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Is a Housing Crisis Approaching?

Our conversation yesterday -- and the weak Existing Home Sales data -- lead us to an inevitable question: Is a Housing Crisis Approaching?

For some insight into this issue, let's pull some data from a fascinating discussion in Barron's this past weekend. Lon Witter puts forth a different and intriguing notion. Witter observes that we don't have a Housing bubble, what the U.S. has is a lending bubble. His evidence is how loose the lending standards have become, and why not? The banks ultimately just flip the loans to the Fannie Mae (Federal National Mortgage Association, on the NYSE: FNM), where foreclosures and defaults become the headache of buyers looking for greater risk and return. 

Witter claims his careful look at the reasons for the rise in housing give a good indication of the impact housing may have on the stock market. He observes the causes (in chronological order) of the rise and ultimate fall of Housing:  "The collapse of the Internet bubble, which chased hot money out of the stock market; rock-bottom interest rates; 50 years of economic history that suggested housing never goes down, and creative financing."

Traditionally, Mortgages have been low risk lending, as the loan is securitized by the underlying property. When banks were lending less than the value of the property (LTV), to people with good credit, who also were invested in the property (substantial down payments) you had the makings of a very good business: low risk, moderate, predictable returns, minimal defaults.

That model seems to have been forgotten.  THIS IS REMINSCENT OF THE S&L CRISIS -- where lenders did not have any repercussions for their bad loans!

As bad as the above numbers look, the thinking behind them is worse:

"Lenders have encouraged people to use the appreciation in value of their houses as collateral for an unaffordable loan, an idea similar to the junk bonds being pushed in the late 1980s. The concept was to use the company you were taking over as collateral for the loan you needed to take over the company in the first place. The implosion of that idea caused the 1989 mini-crash.

Now the house is the bank's collateral for the questionable loan. But what happens if the value of the house starts to drop?"

A good example of how this is unfolding at lending institutions comes from Washington Mutual: You may recall Washington Mutual laid off 2500 employees in their mortgage broker department earlier this year. As LTV went above 100%, and then as property values decayed from recent peaks, the collateralized aspect of these mortgages suddenly is at risk.

Here's how this has played out over the past few years via WaMu's ARM loans (data via Washington Mutual's annual report):

- 2003 year end, 1% of WaMu's option ARMS were in negative amortization (payments were not covering interest charges, so the shortfall was added to principal).

- 2004, the percentage jumped to 21%.

- 2005, the percentage jumped again to 47%. By value of the loans, the percentage was 55%.

So each month, the borrowers' debt increases; Note there is no strict disclosure requirement for negative amortization -- Banks do not have an affirmative obligation to disclose this to mortgagees.

Thus, a large part of our housing system have become credit cards. And according to Witter, "WaMu's situation is the norm, not the exception."

Even worse, Witter notes that negative amortization is booked by the banks as earnings. "In Q1 2005, WaMu booked $25 million of negative amortization as earnings; in the same period for 2006 the number was $203 million."

This situation is unsustainable. Witter's housing and market forecast is rather bearish:

"Negative amortization and other short-term loans on long-term assets don't work because eventually too many borrowers are unable to pay the loans down -- or unwilling to keep paying for an asset that has declined in value relative to their outstanding balance. Even a relatively brief period of rising mortgage payments, rising debt and falling home values will collapse the system. And when the housing-finance system goes, the rest of the economy will go with it.

By the release of the August housing numbers, it should become clear that the housing market is beginning a significant decline. When this realization hits home, investors will finally have to confront the fact that they are gambling on people who took out no-money-down, interest-only, adjustable-rate mortgages at the top of the market and the financial institutions that made those loans. The stock market should then begin a 25%-30% decline. If the market ignores the warning signs until fall, the decline could occur in a single week."

As we saw yesterday, the housing data has begin that downside surprise. We have yet to see if July's downard acceleration was a one off or the start of something much more ominous.

Anecdotally, a friend who is a Real Estate attorney in Virginia emailed the following after yesterday's discussion:

'We’re seeing substantial increases in foreclosure volume, with more loans going to sale and being bought back by noteholders. Most are loans which have originated since 1/1/05.  many are conventional ARM loans. Foreclosure investors are now sitting on the sidelines.

Huge increases in available real estate up and down the i-95 corridor  with stuff sitting for extended periods, even in resort areas."

Thus, our Housing driven Economy has now moved into the next phase: the long glide downwards in prices, sales volume, and foreclosures.

And, we have new Home Sales today at 10am

More on this later . . .

Source:
The No-Money-Down Disaster
LON WITTER
Barrons, MONDAY, AUGUST 21, 2006   
http://online.barrons.com/article/SB115594208047539900.html

Thursday, August 24, 2006 | 06:54 AM | Permalink | Comments (70) | TrackBack (12)
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Comments

The crisis is already here and Sarasota County and it has just begun. Panic will set in shortly.

http://heraldtribune.com/apps/pbcs.dll/article?AID=/20060824/BUSINESS/608240352

Posted by: Jim | Aug 24, 2006 7:57:17 AM

«Thus, our Housing driven Economy has now moved into the next phase: the long glide downwards in prices, sales volume, and foreclosures.»

Or the long glide up in ''inflation'' because of the political necessity to bail out real estate investors with low interest rates and rising prices. Does the Greenspan Put apply to housing too? Are real estate investors less economically or politically important than stock investors?

Posted by: Blissex | Aug 24, 2006 8:21:01 AM

Wouldn't an attempt at a housing put
cause long-term rates to skyrocket??

Posted by: tman | Aug 24, 2006 8:40:18 AM

For those of us that have lived thru a real estate "crash" (Houston/Dallas/other oil towns in the late '80s), the current episode has been very disturbing.

There is a subtle problem mentioned in Barry's missive that is simply not understood by the majority of homeowners and investors (nor lenders??):

people that have bought those homes with very little down, let alone zero down (and don't forget, there were some 105% loans that even paid for closing costs), have nothing to lose. they bought a cheapie call. they're renting.

in the late 80's, when oil went to $12/bbl, the oil towns saw their leveraged real estate bubbles pop in unison. there was a large group of homeowners in those oil towns that learned about "non-judicial foreclosures" by word of mouth.

in extreme cases of people who were upside down, they began to feel each month's mortgage payment was the equivalent of flushing money down the toilet. when they stopped making payments they found out you can live "rent free" for up to a year before the overwhelmed banks can apparently get to your file and kick you out.

During the past few years I've heard the mantra re: homes are different than stocks because you *have* to live somewhere. but that phrase is long forgotten when you're upside down to the tune of 30-40% of your loan balance. home sweet home becomes a daily reminder of a horribly sick sinking feeling. puts stress on a marriage. you feel like the sucker that you are for buying at the top.

thus, the natural human reaction-- the rationale choice- is to throw the keys at the bank and move on. you think inventories are high now?...

Posted by: financialrx | Aug 24, 2006 8:46:38 AM

First, to comment on your last Linkfest: GO SEE Little Miss Sunshine! You will love it based on your taste in movies/music, etc. This should be your 1st priority.

Second, this real estate commentary echoes comments on the Minyanville site by Jeff Saut of Raymond James.

Posted by: Wendell | Aug 24, 2006 8:47:20 AM

I'm going to post a brief excerpt from a good page on mortages and the bubble here: http://patrick.net/housing/crash.html

(I'm not connected with the author, I just found it when researching the non-recourse loan issue via google.)

"If you have a single loan with just the house as collateral, it may be a "non-recourse" loan, meaning you could indeed walk and not lose anything other than your house and any equity in it (along with your credit record). But if you refinance or take a "home equity loan", the new loan is probably a recourse loan, and the bank can get very aggressive, not to mention what the IRS can do. A reader who lived through the 1989 housing crash in LA pointed out the following nasty situation that can happen:

• Let's say you buy a house for $600,000, with a $500,000 mortgage.
• Then the house drops in value to $400,000, you lose your job, or otherwise must move.
• If you can't make your payments, the bank forecloses on you and nets $350,000 on the sale of your house.
• The bank's $150,000 loss on the mortgage is "forgiveness of debt" in the eyes of the IRS, and effectively becomes $150,000 of reportable income you must pay tax on.

It is true that buyers who put zero down and have nothing invested in the house are much more likely to walk away. The large number of new uninvested buyers increases the risk of a horrifying crash in prices rather than a "soft landing". "

Posted by: T | Aug 24, 2006 9:37:48 AM

Good morning. The recession has started.

Have a nice day! ;-)

Posted by: Craig H | Aug 24, 2006 9:42:07 AM

How can this not end badly? The market seems to shrug this off. Shouldn't it be obvious that most economic growth in the last few years has been through leveraging homes (which is incredibly stupid) and that this is not sustainable? Seems obvious to me anyway.

Posted by: Mike M | Aug 24, 2006 9:42:14 AM

Some food for thought:
1. At least 30-50% of ALL loans applications in the last five years have some sort of not-so-little white lies or involve outright fraud. I'll bet ya.
2. The current inventory of new and used homes for sale provided by NAR and local MLS's, as well has home builders, does not include a huge number of vacant properties with no sign, FSBO's and flips in process or remodels.
3. Returning the keys and walking? See tax laws regarding mortgage relief after foreclosure and subsequent REO sales by lenders. Your 1099 will be in the mail. That's a fact jack.
4. In areas such as Phoenix, prices increased by 150% since 2001. Prices will drop by 60-80% from their 2005 peaks in the next 4 years. My expert opinion!
5. Massive layoffs in the real estate, mortgage and construction industry are already occuring, and many of these lost jobs are not reflected in official employment statistics, e.g. real estate agents and illegals.

Posted by: fred hooper | Aug 24, 2006 9:45:39 AM

Wendell,

1) I saw Little Miss Sunshine -- and Miami VIce -- this weekend. (Liked 'em both);

2) Jeff and I have had several long conversations about RE -- most recently, at Minyans in the Mountains.

While he is very cautious, I am more bearish then he is on the implications of this long term.

Posted by: Barry Ritholtz | Aug 24, 2006 9:49:46 AM

I can't count how many newsletter spam emails I've received predicting the meltdown of R.E.

Almost without variance, each has pushed gold as the place to be once it happens.

Anyone have an opinion on the inflationary/deflationary prospects going forward?

If you really believe this is going to play-out as a disaster, is it equal parts CASH and GLD, or WHAT???

Posted by: wnsrfr | Aug 24, 2006 10:08:58 AM

Financialrx. You reminded me of something I've been pondering regarding the "you have to live somewhere" argument used by housing bulls. A large percentage of single women were buyers of housing over the last five years. They will be hard hit in this recession. In addition, many people in their 20's and 30's are still living with their parents. I'm guessing here, but I'd bet the occupants per bedroom ratio (OBR) is currently at a historic low. More youngsters will move back home and singles will start shacking-up for economic reasons. Finally, many boomers are taking-in their elderly family members. I'm single, and depending on how things play out, will do the shack-up thing and/or move in and take care of my elderly mom. If both happen, add 2 townhouses to the vacant category.

Yet again, Craig H wins first prize today. The recession has started.

Posted by: fred hooper | Aug 24, 2006 10:09:17 AM

In regards to the I-95 corridor comment from Barry's friend: this isn't happening in Connecticut (Fairfield County at least). We're seeing softening prices, but the bottom line is that there is not that much room to develop here, plus some of these towns have fairly snotty zoning limits for building. Money keeps flowing from NYC, and the hedgies in Greenwich and Stamford, which will prop up the markets. The impending real estate bust/soft landing will be more of a localized issue.

Posted by: ch | Aug 24, 2006 10:11:08 AM

"We have yet to see if July's downard acceleration was a one off or the start of something much more ominous."

Uh, something more ominous!

Posted by: me | Aug 24, 2006 10:12:13 AM

"Witter observes that we don't have a Housing bubble, what the U.S. has is a lending bubble"

What nonsense. Almost no one buys a house for cash. Houses are bought with loans. A lending crisis IS a housing crisis.
We are already in a housing crisis. It is unfolding as a classic bubble collapse. Prof Shiller is proven right, again.

Posted by: edhopper | Aug 24, 2006 10:13:53 AM

And we can add this fro Daily Reckoning:

"Anyway, the thing I wanted to highlight, as proof that the U.S. economy is going south quickly, was this observation by Dr. Richebacher, "Over the three months April-June, the BLS reported the creation of 329,000 non-farm jobs. But this has come about with a stunning contribution of 657,000 from the net birth/death model, accounting thus for about 200% of the total job creation. Without this adjustment, reported employment would have slumped. Please note that these net birth/death jobs would, if annualized, add up to more than 2.6 million new jobs.""121

Posted by: me | Aug 24, 2006 10:30:31 AM

Don't want to wander too far off the reservation here, but two comments posted above reference nasty IRS issues due to forgiveness of debt.

It is true that forgiveness of debt = income. It is also true that in some cases that person could receive a 1099 (or if it were rental properties held in a partnership that "phantom income" would show up on the K1).

But there is an arcane place in the tax code that provides relief: if you have income from forgiveness of debt you may be able to exclude it, either whole or in part, if you are technically insolvent.

think of it in the context of someone that files bankruptcy. you can't squeeze blood out that turnip, since by definition a bankrupt person does not have the means to pay a tax if they can't even pay their bills. thus, most walk away with a clean slate.

like it or not that is the purpose of tax and bankruptcy policy as it stands (to provide a clean fresh start so that person can recover and once again become a productive taxpaying citizen).

I've intentionally skipped the usual caveats and exceptions our tax and bankruptcy laws are famous for, thus, individual results may vary. and I'm not your tax attorney, nor do I play one on TV (although I did stay at a Holiday Inn last night).

Posted by: financialrx | Aug 24, 2006 10:31:38 AM

Witter observes that we don't have a Housing bubble, what the U.S. has is a lending bubble. His evidence is how loose the lending standards have become, and why not?

Barry,

I think this is right on, to focus on the lending. There are just way to many bits of negative data that individually get dismissed, but inevitably add up to a real problem.

Since 2001 subprimes have gone from less than 10% of the market to +25% and option mortgages went from next to nothing to +25%, and up to 75% of those people are paying the minimum, negative amortizing rate.

Here's something I've never seen really looked at: Are people being approved based on their ability to pay teaser and/or neg amortization rates? I have seen allusions to this that lead me to believe they are.

There is a lot of room bull$hit in the way mortgages are handled now. A study looking at no-doc mortgages found that 50% of applicants exaggerated their income by at least 60%.

Mortgage brokers and assessors are wholly disconnected from any risks and rewarded for volume over prudence. The lenders are insulated from risk by securitizing their portfolios.

The people holding the risk--i.e., non-agency, mortgage backed securities bonds--are basing the pricing on data that is, at best, highly suspect.

I think these bonds are going to head down the tubes and I try to avoid any investment that may have a connection to these (the whole financial sector) and have Jan 2008 puts on CFC, FED and LEND. About half of FED's profits are attributable to the negative amortizations created from people making the minimum payment on their option ARMs. Their profits are holding up merely because their customers can't afford the mortgages they gave them! ;-)

Posted by: Bob_in_MA | Aug 24, 2006 10:32:50 AM

The one thing that really bothers me is that at the peak, July 2005, nobody was saying this would end. Even Greenspan wouldn't admit it. But when you looked at the fundamentals 4 standard deviations out of whack it was blindingly obvious this was coming. I don't trust the "economists" at the NAR or the media that quotes them anymore.

The title of David Lereah's (head NAR 'economist') book is
"Are You Missing the Real Estate Boom?: The Boom Will Not Bust and Why Property Values Will Continue to Climb Through the End of the Decade - And How to Profit From Them"

And the papers are still asking this guy for his forecast!!

Posted by: KirkH | Aug 24, 2006 10:35:08 AM

Won't the new bankruptcy laws have an effect here? Sure, before you could walk away, and the repercussions were minimal. What about now? won't these folks have to pay something back forever, on their long gone dreamhouse? won't that encourage them to do anything to say put?

Posted by: Thom H | Aug 24, 2006 10:41:49 AM

How do you "stay put" when the ARM on your dreamhouse readjust and your monthly mortgage triples?

Posted by: edhopper | Aug 24, 2006 10:54:47 AM

economist.com posted a story on this type of a scenario about a year ago... It was a basic story of the impact that a housing slow down would have on the economy in terms of the consumer.... I know that I sound like a scrached record. If anyone has any Idea of what anyone can do to prevent this impending disaster, I would like to hear about it. It really looks, sounds, smells and feels bad.

Posted by: albiegf13 | Aug 24, 2006 11:12:47 AM

Time to go long cardboard boxes, cat food, and STZ, maker of the finest bum wines.

Posted by: Brian | Aug 24, 2006 11:20:34 AM

At least the note here needs to be bolded, if not the whole thing. How many people have neg-ams and don't know?

Note there is no strict disclosure requirement for negative amortization -- Banks do not have an affirmative obligation to disclose this to mortgagees.

Posted by: crack | Aug 24, 2006 11:25:18 AM

Careful Brian. You might want to short Fancy Feast.

Posted by: KirkH | Aug 24, 2006 11:38:58 AM

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