August 22, 2007

JustQuotes: Is This A Blip, A Bump, Or More In The Mortgage Market?

FBR Research said on Wednesday that $150 billion to $250 billion of permanent capital is needed to normalize pricing in the depressed market for mortgage-backed securities.

However, in a note to clients, the research arm of securities firm Friedman, Billings, Ramsey & Co Inc said the process would take up to a year and will be painful for mortgage investors and originators. FBR Research said the new capital is needed to compensate for the massive "deleveraging" underway among companies that hold mortgages.

More than $20 billion worth of mortgage bonds not backed by mortgage finance companies Fannie Mae and Freddie Mac [Editor’s Note: think Jumbo] have been offered for sale in the past few days.

Mortgage investors increasingly question the underlying value of mortgage-backed securities given that orginators' lax lending standards which led to a jump in defaults. Also, many economists expect weak home prices to drop further."

Mortgage mkt needs up to $250 bln of capital [Reuters]

First Published: August 22, 2007 1:20 PM

Comments from "Plugged In" Readers

Here is a good article on what is happening with the top mortgage lenders. It's from Bloomberg so its very reputable.

The one quote that was really scary--I don't even think it will be this bad is as follows.

"The tone in the mortgage market is ``exceptionally cautious,'' Lonski said. ``You're looking at what will be in all likelihood the worst case of home price deflation since the 1930s.''"

http://www.bloomberg.com/apps/news?pid=20601087&sid=aEwM_qB6qOBI&refer=home

Posted by: [cooper] at August 22, 2007 1:27 PM

I have said it before and I will say it again, this current crisis is just the water getting sucked out of the bay ahead of the reset tsunami that will hit in Oct and won't begin to recede until Sept '08.

Posted by: badlydrawnbear at August 22, 2007 1:34 PM

Will former mortgage brokers make good health care workers or teachers? Hmm . . . just trying to think of what types of jobs they should be looking for since layoffs are apparent (and literal) in the industry.

My gut says that rates are going to go way up - and so are rents.

Posted by: Jamie at August 22, 2007 2:08 PM

who's gonna put money in mortgages now.

From Bloomberg:
"Mortgages Lead Biggest Rise in Late Loans Since 1990"

"Aug. 22 (Bloomberg) -- U.S. banks and thrifts suffered the biggest increase in late loan payments in 17 years as more homeowners fell behind on mortgages, the Federal Deposit Insurance Corp. said."

http://www.bloomberg.com/apps/news?pid=20601087&sid=as2Ho_PwtqjM&refer=home

Posted by: ex SF-er at August 22, 2007 2:20 PM

quick question...what's the difference between high prices/low rates and deflated prices/high rates to the homebuyer?

aren't they about the same at the end of the day, and therefore, won't the SFreal estate market continue to be difficult to enter for all the people waiting for prices to go down?


Posted by: anon at August 22, 2007 2:24 PM

"My gut says that rates are going to go way up - and so are rents."

Perhaps.
But there is a big difference between buying and renting.

When you buy, you can BORROW against your future earnings. With loose lending, mortgages were able to decouple from income over the last few years. (i.e. teaser rates, no doc loans, etc)

However, you cannot borrow money for rent. It must come out of your salary. The check must truly be in the mail, so to speak

So I agree that more people will try to rent, pushing up demand for rental units which will tend to raise rental prices. But rents can only go up to what is affordable based on a renter's salary, no further.

Posted by: ex SF-er at August 22, 2007 2:26 PM

Certain mortage-securities funds going from AAA to junk? I guess it's true those ratings aren't worth the paper they're written on ;)

Posted by: dub dub at August 22, 2007 2:49 PM

"[Treasury Secretary] Paulson said the turmoil in the credit markets would take time to settle, but stressed that the underlying U.S. economy remains in good shape.

"This will play out over time, and liquidity will return to normal when the market has a better understanding, when investors have a better understanding, of the risk return trade-off," Paulson said."

This pretty much sums up why I think the One Rincon debate going on in the other room is completely premature and, quite frankly, ridiculous.

Posted by: RinconHill_Res at August 22, 2007 3:44 PM

what else is the Treasury Secretary going to say???? It's not like he's going to say "Oh my god, the world is on fire!!! run for the hills!!! sell sell sell!!"

Besides, he said only the credit markets would "settle down", not that we'd go back to the days of reckless lending!

Posted by: ex SF-er at August 22, 2007 4:03 PM

He said things would return to NORMAL not the craziness we had for the last 5 years. Was it normal to hand a million dollars to a migrant farmworker? Probably not. Those loans would not have been made in normal (not bubble times). They are not being made now.

The liquidity of a bunch of undocumented loans should have been exactly what it is now, nonexistent. And packages of loans with a few of those loans mixed in should have no liquidity. And in fact, they are being forced out of the market as we speak.

Although all jumbo loans shouldn't be out of favor, jumbo loans with 20%+ down, documented income and sufficient assets should be the only loans with any liquidity. And that's very close to where we are right now, once the locks start expiring next month, that is.

So the discussion in the other thread is not ridiculous. What is happening right now IS normal liquidity. Bunches of BB- rated loans that were rated AAA are not normal and those loans should never have been traded.

Get used to normal. The industry is laying off by the thousands, and it's not because they are going to be approving anywhere NEAR the number of loans they had been.

Posted by: tipster at August 22, 2007 4:12 PM

After the market closed today, it was announced that Bank of America just bought $2 billion worth of Countrywide securities, and it believed the market had underestimated the value of Countrywide. This vote of confidence will most definitely contribute to the psychological comfort of investors and speed up the recovery in the credit market.

Posted by: Steve at August 22, 2007 4:29 PM

As a buyer looking to get into the market, what does all of this mean for me? Should I hold off for a few months? A year? I've been trying to take all of it in, but its a bit overwhelming for a newbie.

Posted by: kelly at August 22, 2007 4:52 PM

"Besides, he said only the credit markets would "settle down", not that we'd go back to the days of reckless lending!"

Exactly, at that's a good thing.

Posted by: RinconHill_Res at August 22, 2007 5:10 PM

[Kelly] - Humble suggestion: we will know alot more in about six months. If there's going to be a huge financial failure or blowup, I believe it will happen by then. The credit markets are already discounting a major institutional failure, I think.

If the world hasn't ended by then, then just buy what you like and can afford with a conventional loan, stop thinking about your house as an investment, paint the walls whatever color you want, raise a family (if you want), and have a nice life!

If the world has ended by then, then do the same thing...

And of course, don't forget socketsite's housewarming invites! :)

My advice is guaranteed to be worth what you paid for it, of course. But if you keep waiting to get on with your life, you might end up a bitter [Removed by Editor], and nobody wants that!

Posted by: dub dub at August 22, 2007 5:11 PM

Steve:

I've been trying to make sense of the BofA situation since it happened. I would guess it is BAD and not good.

1. BofA bought $2Billion of NEWLY issued PREFERRED stock with a dividend of 7.25% I believe. why would countrywide sell this if they were financially sound??? I mean, 7.25% is ABOVE the Fed Funds rate AND the Feds Discount Rate and even LIBOR.

Preferred stock puts BofA near the front of the line (not the front, but close) IF Countrywide is ever liquidated. also, it's at a 7.5% dividend... not bad... so it makes some sense for BofA, especially if they were able to swap out other positions with CFC that were more hairy to do this deal...

2. Stock investors will soon realize that their share of the company was just diluted by $2 billion (not to mention the dividend payments that will come). Countrywide's Market cap is only 12.6 Billion!!! So their share in the company was diluted by 15% today!!!!

Besides, the stock is convertible at $18... that's significantly BELOW where countrywide was trading today. Why would a stock investor who understands stock pay $21.82/share for a stock that has $2Billion in convertible Preferred stock at $18/share?

3. why does Countrywide need this money anyway? they just got $11.5 Billion last week?

IMO, the stock was bid up by people who don't understand the markets which likely caused a short squeeze.

A sound company doesn't issue Preferred Stock at 7.25% dividend when the Fed Funds Rate, LIBOR, and even the Discount window are below this. (as low as 5.25%).

This deal was clearly a company in dire straits (countrywide) selling itself through an issue of Preferred Stock to buy a little more time to try to work itself out.

Posted by: ex SF-er at August 22, 2007 5:13 PM

Kelly - here’s my two cents. I’m pretty neutral on the market right now, and I personally don’t believe that we’ll have the huge corrections like many on this blog are predicting. With that said, I would suggest waiting a few months to see how the dust clears from the current credit fiasco. As interest rates stabilize and a little more confidence returns to the market, then you should think about purchasing a place. While prices could very well rise in San Francisco over the next couple of months, it’s very unlikely. I’d say that the chance of downside to the market outweighs any potential benefit of jumping in right now. Also, there isn’t much inventory on the market right now, so you’ll have better choices later. Finally, when you do decide the time is right – think longer term (i.e. – don’t do it if you’re going to try to sell in couple of years). I hope this helps.

Posted by: Lance at August 22, 2007 5:20 PM

ex SF-er:
You have made a very compelling argument, but if you look at the other side of the equation, the opposite is equally true. If B of A is making such a large bet despite all the negatives that you pointed out, it must have concluded that the potential benefits will outweigh the potential risks. I think when the investors' nerves are calmed down, liquidity will return to Countrywide, which in turn, will allow it to continue to make loans, using the same model it has been using. With the B of A deal, I think it will be a much speedier recovery.

Posted by: steve at August 22, 2007 6:05 PM

steve:
the BofA/Countrywide deal is a head-scratcher, it certainly has me befuddled.

You may be correct, and BofA sees Countrywide as "saveable" if they can just get through this crunch (which could very well be true). If that is the case, then when Countrywide emerges there will be less competition (everybody else is falling by the wayside) and BofA will make a killing on those Preferreds convertible at $18.

there is a large chance that Countrywide will survive, though not likely by regular market forces.
---

another theory bopping around (rather tinfoil hat-like though): 4 big lenders all borrowed $500 Million from the Fed Discount window at 5.75% today.

Suddenly, BofA buys $2Billion of Countrywide (at 7.25%).

If countrywide had borrowed from the Discount window itself, everybody would have known they were dead.

However, if 4 banks borrow from the Discount, then lend that money to BofA, who uses it to buy Countrywide preferred stock, now the link is less clear, and Countrywide gets the $$$ it needs from the Federal Reserve without raising eyebrows.

this is not dissimilar from some of the orchestration done with LTCM.

regardless, it is interesting. I wouldn't read too much into this deal yet, good or bad... simply not enough information.

Posted by: ex SF-er at August 22, 2007 6:55 PM

The Fed specifically encouraged the big banks to borrow from the discount window as a sign of confidence in the U.S. marketplace last week. Historically, when banks went to the window it was viewed as a negative and considered a last resort option but the Fed wants to change this viewpoint. Most of the large banks can borrow short term cheaper than the 5.75% window level but chose to draw down from the Fed. The window is typically used for overnight transactions (although the Fed just allowed extended terms to 30 days which can be renewed at the end of the term) and the banks can pledge different collateral including treasuries, agencies, and most importantly MBS [Editor's Note: Mortgage-Backed Securities]. Countrywide has the ability to borrow from the window and I suspect they will or already have considering the fact they are unable to entice investors into their commercial paper. Banks can also go to the window on behalf of their clients (i.e., investment managers, hedge funds, etc.) acting as an intermediary. Countrywide drew down on their bank lines of credit for the $11.5 billion last week which is short term by nature and eventually they will need to pay down the lines with either terming out their debt or until they have the ability to issue short term debt/commercial paper again. The initial market reaction to this transaction has clearly been positive as Countrywide stock is up over $4 is aftermarket trading.

"A sound company doesn't issue Preferred Stock at 7.25% dividend when the Fed Funds Rate, LIBOR, and even the Discount window are below this. (as low as 5.25%)."

Puulleeze, since when are corporations ever able to issue Preferred stock at Fed Funds, LIBOR or Discount window levels? U.S. Banks/Corps (rated A or better) have recently been issuing Preferred stock in the 6.375%-6.75% area in the last couple of months so 7.25% is definitely not out of line. Because the preferred was issued "in the money" with regards to the convert provision, it probably helped to achieve this 7.25% level otherwise it would of likely been much higher. Their outstanding debt in the secondary market is yielding anywhere from 8%-15% with no bids. This is a smart move to shore up some confidence.

Posted by: anon at August 22, 2007 8:43 PM

The theory mentioned by ex SF-er is interesting and I am all intrigued by this deal now. However, the Fed lowered the rate on 8/17 and the $2 billion is already funded today (8/22). I am not so sure that a multi-party $2 billion deal can happen so fast. In any event, I am keeping an eye on how the market reacts to this in the next few days.

Posted by: steve at August 22, 2007 10:23 PM

I think ex-SF-er is spot on. More than 4 banks have been encouraged to tap the discount window to remove the stigma attached in doing so. Watch today's 1:30pm (Pacific) announcment on discount window borrowing this week. They don't announce names, but they break it down by the 12 Fed districts which will encourage some degree of speculation I'm sure about who is doing what. A typical week might be $200mm, but we already know today's announcement will be in the billions.

Posted by: beguine at August 23, 2007 6:36 AM

When Socketsite flipped in 2006 from being somewhat oppositional to the Housing Bubble, and then became the housing fetish site that it is today--that was THE Top. Now it's just a matter of time before we see "Dolly Back, Slow Fade to Black." Mean reversion will be ferocious.

It will be interesting to see what perspective SocketSite will be serving 18 months from now. There is no question it will be radically different, from today. However, I am sure it will be beautifully done, as this site remains quite artful.

--The Kid.

Posted by: SurveyKid at August 23, 2007 10:52 AM

"I’d say that the chance of downside to the market outweighs any potential benefit of jumping in right now. Also, there isn’t much inventory on the market right now, so you’ll have better choices later."

I've been looking for a SFH for 2-1/2 years in a neighborhood where the median price for a SFH has increased 100K over the last year. Is it possible that right now (pre-labor day, pre-settling) could prove a unique opportunity for qualified buyers who've been up against a dozen other people every time they bid? Why not bid 10+% less on a property and be the bird-in-the-hand when no one else is in the game? Would the opportunity to get a property at 10-15% below asking put you in a good position to weather the next few years? Granted most sellers will hold out, but...

Posted by: maieutic at August 30, 2007 5:46 PM

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