3rd Inning of MBS crisis..Hussman

[RockOn]

Here is what Hussman thinks, anyone see any problem with this analysis?


Quote from Hussman:
Which “inning” of the mortgage crisis are we in?
One of the fascinating aspects of Wall Street is the ability of analysts to provide opinions without the faintest backing from evidence. Among the latest topics of opinion is how far the mortgage crisis has to go. Evidently, the idea is that the recession that these analysts didn't forecast is already over, so it is time to “look across the valley” on the belief that most of the writedowns are behind us.
A good way to estimate where we are in the process of writedowns and foreclosures is to revisit the schedule of resets for adjustable rate mortgages.

Source: Bank of America
The chart doesn't extend out to 2010, where another spike in resets will occur in the third quarter of that year, but it is enough to recognize that resets are only now entering the heavy period. To understand the implications of this schedule, it is important to recognize the foreclosure timeline. Once a reset occurs, it takes up to 30 days for the first payment to be missed. After 90 days of attempts to catch up on missed payments, the homeowner is served with a “Notice of Default.” It then takes another 90 days with the homeowner in default for a “Notice of Trustee Sale” to be delivered, shortly after which the property is sold in a foreclosure. In short, there is generally a span of about 6 months from reset to foreclosure, which means that we have to lag the data to get the profile of anticipated loan losses.
Fortunately, only a portion of the mortgages that reset will actually go into default, but we estimate which “inning” we are currently in by calculating the cumulative amount of mortgages that will have reset at each point in time (i.e. integrating the curve), and lagging it by 6 months (roughly the span between reset and foreclosure). That produces the following profile for the cumulative losses that can be expected:

Clearly, as we enter April 2008, we appear to be quite early in the mortgage crisis, with only about a quarter of the cumulative resets having occurred. That places us near the start of the third inning, where we can expect each of the nine “innings” to be about three months in duration. Unfortunately, the next three innings (quarters) are when the heavy hitters on the opposing team will come up to the plate, as the cumulative amount of resets will surge. With that surge, loan losses and foreclosures will also predictably spike higher.
Moreover, because of the bundling, securitization*, and slicing and dicing of mortgage obligations, financial companies have little ability to take the required writedowns in advance, because they don't know yet which ones will go into default. To opine that we are in some late “inning” of the mortgage problem, without reference to the reset data, is just naïve. If anything, the probable rate of foreclosure on later resets will be higher, not lower, than the earlier resets, because those later resets represent the mortgages initiated at the peak of home prices and the trough of lending standards.

[DblDoc]

I've seen similar data elsewhere and have to agree with you that the game has only begun. In terms of the writedowns this will likely snowball as the foreclosures lower prices creating more upside down mortgages and the cycle continues...

DD

[RockOn]

One way I can see this coming to a "non-meltdown" end is if mortgage rates would come back down allowing everyone to refi again into low fixed rates. With tight moeny low rates seem to be a ways off. So far, as the Fed cuts rates, mortgage rates have hardly budged, not good.

Even if this would happen, is it really a solution or a bandaide?

[Hamlet]

I don't think lower rates will do anything. Most of the problem loans don't have the equity or credit scores to be refinanced. If they did, current rates are low enough to make the loans workable. The long term rates are only a point or so off of their lows anyway.

The big issue is that these loans were made with stupid low teaser rates that can't be duplicated no matter how cheap money gets.

Originally Posted by RockOn

One way I can see this coming to a "non-meltdown" end is if mortgage rates would come back down allowing everyone to refi again into low fixed rates. With tight moeny low rates seem to be a ways off. So far, as the Fed cuts rates, mortgage rates have hardly budged, not good.

Even if this would happen, is it really a solution or a bandaide?

[maddythebeagle]

I guess that I would look at it from the bright side....that all of the foreclosures wont happen all at once...

[al_bundy]

libor is around 2.75% which means the loan resets will be around 5% to 5.5% which is a lot better than 7.5% with last year's fed funds rate

those charts are old news. the big question is how many people will refi, how many will keep their loans and how long will the fed be able to keep rates this low

[brewer12345]

Originally Posted by al_bundy

libor is around 2.75% which means the loan resets will be around 5% to 5.5% which is a lot better than 7.5% with last year's fed funds rate

those charts are old news. the big question is how many people will refi, how many will keep their loans and how long will the fed be able to keep rates this low

Wow, the blind squirrel finally stumbled across an acorn.

I totally agree with your assessment. The rate reset will be a non-event since the Fed has whacked rates. The more troubling problem is that the drop in house prices makes it more challenging for leveraged Merkins to refinance, but creative legislators, reglators, etc. seem to be working out solutions to the problem.

[dex]

One aspect not mentioned is that the large write downs that have been done are based upon estimated value of the bond/loan - not after a loan is offically in default.
So if you have 1 billion in bonds and you estimate that 3% of the dollar value will not be collected over the life of the bond you write it down as an asset by that amount.

This is a basic principle of accounting and similar to what credit card companies do - they have a bad debt reseve (which is a different kind of write down) They establish a reserve for bad debt based upon historical defaults.

Also companies would want to do the write down of all the affected bonds now instead of over an extended period of time - it gets the bad news behind them and eliminated the question from future earnings reports.

So the information above should have been taken into account.

The issue is - did they write it down enough or too much?
So to determine where we are in the crisis is the rate of default - is it higher or lower than the percent of write down used. That is the important question.

I'm not impressed with H's analysis here or in other things posted from him.

[al_bundy]

Originally Posted by brewer12345

Wow, the blind squirrel finally stumbled across an acorn.

I totally agree with your assessment. The rate reset will be a non-event since the Fed has whacked rates. The more troubling problem is that the drop in house prices makes it more challenging for leveraged Merkins to refinance, but creative legislators, reglators, etc. seem to be working out solutions to the problem.

home prices are still way to expensive

i remember in 2003 when i got married along with a friend of my wife i was talking to her husband who works in finance. back then an OK home in the NYC area outside manhattan and a few other trendy neighborhoods cost around $380,000. we both agreed it was way too much. it's still too much today i think.

michael milken of 1980's fame has found God and charity after jail and cancer. runs a non-profit think tank now.

few years back he did a study on home prices vs income. found that it fluctuated between 20% and around 40% to 45%. hit the peak twice in the last 60 years. 1981 and 2004, the last year of the study. i think no matter what the government is going to try to do we'll get a reversion to the mean which has been around 30%

[brewer12345]

Originally Posted by al_bundy

home prices are still way to expensive

i remember in 2003 when i got married along with a friend of my wife i was talking to her husband who works in finance. back then an OK home in the NYC area outside manhattan and a few other trendy neighborhoods cost around $380,000. we both agreed it was way too much. it's still too much today i think.

michael milken of 1980's fame has found God and charity after jail and cancer. runs a non-profit think tank now.

few years back he did a study on home prices vs income. found that it fluctuated between 20% and around 40% to 45%. hit the peak twice in the last 60 years. 1981 and 2004, the last year of the study. i think no matter what the government is going to try to do we'll get a reversion to the mean which has been around 30%

Please, keep up the rambling stream of nonsense consciousness, I love it.

[cashflo2u2]

Originally Posted by dex

One aspect not mentioned is that the large write downs that have been done are based upon estimated value of the bond/loan - not after a loan is offically in default.
So if you have 1 billion in bonds and you estimate that 3% of the dollar value will not be collected over the life of the bond you write it down as an asset by that amount.

This is a basic principle of accounting and similar to what credit card companies do - they have a bad debt reseve (which is a different kind of write down) They establish a reserve for bad debt based upon historical defaults.

Also companies would want to do the write down of all the affected bonds now instead of over an extended period of time - it gets the bad news behind them and eliminated the question from future earnings reports.

So the information above should have been taken into account.

The issue is - did they write it down enough or too much?
So to determine where we are in the crisis is the rate of default - is it higher or lower than the percent of write down used. That is the important question.

I'm not impressed with H's analysis here or in other things posted from him.

Give that man (person) a CIGAR!! Must have worked in public accounting.

[Maurice]

Dex 1, Hussman 0.

Hussman's logic is flawed for the MBS market (and for CDOs derived from them), although its reasonable as far as the housing market itself is concerned. Banks can get this behind them once they get the model inputs right. (assuming they have the capital!) But the housing market will keep heading south as long as that inventory of foreclosures keeps increasing faster than buyers.

[ladelfina]

brewer, what's up.. why are you so nasty to al? Maybe you are analyzing tree by tree without looking at the forest as al is doing? Or maybe there is some history I'm not aware of.

There are any number of graphs tracking housing prices; this is just one set chosen at random. Ignore the discussion of one market vs. another; just look at the red lines versus the green lines.
How the Bay Area caused home prices to go up nationally… [Burbed.com]
The further away green gets from red, the more situation = bad, which you kind of acknowledge. But, no fear...

creative legislators, reglators, etc. seem to be working out solutions

The more 'creative' these people get, the more likely they could actually make things worse. There is only one SOLUTION to houses that cost too much, and that is for prices to fall. You can't legislate away the price difference unless the gov. starts buying up homes/mortgages outright. Giving $15k downpayments and other nonsense only prolongs the pain, it would seem to me. Taking an aspirin will lower the fever, but you still have to fight off the infection. Is the economy strong enough to absorb the declines? Are wages going to magically go up and start closing the red/green gap so these homes can actually get paid off? Is unemployment going down or up? Are retail stores opening or closing? Are companies hiring or laying off? Do people have savings to tide them over and keep payments up when they're between jobs? I think elsewhere you said you found prices to be unrealistic. 5-7 million people per year have been buying into, and continue to buy into.. what you call unrealistic prices; how do we make that go away?

Seeing that these assets and the loans against them are a huge part of the economy, there's no way this can't be bad news and it will get worse. That is just my humble opinion. Look at how unstable things are now.. with the decline not yet near the bottom.

As for banks "getting this behind them".. why do I still hear of "pick a payment" loans, interest-only loans, etc.? The kind of legislation that would impress me would be making interest-only loans illegal... anyone see a downside to that?

[al_bundy]

he's just sore i was right about the banks last year while he was hyping them

[brewer12345]

Ah, ladelfina, finally joining the Tinfoil Brigade?

House prices will fall for the next year no matter what is done. What I was referring to was actions being taken to unclog the machinery of the credit markets and not have a huge flood of foreclosed homes all hit the market at once. Part of the solution is for lenders to take some losses and restructure loans without going through the time consuming, expensive, and economically destructive process of foreclosure. But I think most of the losses have been recognized in the securitization market, based on prices for the securities and the write-downs that have been taken. Portfolio lenders (i.e. traditional banks that make and hold loans) will show increased loss provisioning for a while, but for most of them this will amount to a modest decrease in earnings that will likely be offset by other factors (drop in rates, fatter spreads, etc.) and not be a threat to capital or solvency.

[ladelfina]

Yes! I'm not thinking "hats".. no one wears hats. I'm more studying a tin-foil dress line to debut in Milan this spring!



Although depending on commodities prices I might have to substitute materials.

Portfolio lenders (i.e. traditional banks that make and hold loans) will show increased loss provisioning for a while, but for most of them this will amount to a modest decrease in earnings that will likely be offset by other factors (drop in rates, fatter spreads, etc.) and not be a threat to capital or solvency.

It's just hard for me to see this. 'Fatter spread' implies there's somewhere better to put the money to work.. is there? As for capital I don't know if it was WaMu or Wachovia that just sold shares for $7 billion or something. Sounds like banks still need more and more and more capital. Third-hand reporting on a comment thread elsewhere saying "this is great for W*** stock, since now they have more capital!!" Argh.

[brewer12345]

Originally Posted by ladelfina

It's just hard for me to see this. 'Fatter spread' implies there's somewhere better to put the money to work.. is there? As for capital I don't know if it was WaMu or Wachovia that just sold shares for $7 billion or something. Sounds like banks still need more and more and more capital. Third-hand reporting on a comment thread elsewhere saying "this is great for W*** stock, since now they have more capital!!" Argh.

Fatter spread means that the banks can charge a higher rate over treasuries for almost any kind of loan. And spreads are fatter than they have been in years, even on the squeakiest clean stuff. Want a jumbo mortgage and have 35% down? 7% for a 30 year amortizing mortgage. Ain't been that high in a loooong time.

The drop in rates by the Fed adds fuel to the fire for these guys. So they can take that 7% mortgage and finance it with 3% deposits. Most any bank would be thriled to have a 4% net interest spread on an asset with very limited risk, and they can lever it 10+X.

So the picture is kind of muddy. Take Wachovia, for example. They just raised $7 billion in fresh capital. Did they need that much to deal with the problems they already have? I don't know for sure, but if you had asked my to guess at how much they might need I would have likely offered a number half that amount. If that is the true number, then Wachovia raised enough capital to deal with their problems and also to take advantage of the many opportunities they see out there. Or maybe they really do have $7 billion worth of problems. Or maybe they have $15 billion worth, and will be coming back to the well in the future.

Therein lies the game: these are large, complex entities and it is hard even for long term observers to say for sure what the story really is. For some people, the answer has just been to buy banks that don't have these problems and still have capital to clean up in teh market right now (PBCT, HCBK, et al. come to mind), and you can see it in the prices being paid for these stocks. Others have simply thrown up their hands and walked away.

[ladelfina]

well, there brewer, you're kind of helping me make my point, at least in terms of stock valuations. Why should any entity that YOU and "long term observers" can't figure out (I think I recall that you are in some kind of finance job) have ANY serious market value at all? Why shouldn't it be treated as some kind of penny stock?

If IN THEORY they make money, but IN PRACTICE no one knows and the picture is "murky".. why shouldn't that deserve a justified "run".. run awaaaaaayyyy. When you and many in the media talk about BSC and a 'run'.. it makes it sound like some unfair panic based solely on rumors.

"banks that don't have these problems".. no one seemed to think the other banks had problems until all of a sudden they did. What analysis/metric do you use to decide what is a 'good' bank?

Jim Cramer?

People's United Financials (PBCT): 'Second-best, after Hudson City Bancorp … Very well-run, very conservative, but I do like HCBK better.'

Jim Cramer's Mad Money Lightning Round, 2/12/08: Metalico Rocks - Seeking Alpha

Bullish calls:
Wachovia (WB): 'The yield is safe ... [Wachovia, Citigroup and Bank of America are] the trio I want you to own.'
Citigroup (C)

Jim Cramer's Mad Money Lightning Round Picks, 9/10/07 - Seeking Alpha

(Sorry, not implying you invest by following Cramer, just couldn't resist since I came across this when looking into PBCT.)

Then as far as spreads are concerned.. I'm wondering (not challenging, necessarily, but wondering) where are the customers for the 7% loans when people were having trouble paying off for or qualifying for the 5%-6% ones? Fewer customers, fewer originations, maybe.. and higher rates (but on lower loan amounts).. could be a wash?

I think I'm officially throwing up my hands!!