day - August 31, 2007

"It's not the government's job to bail out speculators or those who made the decision to buy a home they knew they could never afford,"

-President George W. Bush.

Wilbur Ross - Words of Wisdom

Can someone please get this guy to run for president?

Wilbur Ross sums it all up

The Panic of 2007

Is it possible that we are on the verge of a full blown financial panic? I remember studying about the periodic financial panics that would hit the United States economy every generation or so. They seemed quaint and remote and not something that could happen in the age of deposit insurance, the Federal Reserve and the heavy hand of government intervention.

There have been so many financial panics in our history that they had to name them after the years they occurred. The panics of 1893, 1907, etc. Most of these panics involved banks, but the concept is the same. They are characterized by lack of confidence in our financial system, with a sudden shock to that system being the accelerant that sparks the conflagration or panic. And then a rush for the door, as everyone tries to get their money out first.

Let's look at what is occurring in our financial system:

1) Credit for purchasing residential real estate is drying up. It's no secret that sub prime and Alt A lending is essentially unavailable, but now it is spreading to prime lending and jumbo mortgages. If you think that jumbo mortgages is an issue only for rich people then you should take a look at the average home price in California, where you need a jumbo mortgage to buy a shack. This credit contraction will accelerate and prolong the housing downturn even further. This, of course, will have repercussions in the economy.

2) A money market fund just "broke the buck" or would have, if it let investors redeem their money. This is the first time that I can remember that this happened since Merrill Lynch, Pierce, Fenner and Smith pioneered these in the early 1980's.(Yes, I purposely used the former name to show how old I am.) Most non-professional investors assume that money market funds are "cash," and they are not.

3) We may be on the precipice of major redemptions in hedge funds, which will trigger another leg down in the equity financial markets. Think of all the money that has flowed into hedge funds the last decade, and then consider what would happen if that river reversed. Now if you think this is about a bunch of spoiled hedge fund managers whining because they have to sell their third vacation home, you are wrong. If I remember my numbers correctly, around 40% of Americans are invested in stocks.

4) We have a hyperactive media where every bit of information is available instantly, and then magnified tabloid style. Don't underestimate the effect that the media can have in creating panics. They are at the center of all of them if you look back at your high school history book.

The last recorded financial panic was in 1910, but of course we have had them since then but they stopped calling them "panics" and started using other terms for them. I hope that this doesn't happen in my lifetime, but I wonder sometime what really can be done to stop these events. After all, by definition, they are "panics," implying uncontrollable events.

Tragedy of The Commons

The Tragedy of the Commons is a concept that refers to the use and ultimate damage done to resources that belong to the public. Here is how it works on a simple economy basis:

An economy consists of a single village. Each resident attempts to gain wealth by putting as many animals on the common pasture of that village as it can. As the village grows in size and more and more animals are placed on the commons, overgrazing begins to impact the pasture. Eventually, no stock can be supported on the commons. As a result of population growth, greed, and the use of the commons, the village collapses.

It occured to me that this concept can also be applied to what is happening with sub prime lending and credit in the economy. Banks and others would make loans and then the loans would be securitized and sold off. The purpose of the securitization was to minimize risk by removing that risk from a lenders balance sheet, etc.

It instead has the opposite effect - by redistributing risk - it increased risk because it made no one responsible for that risk. The risk was distributed to the "commons." A lender could make a bad loan and it wouldn't matter because that loan would be sold off to the marketplace. It is analogous to a common grazing site in a small village as described above.

"Whatsoever a Man Soweth, That Shall He Also Reap"

I am not a religious person, but I couldn't think of a better title for the story below:


Mortgage Broker Loses House