Underwater ARMs ?
How bad is the Adustable Rate Mortage (ARM) situation? Stephanie Pomboy via Barron's Alan Abelson has the straight dope:
"After modest reflection, any disinterested observer can't help but find that accompanying table quite alARMing. It's from a recent MacroMavens report, the handiwork of the incomparable Stephanie Pomboy, whose rants and raves we've had the pleasure of occasionally sharing with you. What its blood-curdling numbers depict is that the woes of mortgage lenders are not, as so widely believed, confined to the beleaguered subprime contingent, but are casting a much larger and chillier shadow.
More specifically, the table shows all too clearly that an astounding percentage of adjustable-rate mortgages already are underwater, and it estimates how much equity would be wiped out if home values decline by 5%, 10% and 15% and translates the corresponding losses into dollars.
As Stephanie comments: "Based on the share of ARMs in some state of negative equity at the end of last year and the decline in home prices so far in 2007, a stunning $693 billion in mortgage loans are already in the red. Assuming lenders are able to recover 70% of those assets -- which seems optimistic given the massive amount of housing inventory yet to be unwound -- that means mortgage lenders are already grappling with $210 billion in outright losses."
And that, she points out, is merely the direct hit. Thanks to what she nicely dubs the "divine miracle of leverage," the total financial exposure to these claims is many multiples of that. To which we say, ugh!
What's more, Stephanie notes, these horrendous losses are coming at a time when the financial sector is "uniquely unprepared to withstand them." Commercial banks, she points out, have let their loan-loss provisions sink to 20-year lows while increasing their exposure to real estate to record highs. Mortgages, she reckons, account for a tidy 55% of total bank loans -- and that doesn't include the trillion dollars worth of mortgage-backed securities on bank balance sheets.
So much for the myth that banks have cleverly "offloaded" their real estate risk.
Every time I hear the phrase "Well Contained," I am reminded of that amusing scene from "The Princess Bride:"
[Vizzini has just cut the rope The Dread Pirate Roberts is climbing up]
Vizzini: HE DIDN'T FALL? INCONCEIVABLE.
Inigo Montoya: You keep using that word. I do not think it means what you think it means.
"Well Contained": They keep using that word. I do not think it means what they think it means . . .
>
Sources:
Truly Al-ARM-ing
ALAN ABELSON
Barron's Monday, July 9, 2007
UP AND DOWN WALL STREET
http://online.barrons.com/article/SB118368600171458761.html
Sunday, July 08, 2007 | 06:30 AM | Permalink
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Tracked on Jul 18, 2007 7:28:23 AM
Comments
Good old Alan Abelson
Ever so eloquent...
Ever so bearish...
And usually wrong!
Posted by: Werner Merthens | Jul 8, 2007 8:36:27 AM
I notice that you did not address the argument that Stephanie Pomboy raised. Your comments remind me of an old lawyer's joke:
When the Facts go against you, argue the Law.
If the Law is on the opposing party's side, emphasize the Facts.
And when the Law and the Facts are against you, call the other lawyer a Schmuck!
Posted by: Barry Ritholtz | Jul 8, 2007 8:49:01 AM
Hey Inigo Montoya! Isn't it time that regulation in the lending industry is put in place to protect AGAINST a homebuyer RATIONALIZING A HOME PURCHASE BY TAKING OUT AN ARM LOAN PRODUCT?
I see it all too often here in NYC real estate.
Buyer cant find home with their budget --> buyer stretches their max price --> buyer finds home well above their max and falls in love with it --> buyer chooses ARM product to make numbers closer to what could work for them --> buyer rationalized poor decision and spending above their means because of a loan product available to them.
When will it end? No way the fed will step in and regulate this, it will have to be done in-house and probably will be done ONLY AFTER all those losses are realized.
Its a shame.
Posted by: UrbanDigs | Jul 8, 2007 9:27:12 AM
PS: He did not say True Love. He said..tooblave..which we all know means to bluff!
So check his pockets for loose change!
Posted by: UrbanDigs | Jul 8, 2007 9:28:53 AM
As I look over my neighbor's forclosed house (and good riddence the worst neighbors I have ever had!) I am trying to apply what I have seen of their spendthrift lifestyle to the loss of equity situation. The question that comes to my mind is that in terms of spending when does the tipping point occour? For those who are frugal the loss of some hypothetical equity in our house does not make a difference.Of course we are the ones with a 30 year loan. I did have a 5 year loan years ago that ballooned but when I got it I was not thinking of how much more might our house might be worth but rather in which direction interest rates were going. It worked out and now we are sitting on a 30 and we try to make an extra payment a year.
So I wonder at what point do those stretched out borrowers the ones who live in the bizzaro world of personal finance, curtatil their spending. I suspect that many who have ARMS at this point might also have a lot of consumer debt. Is there a correlation of late ARM payments and delinquent consumer debt?
for those whogot arms just because that was all they could manage I simply feel sorry for them.
So has the broad effect on this situation already occoured? Is occouring? Or will occour? Also is there anything close to this happening internationally. London?
Just trying to figure out how to bet.
Posted by: alexd | Jul 8, 2007 10:15:45 AM
http://streetlightblog.blogspot.com/2007/03/bad-loans-banks-and-coming-credit.html
It could well be that Mr Abelson and Mrs Pomboy are wrong but if they are it is only by a « small margin » of error 3.250 Trillion of USD which represent the increase of the real estate loans since 1985 until now.
If they are wrong Mr Kash will not be their detractor either, please see at the captioned address.
Frankly the issue is less the outstanding loans than the accounting treatment among banks where it seems that « no one is equal in rights and accounting obligations when it comes to reflect the state of their respective business »
In the year 2000 they were creative (creative accounting was the culprit) in the year 2006/2007 they are secretive .
No more power to the imagination?
Posted by: Philippe | Jul 8, 2007 10:28:49 AM
Maybe (probably) I am simply dimwitted, but doesn't it require a default on the underlying mortgage to produce these losses? Until that default occurs, the value of the loan has been reduced but the actual loss has not occured.
It seems to me that the effected parties will be those who used the underlying loan as collateral and those who loaned against that collateral.
Posted by: Winston Munn | Jul 8, 2007 10:52:53 AM
Winston Munn, yes it does require loan defaults to increase for these losses to be realized. That is what is so alarming about this chart:
http://piggington.com/laid_back_lenders
Notice that this uncanny spike in defaults is occurring against the backdrop af a "great" economy with allegedly low unemployment. I wonder how bad it will get if either of those two conditions worsen... I know, I know, the business cycle has been suspended.
Posted by: Idaho_Spud | Jul 8, 2007 11:15:34 AM
Idaho_Spud:
Thanks for the info. The first item to be effected should be loan loss provisions, due to the increasing risk caused by the reduction in value of the underlying assets.
You may find this of interest, how an Italian bank is being hammered due to credit default swaps: http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/07/03/bcnitaly103.xml
Posted by: Winston Munn | Jul 8, 2007 11:36:14 AM
You are right, I did not address Stephanie Pomboy raised.
I apologize for calling the other lawyer a schmuck.
Whatever the situation may be, only the future will tell which position is right.
I merely meant to point out that the perennial bearish camp is usually wrong, and that the optimists will always triumph in the long run!
Posted by: Werner Merthens | Jul 8, 2007 11:52:32 AM
The other shoe to drop is likely to be personal consumption expenditures as the death of MEW is realized.
Bubble deflation has a very nasty momentum component that tends to exaggerate the woes in related bubbles.
Here's hoping I am still wrong about goldilocks. Maybe she really is a nice girl and not the trollop I have always taken her for.
Posted by: blam | Jul 8, 2007 11:58:31 AM
@ Winston Munn:
Interesting article. Did you notice that the bank in question was dabbling in a much less opaque market than CDO/MBS equity tranche stuff?
They got crushed in a market that sends precise daily signals, as opposed to the murky waters of the mark-to-model stuff that mortgages have become.
I suspect we would all freak out if the curtain were suddenly pulled away and this stuff were marked to market. Which is probably why certain investment banks are colluding not to sell any - or else trying to create an IPO to unload it. LOL.
Posted by: Idaho_Spud | Jul 8, 2007 12:32:22 PM
My name is Inigio Montoya. ARMs killed my father. Prepare to die.
Posted by: S | Jul 8, 2007 12:40:42 PM
It appears to me that we sit on the verge of a massive liquidity contraction that could occur virtually overnight as loans are called in while margin calls go out.
Posted by: Winston Munn | Jul 8, 2007 1:10:32 PM
I merely meant to point out that the perennial bearish camp is usually wrong, and that the optimists will always triumph in the long run!
In the long run we ALL DIE!
Posted by: D. | Jul 8, 2007 1:36:58 PM
The most important for borrowers is to service the interest payment and arrange a differed repayment schedule for the principal.
Lenders will not object they have no advantage in inflating the number of houses to be sold.
Over time the real estates crisis have always recovered with higher prices.
Posted by: Philippe | Jul 8, 2007 1:45:05 PM
Anybody who has studied markets, knows that real estate will correct severely before it ever gets better.
The question really is what impact will this have on the economy. A loss of a trillion in wealth seems like a lot. But then that's how much we lost by going to war in Iraq. We've managed to get through that.
Posted by: jesus | Jul 8, 2007 2:04:19 PM
How exactly is the number "amount of ARMs in negative equity" computer? Say a house is worth $500K and has a $500K outstanding loan balance, for equity of $0. Now the local housing prices slip and the house is worth only $400K, for an equity of negative $100K.
Would Pomboy's analysis count this at $100k, which is the amount of the negative equity, or at $500K, which is the amount of the loan which is in a negative equity condition?
Posted by: david foster | Jul 8, 2007 2:10:45 PM
Jesus's comment suggests he hasn't studied markets, at least not home prices.
About those very scary numbers in the chart: have home prices ever corrected 15%? When, and how often?
Seems like a very scary and very unlikely outcome based on history.
But that doesn't sell newspapers does it?
Posted by: REW | Jul 8, 2007 2:54:28 PM
Sure, it is still a buyer's market. but housing around Boston is turning around. thanks to Fed pumping liquidity by defending low short-term interest rate. mortgage rate is still historically low. and that mean your call on housing is wrong.
Posted by: you are wrong | Jul 8, 2007 3:03:33 PM
Philippe:
While it is true that the U.S. economy can handle the $500 billion to $1 trillion dollar lost on ARM mortgages so far, you must see that this $1 trillion is on the front end of a leveraging process that multiplies the initial $1 trillion many times over.
The ARM's are packaged into RMBS's, these are packaged into CDO's, these are bought by hedge funds leveraged 10 times over, credit default swaps are formed based on the CDO's and these are formed into synthetic CDO's, the synthetic CDO's are bought by hedge funds leveraged 10 times over, the hedge funds are funded by funds of funds leveraged 4 or 5 times...
The initial $1 trillion at risk ends up becoming a few hundred trillion at risk.
Posted by: Dale C. | Jul 8, 2007 3:22:49 PM
-...optimists will always triumph in the long run!-
Go long and stay long Werner....You da man!
Posted by: brion | Jul 8, 2007 3:24:24 PM
"A loss of a trillion in wealth seems like a lot. But then that's how much we lost by going to war in Iraq. We've managed to get through that."
(somebody has to say it...)
Jesus, a Trillion here and a Trillion there and pretty soon you're talking about real money...
(that phrase began life as a "million" quote, moved on to "billion" and is now headed to "Kajillion")
Posted by: brion | Jul 8, 2007 3:29:34 PM
you are wrong; You are wrong...! Couldn't resist... ;-)
Have you ever hesrd of a "Dead cat bounce...."? You may have some seasonal improvements. However, Boston is just circling the toilet bowl at a slightly higher level for the moment....
Best regards,
Econolicious
Posted by: ECONOMISTA NON GRATA | Jul 8, 2007 3:29:59 PM
"housing around Boston is turning around"
Living in Boston I might have agreed a month or so ago but I've seen the For Sale signs repopulate the area and seen strange sights such as "Luxury" townhouses (seemingly "soldout" a year ago) now back on the market as "luxury rentals".....this in a "great" area.
Might be wrong but my experience has been that when things appear that make NO sense, there's something BAD going on behind the scenes. I've never seen "for rent" signs in my neighborhood area (a nice one) in 20 years. Now they're routine. If I could short the Boston housing market, I would.
Posted by: jag | Jul 8, 2007 3:51:12 PM
