July 8, 2008
Alt-A Powerhouse IndyMac Takes A Step Closer To
As another plugged-in reader noted yesterday, IndyMac – second only to Countrywide in terms of indypendent U.S. mortgage lenders last year – has effectively stopped originating new home loans citing a “continued downward trend in home prices” (think losses and need to raise additional capital) and a lack of “stability and uncertainty” in the mortgage markets (think inability to raise said capital).
Keep in mind that IndyMac is the largest “Alt-A” – not subprime – lender in the land.
∙ Indymac Issues Stakeholder Letter [The IMB Report]
∙ JustQuotes: You Had Better Watch Your Fannie (As Well As Freddie) [SocketSite]
First Published: July 8, 2008 6:45 AM
Comments from "Plugged In" Readers
They should only write loans for properties in the "real SF." That market is still fine.
Posted by: Foolio at July 8, 2008 8:21 AM
What happened? I posted a link to a story at MSN called "34 Cities Where It's Still Better To Rent" and it disappeared after posting. Twice.
[Editor's Note: Sorry, we tried to send you a note to explain (and to suggest submitting the story as a "tip"), but the email you supplied wasn't valid. Twice. In essence, off topic to the post (but thanks for plugging in).]
Posted by: Anonymous at July 8, 2008 9:12 AM
Does this mean it will be harder for people to get loans? Or is Alt-A for the undocumented income people and this company is now in trouble because of giving out too many risky loans of this type? I read someone's comment on another post recently saying that loans are going to get harder and harder to get. How does this all tie in with the big news on Fannie & Freddie yesterday? Is that going to be the case with refinancing too (even with a lot of equity)? I thought the credit markets were already as tight as they could be. Would appreciate your input.
Posted by: Serena at July 8, 2008 9:29 AM
The solutions that are always proffered to "save" the housing market go like this:
We'll find a very dumb person with a LOT of money who will pay us for all our bad loans and everyone (but that person) will be fine.
The search for that person continues, but alas, we cannot find him.
Last year it was the Super-SIV. Investment banks would pool their bad loans into a super SIV, some idiot would buy them (apparently at full price), and the banks would have more money to make more stupid loans, which could then be pooled, etc. Plenty of money would be available for mortgages! The super-SIV died and for awhile, there was no money.
This year: it's "capital". Fannie, freddie, and regional banks like Indymac would get "capital" from supid rich people, which would evaporate as it was used to soak up loans for houses that had doubled in price due only to loose lending, but the infusion of "capital" would allow banks to continue to make loans that got them in trouble in the first place.
"Capital" is magical in that people apparently give it up without any concerns for the business prospects of the party receiving it, so there is apparently an endless supply of it lining up to be handed to companies with broken business models.
Like the Super-SIV, no one wants to give anybody "capital" this year either, except for a few idiots who handed some over when all the heads of the banks who needed "capital" announced "the worst was 'definitely' behind us". Fannie and freddie need more "capital", but it appears the "capital" they have is flying out the window, and no one wants to give them any more. Indymac went looking for "capital" but, though they haven't stated it wasn't available, they did state yesterday that "If there were any other alternatives (to not making any more loans), we would have taken them".
So "Capital" appears now to be in short supply, at least to the mortgage industry, which is kind of, sort of, going to make it a teensy bit more difficult to loan (it's harder to do that when you have no money, and as your money dries up, you get a run on the bank, causing your collapse).
I would expect a different plan involving stupid people with a LOT of money handing it to people who make mortgage loans in a declining market. But it's OK, because after, (what? all of 9 months?), the worst is "definitely" behind us.
Posted by: tipster at July 8, 2008 10:14 AM
"They should only write loans for properties in the "real SF." That market is still fine."
It's lovely to see such earnest engagement from someone in the thick of things.
Posted by: fluj at July 8, 2008 10:23 AM
Accurate, tipster, but I think you underestimate the American propensity to borrow any and all money available to solve today's problems at the expense of our collective progeny. Where did the money for all those stimulus checks come from?
I think IndyMac, Thornburg, and a lot of similar operations are done for. That said, I still see a massive bailout looming for the GSEs and other players deemed "too big to fail."
The mortgage market will not be allowed to grind to a halt. If the free market is unwilling to provide capital to keep it operating, our government will do it using taxpayer money (i.e. borrowing more from foreign interests).
I expect lending conditions to tighten further and/or rates to rise, but I doubt it'll get to the point where prime borrowers can't get mortgages because the system is "lent out."
Posted by: Dude at July 8, 2008 10:50 AM
Is this when I get to quote you back to yourself? I think it goes something like, "You don't know me, bro. Whatever."
Did I get it right?
Posted by: Foolio at July 8, 2008 11:27 AM
... wait and watch
Posted by: Max2 at July 8, 2008 11:45 AM
Does this mean it will be harder for people to get loans?
Yes. think of it this way: 2 of the largest (and many smaller) mortgage lenders efectively went out of business. this is because their business (mortgages) is unprofitable. To become profitable, they must either reduce costs, or increase revenue.
reducing costs is difficult because places like Countrywide already had bare-bones costs, but you could reduce costs by limiting losses on your loans. losses could be reduced by restricting to whom you lend. (i.e. "stricter" lending guidelines).
Revenue could be increased by increasing how much mortgages cost to a consumer (i.e. raising rates)
In the end, mortgage rates are quite low by historical standards, and thus it would not be unreasonable to have mortgage rates of 8%. (I'm only saying rates of 8% would be reasonable given historical mortgage rates, I'm not giving a prediction that rates will or should go that high)
Or is Alt-A for the undocumented income people and this company is now in trouble because of giving out too many risky loans of this type?
both. Indymac was aggressive in their lending (gave out risky loans). now those loans are doing very poorly, causing major losses. thus, this is Indymac's "fault" as they lent unwisely.
There is confusion about what Alt-A is. Alt-A really only means that there is something about the loan that makes it not "prime" but not so bad as subprime. In general, it could be that there is lower documentation, it could be that the FICO score is a bit lower (but not subprime low), it could be that there is a high Loan to Value ratio for the loan. or perhaps a high Debt to Income ratio. Thus, Alt A was by definition "more risky" than prime and "less risky" than subprime.
however, you must understand something that the majority of people DON'T understand. In theory, losses on Prime should have been less than Alt A which should have been less than Subprime. However in practice, we are finding out that this is NOT necessarily the case. In fact, they are finding that FICO score have only been minimally important when it came to losses on loans. Much more important was the Loan To Value ratio and also the debt to income ratio. ironically, often times Alt A and even Prime loans have LTV and DTI ratios that are as bad if not worse than subprime. (this is San Francisco's problem by the way... the loans tend to be high DTI and high LTV due to SF's high Cost of Living).
Thus, although the cracks showed earliest in subprime (making people think that this is a "subprime problem") we are finding that losses on alt-a and even prime loans are accelerating and may even surpass those of subprime.
This is partially because Alt A and Prime loans have higher nominal values... it's more painful for the mortgage backed securities if one $1M home forecloses than for five $100k homes to foreclose.
therefore, the mortgage market is "broken". the old models used to estimate risk are proving wildly inaccurate. the "safe" loans are defaulting just as the "unsafe" loans.
what seems to be clear is this:
lending a high percentage of a home's value to people (a high loan to value ratio) leads to increased foreclosure/default rates
lending people a lot of money compared to their income (high debt to income ratio) leads to increased foreclosure/default rates.
thus, going forward many banks will likely
-reduce the LTV. (as example, bring back the 20% down rule... or perhaps even 30% down)
-reduce the DTI. (as example, go back to the maximum PITI payment of 28% of net income and 36% of gross income).
the above 2 rules were in effect for decades until the 2000's. It is my thought that they will go back to something similar, or maybe even overshoot.
as a ROUGH example of "stricter but sane" lending, if you used the above rules, a person making $200k/year would be eligible for a PITI payment of about $6000/month. doing the math backwards at 7%, they could buy a $1M home putting $200k down.
this is very reasonable by historical standards, but far stricter than what we've seen since 2001.
so it's not that lending really will tighten per se... it's that it will likely tighten back to "normal" from "extremely loose", where it's been for too long.
Posted by: ex SF-er at July 8, 2008 12:19 PM
One more point.
Indymac going under is a SYMPTOM and not a CAUSE of the problem.
the problem is that for years banks lent people money and immediately sold those loans to investors. Because of this, the banks didn't really care if the loans got paid back or not, since they didn't own the loans... the investor did. Because of this banks lowered their risk guidelines tremendously... and just offloaded that risk to the investors. why should the bank care if they loan out $2M to a person making $200k? they're selling it to the investors anyway! who cares if they lend out $350k to an illegal immigrant strawberry picker? they're selling it anyway!
As losses started coming in it hit the investors, not the banks. thus, the investors STOPPED buying those loans (and they made the banks buy back some, but not all, of the bad loans). So now the mortgage lenders and banks are stuck with a bunch of bad loans that they can't sell. Their money is now "tied up" in these bad mortgages because they can't sell these loans. therefore they don't have as much money to lend out to new customers.
This is the "credit crunch". The banks are stuck with crap in their portfolio that they don't want and that they can't sell. This leaves them with less money to lend to new customers. Investors will NOT buy the old loans from the banks. So the banks aren't making money (money tied up in mortgages) and they are losing money (those bad mortgages), thus the banks are going under.
So the Fed has dropped rates a lot. The banks are using this cheapened money to try to repair their balance sheet. This is why the Fed Funds Rate is dropping, but new mortgage rates are not dropping. The banks are trying to borrow low from the Fed and lend high to consumers... it's a race against time... can they get enough money quick enough before their losses make them bankrupt??? Indymac couldn't. neither could Countrywide. neither could Bear Stearns. And people worry that Lehman Brothers and Washington Mutual are also in this boat.
Initially, early in the credit crunch everyone thought it was a transient thing. So big banks got in trouble, and raised cash to cushion themselves (like citibank as example). but now this is going on and on, and the first investors took a major beating. So now banks are having a hard time raising capital. (who wants to invest in a bank right now???)
so now the only game in town is Fannie/Freddie/Ginnie/FHA (ok, not the only game, but 80%+ of the game). the reason is twofold. First, because they have access to cheaper cash than the other banks (less cost). And more importantly because those firms have implicit (Fannie/Freddie) and explicit (Ginnie/FHA) GOVERNMENTAL gaurantees, so the investors don't worry about losses from the securities they buy from the GSEs.
an investor won't buy a loan from Indymac directly, fearing more losses. But they will buy from Fannie and Freddie, because if there's a loss it's gauranteed (sortof). But now Freddie and Fannie are taking HUGE losses. what happens if they go under? will the govt really make all their investors "whole"?
anyway, a lot of rambling, but perhaps that elucidates a little bit better what the problem is right now... and why it will take YEARS AND YEARS to sort out. We're about a year into the credit crisis... and the banks are still taking huge losses... mortgage securities are still losing money like crazy. housing values are still going down (making hte mortgage securities lose more money), and so on.
there is one wild card: the federal govt. They could do things that would markedly change the above issue. However, it would come at HUGE taxpayer costs. As example, the govt could buy ALL of the bad mortgages, making all the banks and investors whole again. CEO's could take in huge bonuses. Banks would lend again. But the bill would be astronomical and our dollar would tank. $8 gas anyone?
In the end, I strongly believe that there will be a partial bailout (I've said so many times). Fannie and Freddie will possibly near Bankruptcy in a few years and then the govt will have a choice. I believe they will bail those 2 orgs out. Thus, everyone is dumping everything they can into Fannie Freddie as we speak.
by the way, the government bailed out the lenders big time before... in the Savings and Loan scandal.
Posted by: ex SF-er at July 8, 2008 12:39 PM
ex-SF-er. That was incredibly informative. Thanks.
Posted by: Serena at July 8, 2008 12:50 PM
One again, a well written piece with an accurate analysis of the issues facing the capital markets.
Just wondering if you saw Jaime Dimon's comments ... comments that appear to have prompted a spike in financial shares today. In a nutshell, he feels that buyers for some types of mortgage instruments are returning, and that the credit crisis will ease. Granted, his comments may be rather self serving, but I wonder if there is some accuracy to them.
Posted by: Recent ORH buyer at July 8, 2008 1:13 PM
On "the Real SF" -- I never said it. You did. Keep it. This cynical goading doesn't suit you.
Posted by: fluj at July 8, 2008 1:25 PM
Wow, awesome stuff ex-SF. Everyone should read this at least twice. Very, very useful.
Posted by: Foolio at July 8, 2008 1:40 PM
Nice try, buddy. It's clear when the "cynical goading" started, and it wasn't with my post.
Posted by: Foolio at July 8, 2008 1:42 PM
well written pieces ex-SF er
banks/mortgage lenders make money very simply:
1.) Take money (deposits) - pay interest to depositor.
2.) Lend out money (mortgage). Collect interest (and principal) from mortgagor.
A key element of the above formula is to hold deposits (capital) equal to a small percentage of the outstanding loaned money. Fractional reserve banking. Leverage works wonders creating profit. It also works wonders in creating massive losses.
Certain lenders, but not all of them, leveraged themselves severely, and made very risky loans. The result was that when the value of the collateral for the loan dropped (house in stockton dropped by 50%), and payments to the bank from the mortgagor stopped, the actual amount that the bank could replenish itself with (perhaps by foreclosing on said property), was much less than they had estimated.
Uh-oh. Now a bank that thought it was leveraged 4:1 (lent out 4 dollars for every dollar of deposits) was actually leveraged 8:1. As this chain reaction developed, the Countrywides, New Century's, IndyMac's of the world were forced to restore their deposits (capital). But from where? How? No one will lend to a bank that can't make good on its debts. Vicious cycle ensues.
But, hey, then why haven't rates on mortgages skyrocketed? Solvent, but reeling banks can borrow at much lower rates now than one year ago due to downward pressure on short term rates (partly due to the Fed). Unfortunately, they can't lend out to potential mortgagors at very high rates and make money off the giant spread.
Why not? Isn't supply and demand the rule here? It is, but because not all mortgage lenders overextended themselves to the same degree, some banks can afford to lend at lower rates than others.
Why does this matter? Well, due to new restrictions on mortgage qualification, lendors are fighting for a smaller pool of potential new mortgagors. But a few mortgage lenders are holding stronger hands. Their leverage was smaller, their loans were not as risky, and their balance sheets were consequently in much better shape. These lenders then looked at the situation and realized they could fractioanlly undercut their competitors, and still make a healthy profit on the spread.
The credit crunch is real, and it has affected every mortgage lendor to one degree or antoher. It is not true, however, that all lendors are created equal. Those that underestimated risk, those that forgot to cover their flank, they are now caught in a no-win situation. They can't get new mortgagors unless they lower their rates, but they need bigger spreads to either be able to sell their loans or make significant enough profits to stave off the wolves.
Fractional reserve banking has always been susceptible to this chain of events, and a Darwinian survivial of the fittest is now taking out those banks that were merely crippled recently. The strong (JP Morgan) eat the weak (Bear Sterns). This is how it should be. IndyMac and other lendors that did not understand the potential for this problem deserve their fate.
If you play chess, and you do not castle early, sometimes when you most need to castle it is too late. Checkmate.
Posted by: enonymous at July 8, 2008 1:49 PM
How could I have possibly beat the first post of the thread? But it's cool. I will not respond to "the real SF" any more. You win. OK?
Posted by: fluj at July 8, 2008 2:40 PM
*I must apologize to the other posters but after reading through all the comments I felt the need to say something*
hey fluj, if you never said "the real SF" then stop responding to it every time it is brought up, ESPECIALLY when you name isn't mentioned in the post ...
They should only write loans for properties in the "real SF." That market is still fine.
Posted by: Foolio at July 8, 2008 8:21 AM
See, this post isn't about YOU, you're name isn't mentioned. It's just a comment some stranger left on a message board on the internet.
Instead, why not focus on the other excellent posts in this thread and ignore the snarkier posts that aren't about you in the first place.
Posted by: badlydrawnbear at July 8, 2008 2:48 PM
Good stuff, enonymous. Who are some of the lenders who are doing better, and, why can't they simply raise rates some, but not as much as they in-the-pain lenders need to make money?
To compare to an industry I know much better, airlines without high labor costs often can use that increased pricing power to drive both profits and higher prices. I don't understand why the better-positioned lenders can't do the same thing (perhaps they are), by floating "test baloon" price increases to see if other lenders follow suit.
Posted by: Foolio at July 8, 2008 2:54 PM
There's a backstory about this exact phrase and Foolio wasn't necessarily goading me personally. No, he was goading a group of posters and I am squarely in that group. As I accede to your wishes and sign off I will again say how refreshing it is to see such earnest engagement begining a thread.
Posted by: fluj at July 8, 2008 2:59 PM
Recent ORH buyer: I'm just listening to his speech right now. I thought I'd listen because it is very rare for Mr. Dimon to give a speech.
overall, the soundbite was misleading. He basically said he sees glimmers of improvement here and there but that things can get a lot worse before they get better. (so he's not calling "a bottom".)
Here is a video of his speech. I would listen to it and not the soundbites. it's 22 min long so doable.
Video of James Dimon's Speech at NY Times.
Overall, the speech is EXTREMELY negative short/medium term. He seems to be bullish long term (but doesn't elucidate time frame). However it is very interesting because he lays out what he feels the cause of the fiasco was, and who is to blame (everybody). He also discusses some ways to improve the situation and some unique technical points that needed to be said. Of course he is talking his book somewhat, but it doesn't invalidate his points. He has many many good points and some I disagree with.
unfortunately, many people will never hear this speech, and many who do won't understand a lot of this. I was going to give my own synopsis of what he said, but I strongly encourage people to listen to what he says for themselves. He is not an oracle, but he has some good points.
as I've said before (I think) the housing boom was really a side manifestation of a credit boom. Loose credit was everywhere, and not restricted to houses. There was very loose lending going on in housing, auto loans (6-7-8 year car loans), credit cards, leveraged buyouts from venture capital and private equity, leverage in hedge funds and SIVs, overlending in commercial real estate, and so on. This credit boom is now contracting. The last 1 year there has been a lot of unwinding of credit and leverage, but nobody knows how much further we have to go.
In time, I do believe that we can get through this (just like Mr. Dimon says) but it will take time. (I think a couple of years, but it could be a decade, it could be 1 year... who knows?)
Posted by: ex SF-er at July 8, 2008 3:13 PM
I have been of the opinion that a government intervention is just going to prolong the collapse of the credit bubble and drag things out and that a shorter sharp drop is preferable to something like the 15 yr fiasco that was Japan's housing market in the 90's.
Have you seen anything, or can think of anything that argues that against this idea?
The only thing I can really think of is the idea that the Fed should try to engineer an "orderly" unwinding instead of a "panic" which might create greater problems then are warranted.
However, it seems the markets are all looking for that "panic" moment, aka capitulation, before letting the bulls loose again. Many seemed to think it was when Bear Sterns went down but it looks pretty clear that the market rise after the Bear Sterns collapse was basically a "dead cat bounce". It seems that in preventing a panic that the Fed is preventing some kind of important psychological signal to the markets.
Posted by: badlydrawnbear at July 8, 2008 3:24 PM
Another well written post. I agree with your distinctions between the wheat and the chaff in the banking industry. JPM is among the better positioned and yet they had to take $9.2b worth of writedowns and raise about $8b worth of capital themselves. That may answer Foolio's question about why even the better positioned lenders don't "simply raise rates some" as they too need to clean up their balance sheets.
Posted by: Recent ORH buyer at July 8, 2008 3:26 PM
I agree with your point. Govt interference risks prolongation of the pain and even making the eventual pain worse. However, it is unclear if the economy can handle a rapid deleveraging. I personally do not desire a govt bailout, I only mention that it is extremely likely in the future (in my opinion of course). I have no way of knowing what the "correct" path is... should we take our pain quickly and recover, or should we drag it out? can we handle the quick dose? can we handle it slowly?
I think of it like chemotherapy for cancer. We titrate the dose very closely trying to kill the cancer but leave the patient as able as possible. If we overdo it or go too quickly then we risk killing the patient.
many of the financial products out there have NEVER been tested before during recession/contraction (like CDO-squareds). The models used to predict their behaviour have failed miserably. thus, nobody knows what will happen (not me either). to compound matters, the amount of these finanical products exploded exponentially... so it's Trillions and Trillions of dollars and almost every big bank is involved. A lot of this stuff is in the so-called shadow banking system, so it's completely unregulated and again nobody has access to these records. so it's a big question mark. who has what, who has how much, who is linked, and so on.
The fear of the unknown is what caused the Fed to assist in the Bear takeover. They didn't do it to save Bear. they did it because if they didn't Bear would have gone down probably pulling JP Morgan and their other counterparties with them. (JP Morgan was Bear's biggest counterparty). If Bear and JP Morgan went, then the worry was that all their counterparties could fail too, then THEIR counterparties. and so on. systemic risk.
The Fed and govt are making a gamble right now, and I don't know if they are making the right gamble. they are gambling that if they provide enough capital to the banks then the banks can earn revenue to offset their losses and remain solvent until the deleveraging is complete and the economy improves. can they do it? I don't know. should they do it? i don't know.
The sequelae of their actions is that our dollar is toast, price inflation for many goods is sky high, and commodities have exploded. this was to be expected and surprises nobody except for the Fed itself (who knows why).
the thing I dislike is the dishonesty and the opacity. The Bear deal involved taxpayer money. thus I feel taxpayers should be allowed to have access to records, and if the deal works should share in the profits. Instead, if the deal works JP morgan profits, if the deal fails taxpayers out 29Billion bucks.
I dislike the opacity. there are all these lending facilities now, but we have no access to WHO is using them, HOW MUCH they're using them for, and WHAT the assets are that secured these "loans". I understand why the secrecy is required... if it got out that Bank "A" used the TAF then there would be a bank run on Bank "A"... but WHO is overseeing this???? I feel it is very possible that companies (like Goldman sachs) are using crap for collateral and borrowing from the Fed getting Treasuries and then using those Treasuries to bid up commodities... is this what we want????
In the future, it is possible that a big bank will fail. when that comes the Fed and govt will have a decision to make... can the financial system survive the bank going under. If so, they will let it fail. if not, they will nationalize it. in my opinion, Fannie and Freddie are too big to fail. If they go under they will be nationalized. I have no idea if that is the "right" answer or not... but it is what will be done. And then the pisser: they will fail partially because of all these unregulated hedge funds and banks that put their crap into Fannie/Freddie... and those gents will keep their multi-million dollar bonuses.
Posted by: ex SF-er at July 8, 2008 4:15 PM
IndyMac was bailed out by the Fed. Estimated cost to the taxpayers of $4-8B.
"IndyMac Bank's assets were seized by federal regulators on Friday after the mortgage lender succumbed to the pressures of tighter credit, tumbling home prices and rising foreclosures.
The bank is the largest regulated thrift to fail and the second largest financial institution to close in U.S. history, regulators said."
Posted by: Michael at July 12, 2008 10:20 AM