August 16, 2007
Quicklinks: Countrywide “Materially Tightens" Underwriting Standards
"As we have previously discussed, secondary market demand for non-agency mortgage-backed securities has been disrupted in recent weeks," said [Countrywide] President and Chief Operating Officer. "Along with reduced liquidity in the secondary market, funding liquidity for the mortgage industry has also become constrained.”
"Furthermore, as a result of lessened liquidity for loans which are not eligible for delivery to the GSEs [Fannie Mae and Freddie Mac], Countrywide has materially tightened its underwriting standards for such loans, and, we now expect that 90 percent of the loans we originate will be GSE-eligible or will meet our Bank's investment criteria.” (Countrywide Supplements Funding Liquidity Position)
First Published: August 16, 2007 6:07 AM
Comments from "Plugged In" Readers
Kiss home prices goodbye in Cali. Jumbo market is now gone as of this morning.
Posted by: [anon] at August 16, 2007 6:17 AM
don't forget that part of the announcement is that CFC is tapping ALL of its unsecured 11.5 Billion in credit because the can no longer get credit through the markets.
If the credit crunch lasts longer the CFC's 11.5 Billion say goodbye to this countries biggest lender.
Posted by: badlydrawnbear at August 16, 2007 6:41 AM
and while 11.5 Billion might seem a lot, for CFC it's not.
To put the company’s current predicament into perspective a bit, for the month of July Countrywide reported that it had an average daily loan activity of $2.7 billion, so they have effectively bought themselves 4.25 days of operations at that level.
Posted by: badlydrawnbear at August 16, 2007 6:51 AM
Well let's not forget Countrywide was downgraded by ML from buy to sell (and risk of bankruptcy). Got to love wall street analysts - one day buy, next day sell and potentially bankrupt. Gee, thanks for the heads up!
Posted by: AC at August 16, 2007 6:53 AM
Countrywide was the last player who was betting against the downturn, expanding market share aggressively while the rest of the industry pulled back.
They basically figured that, like Goldman's $3B last week, that they were the largest lender and so they were big enough to single handedly prop up the market. If they could do so long enough, they figured investor demand would return before real estate prices collapse and they could head off the bubble burst.
Apparently, they have 4 days left before they too collapse from this colossal blunder, and the investors are flying out of there as fast as they can.
Posted by: Tipster at August 16, 2007 7:14 AM
What a bunch of chicken littles. Yes the primary and secondary mortgage markets are over reacting... and you all think that means the end of credit as we know it? How rediculous. It will take a few weeks, maybe a month or two, and these industries will begin lending again - it's what they DO. sheesh
Posted by: Eddy at August 16, 2007 8:01 AM
"t will take a few weeks, maybe a month or two, and these industries will begin lending again - it's what they DO"
That's what they do: lending to borrowers who can't pay back. A great business model indeed. Yeah, I agree, in a month or two they'll be doing this again.
Posted by: anon at August 16, 2007 8:37 AM
Countrywide is fine.
Posted by: anon at August 16, 2007 8:41 AM
Eddy, I actually agree with you that things will straighten out (although I think it will take longer than a month or two). And jumbo rates may even come back down a bit. But what will definitely not happen is a return to the days of "no money down" which will knock out a huge segment of potential buyers in SF. Whereas anyone could get a million dollar loan six month ago, now you will only be able to get that if you have $200,000 cash to put down. That is a much, much smaller pool of buyers. Knock out perhaps 70% of the potential buyers (that's the figure I've seen for funny loans to SF buyers) and the effect on prices is pretty obvious.
Posted by: Trip at August 16, 2007 8:55 AM
And in a surprise to no one ...
SEC filings show the company's chairman has made a $13 million profit in the past month selling a stock on the decline.
Posted by: badlydrawnbear at August 16, 2007 9:17 AM
The understood risk has changed. While qualified borrowers ability to repay mortgages remains the same as it ever was, there is a now a perceived risk that the mortgaged properties values could collapse, leaving the buyer in a position where they have to choose between jinglemail or continuing to throw money at a property that will be underwater for years.
So, the lenders don't want to hold mortgages--but no one except GSEs are buying them, and they'll only buy non-jumbo mortgages. Loans that can be resold still get funded. The jumbos can't be resold. Lenders are still lending today on good terms, for non-jumbo mortages.
Posted by: Delancey at August 16, 2007 9:23 AM
Given the discussion I find the side ads for Countrywide etc. somewhat ironic.
Posted by: anony at August 16, 2007 9:26 AM
"The understood risk has changed"
exactly. And as "understanding" changes, so does liquidity and availability of credit. My point is simply that we are in a period of fear and over-reaction which will pass.
Yes, underwriting standards have tightened and will remain more stringent than in the recent years of wreckless lending practices (and that's a good thing), but to say that the "Jumbo market is now gone as of this morning" is exactly the kind of over-reaction that will make this period of correction more painful than it should be.
I'm just sick and tired of our doomsayer culture!
Posted by: Eddy at August 16, 2007 9:49 AM
While the days of free money are over, I suspect that after the overreaction settles into the dust we'll be left with 10% down as the new base for a mortgage. Even with the current panic, interest rates are historically low. If I were buying right now, I'd get prequalified with 20% down, and offer a 20% haircut on the asking price and see if anyone bites. Failing that, I'd sit back and just wait...
I don't believe it's the end of the world here, but I do believe it's the end of the party and time for the hangover. And I can think of no better time to be a contrarian than when the victim has a pounding headache and is worrying about paying next month's mortgage bill.
Down the road, I expect 3-5% annual inflation to erase the looming 10% drop in prices in a year or two. The Federal Reserve has already signalled it will happily pump money into the system to keep the music playing. And until we achieve price parity with European cities, even SF is relatively cheap.
Posted by: VultureBoy at August 16, 2007 9:55 AM
> And until we achieve price parity with European cities, even SF is relatively cheap.
Are you saying SF should be comparably priced to European cities? If so, why?
Posted by: supahfly_remix at August 16, 2007 10:13 AM
"but to say that the "Jumbo market is now gone as of this morning" is exactly the kind of over-reaction that will make this period of correction more painful than it should be."
I agree with you. there will ALWAYS be a jumbo loan market, and ALWAYS be option ARMs and other exotics.
the only thing that will change going forward is the pricing of these vehicles. The risk premium will raise significantly, which will likely make the "exotic" products much less attractive for the average buyer. The fed lowering rates won't help, as the non conforming loans have already decoupled from the Fed Funds Rate.
the problem for the SF market is that it has relied on "risky" mortgages for "cheap". that will change now. so although it's not the end of the world, it could be a huge issue as it can add hundreds or even thousands of dollars a month to the average SF mortgage payment. (so the average SF buyer would have less ability to pay high prices)
It will be a LONG time before we'll see Jumbos below 7% again, or many of the subprimes at the previous rates. (remember, 7% is historically a LOW interest rate for a home!!!)
the investors are burned, and burned badly, and AFRAID to purchase anything mortgage related, and anything "opaque" (which includes much of the mortgage backed securities).
Due to how infrequently these things trade, it will be quite some time before a true price is known, and the market can re-function. (I'd guess at least a few months)
Govt could intervene... but it will be politically unpalatable to help "rich San Franciscans" buy million dollar condos...
Raising fannie/freddie conforming loan limits could help... but they're NOT going to raise it anywhere near the average SF loan amount.
Posted by: ex SF-er at August 16, 2007 10:17 AM
"> And until we achieve price parity with European cities, even SF is relatively cheap."
Are you sure about this?
SF is more expensive than Paris as example.
the only European Cities that are more expensive than SF that I know about are:
Posted by: ex SF-er at August 16, 2007 10:19 AM
Go here, click on "Sq m. prices" in the left bar.
It lists the MOST EXPENSIVE AREAS of each major country. (so as example, the central area of paris, by the Louvre and Notre Dame and St Germain Des Pres).
France (central paris) is the 4th most expensive area on the list: (behind Monaco, UK, and Russia)
10,014 Euros per square meter
Equals: $13,409 per square meter
(10.7 square feet per square meter)
Equals: $1253 per square feet in the MOST LUXURIOUS neighborhood in Paris.
Can you buy in the most luxurious area of SF for under $1253/sq ft?
SF is already more expensive than most areas of Europe.
Posted by: ex SF-er at August 16, 2007 10:35 AM
"I'm just sick and tired of our doomsayer culture!"
I'm just sick of the Rebecca of Sunnybrook Farm attitude of mortgage brokers, real estate agents, title insurance execs, CDO sales reps, appraisers (including those at S&P, Moodys & Fitch) and the rest of the bunch who have profited from this real estate asset bubble while millions of middle class families are about to lose their homes. One need not be doomsayer just because they grasp the potential risks associated with bad investment decisions, poor oversight by regulators and the downside of assets bubbles. A bit more appreciation for potential doom and gloom down the road would have served all of those families a whole lot better than the advice they received from those who profited so handsomely from this bubble.
Posted by: Christopher Carrington at August 16, 2007 10:49 AM
Countrywide is still doing business, but with loan approval rules that have them doing a 90/10 mix of conforming and jumbo. At least that's what their press release says. I assume the 10% jumbos are those with fat ratios and APRs 200 basis points above conforming--keepers, in other words.
Posted by: Delancy at August 16, 2007 10:53 AM
Can you buy in the most luxurious area of SF for under $1253/sq ft?
Yes, easily. Examples are easy to come by to support this as well. Check the MLS. While not all properties in a luxurious area are truly luxurious themselves, they are in a luxurious area none the less.
Posted by: Craig at August 16, 2007 11:10 AM
"Can you buy in the most luxurious area of SF for under $1253/sq ft?
SF is already more expensive than most areas of Europe."
I think that depends on how one defines the most "luxurious areas" of SF. For example, grabbing current data from mlslistings.com, Pacific Heights has several listings at ~$700/sq ft, some random picks from SOMA are $750/sq ft (239 Brannan #8C) and $650/sq ft (175 Bluxome St #111).
I didn't cherry pick these, but even many of the listings on this site are well below $1253/sq ft i.e. 69 Waller Street at $482.52 and even the 235 Berry Street units are all under $1000/sq ft so from my naive perspective, it would seem you're describing all of SF in terms of some cherry picked ambitious flippers who will flop.
Do clarify why you think everything desirable in SF is over $1253/sq ft.
Posted by: VultureBoy at August 16, 2007 11:12 AM
Christopher, your posting is what aggravates me so much about this blog. Get on the doomsday train! Don't you think homeowners have profited too, over the past few years? The mentality of this country is to blame someone else for everything -- you blame mortgage brokers, lenders, and realtors for what is going on in the market now -- as if they coerced the general public into buying homes? I think not. People jumped on the bandwagon willingly. It was a gamble, being that the market was due for a downturn, after the frenzy it was in for so many years. Those who gambled the most at the wrong time will also suffer. We have bought and sold several properties over the past several years, and made money on all of them. Nobody talked us into it. Our agents certainly did not twist our arm. Our mortgage broker even warned us about the forecasts for California well over a year ago. We were smart, did our research, and had the money to begin with. Plain and simple. Our culture always wants to blame someone else when something goes wrong -- never take any of the blame yourself for the mess you have gotten yourself into. Most millionaires have made their fortunes in real estate. Most also know it's a gamble when the market turns, and something you should be prepared to hold onto over time.
Sure, there are shady characters engaged in the business of real estate -- just like every other profession. Many of them will get out of the business or be forced out of the business with the downturn. With good riddance. But your mentality of blaming everyone in the business for what is happening with those borrowers and homeowners who could never have afforded to buy a home to begin with, but chose to roll the dice anyway, is simply ridiculous. Don't be so bitter just because the gravy train is drying up for a lot of people.
Posted by: movingback at August 16, 2007 11:13 AM
Ex-SFr, top NYC properties can reach $5k a foot and London even more. Don't forget that at the peak of the Japan housing bubble, prices hit $20k a foot! There is tons of room for upward movement in the long term.
In my building anyway (sobe) a lot of people have multiple homes and can buy a place in cash. At that end of the market, I doubt the current turmoil will have significant affect - they can afford to hold properties indefinitely and don't need to bargain shop if they see a place they like. Of course for the segment of the market for $800k condominiums and first time buyers, there can be a huge impact.
Posted by: anon at August 16, 2007 11:22 AM
Vultureboy, I am not bitter. I am happy as a clam living the good life in paradise, but I am not so foolish as to imagine that the responsibility lies solely with the middle-class mortgage holders (a disproportionate number of whom are black, latino, and single woman). Upwards of 40% of them do not understand the math, much less nor the legal provisions of the mortgage products they hold. They were lured into bad investment decisions by under-regulated mortgage brokers, Pollyannaish real estate agents, browbeaten appraisers (from local ones to the global debt-rating agencies), greedy hedge fund investors, self-interested and manipulative media mavens (poor Cramer) and policy makers do the bidding of the super rich. There is good reason why the European Union will begin an investigation (announced today) of the ratings agencies (Moodys is the first target) for this financial nightmare. And yes, I understand that markets go through natural ebbs and flows and that dislocation is part of a healthy capitalist economy, but I also understand that such financial upheaval can result from too much optimism, from unrealistic expectations, from fantastical thinking and from good old-fashioned, unregulated greed. So, no I am not bitter, but come next year and the economic fallout from all of this asset folly starts to really impact our lives, people will be looking for scapegoats and for new restraints; I intend to do what I can to direct their rage at the vultures, vulture boy.
Posted by: Christopher Carrington at August 16, 2007 11:55 AM
Movingback 11:13 ... developing an understanding of the factors (and actors) involved in creating the current asset bubble is not the same as blaming.
I believe Christopher was expressing frustration with the fact that many people (including your mortgage broker) tried to sound the alarm about the downside to the market and were ignored if not ridiculed.
also, being able to articulate an understand of how the bubble was created is not being 'bitter' it is being, exactly what you yourself claim to be, informed.
It is unfortunate that the RE industry did not regulate itself and require some kind of realistic standard before lending hundreds of thousands of dollars to individuals who had no realistic hope of ever paying it back, but they did.
It is unfortunate that borrowers did not do more to understand the documents they were signing and simply trusted the bank not to loan them more then they could reasonably pay back, but they did.
Understanding these facts is not doom and gloom , is not blaming, is not being bitter. It is taking an honest look at how we came to be where we are.
Posted by: badlydrawnbear at August 16, 2007 12:07 PM
Movingback makes a very valid point about the market and who is to blame. While Christopher is right that the media contributed to this enormous hype that has driven people into the market by any means necessary, they did it voluntarily. Greed and fear govern the real estate market the same way they govern the stock market. When prices are skyrocketing, people will do almost anything to make a quick fortune. For many, that meant signing up for mortgages they couldn't afford because they figured they would have equity later and be able to refi. They gambled, knowingly, that the market would go up. Were they encouraged by real estate professionals, no doubt, but ultimately, they made the decision.
As far as Countrywide is concerned, it is important to remember that while they did grant a large number of sub prime loans, they also have a vast number of 30 year fixed loans that are paid on time, by people who got a loan they could afford, for porperty in far more stable markets than California. They will pull through.
Posted by: Real Estate Spectator at August 16, 2007 12:25 PM
"People will do almost anything to make a quick fortune."
Amen. There are very few victims here, IMO. The same people screaming for help now would have been laughing at us naysayers had the charade gone on longer, and they were able to flip for thousands in profit. The market will distribute the blame proportionally:
Evil realtors are doing less deals, commissions dry up, and they get second jobs selling appliances. Maybe their Lexus SUV gets repo'ed.
Evil mortgage brokers are getting laid off by the thousands as we speak. Good luck transferring that skill set somewhere. Maybe selling used cars?
Evil lenders are writing off billions in loans, and are teetering on insolvency. Their future deal flow will be lower in volume and margin.
Evil Wall Streeters will get shafted on the next bonus round, many will get laid off as well.
Let the free market run its course unfettered, and justice will likely prevail.
Posted by: Dude at August 16, 2007 1:14 PM
Home purchases are an emotional purchase for the buyer, a rational business deal for the lender. Until the last 5 years or so, the lenders were the only group showing any restraints.
The lenders unhooked the restraints, and the buyers ran as wild as a college coed from a strict, catholic high school.
Who is at fault? Both. And both will now suffer.
And as for those perfectly fine home loans countrywide has so many of? They sliced them, diced them, and sold them off ages ago. They are in big trouble.
Posted by: tipster at August 16, 2007 1:34 PM
"Evil mortgage brokers are getting laid off by the thousands as we speak. Good luck transferring that skill set somewhere. Maybe selling used cars?"
This is exactly what my last realtor is doing now.
Posted by: Craig at August 16, 2007 1:35 PM
Let's look closely at the most common "victim"-painted case study: Someone who used to have bad credit and insufficient income to afford home ownership in this part of the country, who was subsequently blessed with a loan approval, who got oneself into a house, who now faces foreclosure.
What's that one's situation now?
That one now has (HORRORS!!!!!) bad credit and insufficient income to afford home ownership in this part of the country.
The only downside I see was that, for a while, one spent more on housing expenses than renting would have cost.
Those rapacious lenders! Those asleep-at-the-wheel regulators! Curses!
Posted by: SerialJingleMailer at August 16, 2007 1:49 PM
Does anyone have the default rates for jumbo loans? I just heard somewhere that the default rates are not very different from conforming loans.
If this were true, would the spread between jumbo and conforming loans be a market dislocation? If the risk differential is minimal, then the spread is way too high right now.
Posted by: Usually Named at August 16, 2007 2:20 PM
"Do clarify why you think everything desirable in SF is over $1253/sq ft."
Sorry, I didn't mean to imply that, but I see that I did imply that accidentally.
I meant to say that the median sales price for San Francisco is comparable or more than the average comparable European market, excepting Moscow, London and Monaco, and maybe Netherlands
$1253 is the MEDIAN sales price per square foot in THE MOST desireable neighborhood of Paris (i.e. St. Germain des Pres). Of course that means half sell for more and half less.
I would argue that the median price of San Francisco's ELITE neighborhoods (cow hollow, the "real" Pac Heights, and sea cliff) are at right around that level, if not more.
SoMa and Rincon Hill are nowhere near SF's most desireable neighborhoods, so don't compare to the above price.
others mentioned that SF is a "bargain" for most europeans. I disagree. except for Moscow, London, Monaco and Amsterdam, which I already stated above. Paris is the 4th most expensive European market, and overall it is by far cheaper in Paris than San francisco (having lived in both I can easily attest to that)
Posted by: ex SF-er at August 16, 2007 2:24 PM
Not sure on default rates, but the prime difference is that the secondary market for jumbos is less liquid than for conforming, so banks can't unload them as easily. Therefore, they have to underwrite based on what they feel comfortable holding, hence the spread difference. Not a dislocation, an illiquidity premium.
Posted by: Dude at August 16, 2007 2:27 PM
Usually Named --
The default risk of conforming loans and jumbo loans may be the same, but the market for them is hugely skewed by the GSAs, who will buy conforming loans, but will not buy jumbo loans.
The perceived default risk for BOTH is now very high. But the GSAs' charter demands they keep buying mortgages (conforming ones). Thus, conforming loans still get funded, and jumbos do not.
(Why do I need to keep repeating this?)
Posted by: Delancey at August 16, 2007 2:29 PM
GSA should be GSE, or Government Sponsored Enterprise. Specifically, Freddie Mac and Fannie Mae, which are publicly-traded corporations charged by the government to buy conforming mortgages (prime loans up to $417K) from banks to maintain liquidity in the mortgage market and help us all achieve the American dream.
Fannie just went through a multi-year accounting scandal costing taxpayers billions of dollars. Perfect time to let these folks dabble in jumbos/Alt A.....
Posted by: Dude at August 16, 2007 2:56 PM
Nothing like some credit downgrades on Countrywide to rock the boat.
Posted by: Jamie at August 16, 2007 3:03 PM
Maybe I am confused but, I would think Jumbo loans are a high risk given that luxury home prices have a huge range to swing (up and down). I cant count how many times I have come across a home on zillow.com that was bought for $500,000 in 1992 and sold for $2.1m in 2005! We just spent the last decade seeing the prices rapidly appreciate in SF. What is to say it can't depreciate at the same rate? If someone is sitting in a home with a $1m mortgage that is worth a fraction, why should he not walk away? SF real estate has been holding up this year BUT luxury real estate in Miami hasn't...
Posted by: anon at August 16, 2007 3:15 PM
Nah, Jumbos aren't a big deal. I think the problem is this: funds like hedge funds hold the mortgage backed securities and let people buy into the funds. Unlike a mutual fund, which is made up of stocks that are easily valued, the managers of the funds themselves put a value on the funds for sales and redemptions.
So lets say you are a fund manager you're subprime portfolio is now worth 30 cents on the dollar, and your prime jumbos are worth 85 cents. But you are a lying thief, and you don't want the investors to bail out when they learn you've lost a LOT of their money, so what you do as a fund manager is tell everyone that your fund is worth 85 cents on the dollar, a little loss but not bad. Because it is entirely up to you to decide what the value of your fund is, you can say whatever you want as long as there is some reasonable basis in it.
As people demand their money back, if you sell the subprimes in your portfolio, you'd have to write down the value of the fund because now you have the 30 cents, and can no longer value it at 85. So you sell the jumbos at 85 cents to meet the request for redemptions and hold those 30 cent subprimes so that you don't have to admit to your investors that the fund hasn't just lost 15% of its value, it's lost a lot more.
And you sure as hell aren't going to buy any new jumbos at 100 cents on the dollar. So no one wants jumbos anymore because they are lying through their teeth hoping the redemptions don't get to be so large that they have to start selling the subprimes: if they have any cash, they will hold it, or use it to buy jumbos at 85 cents, not new ones at 100 cents.
If they can keep this up and stay alive hoping the value of their subprimes come back before they have to start redeeming them, the managers of these funds will skate through with their hefty fees intact.
The government agrees to repurchase contracts because they know that allows everyone to keep all this crap on their books at full value, but gives them access to cash for redemptions - no one would actually sell their subprimes to the government for the same reason. Same for Goldman's $3B "investment" in their own funds. Those funds need the cash: they have the securities, but they can't sell them because that would trigger a reaccounting that no one wants to do.
So jumbos are not a big problem, and they'll probably be back with 20% down, which very few buyers actually have, but for now, the world is awash in jumbos because its the only thing anyone can sell that they didn't already unload onto Fannie and Freddie. So no one needs any new ones.
Countrywide leverages the cash it has by using it for a short time to ORIGINATE mortgages,which they sell off and use the money to start over again and again throughout the year. This lets them get fees on multiple loans using the same money. Their whole business depends on their ability to use one set of cash multiple times. Their overhead costs are too high to just use their own money once and lock it up for 30 years.
So if they can't sell Jumbos, they have to hold them, and they aren't going to hold anything but the most profitable ones. They can't sell jumbos any more than anyone else right now, thus their announcement.
But so many investors have now been burned so badly, and it could get a lot worse, it will probably be years before they are willing to wade back into the jumbo loan market. There is no one they can trust to tell them what the interest rates should be, the rating agencies and the fund managers were just crooked as can be, or at least they didn't appear to really know what they were doing, they just followed the herd. So investros will cede the whole thing to Fannie and Freddie for 2-3 years at least.
Posted by: tipster at August 16, 2007 3:45 PM
Miami has something like 10 times more units coming online (30,000+) vs SF.
Why would someone sell a home at a loss unless they absolutely had to. Remember Warren Buffet's rule "Never lose money." Especially if the owner likes their home and doesn't want to move. And in five years from now prices will be higher than ever....especially in Downtown SF, Rincon Hill, SoMa, SoBe, Mission bay, which are getting better every single day.
Don't forget that a substantial portion of the appreciation in those neighborhoods is because living there is dramatically better than five years ago, and keeps getting better on a continual basis. Four years ago there weren't even any supermarkets!
Posted by: anon at August 16, 2007 3:51 PM
Wow tipster, what a great and informative post. Can you go on CNBC?
Posted by: howard at August 16, 2007 4:04 PM
Tipster, I don't think jumbo and subprime are mutually exclusive.
Posted by: Delancey at August 16, 2007 4:12 PM
Tipster - The problem is that there WILL be some current homeowner's who are quite overextended and won't be able to handle the rate adjustments. I'm not talking about sub-prime borrowers, but those in the prime-borrowing class who just overextended to get into that Brannan unit a few years back.
While housing prices have held up so far in SF, this is mainly due to the low volume of supply on the market, as some of the overextended owners' seeing the future tea leaves, decided to keep their homes off the market for as long as they could.
However, the next 6 months we will be entering the peak period where a majority of the ARMs will be reset (with the peak occuring somewhere around Feb/March of '08). Of course, there will be some lag effect before this volume hits the for sale market, but you can expect the supply to open up in the coming months. Once this happens, natural microeconomics will happen with supply/demand and you can expect some aggressive pricing as owners in high-competition markets try to move their properties.
You can see this wave occuring already in the South Bay, with it also moving up into the peninsula as well. Sub-prime condos/homnes (no pun intended)........those homes who are location/layout/style challenged will naturally be first to tumble. In SF, you are starting to see homes in Sunset flooding the market. Crapboxe homes in Sunset who in last year's market would have tried asking in the high $800K, are now pricing themselves in the low to mid-$700Ks. Richmond will be the next area to be hit as well. Really worse off areas like Ingleside Heights or Merced heights are already sitting on the market for quite a bit.
The condo market in SF is going to be hit the hardest though. On one end, you have a large amount of new condo supply which will hit the market in '08, but you will see quite a bit of owners in South Beach/Mission Bay condos trying to exit. You are already seeing this pricing pressure in the Beacon in 1 bedrooms. Just last year, these units were priced in the mid $600Ks are now down to the mid $500Ks. The super skyrise condo towers in Rincon Hill...........that is going to be the million dollar question. With HOA fees already in the $700+/month range, the long-term sustainability of homeowners who can pay that plus their mortgage on $900+/sq. ft condos is in serious question.
Posted by: SF Bubble at August 16, 2007 4:22 PM
nice insights. question. why dont you update your site. i read it last year but it hasn't been updated.
Posted by: ???@???.com at August 16, 2007 4:36 PM
I am still at a loss to understand why so many on this site use prices in London and New York City as a justification for how "cheap" San Francisco is. That is like living in Seaside and saying it is undervalued compared to Pebble Beach. Our economy and housing market has NOTHING to do with what is going on in London or Paris.
Posted by: anon94123 at August 16, 2007 4:46 PM
SF BUBBLE -- I think your observations are right on. Of the many, many overextended owners who can see the difficulties looming, the smart ones are those who put up their places NOW before it really hits the fan. They will escape far better off than those who wait around hoping for a miracle.
Posted by: Trip at August 16, 2007 4:55 PM
I disagree with SF Bubble's opinion on the SF condo market being most vulnerable. From a pure supply/demand perspective, one might superficially argue that there will be downward pressure on prices, but the condos in the pipeline can be segmented into different categories and they meet the demand of different classes of consumers.
For instance, the Brannan, Watermark, Rincon and Infinity can be grouped in one category, while the Palms, 170 Off Third and 255 Berry are in a different class, and Four Seasons, Millenium, Ritz Carlton belong yet to another class and cater to a different population segment. So, there might be pricing pressure within a particular category, one cannot make a blanket statement that all condo prices will be pressured because of the additional supply.
Additionally, there could be further subcategorization within a category. For example, there appears to be a higher supply of 1 bedroom units than 2 bedroom ones; so I think 1 bedroom condos will experience a different pricing pressure than the 2 bedroom ones. Also, there are developments that distinguish themselves by offering unique products; for example, the units at Park Terrace in Mission Bay are much larger than the average unit in that area. So, for those condo buyers who are looking for larger units in South Beach/Mission Bay, they really don't have that much to choose from.
Furthermore, the recent trend indicates that empty nesters are migrating to downtown condos, so it appears there will be a steady increase in demand for condos and a steady increase in supply for single family homes.
It is overly simplistic to say that because of all the new condos in the pipeline, the condo market will be negatively impacted.
Posted by: Steve at August 16, 2007 5:15 PM
The problem with the condos coming on line is this: some bought them for speculative purposes and that's not looking too good right now. Those people will walk away from their deposits.
The developer will take them back and now he can lower the prices by the amount of their deposit and still make his original profit, which was high to start with, so he'll drop them by 15% to unload them. And that will set a new bar for other units: everything will drop by 15%. And that will cause other people to realize the game is over and to sell. They aren't selling at a loss: they bought years ago, but that will start the run for the exits.
And that will hit the new mortgage holders and so people will start to bail on them. Especially the 0% downers. The quicker they run the better and california is a no recourse state. Some will wait for the resets and bail then. Either way, its looking pretty screwed up for the next couple of years.
And those of you who think the upper end will hold up better didn't read the "Millionare Next Door": self made people people with high net worths rarely buy the uber luxury buildings, they might buy nice homes but they didn't make their money by throwing it out the window on Valet parking attendants. The people in those buildings either have trust funds, or have NO net worth. They spend money like water. Those people will bail when the resets hit. And if they didn't lock, they won't qualify at all any more, and I'd be willing to bet lots didn't lock.
Posted by: tipster at August 16, 2007 5:51 PM
Great post Steve. Totally true.
For example how many 2 or 3br condos have unobstructed waterfront views, are within a block or two of the embarcadero, and are on the 10th floor or above. Not many. And not many more will be built in the foreseeable future that meet those criteria.
Look at Vancouver. Huge tower after tower was built, and last time I was there entire towers would sell out the day the sales office opened and before ground was broken. No one thought that many people would want to live in these dozens of highrises. The demand will be there sooner or later.
Posted by: AC at August 16, 2007 5:56 PM
Does anyone know when Infinity and ORH are actually going to start closing sales?
Tipster, if you are right and a substantial portion of the profit for the developers of these towers disappears, then 2RH and the second Infinity tower and others will not be built for awhile. I tend to think that people buying in this city have a lot more cash than you think. I know some ORH/Infinity etc... buyers and they have plenty of cash and rate locks. Actually, I hope you're right, I would love to get a unit at the Infinity for 20% off current prices, I just don't think it's going to happen.
Posted by: anono at August 16, 2007 6:39 PM
Click on my name and you will find a great article from Julian Hebron - Mortgage Banker @ RPM who does an awesome job summing up the situation.
Posted by: Katy Dinner at August 16, 2007 8:25 PM
Hey tipster: thanks for sharing with us excerpts from your PhD theses in economy! I guess you are at Harward. So now everything starts making sense. LOL
Posted by: anon at August 16, 2007 9:36 PM
Katy, Julian's comments on your site were fantastic. Thanks for the link. He does a very thorough job of explaining the situation, and in my opinion, explaining the most realistic situation for the market in general as well as the Bay Area.
Posted by: movingback at August 16, 2007 10:46 PM
For all those who keep cheerleading the market, are you claiming NOW is a good time to buy a condominium (850 to 1.3 range)? Do you think the market is so healthy that if they were to begin ORH2, would that tower sell as fast as the first? How many of those who savor the opportunity to have "fine wine and imported cheese" at their homeowner meetings really have $270,000 laying around for a deposit for a purchase? And since some of you think real estate only goes up,what percentage increase should the ORH2 units be sold for?
Posted by: anonon at August 17, 2007 4:56 AM
overall I really enjoyed your synopsis EXCEPT for two things:
"But lenders are using risk-based pricing (as opposed to market pricing)"
this is incorrect. Market pricing of Jumbo loans has ALWAYS consisted of the yield from 10 year treasuries PLUS a risk premium. Over the last 10 years there was a loss of this risk premium due to newly created secondary mortgage securitization forces. That premium is returning. It will likely overshoot at some point, but it is still "market price". I guess if you meant to say that risk is more important in today's pricing, I'd agree with that.
(in fact, risk is ALWAYS part of market pricing of all investments... this is why IN GENERAL you get more yield on a 10 year Treasury than a 28 day treasury, to compensate for inflation risk... or why you may yield 10% for a junk bond compared to 5% for a Treasury, to compensate for default risk)
"And here in the Bay Area, there’s a lot less property supply than there is in other U.S. markets, so we shouldn’t see quite the same decline in demand even as borrowers drop out because of qualification issues."
Supply and demand are different.
If borrowers drop out there is less demand, period, regardless of what supply is doing. hence the supply/demand curve.
(example: if you have 100 units for sale and 1000 buyers= demand is 1000. then later if there are 75 units for sale and 500 buyers... demand is now 500- in other words lower- even though supply tightened in this case)
but regardless, supply may noticeably increase as lending tightens, if overextended homeowners are forced to sell or go into foreclosure due to their ARM resets.
As you should well know, supply can change very rapidly. Look at what happened in San Diego and Sacramento and South Florida and Phoenix and Las Vegas and countless other cities the last 2 years as example.
To me there are 2 unknowable questions:
1. how many buyers will be removed due to tighter lending? (some people claim that SF residents are rich, and thus won't care, others claim that all SFers need "liar loans" to get a mortgage. obviously the truth is somewhere in between... but where?)
2. how many owners will need to sell (or foreclose) due to tighter lending? (Ivy Zellman did an amazing research report frmo Credit Suisse that showed that there are something like a Trillion dollars of ARMs resetting in the next 18 months. will current ARM holders in San Francisco qualify for a refinance? If they do not, can they afford their reset payments?)
It is hard to guage what will happen in San Francisco when lending tightens, because
1. SF is very unaffordable to most residents. So a tightening in lending will hurt the AVERAGE SF resident more than a person in a cheap COL area.
2. most people in SF rent, and it is difficult to get the economic data on SF OWNERS to find out if they can truly "afford" SF homes with traditional-style lending.
Regardless, IMO this will play out over years, even though to me the time I knew the game was up was when Bear Stearn's hedge funds blew up a while back. (I've posted this before)
Posted by: ex SF-er at August 17, 2007 5:40 AM
God bless the Fed and their 50 bps cut on the discount rate! Just in time.
Posted by: Jamie at August 17, 2007 6:53 AM
Indeed. God Bless the Fed! CNBC is reporting that if this action was not taken by the Fed. there would have been a possibility of Countrywide going under, but of course this will not happen, at least for now. We were closer to the edge than many people realize.
Posted by: adam smith at August 17, 2007 9:04 AM
Can someone with deeper knowledge explain how a 50bp discount rate cut will help any of this in the long run?
Pardon my naivete, but the discount rate applies to Fed loans to "credit worthy banks", so if you are a lender/bag-holder in trouble, how does this cut help you specifically?
Long informed posts welcome (I'm looking at you tipster, ex-SFer :) ). Thanks!
Posted by: dub dub at August 17, 2007 9:56 AM
Isn't this a bailout?
Posted by: remark at August 17, 2007 10:45 AM
This will help lenders (i.e. Countrywide) somewhat. They are having to borrow from banks to continue operations, and this should permit banks to lend at slightly lower interest rates. However, the reason lenders need to borrow from banks is because nobody is buying the mortgages they write and hold. That will not change with this action. I can't see this affecting the new, tightened restrictions on lending to homeowners--especially re jumbo loans--at all.
Posted by: Trip at August 17, 2007 10:50 AM
I was thinking about this situation, and the following resolution came to mind. The holders of these securities are faced with either collecting a lower return on them or losing 10-50% of their principle.
What's to stop them from putting off the reset indefinitely? They could stretch the pain out for years into bite-sized chunks, or am I missing something?
Posted by: VultureBoy at August 17, 2007 10:52 AM
@Trip: thanks, but why would a solvent bank funnel any of its newfound liquidity to a troubled lender like countrywide?
@Vultureboy: I'll take a crack at your question: the act of pushing resets back on existing paper would render them worthless or, as we say in polite society, "illiquid". Who would buy it? You'd be holding an IOU from a "deadbeat tranche".
Others might be able to give a better explanation why this idea would not work.
Posted by: dub dub at August 17, 2007 11:48 AM
Countrywide is a big company with a lot of assets. Just because it is in a serious crunch and may even be close to bankruptcy does not mean nobody would lend it money. Even in the worst case, bankruptcy, it is the stockholders who get shafted. Lenders and bondholders go to the front of the line and indications are they would likely be paid close to 100 cents on the dollar unless things unexpectedly tank (which they might -- hence their borrowing costs are probably higher). Banks were willing to lend billions to Countrywide even before this latest discount rate cut. Now they will be willing to do so at slightly better rates for the company.
Posted by: Trip at August 17, 2007 11:58 AM
The Wall Street Journal has some musings from economists and market players about the effect of the Fed's discount rate cut, just click on "anono" (hopefully the link works).
Posted by: anono at August 17, 2007 12:40 PM
"For instance, the Brannan, Watermark, Rincon and Infinity can be grouped in one category, while the Palms, 170 Off Third and 255 Berry are in a different class, and Four Seasons, Millenium, Ritz Carlton belong yet to another class and cater to a different population segment."
Steve, I agree that certain buildings may be categorized differently, however, have you ever stepped foot in the Palms, 170 Off Third and 255 Berry? I would put 255 Berry, Park Terrace and 235 Berry in one category and 170 off third, the Palms and Arterra in another. Sorry to be off topic, but please...
Posted by: Anonymous at August 17, 2007 2:04 PM
"Can someone with deeper knowledge explain how a 50bp discount rate cut will help any of this in the long run?
Pardon my naivete, but the discount rate applies to Fed loans to "credit worthy banks", so if you are a lender/bag-holder in trouble, how does this cut help you specifically?"
WARNING LONG POST:
I'll try to answer this how I am reading it, but please don't take this as gospel.
I will start by stating that I am not a specialist in Federal Reserve operations, and also that I believe that the Fed is somewhat divided in how they should approach this. As example, Bill Poole, outspoken hawkish voting member for the Federal Reserve, was REPLACED for this vote presumably so that the Fed could vote unanimously for the discount rate cut. Due to internal divisiveness, it may be impossible to accurately say why the Fed does what it does
That said, here is my take.
The Federal Reserve has a few different mandates,
-to conduct the nation’s monetary policy,
-to provide and maintain an effective and efficient payments system,
-and to supervise and regulate banking operations
Many people reinterpret the above to mean: "to ENSURE PROPER AND SMOOTH WORKINGS of the credit markets".
Over the last few weeks, we have seen a progressive and major breakdown in the credit markets. Originally, it is easily argued that the breakdown was APPROPRIATE. In other words, it was appropriate for certain poor-quality mortgage products to not trade well. The companies that dealt with that toxic garbage took huge losses, and it was appropriate, so despite their cries for help, the Fed did nothing.
however, this is spreading rapidly. At this time due to FEAR in the marketplace, there are many TOTALLY different types of products that are not trading well at all either (that "should" still trade ok)
one of those products (and the most important to this long post) is called "Commercial Paper". Commercial Paper (henceforth called "CP") is KIND OF like a line of credit that a big business often uses to finance it's day to day operational expenses.
CP is usually short term (from a few days to a few months) and a big business will often keep a CP line open with one or several big banks and use it all the time. the rates of CP are typically far cheaper than comparable lines of credit or loans.
The Banks make money from the interest on the CP, and ALSO the banks often get paid a fee for all of the available CP that ISN'T used... overall CP is considered "safe" because only the biggest/best companies get to have CP lines, and it's short duration. The companies with CP lines benefit because they have a cheaper source of funding of their operational expenses.
Subprime happened, and then Alt A, and then Jumbo loans happened. Now there are lots of securities (lots of "3 letter words" like MBS, CDO, CDS, synthetic CDS and so on) that are barely trading at all. Due to this, many big banks and other financial powerhouses DON"T KNOW how much their portfolios are worth, and DON"T KNOW how much losses they might have and DON"T KNOW how much risk they have in their portfolios.
due to this, many of the "big boys" are afraid to purchase securities, ANY securities... even securities such as CP, even though CP really doesn't have much to do with mortgages at all. There is simply FEAR about any security
So now there are problems with the CP security market... and the CP isn't trading well. Due to this, at first the crappy mortgage companies can't "roll" their CP... in other words their financing costs on their daily operations just SKYROCKETED. (they have to use other methods of funding, which have higher rates and are more costly). As the crappy companies lose their CP lines, they approach bankruptcy, which sends a shudder through the CP market (remember, the CP market is supposed to be "safe" so a near-bankruptcy is very bad)
Now, due to the bad company CP problems, fear spreads to the better company CP market. So even "good" companies (like Thornburg Mortgage, which has a great portfolio) can't get their CP funded. The concern is that this might continue to spread... maybe so bad that the CP market FREEZES as well, and then other companies that have nothing to do with this at all(like Prctor and Gamble to MAKE UP an example)
So now what happened this week:
This week CountryWide showed some cracks. Their secondary market for their mortgages SHUT DOWN. Thus, they had all these mortgages that they couldn't sell. which meant that they have MORTGAGES on their books, but no CASH to pay the rent/operational expenses. There was a concern they could be financially insolvent.
Due to the new situation, it's debt was DOWNGRADED. By being downgraded, CountryWide must pay MORE money for its credit lines. this obviously hurts their cash position. How will they fund their operational expenses and stay open????
One thing Countrywide did yesterday was to call in their dedicated lines of credit (the $11.5 Bilion from 40 banks). they could do this because the money was pledged to them. (if you remember above, I spoke about how some banks are paid for CP lines that are NOT being used... this is the downside to that for the banks!)
But $11.5 Billion isn't enough. I don't know how long CountryWide can survive on that, but NOT LONG. Thus, if they want to survive, they have to raise money (debt) elsewhere. I heard reports that they were being quoted 13%. That is not doable for them.
So without help, CountryWide goes under. If CountryWide goes under, MANY people in MANY security markets lose BIG money. But worse (for the Fed), the Commercial Paper is all worthless. This could potentially FREEZE the CP market totally. (imagine nobody funding GE or Microsoft's CP needs!).
Also, CountryWide is a loan SERVICER. (they service more loans than anyone in the country)
So although CountryWide in and of itself is NOT too big to fail, it may be too big to fail RIGHT NOW.
and if countrywide is having these problems, then how many other banks are in trouble?
So the fed has 3 choices
1. do nothing. Countrywide may fail. CP market shuts down. total credit collapse. Dangerous
2. drop the Fed Funds Rate. This allows EVERYBODY (all the dirty hedge funds) to go back to crazy trading again, and it "bails out" all the bad guys, and we get massive inflation and the dollar tanks. also, the Fed said it WOULDN'T drop rates, so if it did drop the Fed funds rate people would FEAR that we're in meltdown mode.
3. drop the discount rate. the discount rate allows BANKS (not everyone) to have a loan at a PREMIUM (it is HIGHER than the Fed Funds Rate, not lower) with GOOD collateral. thus, you don't get hedge funds mucking around. Banks who don't need it will just use the Fed Funds Rate. But a bank in SHORT TERM TROUBLE who CAN'T finance it's daily operations, could turn in GOOD assets (like conforming loans, certain securities) and get a good short term loan (higher than the Fed Funds Rate, but probably lower than other options). this buys time. that's it.
So in this case, the Fed bought CountryWide 30 days of operational expenses. (it can be renewed though). thus, Hopefully, Countrywide can find other sources of funding in the next 30-60-90-120 days, or they can be liquidated in an orderly fashion during that time...
It also is SYMBOLIC to show the market that it is benevolent and watching, but won't bail out.
It also will help OTHER banks that are quietly suffering like Countrywide.
Now today, the Fed discussed with many of the Big Boys, to ENCOURAGE them to all borrow from the discount window. The reason: to act as smoke screen. if wells and Bear Stearns and Citi and Wachovia all borrow from the discount window, then a failing bank can also borrow from the discount window without everyone knowing that they're dead in the water.
and lastly, the Fed hopes the drop in this rate will encourage the banks to LEND in the CP market again, getting that market going.
In other words:
keep letting housing get crushed
keep letting leveraged hedge funds get crushed
but save the CP market
sorry for long post, hope that helps.
Posted by: ex SF-er at August 17, 2007 10:03 PM
Pardon my naivete, but the discount rate applies to Fed loans to "credit worthy banks", so if you are a lender/bag-holder in trouble, how does this cut help you specifically?"
quick resonse to this:
you don't have to be a "good bank". you just have to be a bank with good collateral.
so in this case, Countrywide, although possibly insolvent, has some mortgages that really are worth significant $$$.
so the fed will take those mortgages, lend to countrywide... if countrywide goes under the Fed has the high quality mortgages.
Posted by: ex SF-er at August 17, 2007 10:05 PM
Bravo, Ex SF-er. Fantastic explanation of a complicated subject.
Posted by: tipster at August 19, 2007 5:45 PM