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Distressed Housing

Underappreciating Risk

August 7, 2007 | 12:01 am | |

Here are some swirling thoughts about risk.

Although interest rates are slipping, mortgage rates are rising. James Hagerty’s page one WSJ story Mortgage Fears Drive Up Rates On Jumbo Loans covers the issue of jumbo mortgages, to high end buyers with good credit, are seeing their mortgage rates climb.

One could argue that this could be an over reaction by the markets and more sanity will return soon. Of course, you could say that the Bosox are going to win the pennant (sorry, cheap shot – Yanks are now only 6.5 games back). However, this is a credit correction, and has taken the place of a significant housing correction anticipated by many over the past 2 years, but was largely a slow bleed.

And take a look at what the last two weeks have done to the probability of a fed cut by October. The odds of the Fed holding rates steady fell from 85% two weeks ago to 55% this week.

Floyd Norris’ The Loan Comes Due gives a great break down on the different loans that are affected by the credit crunch (hint: it isn’t only home mortgages.) There’s also an amazingly large and well down flow chart of the mortgage market and hedge funds.

Click here for full sized graphic.

Source: NYT

All this has happened with few defaults. Mortgage delinquencies are up, particularly on loans made in 2006 when credit standards were very low, but the real problem is that lenders and investors fear things will get much worse.“This is what we would characterize as the first correction of the modern neo-credit market,” said Mr. Malvey of Lehman Brothers. “We’ve never had a correction with these types of institutions and these types of instruments.”

It now seems likely that the rating agencies, and investors, were lured into a false sense of security by the lack of defaults. With the value of homes, and companies, rising, it was usually possible for a borrower in trouble to refinance the debt or, at worst, sell the home or business. Either way, lenders got paid.

So its not only about the bad things that happened. Its about things that may happen. Wait a second…isn’t that what risk is?

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[List-o-links] 6-29-07 Subprime Cuts: iPhones Used To Get Past Subprime Disconnect

June 29, 2007 | 12:32 pm | |

Ok, not really but its a great way to present both subjects, which dominate the news right now. I was inspired by a colleague of mine who favors graph paper style shirts, and who suggested I address how the subprime mortgage implosion can be resolved through use of iPhones.

But try not to read between the lines.


[In The Media] BBC World Business Report Clip for 6-13-07

June 14, 2007 | 12:00 am | Public |

I have always loved watching BBC TV for news and listening to BBC radio because it provides an outsider’s perspective, a clinical interpretation of world events. I made the mistake of walking to the studio for this interview and it was very humid outside. Sort of like sitting in a sauna with a suit on (which I try not to do). The host Dharshini David, a former economist, is very personable and has the best British accent on television (if you take note of that sort of thing).

This clip covered the doubling of the number of foreclosures in the US as compared to the same period last year.

Foreclosures are rising as mortgage rates reset and homeowners can’t refinance their way out of trouble.

However, one of the reasons we have a higher potential for the number of foreclosures (versus percentages), is the fact that home ownership is near record levels at more than 68% of all households. The BBC and some economists (and one appraiser) suspect that the inflation threat is short lived. I suggest that the impact of the weakening US housing market has not had the opportunity to fully impact the US economy. Comprising 25% of GDP, housing plays a significant roll in the US economy and by rote, the global economy.

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Inflated Housing Expectation’s Sticky Downside: Recession

April 30, 2007 | 11:13 am | |

Waiting for the other shoe to drop and its getting sticky.

Since the housing boom ended in mid-2005, the Fed has continued to play the roll of inflation hawk, worried that an over heated economy will force them to raise the federal funds rate even higher. I get the impression that they have been saying this for so long (2004) that they seem to be missing the economic slowdown (of course, I am exaggerating).

This topic is covered in the Bloomberg piece Bernanke Is Wrong on Inflation, Goldman, Merrill Say.

“House prices could decline as much as 10 percent,” said Maury Harris, chief economist at UBS in New York, in an interview. UBS, based in Zurich, is the world’s biggest money manager for the wealthy. Fed research doesn’t agree. The central bank reported “signs of stabilization in housing demand in most regions of the country,” according to the April 11 report. “Home-buying attitudes improved and continuing job growth could be expected to support home sales.”

I wonder if they are speaking to New York market participants only, because the market here is one of the few in the country that is doing well. The economy is showing weakness and a recession is a growing concern but not on many people’s radar these days.

GDP grew 1.3% in the first quarter, averaging 2.2% for the past year and well below the Fed’s 3% expectation level.

Two hands…
On one hand, the Fed is concerned about inflation and higher mortgage rates further crippling an already weak housing market. On the the other hand, the other side views the economy as not yet bearing the full brunt of the housing slowdown. I have been on the latter side, contending that the lag time for housing to fully impact the economy is probably more like 1-2 years from the point the housing market began to slow.

Since that point was about mid-2005, that means right about now. Yet the odds of a rate cut seem to be slipping. Muddy economic discussions lumber along, with an occasional insertion of the word “inflation” to nudge us awake periodically.

Housing prices tend to be sticky on the downside, falling at a far slower than they rose since many sellers simply opt not to sell. Hence the delayed housing market reaction, only accelerated (or primed – ok, sorry) by subprime. Nationally, foreclosures are rising, the number of sales are falling and prices are slipping.

I am guessing that if the Fed is very much wedded to holding firm for a while, which will keep mortgage rates stable and at low levels, but if it doesn’t cut rates by the end of the year, its going to get sticky and we may be using the “R” word a whole lot more. Or perhaps the “S” word (stagflation).

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[In The Media] CNBC Power Lunch Clip for 4-24-07

April 25, 2007 | 12:01 am | Public |

This was a split screen discussion on luxury foreclosures. Note my two titles in the video.

A few thoughts about auction properties:

  • The discount achieved is usually based on an unrealistic list price, suggesting a wildly large discount.
  • When a listing is sold through an auction, the discount, if any, is the result of a short marketing period. In other words, the property is exposed to a specific buyer for a very short period of time. The advantage to an auction sale is that sellers to whom “time is of the essence” get a reprieve and unload the property sooner. Its not a discount for the sake of a discount. They are essentially paying for a shorter marketing time.

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[List-o-links] 3-19-07 Subprime Cuts: Calling All Cows

March 19, 2007 | 12:01 am | | Public |

With the subprime cows relegated to dairy duty, here’s a collection of some key prime mortgage stories of the week.

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Housing Gloom Recap Leads To March Madness

March 13, 2007 | 10:33 am | |

Lets recap the potential path for housing and the economy based on news reported in March:

  1. Economy so-so
  2. Investors get risk averse
  3. Subprime defaults increase
  4. Mortgage underwriting guidelines tighten
  5. Weak housing market gets weaker as a result
  6. Housing related jobs decrease
  7. Economy weakens further, skirts with recession
  8. A few years of weak housing conditions remain

To expand on each point…

1. Economy so-so [FDIC – pdf]

Pronounced weakness in the housing sector is being largely offset by continued strength in the corporate sector, commercial construction activity, and exports…Still, some negative trends have emerged for banks. They include a narrowing of net interest margins, particularly among larger institutions; increasing concentrations of traditionally riskier commercial real estate loans; and emerging signs of credit distress in subprime mortgage portfolios. Ultimately, it is local economic conditions that are the most important determinants of credit quality and earnings strength at the majority of banks and thrifts. In this issue of the FDIC Outlook, our regional analysts identify trends that are expected to affect banking in their areas during the remainder of 2007.

2. Investors get risk averse [Bloomberg]
The concern over subprime lending and rising defaults is increasing the flight to safety. That is, investors are buying treasuries. Price goes up, yield goes down. Lower yields on a ten year have limited effect on most mortgage rates because the term is too short but still, it would probably help maintain a low rate environment.

“The biggest risk we can identify is from the spate of foreclosures in the subprime market increasing the inventory of unsold homes and weighing on home prices,” said Amitabh Arora, head of U.S. interest-rate strategy in New York at Lehman Brothers Inc. “We are much more cognizant of that than we used to be.”

3. Subprime defaults rise [MSNBC]

“Just as the case often was back in college, when you have too much liquidity sloshing around for too long, people tend to do some foolish things,” Wachovia senior economist Mark Vitner wrote in a recent research note. “Apparently that includes loaning money to folks with spotty credit histories to purchase homes not only to live in but also to speculate on.”

4. Mortgage underwriting guidelines tighten [WSJ]

Early February, the Federal Reserve reported a sharp increase in the number of banks tightening mortgage-lending standards. On Tuesday, Freddie Mac — whose main business is repackaging mortgages into mortgage-backed securities — said it was tightening standards on purchases of risky, subprime mortgages. On Friday, banking regulators proposed stricter mortgage guidance.

5. Weak housing market gets weaker as a result [LA Times]

That could hurt the housing market by shrinking the pool of eligible buyers. In addition, many homeowners with high-risk loans whose rates will adjust upward in the next year or two won’t be able to refinance into loans with better terms. That could put some into foreclosure.

6. Housing related jobs decrease [MSNBC]

Housing-related job losses once again put a dent in February job growth, which saw an overall gain of 97,000 — down from a gain of 111,000 in January. Employment in housing-related industries fell by 11,000 in February, bringing to 176,000 the total number of jobs lost in the sector since at sector since April 2006, according to figures compiled by

7. Economy weakens further, skirts with recession [Bloomberg]

Alan Greenspan, who jolted investors by predicting a one-in-three chance of a recession this year, isn’t as bearish as the bond market, where the risk of a downturn is even money. The probability the U.S. economy will shrink for two quarters has risen to 50 percent, according to a model created when Greenspan ran the Board of Governors of the Federal Reserve System. The formula is based on differences in yields on Treasuries.

8. A few years of weak housing conditions remain [CNN/Money]

Celia Chen, director of housing economics for Moody’s, says she thinks it will take until 2009 for prices nationally to reach the peaks hit in 2005. Take inflation into account, she said, and a full recovery could take more than 7 years.

I’d have to agree that its not simply a matter of time before the national housing market returns to 2004/2005 conditions. The housing boom was a period where all the stars were aligned and the universe was in sync. The combination of unusually low mortgage rates prompted by 9/11, loose or perhaps non-existent underwriting guidelines for mortgages, expansion of subprime lending, exotic mortgages, a solid non-inflationary economy, rising productivity, risk oblivious investors who had moved out of the stock market after the 2000-2001 period of volatility, shifting demographics that saw more immigration and a get rich quick mindset created the housing boom.

The news isn’t all bad, however. Modest growth in the housing sector would go a long way in keeping housing more affordable. I think Fannie Mae’s record of 69% home ownership reached last year, which has since slipped, is not going to be passed anytime soon.

On the bright side, March Madness is nearly here and my son’s basketball team won our town’s 3rd grade basketball championship.

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Banking On Profits, Not Risks

February 26, 2007 | 12:01 am | |

Weakness in the national housing market hasn’t really hit the banking sector results yet, or so it would appear to be the case. Here are a few thoughts:

Banking Profits/Credit Quality
On Friday the Federal Deposit Insurance Corp (FDIC) announced that banks and thrifts reported record earnings in 2006, the sixth yearly increase in a row. The FDIC is an independent agency of the federal government created to maintain public confidence in the banking system.

However, credit quality of mortgage loans has fallen as evidenced by the increase in mortgages that are more than 90 days delinquent and the increase in charge-offs.

Residential mortgage loans that were noncurrent (90 days or more past due or in nonaccrual status) increased by $3.1 billion (15.6 percent) during the fourth quarter. This increase followed a $974 million (5.2 percent) increase in the third quarter. Net charge-offs of residential mortgage loans totaled $888 million in the fourth quarter, a three-year high.

Exotic Mortgages
Even negative amortization adjustable rate mortgage (NegAm ARM) delinquencies, the universally loathed and blamed mortgage product of all that is bad with mortgage lending these days (excluding subprime) has remained relatively low so far. The risk of their delinquencies may rise as housing prices fall, especially since these products were more popular in markets that saw the largest levels of appreciation. Its a little premature to attribute the lack of significant problems with these types of loan products as a sign that they really weren’t a big problem to begin with.

According to RealtyTrac, foreclosures are clearly on the rise. January 2007 versus 2006 saw an increase of 25%. A scary number but percentages can be a little misleading since the hard numbers are not presented as a percentage of the total mortgages outstanding. According to the Mortgage Bankers Association, the December 2006 total delinquency rate was 4.67%, which is not high by historical standards. The largest portion came from subprime loans. However, delinquency is a broader definition than foreclosure, but for argument’s sake, its getting worse.

Click here for full sized graphic.

Risk Assessment
One of the problems with mortgage underwriting during the housing boom was the lack of understanding of risk. Automation and detachment from the collateral itself allowed lending institutions to marginalize the risk, perhaps by pushing it off onto theoretically unaware secondary market investors.

One of my favorite, go-go 1980’s books was Liars’ Poker by Michael Lewis (along with Barbarians at the Gate: The Fall of RJR Nabisco and Den of Thieves).

One of the stars of Liar’s Poker was Lewis Ranieri who helped invent the mortgage backed securities concept – selling bonds tied to mortgages was part of an excellent James Hagerty piece in the WSJ on Saturday called Mortgage-Bond Pioneer Dislikes What He Sees [WSJ].

Ranieri and his colleagues in the late 1980’s (thoughts of my Liar’s Poker readings included them bragging about having more powerboats than polyester suits and how they ate onion cheeseburgers for breakfast) combined

regular mortgages into giant pools of loans that could be divided up and resold as bonds to pension funds and other institutional investors. These bonds come with a variety of credit ratings and are repackaged in endless permutations to meet investors’ varying appetites for risk.

Ranieri’s current assessment of the problem is that today’s investors don’t understand the risk because the expansion of offerings has changed dramatically in recent years and they don’t have the historical perspective.

The problem, he says, is that in the past few years the business has changed so much that if the U.S. housing market takes another lurch downward, no one will know where all the bodies are buried. “I don’t know how to understand the ripple effects through the system today,”

One of the reasons, has been the meteoric rise in collateralized debt obligations, or CDO’s which are sort of like mutual funds for mortgage securities investors who want to spread their risk. The problem is that he says that buyers of the debt don’t understand the risk like secondary market investors do because they don’t have access to the same level of information.

Take away:
Its ok to work hard for profits, and banks have every right to do that. In fact its their responsibility. However, its also their responsibility to understand the risks that are out there. Mortgage lending played a significant role in the housing boom. I am not confident that the banking industry can remain impervious to the by-product of the aggressive lending we’ve seen in recent years, characterized by the don’t ask, don’t tell mentality. I am surprised that more attention hasn’t been placed on the risks in the mortgage collateral pool (note: faulty valuation of assets).

There hasn’t been enough time for the housing slow down to affect banking’s bottom line yet. We are starting to see signs of weakness in terms of rising foreclosures and noncurrent loans. However, I wonder if there is greater long term risk associated with the lack of understanding of the risks themselves, or simply greater demand for a good polyster suit with cheeseburger grease stains.

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Housing Fundamentals Go Boom!

February 12, 2007 | 11:50 am | |

One of my economics heroes, Robert Shiller whose work I have admired (but not always agreed with) wrote a provocative commentary on “Booms” in the Wall Street Journal last week called, interestingly enough: Things That Go Boom [WSJ].

We shouldn’t blame these people for not seeing the boom coming. Nobody did. But those economists who say today that the real estate boom has been justified by “fundamentals” have to explain why they weren’t able to forecast the high home prices we have today based on those fundamentals.

With the failure of anyone really to predict today’s high home prices, one may well conclude that no one can predict today whether a home-price bust is coming, or whether the housing market will land softly, or even is poised to resume its upward climb. That may be the right conclusion about our ability to forecast the markets.

On the other hand, there is another perspective on this colossal failure to predict. Maybe it doesn’t mean that no one can forecast, but instead that the high home prices today are just an enormous anomaly that will have to correct downward sometime, if not right away.

Basically, the premise in his piece is the idea that fundamentals didn’t help us predict the housing boom to the extent that it occurred, which means that fundamentals can’t tell us whether we will have a hard or soft landing either.

Can anyone define what housing fundamentals actually are? The term is always used rather loosely and infers strenuous economic consideration. How about: Employment? Housing Starts? Inventory? Mortgage Rates? GDP? Its seems to me that the list is subject to debate, and the assumption that fundamentals are solid is based on a list that is not universally agreed as fundamental.

Professor Shiller was the creator of the housing index used as the basis for trading on the Chicago Mercantile Exchange last May, which has been characterized as garnering very little interest by investors.


Perhaps the lackluster interest is because it doesn’t include all elements of the housing market including new home sales (a significant factor) and foreclosures (a rising factor). The index predicts price declines in 10 major markets that are currently being covered but it seems like the same sort of experience (in reverse) made by individual investors who could do no wrong in the late 1990’s because every stock was going up.

I lost interest in following the CME price patterns because of the low trading volume. The volume in specific markets seems to be more of the story these days than the reliability of the pricing.

We are left with a deeply uncertain situation, but one in which it would seem that a sequence of price declines continuing for many years has some substantial probability of happening. Traditional finance theory has trouble reconciling even a semi-predictable sequence of price declines with basic notions of market efficiency. The situation we are facing is a reminder of the glaring inefficiencies and incompleteness of existing markets for residential real estate, and may be regarded as evidence that institutional changes will be coming in future years to fundamentally change the nature of these markets.

It doesn’t seem like anyone has a handle of the direction of macro real estate markets at the moment, beyond relying on conventional wisdom. Professor Shiller seems to be moving away, if just a little, from the position that indexes can be used to accurately predict real estate markets, despite his groundbreaking work in this area. He seems to be moving toward the conventional wisdom argument what comes up must come down.


Banking Acronyms And Predatory Lending

February 12, 2007 | 11:09 am |

A few years ago, I was amazed at how profitable sub-prime lending was and how national banks were flocking to buy them. The first danger sign for me was when Citibank ran into problems when they purchased The Associates and subsequently assumed their legal woes and eventually settled. But it didn’t end there. In addition to large national retail lenders, International banks got into the game, including HSBC.

Daniel gross wrote a witty piece on HSBC called Hey Sucker Banking Corporation: How a British bank blew it in America [Slate]:

HSBC’s woes are the most highly visible evidence that the real estate-credit orgy of recent years is coming to an unhappy end.

Other names for the acronym HSBC other than its actual Hong Kong Shanghai Banking Corporation have been proposed but HSBC has become the posterchild for all that is wrong with subprime lending.

Don’t get me wrong, subprime serves a need. However, the search for quick profits and lapses in ethical standards associated with subprime lending has begun to take its toll on the lending sector of the economy. Sub-prime lending comprises 20% of all mortgages [MW] so its not an insignificant sector. It doesn’t mean that all sub-prime is predatory but its significant.

In a recent staff report by the New York Fed called Defining and Detecting Predatory Lending explores this topic:

We define predatory lending as a welfare-reducing provision of credit. Using a textbook model, we show that lenders profit if they can tempt households into “debt traps,” that is, overborrowing and delinquency.

This is all scary since those that borrow in this sector are the least likely to afford outside advice.

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Mortgages: Wondering Where All The Delinquents Are

September 20, 2006 | 6:37 am | |
Source: Wachovia

According to the recent press release by the Mortgage Bankers Association Some Delinquency Measures Tick Upwards in Latest MBA National Delinquency Survey:

2Q 06 delinquency rates fell 2 basis points to 4.39% from 1Q 06 and were up 5 basis points from 2Q 05. The decline from the prior quarter was attributed to the surge in delinquency after Hurricane Katrina.

“In previous quarters we indicated a number of factors including the aging of the loan portfolio, increasing short-term interest rates, and high energy prices have been putting upward pressure on delinquency rates. To this point, generally healthy economic growth and labor markets have kept delinquency rates from rising. However, we are seeing increases in delinquency rates for subprime loans, particularly for subprime ARMs. It is not surprising that subprime borrowers are more susceptible to these changes.”

Foreclosure rates, the next stage of the delinquency process were 0.99% in 2Q 06 up from 0.98% in the prior quarter. The RealtyTrac foreclosure rates that are released each month infer much higher foreclosure levels which I discussed in an earlier post. Overall foreclosure rates are still considered low but a weakening economy is bringing additional concerns.

Source: Wachovia

A Wachovia Corporation Economics Group report [pdf] (via FXstreet) suggests that the delinquencies are concentrated in a few states yet the projected income growth in these states is above the national average. The article suggests that the growth in income will temper some of the problems as mortgage rates reset over the next 12-18 months. Since the delinquencies seem to correlate in markets known for investor and flipping purposes, the numbers don’t show a national problem, yet.

In David Berson’s weekly commentary post, he wonders Mortgage Delinquencies remain low, but will they stay that way? [FNMA]

First of all, the behavior of home prices is an important determinant of serious delinquency rates. If a household has enough equity in a home it could either sell the home or extract some equity, so a delinquency resulting from a negative shock to a household (e.g., job loss, serious illness, etc.) should not lead to a foreclosure. The rapid home price growth seen over the past few years in much of the country should mitigate the risk of foreclosure. However, we expect national home price appreciation to slow this year and next, and some areas of the country could see declines. In those areas, a decline in home prices could leave some households with a mortgage balance significantly in excess of the value of the home. Increases in interest rates that would cause payments on adjustable-rate mortgages (ARMs) to rise sharply relative to incomes could also lead to increases in the serious delinquency rate. While only about 30 percent of prime conventional mortgage originations last year were ARMs, the ARM share was significantly higher in the subprime market. Many of these subprime ARMs have short fixed-rate periods and will be adjusting in the next year, which could lead to rising serious delinquency rates.

Note: Berson’s link lasts one week. After 9/24/06, go here and search for his 9/18/06 post.

I think the overall problems related to the mortgage delinquency rate will be strongly influenced by how quickly mortgage rates move upward. Right now mortgage rates are projected to be stable as the economy continues to weaken and inflation is held in check. However, mortgage rates are already higher than when many adjustable rate mortgages (approximately 30% of the all mortgages) were issued.

Rising personal incomes may serve to contain the problem since the areas with the highest real estate investor concentrations are located in areas with the largest personal income upside. I wonder if good job prospects in these areas helped fuel the speculative characteristics of local markets.

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Making The Blame Transition From Housing To Mortgages

September 5, 2006 | 12:01 am |

Last week I posted about Confusing A Housing Bubble For A Lending Bubble and how the housing boom was really caused by an erosion in underwriting quality. I suspect until we see major stats on housing price declines in some markets, we are going to see a lot more articles about mortgage lending.

Businessweek had a particularly vitriolic cover this week: How Toxic Is Your Mortgage? The cover story was called Nightmare Mortgages. Its a thorough piece that basically outs most creative financing. This is one of the first large scale pieces I have seen that really fleshes out exotic mortgages and shows how so many people were duped or didn’t fully realize what they were getting into.

My first thought was along the lines of: Why didn’t the borrowers take more responsibility for the process of getting a mortgage rather than simply signing on the dotted line? But in reality its hard to be that tough on someone that was misled and a victim of some type of fraud. However, I am amazed at how many people simply signed. Herd mentality rules.

My second thought was: This seems to stereotype the entire mortgage market, giving the impression that nearly every mortgage that isn’t a 30 year fixed is “toxic.” I think the reality is that exotic products are found in differing amounts in different markets and with different demographic groups. Its not a small problem, but I would guess that this article tends to exagerate how widespread the problem is.

My third thought was (ok, it was my first thought): What about all the other people that will be hurt by the falling values of properties that purchased with these products if they are foreclosed in rising numbers? The article seems to suggest there are many who are vulnerable, especially as mortgage rates reset, that this lending pattern will hurt many others indirectly.

And if all this isn’t bad enough, Steve Irwin passed away unexpectedly [CNN]. Crikey!

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