Oct 19, 2007
by Philip Hamilton, Bend Meridian Financial
I came to follow the yellow brick road in 1978. Mortgage finance was my first real job, downtown, with suit and salary. I haven’t left the mortgage business since. As a result, I experienced first-hand the oil embargos and high inflation of the late 1970sthe back-to-back recessions between 1980 and 1982 - biggest downturn in post WWII America the trouble in the oil patch in the mid 1980’s the stock market crash of 1987 the FSLIC bailout of 1989 the end of the Cold War and resulting housing recessions on the two coasts in the early 1990’s the global debt and currency crisis of 1998 and LTCM’s hedge fund meltdown and the NASDAQ “Dot Com” collapse early in this decade.
I witnessed all eight of these events up close and personal. Black Tuesday 1987 took the biggest bite out of me and sent me to Central Oregon to start over. I have been writing about each event as an observer, mortgage market analyst and as a loan officer. I examined how each affected housing, the mortgage market and the macro economy, which you have been reading in CBN these past many years.
All these financial events pale by comparison with the events of recent weeks. They pale in two ways-speed and magnitude. Never before have national firms in the top ten disappeared within ten days of an announcement of liquidity problems-a la American Home. Never before have so many mortgage companies completely closed down in such a concentrated timeframe, 156 major U.S. firms have closed year to date. Unfortunately, especially for the people involved, more firms will fail before this situation plays itself out.
So, precisely what has happened to cause such turmoil and tumult in the credit markets? To me, it’s really quite straightforward: Investors in the non-prime/agency debt securities simply stopped buying. Fear set in, arguably replacing greed. These buyers, quite literally, are on strike. And why did they go on strike? As best as I can tell, investors in the cornucopia of non-prime/agency mortgage instruments and investments felt mislead, lied to about the performance of what they had purchased. Many bought what they thought were AA and AAA-rated securities and these evaluations were confirmed and blessed by Moody’s, Fitch and S&P. Regrettably, what the investors bought turned into headaches, bad press, downgrades, increased scrutiny and mark-to-market acid test.
Earlier this year the market began to learn that a disproportionate percentage of non-prime loans weren’t performing to model. Delinquencies were rising and defaults mounting. And as this was happening, several other things began to change or had already changed. First, short-term interest rates had risen. Second, home- price appreciation was slowing. Third, loan demand was softening. Fourth, underwriting was tightening. Fifth, the supply of vacant and “for sale” homes soared... Now supply handsomely exceeds demand. Coast to coast, America is over-housed. In total, about 5.5 million homes are available.
The increasing rate of delinquency and default was evidence that investors pension funds, trust, hedge funds, banks and others, both here and worldwide, got shafted by the guys from Wall Street. Gordon Gecko ,from the movie “Wall Street”, would be proud of the way the Street hosed those investors. There are $800,000 billion of securities outstanding that are collateralized by subprime mortgages. What is it worth? I know of cases where it is at 30 to 40 cents on the dollar. And, for the record, this is the third time Wall Street entered the mortgage business, made a billion dollar mess and led a hasty retreat. Wall Street has pillaged Mortgage Land in the late ‘80s, late ‘90s and now once again.
It seems that since the ‘80s, we have experienced something more than just normal business ups and downs. The pendulum appears to move violently from one extreme to another. Everything is overdone. No moderation applies despite claims by the Fed that business cycles have been smoothed out by its monetary fine-tuning policies.
We, as an economic system, are reaping what we sowed. The voices in the wilderness told us way back in the early ‘80s that running up the national debt and putting our present on a charge card would impair our future. And now, that future is here and we are scrambling around trying to find enough band-aids to fix the mess that was predicted. Robbing Peter to pay Paul is not the program, just as Hope is not the program. We have dug a deep hole and find that China truly does exist at the other end, be it the other side of the globe or the other side of the debt transition. How could we have been so foolish as to believe that the piper would never get paid, that the Fed would always refill the punch bowl and that money grows on tress?
As a nation, we are spoiled by easy credit and lured on with visions of vast wealth. Hence, the aversion to pay taxes and take financial responsibility for our actions. Bailout is always the first option we seek. Isn’t it ironic that many of our government entities raise their money by encouraging the public to gamble? Win the lottery and retire. Take out an adjustable mortgage and hope it never adjusts upward. Didn’t Uncle Alan say that was a good idea?
Thanks again, Greenspan. It was incredibly negligent for the Federal Reserve Board and the Bush administration to allow the housing bubble to grow unchecked and, especially to allow the sort of mess perpetrated against moderate-income homebuyers in the subprime market. Now the Federal Reserve policy makers are being forced to cut interest rates to prevent the housing recession from bringing the rest of the economy down. And, I was surprised by the Fed’s September 18, 2007, half-point slashing of both the Fed Funds Rate and the Discount Rate. This was the first downward move since 2003 and the first move under Bernanke.
More surprising was the fact that the vote was unanimous. Although the move will not heal the ailing credit markets overnight, the injection of liquidity will help the capital markets and that will in turn help all of us in the “Primary Markets”, selling/buying and financing real estate. Perhaps, more importantly, it gives down-and-out ARM holders a chance to reset lower or lock fixed-rate loans.
As you have probably gathered, it all started with subprime. Therefore, it will make sense that the areas with the greatest number of these loans will have the bigger problem working through the housing bubble fallout. These areas are Nevada, which has the highest percentage of subprime loans in the U.S. at 21 percent followed by Mississippi at 19 percent, Arizona at 18 percent, and California at 15 percent. Central Oregon had very little subprime and that will go a long way in our market stabilizing and being one of the first areas to come out. In fact, I believe we are floating along the bottom of our price decreases, even through other areas have a ways to go.
We will have to, of course, wait for the rest of the nation to heal before we see any gains in appreciation and that may be awhile, 17 months is my prediction. But, from this point forward, things will get better for the housing industry for a couple of reasons. The Fed is always late to help and the help they gave us was BIG. Overseas investors are buying American real estate, saying it is a good buy. So, my friends, when we look back at this dark period, we will agree that August of 2007 was the pit on the bottom of the housing recession. Now is time to get off the fence and pick up the deals. It will be hard to get much better than these prices and concessions! Please, stay in touch, hang in there and let me know how you are doing. If I can help, please give me a call.