While I am not arguing about the fact that the subprime mortgage situation is played havoc on many Americans personal financial situation and the net effect has not been good, I have been questioning the overall way the situation has been portrayed. I did this last year and again here.

Kenneth Harney’s The Nation’s Housing addresses this topic quite well in: Finding Bright Spots Among the Dark Clouds were he provides greater insight than the press releases dished out by the Mortgage Bankers Association and RealtyTrac whenever foreclosure numbers are released.

Harvey has a bunch of foreclosure stats, good and bad, crammed in the article. For sake of argument, I cherry-picked the positive stats.

  • 97.4 percent of mortgage payments are paid on time.
  • 2% of prime-credit borrowers with fixed rate loans are paying late.
  • In 34 states, the rate of new foreclosures actually decreased.
  • Without California, Florida, Nevada and Arizona, foreclosure filings would actually be falling.

Its all about the mix right now. There are four states that are skewing the foreclosure mix and these locations were characterized by significant investor speculation during the housing boom. The foreclosure situation will likely erode further before it gets better, especially if we slip into a recession in early ’08


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10 Responses to “The Contrarian Foreclosure Story”

  1. mike says:

    First off, thanks for all your market insights and freely available info – it’s great to see the underpinning data to support or negate what is seen in the press.

    When looking at the credit situation and speculating on what may happen in 08, one question that comes up regarding Manhattan realestate is the international contingent. In your opinion, how much impact do international buyers have on real estate prices in Manhattan? I assume the effect is concentrated at the high end of the market but due to the weak dollar this may be seeping into lower price points?

    At the end of the day, how much do international buyers drive market prices and do you expect their influence to soften the blow next year?

    Thanks again for all your insights.

    btw, liked your article on how the credit crunch will push out the purchase horizon i.e., eradicate “instant gratification”

  2. Thanks Mike! International has always played an important role in Manhattan real estate. Because of the strong economies in Europe, its been more important as of late. I agree, I think that the impact of weaker bonus payouts will be tempered by foreign demand.

  3. John says:

    Hi, Jonathan–

    Terrific blog, I’ve been reading it for quite a while and always find your informed opinions enlightening.

    One thing on the ‘contrarian’ stats: it’s not really about the stats. I think it’s more to do with the social mood and the interconnectedness of the financial markets. The mood has been turning slowly for well over a year now. Not in a straight line, so to speak, but becoming increasingly negative. The stats reported, themselves, more and more are the ones focused on negative developments, not status quo or positive ones. The media is part of the mood, after all.

    Like the credit markets, the stock markets, the bond markets, etc., it’s all a matter of confidence. Once people’s confidence begins to be shaken, it takes larger and larger doses of good news and local anecdotal evidence to reinstate their faith. Needless to say, we haven’t exactly been getting this.

    Then you have the whole issue of tightly interwoven, highly complex financial markets, of which real estate/mortgages is now a part. One market starts to fall, others fall with it, which causes further declines, creating a sort of spiral–the opposite of a virtuous circle.

    Faith, confidence, optimism or the lack thereof are starting to have a greater impact than the numbers, even if those are still relatively well balanced.

    Sorry for rambling, I’m at work and trying to think about four things at once.

    Thanks again for your insights.

  4. L'Emmerdeur says:

    Foreign demand is and will be strong, unless there is a significant drop in the USD versus other currencies. If you look at the level of USD/DEM by converting from EUR/USD at the fixed EUR/DEM rate, you see the USD/DEM is not far from historical lows. Furthermore, if the JPY carry trades continue to unwind, the USD/JPY could be testing historical lows soon enough – this would be a 30% drop from current levels.

    If you are a Japanese investor, and buy today, such an event would mean a 30% loss on a real estate investment, even if it is in a mythical Manhattan that never falls in USD-denominated price.

    And if you think that can’t happen, ask BOT/Mistubishi, who in JPY terms lost over 80% of their investment in Rockefeller Center because USD/JPY fell from 250 to 90 between purchase and sale, along with the last real estate correction that sent the property into bankruptcy.

    And this market looks far, far worse than the late 1980s, in my opinion.

  5. Thanks John – much appreciated! I agree, its all interwoven and the press and psychology are part of the process. An important part, for sure. But isn’t that what markets are? These factors aren’t really some extra new feature. They are a constant. I would suggest its like the red light theory, you only notice them when you are in a hurry.

  6. L’Emmerdeur – but your example only applies to the Japanese? Could you elaborate on the Europeans? They seem to comprise the lion’s share of foreign buyers. The dollar is half the pound and GDP is at a high level in most european countries now.

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  8. John says:

    Jonathan–

    You’re absolutely correct, of course. My point is that when the mood is very positive, you get market surges, and any negative stats are brushed aside by almost everyone in the media (like the past few years, for instance, when ‘no one saw it coming’). When the mood turns negative, the emphasis shifts to negative stats–even when positive stats still exist. They are no long relevant to the social mood, and become underreported. That’s where we pretty much are now. That’s why the positive stats about foreclosures don’t really matter.

    It’s like at the height of the Internet bubble, when guys like Buffet stood around wringing their hands and saying it didn’t make sense according to the hard business facts. They were right. But it didn’t matter until the pop.

  9. John says:

    onathan–

    You’re absolutely correct, of course. My point is that when the mood is very positive, you get market surges, and any negative stats are brushed aside by almost everyone in the media (like the past few years, for instance, when ‘no one saw it coming’). When the mood turns negative, the emphasis shifts to negative stats–even when positive stats still exist. They are no long relevant to the social mood, and become underreported. That’s where we pretty much are now. That’s why the positive stats about foreclosures don’t really matter.

    It’s like at the height of the Internet bubble, when guys like Buffet stood around wringing their hands and saying it didn’t make sense according to the hard business facts. They were right. But it didn’t matter until the pop.

  10. L'Emmerdeur says:

    Jonathan, my example applies to any investor who calculates P&L in a currency other than USD.

    Say the Fed cuts rates aggressively starting today. Normally, what happens is the currency with lower nominal interest rates weakens against the currency with higher nominal interest rates. We would expect the USD to weaken just because of this. Add to that the worsening economic picture in the US. This makes investors want to shift capital to the zone and currency with higher returns – both because interest rates are higher (if you are investing in securities like bonds) and because growth is better (which should lead to higher equity prices).

    So if you think the dollar will weaken, and the US equity markets will fall, you want to shift out of the US and out of the USD. Federal Reserve data I have seen depict just that: foreign purchases of US securities have slowed dramatically this year.

    Say you are holding real estate in Manhattan worth $10 million. In EUR, that is about EUR 7.21 million today. If Manhattan prices remain unchanged, but the Euro goes from 1.387 USD/EUR to, say, 1.5 USD/EUR next year, your EUR-denominated value is now EUR 6.67 million. So you just took a foreign exchange loss EUR 540,000.

    This is one of the greatest reasons treasury departments exist in every major company. They use foreign exchange forwards and options to lock in exchange rates in the future based on expected non-USD revenue. You don’t want the Mexican Peso earnings you are going to receive from selling Fords in Mexico to devalue 20% because the Mexican Peso weakened.

    One more thing about interest rates: the burning question right now is whether Bernanke will sacrifice the US consumer to save the dollar or the dollar to save the US consumer. If he lowers interest rate over the next 6-12 months, the dollar will get crushed, but consumers (also known as voters come September 2008) might not. If he holds steady, the dollar might still fall, but nowhere near as much, and the US economy goes into a nasty recession.

    Of course, nothing is to say that the dollar and the US consumer don’t both get crushed regardless of what he does – which is my expectation.


    A couple of other tidbits: the lion’s share of all the toxic debt that has been in the headlines the last couple of months is held by non-US, mostly Asian and European investors. So they are in even greater need of cashing out their liquid assets to cover margin calls and capital requirements. After all the stocks and bonds come the less liquid assets, like real estate. Don’t be surprised if you start reading stories about major budget problems in the Municipality of Paris or reduced expenditures out of the Vatican. These guys own major holdings in US real estate – and they loved Manhattan, so they are going to have to liquidate the good stuff to cover the budget gaps created by the bad investments (it’s not like they can issue debt for this in the current environment).

    The wondrous thing is that the same vultures who swooped down in the 1970s and 1980s to buy up the (at the time) worthless NY properties are waiting in the wings, cash in hand, to pick the pockets of all these foreign investors like they have done in every other NY real estate cycle. I love New York. I truly do.