Housing - The numbers only
Why are folks panicking about the housing market?
It has 2 parts, really:
1. Financial market turmoil not seen since the last financial S&L turmoil
2. Millions of people kicked out of their homes
Obviously, both add up to major economic consequences.
But how much of this is realistic and how much is just for the media circus?
To understand that, we need to understand what kinds of loans are collapsing and how much they represent.
WHAT IS THE DIFFERENCE BETWEEN ALT-A AND SUBPRIME
Answer: not much
Subprime – debt ridden, have no liquidity, and have a history of defaulting. Subprime have either a proven history of defaulting or will topple over if the winds change even slightly.
Alt-A – No documented income, stated income, or not owner occupied. The abuse of the stated income is quite rampant and often target speculators (second homes)
IT'S ALL ABOUT TIMING
Fannie Mae estimates ~ $3T in ARMs were written over the past 5 years (out of $10T since 2000). In fact, ARMs were 30% of all mortgages from 2004~2006 - higher in some markets like California. That's important because folks opt for ARMs typically because they can't afford the house at normal rates. Of the $3T in ARMs, almost all re-set in 2007 and 2008.
The average loan amount is $260K, but we’ll use $300K because of the California skewing. That’s 10M homes facing higher rates.
ZEROING IN ON THE ALT-A/SUBPRIME EXPOSURE
According to most estimates, the suprime and Alt-A share of the resets:
Subprime = 47% of resets or $1.4T (4.7M homes)
Alt A = 25% of resets or $800B (2.5M homes)
The Subprime default rate has risen to 15% and is still rising (Countrywide had 20% in August). That means at least $210B in loans will default.
The Alt-A default rate is now 5% (6% at Countrywide). That’s $40B in loans that will default.
A combined $250B in losses for 2007/2008. How well are lenders covered? Here are loss reserves so far:
Citigroup $11,000,000,000
Merrill Lynch $8,400,000,000
Barclays Capital £1,300,000,000
HSBC $3,400,000,000
Swiss Re $ 1,070,000,000
UBS AG $3,600,000,000
Deutsche Bank €2,200,000,000
Bear Stearns $1,200,000,000
Morgan Stanley $3,700,000,000
Lehman Brothers $700,000,000
Freddie Mac $3,600,000,000
Against $250B of likely losses in just 24 months, not even $45B has been put into loss reserves. Even if the homes can be re-sold for 50% of loan value, that’s $80B more that must be put into reserves ($250B * 50% - $45B).
A fraction of that exposure is also held by pension funds and insurance companies, but these companies are a major source of lending, so they might as well be considered lenders.
So it's two issues here: more creditor losses and a general shrinking of funds available to lend. Nobody can shrug off $250B in losses. And given that these funds are leveraged in the marketplace, the financial investing impact is at least $1 Trillion.
FORGET BANKS, HOW WILL PEOPLE BE AFFECTED
Go back to the home units that will enter default. The estimates are that 7.2M properties re-setting as Alt-A and subprime. If the default rates stay flat, almost 850K homes will be foreclosed on and re-enter the inventory stock. (For the 2 years 2007/2008)
How realistic is that? It’s actually on the low side: ~800K properties were already foreclosed on in the first 9 months of the year. There were ~450K foreclosures in the 3rd quarter alone. http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=3567&accnt=64847
With ARM resets peaking in December, we might as well call it 1.5M homes for 2007. That’s ~3M homes for the period 2007/2008.
Of the 7.2M homes under re-set in 2007/2008, default rates seem to be ~40%. I think it’s higher, here’s why:
1. Pushing down that rate is the fact that not all foreclosed homes are these resetting loans.
2. Pushing it up is the fact that banks are being slow to pull the trigger on defaults. I would guesstimate that the true default rate is easily 60%.
3. Housing prices continue to drop, pushing out the likelihood of short sales and sales that would avoid defaulting
Also, notice how there are more filings (635K) to properties (446K). That’s indicative of the fact that most borrowers used multiple loans. In and of itself, that is proof that these folks could not afford the mortgage without tricking the system.
At 40% default rates, we will see a total 2.9M homes defaulting or $1.2T.
At 60% default rates, we will see 4.5M homes defaulting. That’s $1.8T in losses.
That’s millions of people tossed out of their homes.
Should you feel sorry for them? No way. First of all, under traditional borrowing standards, they'd be exactly where they are heading: renting apartments. Many others were gambling and lost. Others were simply living beyond their means. Or they took equity out of their house and blew it on cars and vacations.
Add it all up and you have millions thrown out of their homes and effectively removed from the consumer spending marketplace. You also have fortunes erased as individual speculators lose their investments. These are the fundamentals of a recession.
Adding to the pain of falling spending is the tightening of lending.
No amount of free ride on defaulting loans will restore the fortunes of investors and homeowners who can't even pay their property taxes. These folks will not suddenly feel comfortable enough to go out and buy new cars. They will be pinching pennies.
The scale of this is massive.
On the othe rhand, if you can weather the situation, this is a blessing coming your way. Anyone with cash and good credit will have an unparralleled opportunity to buy assets cheap.
It has 2 parts, really:
1. Financial market turmoil not seen since the last financial S&L turmoil
2. Millions of people kicked out of their homes
Obviously, both add up to major economic consequences.
But how much of this is realistic and how much is just for the media circus?
To understand that, we need to understand what kinds of loans are collapsing and how much they represent.
WHAT IS THE DIFFERENCE BETWEEN ALT-A AND SUBPRIME
Answer: not much
Subprime – debt ridden, have no liquidity, and have a history of defaulting. Subprime have either a proven history of defaulting or will topple over if the winds change even slightly.
Alt-A – No documented income, stated income, or not owner occupied. The abuse of the stated income is quite rampant and often target speculators (second homes)
IT'S ALL ABOUT TIMING
Fannie Mae estimates ~ $3T in ARMs were written over the past 5 years (out of $10T since 2000). In fact, ARMs were 30% of all mortgages from 2004~2006 - higher in some markets like California. That's important because folks opt for ARMs typically because they can't afford the house at normal rates. Of the $3T in ARMs, almost all re-set in 2007 and 2008.
The average loan amount is $260K, but we’ll use $300K because of the California skewing. That’s 10M homes facing higher rates.
ZEROING IN ON THE ALT-A/SUBPRIME EXPOSURE
According to most estimates, the suprime and Alt-A share of the resets:
Subprime = 47% of resets or $1.4T (4.7M homes)
Alt A = 25% of resets or $800B (2.5M homes)
The Subprime default rate has risen to 15% and is still rising (Countrywide had 20% in August). That means at least $210B in loans will default.
The Alt-A default rate is now 5% (6% at Countrywide). That’s $40B in loans that will default.
A combined $250B in losses for 2007/2008. How well are lenders covered? Here are loss reserves so far:
Citigroup $11,000,000,000
Merrill Lynch $8,400,000,000
Barclays Capital £1,300,000,000
HSBC $3,400,000,000
Swiss Re $ 1,070,000,000
UBS AG $3,600,000,000
Deutsche Bank €2,200,000,000
Bear Stearns $1,200,000,000
Morgan Stanley $3,700,000,000
Lehman Brothers $700,000,000
Freddie Mac $3,600,000,000
Against $250B of likely losses in just 24 months, not even $45B has been put into loss reserves. Even if the homes can be re-sold for 50% of loan value, that’s $80B more that must be put into reserves ($250B * 50% - $45B).
A fraction of that exposure is also held by pension funds and insurance companies, but these companies are a major source of lending, so they might as well be considered lenders.
So it's two issues here: more creditor losses and a general shrinking of funds available to lend. Nobody can shrug off $250B in losses. And given that these funds are leveraged in the marketplace, the financial investing impact is at least $1 Trillion.
FORGET BANKS, HOW WILL PEOPLE BE AFFECTED
Go back to the home units that will enter default. The estimates are that 7.2M properties re-setting as Alt-A and subprime. If the default rates stay flat, almost 850K homes will be foreclosed on and re-enter the inventory stock. (For the 2 years 2007/2008)
How realistic is that? It’s actually on the low side: ~800K properties were already foreclosed on in the first 9 months of the year. There were ~450K foreclosures in the 3rd quarter alone. http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=3567&accnt=64847
With ARM resets peaking in December, we might as well call it 1.5M homes for 2007. That’s ~3M homes for the period 2007/2008.
Of the 7.2M homes under re-set in 2007/2008, default rates seem to be ~40%. I think it’s higher, here’s why:
1. Pushing down that rate is the fact that not all foreclosed homes are these resetting loans.
2. Pushing it up is the fact that banks are being slow to pull the trigger on defaults. I would guesstimate that the true default rate is easily 60%.
3. Housing prices continue to drop, pushing out the likelihood of short sales and sales that would avoid defaulting
Also, notice how there are more filings (635K) to properties (446K). That’s indicative of the fact that most borrowers used multiple loans. In and of itself, that is proof that these folks could not afford the mortgage without tricking the system.
At 40% default rates, we will see a total 2.9M homes defaulting or $1.2T.
At 60% default rates, we will see 4.5M homes defaulting. That’s $1.8T in losses.
That’s millions of people tossed out of their homes.
Should you feel sorry for them? No way. First of all, under traditional borrowing standards, they'd be exactly where they are heading: renting apartments. Many others were gambling and lost. Others were simply living beyond their means. Or they took equity out of their house and blew it on cars and vacations.
Add it all up and you have millions thrown out of their homes and effectively removed from the consumer spending marketplace. You also have fortunes erased as individual speculators lose their investments. These are the fundamentals of a recession.
Adding to the pain of falling spending is the tightening of lending.
No amount of free ride on defaulting loans will restore the fortunes of investors and homeowners who can't even pay their property taxes. These folks will not suddenly feel comfortable enough to go out and buy new cars. They will be pinching pennies.
The scale of this is massive.
On the othe rhand, if you can weather the situation, this is a blessing coming your way. Anyone with cash and good credit will have an unparralleled opportunity to buy assets cheap.
posted by Andrew at
8:42 PM
5 Comments:
Perfect analysis.
I'd wager that most people have no clue how big a deal this housing mess is. Personally, I have basically no sympathy for people on Wall Street who are going to lose big in the next few months. We like risk has been a mantra on the Street for years. Guess where too much risk leads?
Excellent overview of the Housing Situation - By the numbers.
A must read! Good summary.
Andrew , I always wanted to ask you about the right time in a day to sell or buy shares. I know lot of folks avoid the first hour. At 12 to 12.30 markets get interesting when the Wall Street is hungry. The last hour summarizes the day but also you see the big boys play. Appreciate if you could share your view point and any information in terms of links, books that give some insight.
Than you.
There is a lot of denial about the state of affairs. My experience is that these situations are like a dam: the longer it takes folks to acknowledge the reality, the harder the collapse.
That suggests next summer will be very, very upsetting.
Regarding the right time of day to buy or sell, you nailed it when you said that the big boys play games.
Most funds use a program that staggers their trades. No need to tip the hat with a 100K share order.
Often, after hours trading will show a major trade, but that's usually a deal that was cut between the big boys. Goldman selling in-house shares at an agreed upon price, for example.
I don't think that I have seen real quality analysis of this point. Maybe others will chime in.
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