City of Debt

The city of Stockton in California is at the centre of the mortgage crisis now sweeping America.

Because, with house prices tumbling, more people in Stockton face the repossession of their homes than anywhere else in the US.

But Stockton is also a place where you can really get a feel for the staggering amounts of money banks loaned during the boom - with few or no questions asked.

Lending frenzy

In his 25 years as an estate agent in Stockton, Kevin Moran had never seen anything like it as seemingly limitless bank loans sent house prices rocketing.
"It was crazy", he says. "People felt that if they didn't make a high enough offer on a house, it would be gone.

"Instead of saying 'What do you want to do on a Saturday? Let's go to the park', they'd say 'Let's go buy a house'".
At the height of the buying frenzy, in 2006, Will Trawick was selling new homes for a Stockton developer.
Faced with crowds of a hundred buyers, bank loans in hand, all chasing the 20 houses he might have on offer, he organised bingo-style lotteries.
"We had ping-pong balls with numbers, just like you'd see on a TV show", Mr Trawick recalls.
"Everybody would have a number. We'd put the ping-pong balls in, spin it and, you know 'Number 22! Yoo-hoo!' They'd jump up and yell, come on up and pick which home they wanted, and leave a deposit cheque".
It was not only home-buyers who banks were keen to lend to.
With house prices soaring, pretty well anyone who owned a home in Stockton suddenly found they had plenty of equity in their property - equity the banks were eager to convert into cash.
Steve Carrigan is in charge of economic development for Stockton. He says bank loans made it a party every day.
"People went to the bank and got a loan on the increase in the price of their home. They went out and spent all that money," he explains.
"Price of the home went up again, they went back to the bank and got another loan. They went out again and spent that money on cars and jewellery and furniture - whatever they wanted."
With the help of the banks, Mr Carrigan says, people in Stockton "spent their house".
But that is not how it was meant to be.

Rule dodging

After previous financial disasters caused by excessive bank lending, regulators developed rules to limit how many loans a bank could have on its balance sheet.

The rules are complex, but as a rough rule of thumb, they say that for every $1 (50 pence) of shareholder capital a bank has on its balance sheet, it can also have about $10 of loans.
But, as is clear from the torrent of home loans in Stockton and across America, banks were lending far more than that 10 to 1 ratio.
How had they managed to do it?

Professor Roubini says banks skirted around industry rules
The first technique banks used to circumvent regulators' rules is known as "securitisation" - a way of a bank getting loans it had already made off its balance sheet.
They did this by selling their loans off to pension funds, insurance companies, even to other banks around the world.
Professor Nouriel Roubini, the head of a leading New York firm of economic analysts, says securitisation was key to helping banks avoid the regulators' 10:1 rule.
"You make a bunch of mortgages and then you package them and you sell it to someone else," he explains.
"Therefore it goes off the books and therefore you can make even more loans."
As a result, the amount of lending banks could do was "much more massive", he says.

Financial alchemy

The banks' loans should have been hard to sell because they were low quality - since they were issued with no questions asked, there was little assurance they could be repaid.
But the banks had an answer to that.

To make their risky loans appear attractive to buyers, banks used complex financial engineering to repackage them so they looked super-safe and paid returns well above what equivalent super-safe investments offered.

Even savvy Wall Street veteran and billionaire Wilbur Ross could not figure out what was happening.
"What they were fundamentally doing was taking a $100 pile of low quality securities and creating something they could sell to investors for $103," he says.
"So there was an alchemy - making more price than there was value."
Banks even found ways to get loans off their balance sheets without selling them at all.

They devised bizarre new financial entities - called Special Investment Vehicles or SIVs - in which loans could be held technically and legally off balance sheet, out of sight, and beyond the scope of regulators' rules.
So, once again, SIVs made room on balance sheets for banks to go on lending.

Final countdown

As long as house prices went on rising, few people raised questions about the potential risks in the structures the banks had created.
Everyone was making too much money to be worried.
But then in 2007, when American house prices began to plummet, the true dangers began to be revealed.
If you have a $200bn loss, that reduced your capital by $200bn, you have to reduce your lending by 10 times as much

Banks had got round regulators' rules by selling off their risky loans, but because so many of the securitised loans were bought by other banks, the losses were still inside the banking system.

Loans held in SIVs were technically off banks' balance sheets, but when the value of the loans inside SIVs started to collapse, the banks which set them up found that they were still responsible for them.

So losses from investments which might have appeared outside the scope of the regulators' 10:1 rule, suddenly started turning up on bank balance sheets.

No-one knows how big the losses from investments based on American mortgages will eventually prove to be - estimates now range from $200bn upwards.

The problem now facing many of the biggest lenders is that when losses appear on banks' balance sheets, the regulator's 10:1 rule comes back into play because losses reduce a banks' shareholder capital.

BBC

Idiocracy

The Century of the Self

Happy Christmas

A Crisis Long Foretold

A truism of crisis management is that most seemingly out-of-the-blue disasters could have been prevented if someone had paid attention.

An article in The Times on Tuesday by Edmund L. Andrews leaves no doubt that the twin crises of the subprime lending mess — mass foreclosures at one end of the economic scale and a credit squeeze afflicting the financial system — are rooted in the willful failure of federal regulators to heed numerous warnings.


The Federal Reserve is especially blameworthy. Starting as early as 2000, former Fed Chairman Alan Greenspan brushed aside warnings from another Fed governor, Edward M. Gramlich, about subprime lenders who were luring borrowers into risky loans. Mr. Greenspan’s insistence, to this day, that the Fed did not have the power to rein in such lending is nonsense.

In 1994, Congress passed a law requiring the Fed to regulate all mortgage lending. The language is crystal clear: the Fed “by regulation or order, shall prohibit acts or practices in connection with A) mortgage loans that the board finds to be unfair, deceptive, or designed to evade the provisions of this section; and B) refinancing of mortgage loans that the board finds to be associated with abusive lending practices, or that are otherwise not in the interest of the borrower.”

Yet, the Fed did nothing as junk lending proliferated — including loans that were unsustainable unless house prices rose in perpetuity, riddled with hidden fees and made to borrowers who could not repay. Mr. Greenspan has said that the law was too vague about the meaning of “unfair” and “deceptive” to warrant action.

The Fed has also disappointed since the current chairman, Ben Bernanke, took over in early 2006. It was not until the end of June 2007 — after the damage was done — that the Fed and other federal regulators issued official subprime guidance. On Tuesday, the Fed issued another set of proposals. Among those, subprime lenders would have to verify a borrower’s ability to repay and include mandatory tax and insurance costs in the monthly payment. In at least one key respect — enforcing the ability-to-repay standard — the proposal is weaker than earlier Fed guidance. Congress is considering other protections that are stronger in many ways.

When all the truth is out, the Fed will have company in the hall of shame. The Office of the Comptroller of the Currency, for example, blocked states from investigating local affiliates of national banks for abusive lending.

If the regulators had done their jobs, there might have been no lending boom and no extraordinary riches for the lenders and investors who profited from unfettered subprime lending. Neither would there be mass foreclosures, a credit crunch and a looming recession.

This crisis didn’t appear unexpectedly. And it won’t go quickly away. Congress and the next administration will have a lot of work ahead to clean up the subprime mess — once and for all.

The New York Times

A must watch Krugman Video

The Subprime Shock Wave

Banks in joint bid to track Lynn's cash trail

BANK of Scotland, Permanent TSB and AIB have agreed to pool their resources in a bid to "follow the money trail" of fugitive solicitor Michael Lynn.

Mr Lynn, who was still at large last night after failing to appear at a court hearing on Wednesday, owes a total of €80m to more than 10 banks.

The co-operation agreement was reached after a number of banks met at Bank of Scotland's St Stephen's Green headquarters on Wednesday evening.

It is understood Bank of Scotland, Permanent TSB and AIB are among the banks who have formed an alliance. Bank of Ireland, which has a relatively limited exposure to Mr Lynn, is understood not to be involved.

"The one lesson that banks have learned from all this is the importance of them joining together," said one lawyer familiar with the Lynn case.

Assets

Mr Lynn's known assets include over 100 properties in Ireland as well as companies and bank accounts throughout Europe.

Land Registry documents show the banks have already moved on several of Mr Lynn's Irish properties, which now carry judgment mortgages and therefore cannot be sold without the bank's authorisation. Moving on the overseas assets, however, could prove more difficult due to the legal and bureaucratic complexities involved.

The Indo

After the Money’s Gone

On Wednesday, the Federal Reserve announced plans to lend $40 billion to banks. By my count, it’s the fourth high-profile attempt to rescue the financial system since things started falling apart about five months ago. Maybe this one will do the trick, but I wouldn’t count on it.
In past financial crises — the stock market crash of 1987, the aftermath of Russia’s default in 1998 — the Fed has been able to wave its magic wand and make market turmoil disappear. But this time the magic isn’t working.

Why not? Because the problem with the markets isn’t just a lack of liquidity — there’s also a fundamental problem of solvency.

Let me explain the difference with a hypothetical example.

Suppose that there’s a nasty rumor about the First Bank of Pottersville: people say that the bank made a huge loan to the president’s brother-in-law, who squandered the money on a failed business venture.

Even if the rumor is false, it can break the bank. If everyone, believing that the bank is about to go bust, demands their money out at the same time, the bank would have to raise cash by selling off assets at fire-sale prices — and it may indeed go bust even though it didn’t really make that bum loan.

And because loss of confidence can be a self-fulfilling prophecy, even depositors who don’t believe the rumor would join in the bank run, trying to get their money out while they can.

But the Fed can come to the rescue. If the rumor is false, the bank has enough assets to cover its debts; all it lacks is liquidity — the ability to raise cash on short notice. And the Fed can solve that problem by giving the bank a temporary loan, tiding it over until things calm down.

Matters are very different, however, if the rumor is true: the bank really did make a big bad loan. Then the problem isn’t how to restore confidence; it’s how to deal with the fact that the bank is really, truly insolvent, that is, busted.

My story about a basically sound bank beset by a crisis of confidence, which can be rescued with a temporary loan from the Fed, is more or less what happened to the financial system as a whole in 1998. Russia’s default led to the collapse of the giant hedge fund Long Term Capital Management, and for a few weeks there was panic in the markets.

But when all was said and done, not that much money had been lost; a temporary expansion of credit by the Fed gave everyone time to regain their nerve, and the crisis soon passed.

In August, the Fed tried again to do what it did in 1998, and at first it seemed to work. But then the crisis of confidence came back, worse than ever. And the reason is that this time the financial system — both banks and, probably even more important, nonbank financial institutions — made a lot of loans that are likely to go very, very bad.

It’s easy to get lost in the details of subprime mortgages, resets, collateralized debt obligations, and so on. But there are two important facts that may give you a sense of just how big the problem is.

First, we had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.

Second, there was a tremendous amount of borrowing into the bubble, as new home buyers purchased houses with little or no money down, and as people who already owned houses refinanced their mortgages as a way of converting rising home prices into cash.

As home prices come back down to earth, many of these borrowers will find themselves with negative equity — owing more than their houses are worth. Negative equity, in turn, often leads to foreclosures and big losses for lenders.

And the numbers are huge. The financial blog Calculated Risk, using data from First American CoreLogic, estimates that if home prices fall 20 percent there will be 13.7 million homeowners with negative equity. If prices fall 30 percent, that number would rise to more than 20 million.

That translates into a lot of losses, and explains why liquidity has dried up. What’s going on in the markets isn’t an irrational panic. It’s a wholly rational panic, because there’s a lot of bad debt out there, and you don’t know how much of that bad debt is held by the guy who wants to borrow your money.

How will it all end? Markets won’t start functioning normally until investors are reasonably sure that they know where the bodies — I mean, the bad debts — are buried. And that probably won’t happen until house prices have finished falling and financial institutions have come clean about all their losses. All of this will probably take years.

Meanwhile, anyone who expects the Fed or anyone else to come up with a plan that makes this financial crisis just go away will be sorely disappointed.

The New York Times

Helicopters start dropping bundles of cash

The central bank helicopters are planning a co-ordinated drop of liquidity on troubled market waters. The money to be dropped now is not that large. But if this does not work, more will surely follow. The helicopters will fly again and again and again.

One point is clear: central banks must be pretty worried to take such a joint action. For what is remarkable about yesterday's statement is that five central banks - the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve and the Swiss National Bank - are co-ordinating their (different) interventions. Their hope must be that this action will trigger not panic ("What do the central banks know that I do not?") but confidence ("Now that the central banks are prepared to intervene in this way, I can at last stop worrying").

It is easy to understand why central banks should have decided to take heroic action. Confidence has fled the markets in a four-month long episode of "revulsion". As a result, monetary policy is not being transmitted to the ultimate borrowers as central banks wish. Particularly worrying has been the widening of gaps between three-month interbank lending rates and policy rates in the dollar, euro and sterling markets. Spreads in the last of these have recently become enormous (at more than 100 basis points).

Yet this is not the only indication of distress: in the US, for example, the spread between the rate of interest on three-month treasury bills and AA-rated asset-backed financial paper has widened to 270 basis points from 30 basis points earlier in the year. This is revulsion, indeed.

So why might yesterday's co-ordinated interventions succeed where previous actions have not?

In a word, the answer is: stigma.

Central banks have become increasingly worried about the unwillingness of banks to borrow from them. These banks reasonably fear that exceptional borrowing is a signal mainly of distress. The hope of the central bankers is that by auctioning funds to a wide group of institutions such anxiety would diminish, if not disappear. That hope is strengthened by the fact that these actions are joint: they are evidently aimed at lifting sentiment rather than saving specific institutions.

Will this work? The answer is that if the fundamental problem in the markets is lack of liquidity (that is, panic), rather than insolvency, and if central banks are believed willing to offer liquidity to solvent institutions without limit at what the latter consider a "reasonable" discount, then symptoms of stress should indeed disappear.

Yet these are both important provisos. In particular, there is good reason to believe that a good part of the stress is caused by worries over solvency, indeed by the reality of threatened insolvency in at least some cases. True, central banks or, more precisely, the treasuries that stand behind them, could eliminate that concern, too, by buying up every piece of paper, good, bad and indifferent. But that would also be an open-ended, possibly very expensive and certainly unpopular bail-out.

Financial Times

Fed, ECB, Central Banks Work to Ease Credit Crunch

Dec. 12 (Bloomberg) -- The Federal Reserve, European Central Bank and three other central banks moved in concert to alleviate a credit squeeze threatening global growth, in the biggest act of international economic cooperation since the Sept. 11 terrorist attacks.

The Fed said in a statement it will make up to $24 billion available to the ECB and Swiss National Bank to increase the supply of dollars in Europe. The Fed also plans four auctions, including two this month that will add as much as $40 billion, to increase cash in the U.S.

Central bankers took the action after interest-rate reductions in the U.S., U.K. and Canada failed to allay concerns that banks will reduce lending, sending the U.S. into recession and hobbling growth abroad. Borrowing costs have climbed as mounting losses on securities linked to subprime mortgages caused lenders to conserve cash.

``This is shock and awe,'' said Fred Goodwin, a fixed- income strategist at Lehman Brothers Holdings Inc. in London. ``The fact that it's coordinated means they have joined together in the war to attack the problem, which is that banks don't trust each other.''

A Fed official told reporters that the U.S. central bank's efforts won't add net liquidity to the banking system. The plans are aimed at buttressing so-called term funding markets, such as for one-month loans, rather than overnight cash. The Fed will balance its various operations, including daily repurchases of Treasury notes and direct loans to banks.

Bank of England

The Bank of England increased the size of reserves it will auction in money market operations and widened the range of collateral it will accept on three-month loans.

Bloomberg

If only we could airbrush the 2006 blip from history

Let's just pretend that 2006 never happened. Certainly, it shouldn't have happened.

The Stalinesque idea of airbrushing last year from the economic history books came from Ulster Bank economist Pat McArdle. It was, he argues, a blip which muddied the waters -- or whatever blips do -- and made it hard to see clearly what is going on.

The word "blip" is mine, not his. It has tended to be used when things turn down but, according to my dictionary, the actual meaning refers only to a temporary upturn. Downturns don't qualify. (It is also another word for a nickel).

I'm not sure I agree with this dictionary definition. What is sure is that, in the year of 2006, things unexpectedly did turn up, and very temporary it proved to be. Whatever one's views on dictionaries, that was a blip, and a rather damaging one.

As to the unexpected nature of the blip, it can be seen in the Budgetary arithmetic from the Department of Finance over the past two years. This gives the department's forecasts for the coming three years. In 2005, they expected that, in 2008, the public finances would show a deficit equivalent to 0.8 per cent of economic activity (GDP).

But then along came 2006, when the economy defied expectations by producing another year of growth close to 6 per cent. The public finances surged into a surplus of 2.9 per cent of GDP. In those circumstances, the department was obliged to up its forecasts. By last December, the projection for 2008 had gone from the 0.8 per cent deficit to a 0.9 per cent surplus. That is a not inconsiderable difference of €2 billion.

Little did we know, as those figures appeared and the Christmas tills of 2006 rang, that the blip was over. Well, some people expected it, but it was well into this year before the facts became incontrovertible.

The blip was caused by the housing market, and ended because of it. Until now anyway, the rest of the economy has performed very well, and very steadily. The surge was produced by the enormous construction of 90,000 dwelling units and the public finances were further swollen by a totally inexplicable 12 per cent rise in house prices.

Transactions plus price rises are a finance minister's dream. One suspects that the surge in building was partly the fault of finance ministers. Developers were mad keen to get stuff up and sold before the lucrative tax breaks ran out. The price rises are harder to explain.

Interest rates began rising in November 2005. The European Central Bank kept ratcheting them up all during 2006, but Irish property buyers ignored them, even as houses became wildly unaffordable, whether for first-time buyers unable to get a big enough loan, or investors unable to get a reasonable return.

One suspects that the tax breaks played a malevolent role here too. They increased the apparent poor yield from rental investment. One sometimes feels that the aversion to paying tax is so strong in many people that they would prefer to lose money rather than give it to the Exchequer.

Whatever the reasons, last year's peculiarities interrupted an orderly slowdown. House construction has plunged from 90,000 to probably less than 55,000 next year instead of declining from the previous 70,000 figure. Once people finally got it into their heads that house prices were too high, they stopped buying. So few sales are taking place that figures for current prices are largely meaningless.

In a rational world, the 12per cent rise would not have taken place and prices would have fallen as rates rose. A drop of 5-10 per cent might have maintained affordability at its historically stable figure of around 28 per cent of disposable income. Now, even allowing for rising incomes, they will have to fall by 15-20 per cent. This has probably happened already, but few are willing to sell. Until now.

The world is not rational and there are few things as irrational as a market in the grip of manic optimism or terror. It is remarkable, though, how they tend to exhibit the same characteristics. The US market turned down some months before ours, and is worth watching. For the first 15 months or so, sellers maintained their asking prices. Then they cracked.

Lo and behold, some 15 months after the Irish downturn comes news that apartments in Ashtown, Co Dublin, have had their prices cut by 20 per cent. The danger, as other developers well know, is that once this starts, it can go beyond what is rational.

In the early Nineties, Irish houses were so cheap they could be bought with little more than 20 per cent of disposable income.

If nothing improves, Brian Cowen will be excoriated for not abolishing stamp duty altogether. But it is hard to get buyers to commit until they believe that prices will fall no further, stamp duty or no stamp duty. From the point of view of the economy and the public finances, a bigger risk is that builders will not return on site until they believe the same. Probably the best way to convince them would be cuts in interest rates. As of last Thursday, though, the ECB was not for turning.

The Indo

The Guaranteed Rental Scam

Irish investors who have splashed out more than €30m on apartments in Turkey are seriously concerned about their investments after the company developing a massive property scheme defaulted on payments guaranteed under rental agreements.

It is believed that up to 500 Irish people have invested in Bodrum's large-scale Orient Palace complex, situated in a Turkish resort popular with Irish holidaymakers.

Most of the sales went through three Irish agents, Astute Property International, Remax, Tralee and Turkey Realestate Direct.

"If I was the one with the bucket and spade I would be worried," admitted Paul Egan of Astute Properties in Leixlip, Co Dublin, who has marketed 90 apartments, some costing over €100,000. His office admitted that it had been receiving "a lot of calls" from concerned purchasers.

Mr Egan, who has had emergency talks with directors of the development company in Germany believes, however, that "the only logical outcome is to complete the site," at a cost of some €30m.

The project has become bogged down by changes in Turkish law leading to serious delays in the granting of title deeds. The developers, as a result, refused to release money to the builder, who is now refusing to complete the work.

Only 40 per cent of the development has been built, leading to further concerns among purchasers, some of whom paid the full asking price to buy their 'dream home' off the plans.

Mr Egan, whose wife is Turkish, said that he has received personal assurances that the developers have lodged sufficient funds with a Dutch bank, and in notary accounts, to complete the development.

The developers are in "partnership" talks with another investor to secure the funding needed to complete the complex, according to Mr Egan.

One of the selling points on the development was that investors buying apartments in the Bodrum complex were guaranteed a 10 per cent annual return.

In other words, if they invested €60,000 in an apartment, they would get an annual rental payment of €6,000 -- after running costs.

This has been described by some sources in the foreign property business as "an incredible deal" and a "no brainer", given that interest rates for borrowers are as low as 4 per cent.

Sindo

The US Mortgage Mess from an Insider

Even before this mortgage mess started, one person who kept emailing me over and over saying that this is going to get real bad. He kept saying this was beyond sub-prime, beyond low FICO scores, beyond Alt-A and beyond the imagination of most pundits, politicians and the press. When I asked him why somebody from inside the industry would be so emphatically sounding the siren, he said, “Someobody’s got to warn people.”

Since then, I’ve kept up an active dialog with Mark Hanson, a 20-year veteran of the mortgage industry, who has spent most of his career in the wholesale and correspondent residential arena — primarily on the West Coast. He lives in the Bay Area. So far he has been pretty much on target as the situation has unfolded. I should point out that, based on his knowledge of the industry, he has been short a number of mortgage-related stocks.

His current thoughts, which I urge you to read:

The Government and the market are trying to boil this down to a ’sub-prime’ thing, especially with all constant talk of ‘resets’. But sub-prime loans were only a small piece of the mortgage mess. And sub-prime loans are not the only ones with resets. What we are experiencing should be called ‘The Mortgage Meltdown’ because many different exotic loan types are imploding currently belonging to what lenders considered ‘qualified’ or ‘prime’ borrowers. This will continue to worsen over the next few of years. When ‘prime’ loans begin to explode to a degree large enough to catch national attention, the ratings agencies will jump on board and we will have ‘Round 2′. It is not that far away.

Since 2003, when lending first started becoming extremely lax, a small percentage of the loans were true sub-prime fixed or arms. But sub-prime is what is being focused upon to draw attention away from the fact the lenders and Wall Street banks made all loans too easy to attain for everyone. They can explain away the reason sub-prime loans are imploding due to the weakness of the borrower.

How will they explain foreclosures in wealthy cities across the nation involving borrowers with 750 scores when their loan adjusts higher or terms change overnight because they reached their maximum negative potential on a neg-am Pay Option ARM for instance?

Sub-prime aren’t the only kind of loans imploding. Second mortgages, hybrid intermediate-term ARMS, and the soon-to-be infamous Pay Option ARM are also feeling substantial pressure. The latter three loan types mostly were considered ‘prime’ so they are being overlooked, but will haunt the financial markets for years to come. Versions of these loans were made available to sub-prime borrowers of course, but the vast majority were considered ‘prime’ or Alt-A. The caveat is that the differentiation between Prime and ALT-A got smaller and smaller over the years until finally in late 2005/2006 there was virtually no difference in program type or rate.

The bailout we are hearing about for sub-prime borrowers will be the first of many. Sub-prime only represents about 25% of the problem loans out there. What about the second mortgages sitting behind the sub-prime first, for instance? Most have seconds. Why aren’t they bailing those out too? Those rates have risen dramatically over the past few years as the Prime jumped from 4% to 8.25% recently. seconds are primarily based upon the prime rate. One can argue that many sub-prime first mortgages on their own were not a problem for the borrowers but the added burden of the second put on the property many times after-the-fact was too much for the borrower.

Most sub-prime loans in existence are refinances not purchase-money loans. This means that more than likely they pulled cash out of their home, bought things and are now going under. Perhaps the loan they hold now is their third or forth in the past couple years. Why are bad borrowers, who cannot stop going to the home-ATM getting bailed out?

The Government says they are going to use the credit score as one of the determining factors. But we have learned over the past year that credit scores are not a good predictor of future ability to repay. This is because over the past five years you could refi your way into a great score. Every time you were going broke and did not have money to pay bills, you pulled cash out of your home by refinancing your first mortgage or upping your second. You pay all your bills, buy some new clothes, take a vacation and your score goes up!

The ’second mortgage implosion’, ‘Pay-Option implosion’ and ‘Hybrid Intermediate-term ARM implosion’ are all happening simultaneously and about to heat up drastically. Second mortgage liens were done by nearly every large bank in the nation and really heated up in 2005, as first mortgage rates started rising and nobody could benefit from refinancing. This was a way to keep the mortgage money flowing. Second mortgages to 100% of the homes value with no income or asset documentation were among the best sellers at CITI, Wells, WAMU, Chase, National City and Countrywide. We now know these are worthless especially since values have indeed dropped and those who maxed out their liens with a 100% purchase or refi of a second now owe much more than their property is worth.

How are the banks going to get this junk second mortgage paper off their books? Moody’s is expecting a 15% default rate among ‘prime’ second mortgages. Just think the default rate in lower quality such as sub-prime. These assets will need to be sold for pennies on the dollar to free up capacity for new vintage paper or borrowers allowed to pay 50 cents on the dollar, for instance, to buy back their note.

The latter is probably where the ’second mortgage implosion’ will end up going. Why sell the loan for 10 cents on the dollar when you can get 25 to 50 cents from the borrower and lower their total outstanding liens on the property at the same time, getting them ‘right’ in the home again? Wells Fargo recently said they owned $84 billion of this worthless paper. That is a lot of seconds at an average of $100,000 a piece. Already, many lenders are locking up the second lines of credit and not allowing borrowers to pull the remaining open available credit to stop the bleeding. Second mortgages are defaulting at an amazing pace and it is picking up every month.

The ‘Pay-Option ARM implosion’ will carry on for a couple of years. In my opinion, this implosion will dwarf the ’sub-prime implosion’ because it cuts across all borrower types and all home values. Some of the most affluent areas in California contain the most Option ARMs due to the ability to buy a $1 million home with payments of a few thousand dollars per month. Wamu, Countrywide, Wachovia, IndyMac, Downey and Bear Stearns were/are among the largest Option ARM lenders. Option ARMs are literally worthless with no bids found for many months for these assets. These assets are almost guaranteed to blow up. 75% of Option ARM borrowers make the minimum monthly payment. Eighty percent-plus are stated income/asset. Average combined loan-to-value are at or above 90%. The majority done in the past few years have second mortgages behind them.

The clue to who will blow up first is each lenders ‘max neg potential’ allowance, which differs. The higher the allowance, the longer until the borrower gets the letter saying ‘you have reached your 110%, 115%, 125% etc maximum negative of your original loans balance so you cannot accrue any more negative and must pay a minimum of the interest only (or fully indexed payment in some cases). This payment rate could be as much as three times greater. They cannot refinance, of course, because the programs do not exist any longer to any great degree, the borrowers cannot qualify for other more conventional financing or values have dropped too much.

Also, the vast majority have second mortgages behind them putting them in a seriously upside down position in their home. If the first mortgage is at 115%, the second mortgage in many cases is at 100% at the time of origination — and values have dropped 10%-15% in states like California — many home owners could be upside down 20% minimum. This is a prime example of why these loans remain ‘no bid’ and will never have a bid. These also will require a workout. The big difference between these and sub-prime loans is at least with sub-prime loans, outstanding principal balances do not grow at a rate of up to 7% per year. Not considering every Option ARM a sub-prime loan is a mistake.

The 3/1, 5/1, 7/1 and 10/1 hybrid interest-only ARMS will reset in droves beginning now. These are loans that are fixed at a low introductory interest only rate for three, five, seven or 10 years — then turn into a fully indexed payment rate that adjusts annually thereafter. They first got really popular in 2003. Wells Fargo led the pack in these but many people have them. The resets first began with the 3/1 last year.

The 5/1 was the most popular by far, so those start to reset heavily in 2008. These were considered ‘prime’ but Wells and many others would do 95%-100% to $1 million at a 620 score with nearly as low of a rate as if you had a 750 score. No income or asset versions of this loan were available at a negligible bump in fee. This does not sound too ‘prime’ to me. These loans were mostly Jumbo in higher priced states such as California.

Values are down and these are interest only loans, therefore, many are severely underwater even without negative-amortization on this loan type. They were qualified at a 50% debt-to-income ratio, leaving only 50% of a borrower’s income to pay taxes, all other bills and live their lives. These loans put the borrower in the grave the day they signed their loan docs especially without major appreciation. These loans will not perform as poorly overall as sub-prime, seconds or Option ARMs but they are a perfect example of what is still considered ‘prime’ that is at risk. Eighty-eight percent of Thornburg’s portfolio is this very loan type for example.

One final thought. How can any of this get repaired unless home values stabilize? And how will that happen? In Northern California, a household income of $90,000 per year could legitimately pay the minimum monthly payment on an Option ARM on a million home for the past several years. Most Option ARMs allowed zero to 5% down. Therefore, given the average income of the Bay Area, most families could buy that million dollar home. A home seller had a vast pool of available buyers.

Now, with all the exotic programs gone, a household income of $175,000 is needed to buy that same home, which is about 10% of the Bay Area households. And, inventories are up 500%. So, in a nutshell we have 90% fewer qualified buyers for five-times the number of homes. To get housing moving again in Northern California, either all the exotic programs must come back, everyone must get a 100% raise or home prices have to fall 50%. None, except the last sound remotely possible.

What I am telling you is not speculation. I sold BILLIONs of these very loans over the past five years. I saw the borrowers we considered ‘prime’. I always wondered ‘what WILL happen when these things adjust is values don’t go up 10% per year’.

Now we’re finding out. If you made it all the way to the bottom, you can see why I decided to run this. Feel free to post thoughts below. Mark will likely be personally responding to any comments.


Market Watch

Developer drops apartment prices by €100,000

Prices of one and two-bedroom units in a new scheme in Dublin 15 have been cut by over 20 per cent in an effort to attract buyers writes Fiona Tyrrell

In a move that could trigger a significant adjustment in new homes prices across the market, a Dublin developer is offering reductions of up to €100,000 at a scheme in Ashtown, Dublin 15.

Capel Construction has cut prices at The Crescent, Ashtown by between €70,000 and €100,000 - representing a reduction of 17 and 22 per cent respectively.

Twenty-seven two-bedroom apartments at The Crescent go on sale today with prices starting at €335,000 and rising to €360,000. When the same two-bedroom apartments were first launched in October of 2006 by Savills HOK, prices for two-bedroom units were between €405,000 and €460,000.

Discounted prices on a wide number of schemes have been quietly offered to investors for some time, but this is the first time in many years that a developer is publicly advertising reduced prices.

Capel's decision to cut prices is likely to make other developers uncomfortable, particularly those who are building apartments in the same area. However,it is the latest indicator of the dramatic slowdown in the new homes market, which has left many builders with unsold stock on their hands.

It will inevitably lead some revise their prices downwards in the hope of selling them over the coming months.

Capel says that the move "brings affordability back into the housing market" and offers buyers "massive savings".

This, however, will be of little consolation to earlier buyers at The Crescent who now face the prospect of negative equity.

The Irish Times

It's Not 1929, but It's the Biggest Mess Since

It was Charles Mackay, the 19th-century Scottish journalist, who observed that men go mad in herds but only come to their senses one by one.

We are only at the beginning of the financial world coming to its senses after the bursting of the biggest credit bubble the world has seen. Everyone seems to acknowledge now that there will be lots of mortgage foreclosures and that house prices will fall nationally for the first time since the Great Depression. Some lenders and hedge funds have failed, while some banks have taken painful write-offs and fired executives. There's even a growing recognition that a recession is over the horizon.
But let me assure you, you ain't seen nothing, yet.
What's important to understand is that, contrary to what you heard from President Bush yesterday, this isn't just a mortgage or housing crisis. The financial giants that originated, packaged, rated and insured all those subprime mortgages were the same ones, run by the same executives, with the same fee incentives, using the same financial technologies and risk-management systems, who originated, packaged, rated and insured home-equity loans, commercial real estate loans, credit card loans and loans to finance corporate buyouts.

It is highly unlikely that these organizations did a significantly better job with those other lines of business than they did with mortgages. But the extent of those misjudgments will be revealed only once the economy has slowed, as it surely will.

At the center of this still-unfolding disaster is the Collateralized Debt Obligation, or CDO. CDOs are not new -- they were at the center of a boom and bust in manufacturing housing loans in the early 2000s. But in the past several years, the CDO market has exploded, fueling not only a mortgage boom but expansion of all manner of credit. By one estimate, the face value of outstanding CDOs is nearly $2 trillion.

The Washingston Post

Peter Schiff on Fox News

A Bull in China

Innovating Our Way to Financial Crisis

The financial crisis that began late last summer, then took a brief vacation in September and October, is back with a vengeance.

How bad is it? Well, I’ve never seen financial insiders this spooked — not even during the Asian crisis of 1997-98, when economic dominoes seemed to be falling all around the world.

This time, market players seem truly horrified — because they’ve suddenly realized that they don’t understand the complex financial system they created.

Before I get to that, however, let’s talk about what’s happening right now.

Credit — lending between market players — is to the financial markets what motor oil is to car engines. The ability to raise cash on short notice, which is what people mean when they talk about “liquidity,” is an essential lubricant for the markets, and for the economy as a whole.

But liquidity has been drying up. Some credit markets have effectively closed up shop. Interest rates in other markets — like the London market, in which banks lend to each other — have risen even as interest rates on U.S. government debt, which is still considered safe, have plunged.

“What we are witnessing,” says Bill Gross of the bond manager Pimco, “is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August.”

The freezing up of the financial markets will, if it goes on much longer, lead to a severe reduction in overall lending, causing business investment to go the way of home construction — and that will mean a recession, possibly a nasty one.

Behind the disappearance of liquidity lies a collapse of trust: market players don’t want to lend to each other, because they’re not sure they’ll be repaid.

In a direct sense, this collapse of trust has been caused by the bursting of the housing bubble. The run-up of home prices made even less sense than the dot-com bubble — I mean, there wasn’t even a glamorous new technology to justify claims that old rules no longer applied — but somehow financial markets accepted crazy home prices as the new normal. And when the bubble burst, a lot of investments that were labeled AAA turned out to be junk.

Thus, “super-senior” claims against subprime mortgages — that is, investments that have first dibs on whatever mortgage payments borrowers make, and were therefore supposed to pay off in full even if a sizable fraction of these borrowers defaulted on their debts — have lost a third of their market value since July.

But what has really undermined trust is the fact that nobody knows where the financial toxic waste is buried. Citigroup wasn’t supposed to have tens of billions of dollars in subprime exposure; it did. Florida’s Local Government Investment Pool, which acts as a bank for the state’s school districts, was supposed to be risk-free; it wasn’t (and now schools don’t have the money to pay teachers).

How did things get so opaque? The answer is “financial innovation” — two words that should, from now on, strike fear into investors’ hearts.

O.K., to be fair, some kinds of financial innovation are good. I don’t want to go back to the days when checking accounts didn’t pay interest and you couldn’t withdraw cash on weekends.

But the innovations of recent years — the alphabet soup of C.D.O.’s and S.I.V.’s, R.M.B.S. and A.B.C.P. — were sold on false pretenses. They were promoted as ways to spread risk, making investment safer. What they did instead — aside from making their creators a lot of money, which they didn’t have to repay when it all went bust — was to spread confusion, luring investors into taking on more risk than they realized.

Why was this allowed to happen? At a deep level, I believe that the problem was ideological: policy makers, committed to the view that the market is always right, simply ignored the warning signs. We know, in particular, that Alan Greenspan brushed aside warnings from Edward Gramlich, who was a member of the Federal Reserve Board, about a potential subprime crisis.

And free-market orthodoxy dies hard. Just a few weeks ago Henry Paulson, the Treasury secretary, admitted to Fortune magazine that financial innovation got ahead of regulation — but added, “I don’t think we’d want it the other way around.” Is that your final answer, Mr. Secretary?

Now, Mr. Paulson’s new proposal to help borrowers renegotiate their mortgage payments and avoid foreclosure sounds in principle like a good idea (although we have yet to hear any details). Realistically, however, it won’t make more than a small dent in the subprime problem.

The bottom line is that policy makers left the financial industry free to innovate — and what it did was to innovate itself, and the rest of us, into a big, nasty mess.


New York Times

The Sunday Times Property Supplement

Bears and Property!!




Stable Doors and horses!! Now where have I seen that before.

The Tip of The Iceberg

Morgan Stanley's top woman leaves

Morgan Stanley has announced that co-president Zoe Cruz is to retire, a move seen by analysts as the latest casualty of the US sub-prime crisis.

The investment bank, which earlier this month revealed a $3.7bn (£1.76bn) loss from US sub-prime mortgage exposure, said Ms Cruz would leave on Saturday.

The 52-year-old had previously been touted as a successor to current chief executive John Mack.

Morgan is just the latest bank to part with senior figures in recent weeks.

'Cruz missile'

Former Merrill Lynch chief executive Stan O'Neal retired with immediate effect on 30 October, and Citigroup's Charles Prince resigned on 4 November.

Morgan Stanley headquarters in New York
The bank says it is reducing its sub-prime loans exposure

Both were also said to have paid the price for allowing their firms to become overexposed to sub-prime mortgage debt.

Ms Cruz had been with Morgan Stanley since 1982, and was nicknamed "Cruz Missile".

BBC

'Last year' of the Tiger as boom peters out

The Celtic Tiger era could be over next year, according to a leading economist.

He said that the growth in the Irish labour market had been the envy of Europe but now the 'second wave' of the boom was coming to an end.

Brian McCormick from FAS predicted that the number of net new jobs will plummet from 69,000 this year to only 17,000 next year. At the same time the unemployment rate will rise from 4.5pc to 5.2pc next year.

Net immigration will be halved from 70,000 this year to 35,000 next year, he told the sixth annual FAS Labour conference held in Farmleigh House.

He said that something like 400,000 Personal Public Service (PPS) numbers had been issued to immigrants over the past few years, mainly to those coming from Poland, Slovakia, the Czech Republic and the Baltic States. About two-thirds of the recipients worked in Ireland at one stage or another and many were still here while others had returned home.

Many of the immigrants worked in the building industry but, with the slowdown in that sector, some of these skilled personnel would move to other countries where construction was picking up.

Success

The turnaround comes after unprecedented success in the Irish labour market which began in earnest in 1998. An additional 600,000 jobs have been created since thenr.

Most of the recent growth was driven by consumer demand and by the construction sector. But now there is a slowdown in that sector along with concerns about competitiveness and credit, added Mr McCormick.

Dr James Wickham, TCD's Employment Research Centre, noted that a high percentage of returned emigrants and new immigrants had skills and third level qualifications. But people could also leave said Dr Wickham who commented that there was a global 'war' for talent.

The Indo

Bank of England warns credit crisis to worsen

Charles Bean said that the banks have so far reported "only a relatively small fraction of the likely losses associated with the US sub-prime market."

"It is quite likely that, over the coming months, there will be more revelations to come out, not necessarily just in this country," he added.

The message from Mr Bean comes after Goldman Sachs warned earlier this month that sub-prime mortgage losses could force banks to slash lending by $2,000bn (£980bn) and push the United States into a deep recession.

Mr Bean said that the immediate future would be characterised by "lots of volatility" and said that it would be "quite a long time before things come back to a full state of normality."
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He made the comments in an interview with the Liverpool Daily Post, and said that the Bank was waiting to see what impact the crisis would have on the wider economy.

"What matters particularly to us is the impact on the economy at large.

"It is reasonable to expect lenders to be more cautious in extending loans whether to households or riskier lending to businesses, maybe some mergers and acquisitions, maybe the commercial property market may be particularly hit.

"That's something that the Monetary Policy Committee will be monitoring closely," he said.

He added that monetary policy would depend on inflationary pressure from the rapidly growing economies of China and India.

"Over the last two or three years, we have moved into a slightly less favourable external environment where the ill-effects of the development of China and India have started to be felt in the form of intense upward pressure they have been putting on commodity prices.

"Those pressures are likely to remain there for some time. The key question will be the extent to which the supply of those commodities can expand to meet the increasing demand from emerging economies.

The Telegraph

Closing the stable door after the horse has bolted

Bank of Ireland has banned 100 per cent mortgages -- except for civil servants in safe, pensionable jobs and other certain high-earning professionals, the Sunday Independent has learned.

The development is clear evidence that civil servants, who have benefited from huge benchmarking pay increases, are regarded as protected from the current economic uncertainty facing most other taxpayers in the credit squeeze.

It also reflects a loss of confidence in the economy, and is a clear indication that financial institutions believe negative equity is now a reality in the housing market, and will be for the foreseeable future.

Only those who have the potential to ride out the storm in the property market, because they enjoy secure long-term employment, will be offered full loans.

This clearly includes cosseted civil servants, who are hoping for further pay increases from the benchmarking body in a fortnight's time.

Their expectations are real following the massive pay rises recently awarded to public sector managers, including members of the cabinet, who received pay increases of between 12 and 15 per cent.

Following inquiries by this newspaper, the bank issued a short statement confirming the new directive: "Having reviewed our policy with regards to our 100 per cent first-time buyers product, with effect from today, Friday November 23rd, our 100 per cent product is now limited to certain customer segments," it read.

The Sunday Independent has learned that the memorandum has already been sent to Bank of Ireland managers and brokers acting on behalf of the country's second largest financial institution.

The clampdown on 100 per cent mortgages comes as a new survey showed that almost €15,000, or close to 5 per cent, has been wiped off the value of an average house so far this year.

The latest Permanent TSB/ESRI house price index showed that last month house prices nationally fell by 1.3 per cent.

Niall O'Grady, head of marketing at Permanent TSB bank, said that the normally strong autumn buying period had been marked by a "deferral of purchase decisions". He said the fact buyers were waiting to see what would happen was now having an impact on the rental sector, where rents are rising steadily.

The Sindo

Sub-prime ‘time bomb’ is set to explode in Britain

Lenders are cracking down on sub-prime borrowers across Britain and could force tens of thousands of homeowners into forced sales of their homes, property experts warned yesterday.

The global credit crunch provoked by the crisis in American sub-prime mortgages is creating a time bomb in Britain’s own market for loans to borrowers with imperfect credit records.

The warning came as figures from the British Bankers’ Association (BBA) suggested that the slowdown in house prices was on course to be the most severe in at least a decade, as would-be buyers take fright at a declining market.The number of mortgages approved in October for home purchases by the BBA dropped by 17 per cent over the month to only 44,105, the lowest figure since the body began to compile figures in September 1997. Approvals were 37 per cent lower than a year ago.

Experts fear that the emerging British sub-prime crisis could further destabilise the domestic property market. As existing homeowners with particularly bad credit records – known as “heavy” sub-prime customers – come to the end of the cheap two-year fixed deals that were readily available until the summer, lenders are refusing to offer similar deals.
In the past, heavy sub-prime borrowers could find a cheap deal if their loan was equivalent to 95 per cent of the value of their home – but the loan-to-value (LTV) ratio has dropped significantly.

Bob Sturges, of Money Partners, a sub-prime lender, said: “These are people who before the credit crunch would have been able get a maximum of 95 per cent LTV. Now the maximum they can get is 75 or 80 per cent. When they come off their fixed-term deal they are going to be disenfranchised from the beneficial rates they have enjoyed. If they can’t afford the higher rates, they face the prospect of selling up and joining the rental sector. This will affect tens of thousands, if not hundreds of thousands of people.”

Those who have insufficient equity in their homes and who do not have the cash to make up the shortfall will be forced to pay their lenders expensive Standard Variable Rate (SVR).

Two years ago, borrowers could snap up a two-year fixed-rate deal for heavy adverse borrowers of 6.58 per cent. Hundreds of thousands of homeowners face being moved on to their lender’s higher rate, which typically will be at 9.5 per cent. On a £150,000 mortgage, this will leave homeowners facing an extra £280 a month in loan repayments. Thomas Reeh, of Black & White Mortgages, the sub-prime broker, said: “There are very difficult times ahead for customers who are habitual defaulters, or heavy sub-prime. They are unlikely to get a new competitive deal, and face significant pressure from their existing lender.”

The higher cost of all mortgages, prime and sub-prime, in the wake of rises in interest rates and the credit squeeze has also put people off from dipping into their housing equity to fund big purchases, in a worrying sign for the retail sector as the Christmas season approaches. Mortgages not for house purchase or remortgage fell to 38,471 in October, the lowest figure since May 2000.

Timesonline

The Blame Game

AN Irish Nationwide Building Society committee set up to approve home loans of over €1m was merely "a device" to satisfy the Financial Regulator, a spurned senior manager has claimed.

In practice there was "limited compliance" with the mortgage provider's own rules and loans were "entirely informal", it has been alleged.

In the first major sign of a blame game within the banking system over the role of mortgage lenders in the recent solicitor's scandals, a senior INBS official has accused his employers of providing leaked reports of his suspension to the media in an attempt to discredit him over the remortgaging affair.

Yesterday, Tipperary native Brian Fitzgibbon, who has been a homeloans manager with the Irish Nationwide since 2000, claimed that he is being "scapegoated" over the approval of loans to disgraced solicitors Michael Lynn and Thomas Byrne.

Mr Fitzgibbon (41) from Liscahill, Thurles, was granted an injunction preventing his suspension after he claimed that his employers victimised him over the approval of loans to the solicitors who are now under garda investigation and whose practices have been closed by the Law Society.

He claims INBS managing director Michael Fingleton was personally responsible for bypassing the society's own procedures for granting loans and he (Fingleton) gave direct approval for at least one substantial loan for Mr Lynn for the purchase of Glenlion House, Howth, where Mr Lynn and his wife hoped to live.

The Indo

Builders hold finished units to wait and see

With an estimated 10,000 empty apartments in the Dublin area, builders are opting to rent them out rather than try to sell them, says Fiona Tyrrell

The former gasholder at Ringsend is one of a number of newly built apartment buildings in Dublin that is lying empty as developers adopt a wait-and-see approach in the ailing new homes market.

It is estimated that there are more than 10,000 empty units in the Dublin area. The vast majority of these are new apartments which have either failed to sell or have not been put on the market.

The most notable example is the Alliance Building, the nine-storey cylindrical apartment block built inside the metal struts of the Victorian gasholder at the Gasworks scheme in Ringsend, Dublin 4.

The landmark structure forms part of a 7.8-acre site bought by developer Liam Carroll from Bord Gáis in the mid 1990s. Six hundred apartments were built here, along with the office complex now occupied by Google. A further 200 apartments were built in the former gasholder.

The first 50 apartments were launched in June 2006 with prices ranging from €675,000 to just over €1 million. However, it is not clear how many of these were sold. The entire scheme has now been withdrawn from the market, according to the selling agent Hooke & MacDonald.

Rumours are circulating among residents at the Gasworks that those who did buy apartments at the gasholder were given their deposits back by the developer. There has even been speculation that the unusual building may be turned into a hotel.

Carroll is one of a growing number of developers who have extra stock on their hands at the moment. In some cases developers are holding off launching entire schemes until conditions improve rather than risk a failed sales launch.

Others are opting to retain the stock themselves and rent them out, taking advantage of the high rents being achieved in the city. Developers are either renting out the last few units in schemes that have failed to sell or in some cases entire schemes that have never been launched.

The Irish Times