Straight Talk on the Mortgage Mess from a Mortgage Industry Insider, as
featured at MarketWatch, 12:11:23 PM, December 6th, 2007.
by Richard Clark
http://www.opednews.com/articles/1/opedne_richard__071208_mortgage_industry_in.htm
Even before this mortgage mess started, this insider with 20 years
experience in the mortgage industry kept saying that this is going to
get real bad. He kept saying this was beyond sub-prime, beyond low FICO
scores, beyond Alt-A, and beyond the imagination of most pundits,
politicians and the press. When he was asked why somebody from inside
the industry would be so emphatically sounding the alarm, he simply
replied, “Somebody’s got to warn people.”
Since then, Mark Hanson has spent most of his career in the
wholesale and correspondent residential arena, primarily on the West
Coast. So far he has been pretty much on target as the situation has
unfolded.
His current thoughts, which I urge you to read, follow a short
introduction, the first part of which is a synopsis of the New Road To
Serfdom article in the May 2006 issue of Harpers, written by Michael
Hudson, who saw what was coming:
"Although home ownership has been a wise choice for many people,
this particular real estate bubble has been carefully engineered to lure
home buyers into circumstances detrimental to their own best interests.
The bait is easy money. The trap is a modern equivalent to peonage – a
lifetime spent working to pay off debt on an asset of rapidly dwindling
value.
Most everyone involved in the real estate bubble thus far has made
money. But all that is about to change. The bubble will burst . . and
when it does, the people who thought they would be living the easy life
of a landlord will soon find that what they really signed up for was the
hard servitude of debt serfdom.
Many home owners are spending tomorrow’s capital gain today by
taking out home-equity loans. For families whose real wages are stagnant
or falling, borrowing against higher property prices seems almost like
taking money from a bank account that has earned valuable dividends. New
home-equity loans added $200 billion to the US economy in 2004 alone.
The problem is, home-owner debt is about to surpass the size of
America’s entire domestic product. And in growing numbers of housing
markets around the country, home prices seem to have reached their peak,
and in some places are already in decline.
Even Alan Greenspan stated home prices had “risen to unsustainable
levels,” and would have exceeded the reach of many Americans long ago .
. if not for “the dramatic increase in the prevalence of interest-only
loans” and “other, more exotic forms of adjustable–rate mortgages that
enable marginally qualified borrowers to purchase homes at inflated
prices.” If this trend continues, Greenspan said, homeowners and banks
alike “could be exposed to significant losses.”
The second part of this introduction is extracted from the World
Socialist Web Site at http://wsws.org:
"The New York Times recently reported that Treasury Secretary Hank
Paulson’s former firm, Goldman Sachs, began unloading its mortgages and
mortgage-backed securities late last year when subprime defaults began
to soar. But the top investment bank continued to package and sell
securities backed by subprime mortgages, marketing $6 billion worth of
these securities in the first nine months of 2007.
Those who were hustled into taking a subprime adjustable-rate
mortgage were assured that they would be able to refinance their loans
before the reset rates—generally 30 percent higher—kicked in two or
three years later because the market values of their homes would have
significantly risen in the interim. But the collapse of the housing
market and sharp decline in home prices has left many of these borrowers
owing more than their homes are now worth.
Seeking relief for banks and big investors
The motivation behind the discussions is the growing alarm on Wall
Street and in Washington over the potentially catastrophic financial
implications of the accelerating housing slump and related crisis on
credit markets. The proposals under discussion are calibrated to avert
(at the least possible cost to the banks and big investors) a collapse
of major US banks and other financial institutions that could be
triggered by spiraling home foreclosures.
In essence, the scheme is aimed at containing the home foreclosure
epidemic sufficiently to shield the major financial institutions from
the full consequences of years of rampant speculation, accompanied by
accounting manipulations that concealed the immense levels of risk
behind the soaring profits and gargantuan salaries reaped by Wall Street
executives.
Were the plan implemented, it would allow holders of
mortgage-backed securities to put off marking down their assets.
The real estate and credit bubbles that have now burst, victimizing
millions of working class and middle class families, were intimately
bound up with fraudulent and predatory lending practices encouraged by
the biggest US banks and investment houses.
What makes it even more disgusting is that it's precisely these
arrogant bastards who created the mess, which they profited from, and
then they laugh as they stick ordinary people with the fallout."
==========================
And now the warning from mortgage industry insider Mark Hanson, as
featured at the MarketWatch web site:
The Government and the market are trying to boil this down to a
’sub-prime’ thing, especially with all constant talk of ‘resets’. But
sub-prime loans were only a small piece of the mortgage mess. And
sub-prime loans are not the only ones with resets. What we are
experiencing should be called ‘The Mortgage Meltdown’ because many
different exotic loan types are imploding currently belonging to what
lenders considered ‘qualified’ or ‘prime’ borrowers. This will continue
to worsen over the next few of years. When ‘prime’ loans begin to
explode to a degree large enough to catch national attention, the
ratings agencies will jump on board and we will have ‘Round 2′. It is
not that far away.
Since 2003, when lending first started becoming extremely lax, a
small percentage of the loans were true sub-prime fixed or arms. But
sub-prime is what is being focused upon to draw attention away from the
fact the lenders and Wall Street banks made all loans too easy to attain
for everyone. They can explain away the reason sub-prime loans are
imploding due to the weakness of the borrower.
How will they explain foreclosures in wealthy cities across the
nation involving borrowers with 750 scores when their loan adjusts
higher or terms change overnight because they reached their maximum
negative potential on a neg-am Pay Option ARM for instance?
Sub-prime aren’t the only kind of loans imploding. Second
mortgages, hybrid intermediate-term ARMS, and the soon-to-be infamous
Pay Option ARM are also feeling substantial pressure.
The latter three loan types mostly were considered ‘prime’ so they
are being overlooked, but will haunt the financial markets for years to
come. Versions of these loans were made available to sub-prime borrowers
of course, but the vast majority were considered ‘prime’ or Alt-A. The
caveat is that the differentiation between Prime and ALT-A got smaller
and smaller over the years until finally in late 2005/2006 there was
virtually no difference in program type or rate.
The bailout we are hearing about for sub-prime borrowers will be
the first of many. Sub-prime only represents about 25% of the problem
loans out there. What about the second mortgages sitting behind the
sub-prime first, for instance? Most have seconds. Why aren’t they
bailing those out too? Those rates have risen dramatically over the past
few years as the Prime jumped from 4% to 8.25% recently. Seconds are
primarily based upon the prime rate. One can argue that many sub-prime
first mortgages on their own were not a problem for the borrowers but
the added burden of the second put on the property many times
after-the-fact was too much for the borrower.
Most sub-prime loans in existence are refinances not purchase-money
loans. This means that more than likely they pulled cash out of their
home, bought things and are now going under. Perhaps the loan they hold
now is their third or forth in the past couple years. Why are bad
borrowers, who cannot stop going to the home-ATM getting bailed out?
The Government says they are going to use the credit score as one
of the determining factors. But we have learned over the past year that
credit scores are not a good predictor of future ability to repay.
This is because over the past five years you could refi your way
into a great score. Every time you were going broke and did not have
money to pay bills, you pulled cash out of your home by refinancing your
first mortgage or upping your second. You pay all your bills, buy some
new clothes, take a vacation and your score goes up!
The ’second mortgage implosion’, ‘Pay-Option implosion’ and ‘Hybrid
Intermediate-term ARM implosion’ are all happening simultaneously and
about to heat up drastically. Second mortgage liens were done by nearly
every large bank in the nation and really heated up in 2005, as first
mortgage rates started rising and nobody could benefit from refinancing.
This was a way to keep the mortgage money flowing. Second mortgages to
100% of the homes value with no income or asset documentation were among
the best sellers at CITI, Wells, WAMU, Chase, National City and
Countrywide. We now know these are worthless especially since values
have indeed dropped and those who maxed out their liens with a 100%
purchase or refi of a second now owe much more than their property is worth.
How are the banks going to get this junk second mortgage paper off
their books? Moody’s is expecting a 15% default rate among ‘prime’
second mortgages. Just think the default rate in lower quality such as
sub-prime. These assets will need to be sold for pennies on the dollar
to free up capacity for new vintage paper or borrowers allowed to pay 50
cents on the dollar, for instance, to buy back their note.
The latter is probably where the ’second mortgage implosion’ will
end up going. Why sell the loan for 10 cents on the dollar when you can
get 25 to 50 cents from the borrower and lower their total outstanding
liens on the property at the same time, getting them ‘right’ in the home
again? Wells Fargo recently said they owned $84 billion of this
worthless paper. That is a lot of seconds at an average of $100,000 a
piece. Already, many lenders are locking up the second lines of credit
and not allowing borrowers to pull the remaining open available credit
to stop the bleeding. Second mortgages are defaulting at an amazing pace
and it is picking up every month.
The ‘Pay-Option ARM implosion’ will carry on for a couple of years.
In my opinion, this implosion will dwarf the ’sub-prime implosion’
because it cuts across all borrower types and all home values. Some of
the most affluent areas in California contain the most Option ARMs due
to the ability to buy a $1 million home with payments of a few thousand
dollars per month. Wamu, Countrywide, Wachovia, IndyMac, Downey and Bear
Stearns were/are among the largest Option ARM lenders. Option ARMs are
literally worthless with no bids found for many months for these assets.
These assets are almost guaranteed to blow up. 75% of Option ARM
borrowers make the minimum monthly payment. Eighty percent-plus are
stated income/asset. Average combined loan-to-value are at or above 90%.
The majority done in the past few years have second mortgages behind them.
The clue to who will blow up first is each lenders ‘max neg
potential’ allowance, which differs. The higher the allowance, the
longer until the borrower gets the letter saying ‘you have reached your
110%, 115%, 125% etc maximum negative of your original loans balance so
you cannot accrue any more negative and must pay a minimum of the
interest only (or fully indexed payment in some cases). This payment
rate could be as much as three times greater. They cannot refinance, of
course, because the programs do not exist any longer to any great
degree, the borrowers cannot qualify for other more conventional
financing or values have dropped too much.
Also, the vast majority have second mortgages behind them putting them
in a seriously upside down position in their home. If the first mortgage
is at 115%, the second mortgage in many cases is at 100% at the time of
origination — and values have dropped 10%-15% in states like California
— many home owners could be upside down 20% minimum. This is a prime
example of why these loans remain ‘no bid’ and will never have a bid.
These also will require a workout. The big difference between these and
sub-prime loans is at least with sub-prime loans, outstanding principal
balances do not grow at a rate of up to 7% per year. Not considering
every Option ARM a sub-prime loan is a mistake.
The 3/1, 5/1, 7/1 and 10/1 hybrid interest-only ARMS will reset in
droves beginning now. These are loans that are fixed at a low
introductory interest only rate for three, five, seven or 10 years —
then turn into a fully indexed payment rate that adjusts annually
thereafter. They first got really popular in 2003. Wells Fargo led the
pack in these but many people have them. The resets first began with the
3/1 last year.
The 5/1 was the most popular by far, so those start to reset
heavily in 2008. These were considered ‘prime’ but Wells and many others
would do 95%-100% to $1 million at a 620 score with nearly as low of a
rate as if you had a 750 score. No income or asset versions of this loan
were available at a negligible bump in fee. This does not sound too
‘prime’ to me. These loans were mostly Jumbo in higher priced states
such as California.
Values are down and these are interest only loans, therefore, many
are severely underwater even without negative-amortization on this loan
type. They were qualified at a 50% debt-to-income ratio, leaving only
50% of a borrower’s income to pay taxes, all other bills and live their
lives. These loans put the borrower in the grave the day they signed
their loan docs especially without major appreciation. These loans will
not perform as poorly overall as sub-prime, seconds or Option ARMs but
they are a perfect example of what is still considered ‘prime’ that is
at risk. Eighty-eight percent of Thornburg’s portfolio is this very loan
type for example.
One final thought. How can any of this get repaired unless home
values stabilize? And how will that happen? In Northern California, a
household income of $90,000 per year could legitimately pay the minimum
monthly payment on an Option ARM on a million home for the past several
years. Most Option ARMs allowed zero to 5% down. Therefore, given the
average income of the Bay Area, most families could buy that million
dollar home. A home seller had a vast pool of available buyers.
Now, with all the exotic programs gone, a household income of
$175,000 is needed to buy that same home, which is about 10% of the Bay
Area households. And, inventories are up 500%. So, in a nutshell we have
90% fewer qualified buyers for five-times the number of homes. To get
housing moving again in Northern California, either all the exotic
programs must come back, everyone must get a 100% raise or home prices
have to fall 50%. None, except the last sound remotely possible.
What I am telling you is not speculation. I sold MILLIONs of these
very loans over the past five years. I saw the borrowers we considered
‘prime’. I always wondered ‘what WILL happen when these things adjust
and values don’t go up 10% per year’.
Comments or questions? Post them here or at the web site here. Mark will
likely be personally responding to any comments.
