Heads up on Housing

I have been following the housing bubble and bust for the past couple of years as a matter of intense personal curiosity. The housing bubble started because there was a massive amount of very cheap liquidity sloshing around the US economy in the aftermath of the Bush tax cuts and the Federal Reserve Bank's decision to yank rates to multi-generational lows AND no productive investments for people to park that money.

And so we saw a boom of new home construction and mortgage equity withdrawals prompted by the combination of low rates and the to be expected combination of proper fiscal innovation, ignorant mistakes and outright fraud as people were looking for a quick buck while convinced that the short term trends would forever continue at a linear upwards rate.

Whoops! The boom turned stagnant, inventories increased, and sales volume decreased significantly as prices flatlined in most MSAs. The initial response has been that the subprime market had some significant problems in approving individuals for mortgages that even under the loose guidelines of the subprime market should never have been close to a bank much less assuming an exotic mortgage obligation. However this story goes that the problems are overwhelmingly confined to the new financing mechanisms that have expanded from being oddities to being common place over the past few years. There is no need to worry about the buyers who have good credit and savings in the prime and near prime Alt-A markets.

Well, Daniel Gross is passing along this NY Times article on problems in the Alt-A market:

"The delinquency rate for Alt-A mortgages remains much lower than the rate for subprime mortgages, but it has been rising. In February, 2.6 percent of Alt-A loans were delinquent by 60 or more days, up from 1.22 percent a year before, according to FirstAmerican LoanPerformance. By comparison, 12.44 percent of subprime loans were delinquent by more than two months, up from 7.84 percent."

The Alt-As are performing absolutely better than the subprime loans. That is to be expected, but there is a nice little caveat here in the year over year information. The sub-prime delinquencies had increased by 158% year over year. The Alt-A delinquency rate over the same time period had increased by 213%, which is 43% higher than the sub-prime problem rate. This could be trouble.

Default rates have been worst for loans written in 2006, as many mortgage companies loosened lending standards...... The companies relaxed the rules in an effort to bolster business at a time when interest rates were rising and the housing boom was fading.

Alt-A loans are also vulnerable to the deterioration .... because they were often used by investors who were buying properties with the intention of quickly reselling them at a profit.

The combination of poor to non-existent underwriting, speculation and the deceleration of housing price appreciation is leading to quite a few decent risks being squeezed, and squeezed hard. Three years ago, the most common solution to a cash crunched borrower was to originate a new mortgage to pay off the old loan, and secure the new obligation to the increased paper equity value of the property. For marginal borrowers this is no longer an option.

As credit standards continue to tighten from absurdly loose to only loose, rolling over bad decisions and loans will not be viable in the future. There are three remaining options. The first and most preferable is for a crunched borrower to find someone to sell their property at a high enough value to get them out of their obligations with minimal damage. The problem here is that housing inventory is still expanding and plenty of people are just as or more desperate to unload their houses as any individual seller. So getting a price that is sufficient, after transaction costs, to pay off a bubble mortgage will be tough. The next preferable solution, and most likely the most common solution, will be for crunched borrowers to suck it up, and try to outlast any housing price downturn while still paying their mortgage and carrying costs. The final solution is for an increase in foreclosures to increase as people walk away from disasters.

The original housing bust story was that the problems were isolated to islands of speculators and to the subprime market where wildcats ran rampant. The story that will be coming out in the next couple of months will be that the problems spilled over into Alt-A and other near prime mortgages, but that the prime market is still strong. I doubt that, as the economy for 90% of America has not generated sufficient wage gains over the past few years to support the debt loads that were needed to pump up the bubble markets at all credit quality levels.