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Housing Bubble Boondoggle: “Is
it too late to get out”?
By Mike Whitney
04/24/07 "ICH"
-- -- - Treasury Secretary Henry Paulson delivered an upbeat
assessment of the slumping real estate market on Friday saying,
"All the signs I look at" show "the housing market is at or near
the bottom.”
Baloney.
Paulson added that the meltdown in subprime mortages was not a
“serious problem. I think it’s going to be largely contained.”
Wrong again.
Paulson knows full well that the housing market is headed for a
crash and probably won’t bounce back for the next 4 or 5 years.
That’s why Congress is slapping together a bailout package that
will keep struggling homeowners out of foreclosure. If defaults
keep skyrocketing at the present rate they are liable to bring
the whole economy down in a heap.
Last week, the Senate convened the Joint Economic Committee,
chaired by Senator Charles Schumer. The committee’s job is to
develop a strategy to keep delinquent subprime mortgage holders
in their homes. It may look like the congress is looking out for
the little guy, but that’s not the case. As Schumer noted, “The
subprime mortgage meltdown has economic consequences that will
ripple through our communities unless we act.”
Schumer’s right. The repercussions of millions of homeowners
defaulting on their loans could be a major hit for Wall Street
and the banking sector. That’s what Schumer is worried
about---not the plight of over-leveraged homeowners.
Every day now, another major lending institution unveils its
plan for bailing out the housing market. Citigroup and Bank of
America have joined forces to create the Neighborhood Assistance
Corporation of America which will provide $1 billion for the
rescue of subprime loans. This will allow homeowners to
refinance their mortgages and keep them out of foreclosure. The
new “30- year loans will carry a fixed interest rate one point
below the prime rate, putting it currently at 5.5 percent. There
are no fees, and the banks pay all the closing costs.”
But why are the banks being so generous if, as Paulson says,
“the housing market is at or near the bottom.” This proves that
the Treasury Secretary is full of malarkey and that the problem
is much bigger than he’s letting on.
Last week, Washington Mutual announced a $2 billion program to
slow foreclosures (Washington Mutual's subprime segment lost
$164 million in the first quarter) while Freddie Mac committed a
whopping $20 billion to the same goal. In fact, Freddie Mac
announced that it “would stretch the loan term to a maximum of
40 years from the current 30-year limit.”
40 years!?! How about a 60 or 80 year mortgage?
Can you sense the desperation? And yet, Paulson says he doesn’t
see the subprime meltdown as a “serious problem”?!?
Paulson’s comments have had no effect on the Federal Reserve.
The Fed has been frantically searching for a strategy that will
deal with the rising foreclosures. On Wednesday, The Washington
Post reported that “Federal bank regulators called on lenders to
work with distressed borrowers unable to meet payments on
high-risk mortgages to help them keep their homes”.
Huh?!?
When was the last time the feds ordered the privately-owned
banks to rewrite loans?
Never—that’s when.
That gives us some idea of how bad things really are. The
details of the meltdown are being downplayed in the media to
prevent panic-selling among the public. But the Fed knows what’s
going on. They know that “U.S. mortgage default rates hit an
all-time high in the first quarter of 2007” and that “the
percentage of mortgages in default rose to a record 2.87%”. In
fact, the Federal Reserve and the five other federal agencies
that regulate banks issued this statement just last week:
"Prudent workout arrangements that are consistent with safe and
sound lending practices are generally in the long-term best
interest of both the financial institution and the
borrower…Institutions will not face regulatory penalties if they
pursue reasonable workout arrangements with borrowers."
Translation: “Rewrite the loans! Promise them anything! Just
make sure they remain shackled to their houses!”
Unfortunately, the problem won’t be “fixed” with a $30 or $40
billion bailout scheme. The problem is much bigger than that.
There is an estimated $2.5 trillion in subprimes and Alt-A
loans---20% of which are expected enter foreclosure in the next
few years. Any up-tick in interest rates or unemployment will
only aggravate the situation.
Kenneth Heebner, manager of CGM Realty Fund (Capital Growth
Management), provided a realistic forecast of what we can expect
in the near future as defaults increase.
Heebner: “The Greatest Price Decline in Housing since the Great
Depression” (Bloomberg News interview)
“The real wave of pain and foreclosures is just
beginning….subprimes and Alt-A are both in trouble. A lot of
these will go into default. The reason is, that the people who
took these out never really intended to fully service the
mortgage---they were counting on rising home prices so they
could sign on the dotted line without showing what their income
was and then 2 years later flip into another junk mortgage and
get a big profit out of the house with putting anything down…
“There’s a $1.5 trillion in subprimes and $1 trillion in Alt-A
the catalyst will be declining house prices which is already
underway. But as we get a large amount of these $2.5 trillion
mortgages go into default, we’ll see foreclosed houses dumped on
an already weak market where homebuilders are already struggling
to sell there houses. The price declines which have started will
continue and may even accelerate in some of the hotter markets.
I would expect that housing prices in “2007 will decline 20% in
a lot of markets”.
“What you are going to see is the greatest price decline in
housing since the Great Depression…..The one thing that people
should not do, is go near a CDO or a residential mortgage backed
security rated Triple A by Moody’s and S&P because these are
going to get down-graded by the hundreds of millions---because
they are secured by subprime and Alt-A mortgages where there’ll
be massive defaults”.
Question—Will the losses in the mortgage market exceed those in
the S&L crisis?
Heebner: “They’re going to dwarf those losses because the losses
could easily approach $1 trillion---that dwarfs anything that
has ever happened. Enron was $100 billion---this will be far
greater than that…..The good news is that most of these loans
are owned by Hedge Funds…You hedge funds buying these subprime
and Alt-A loans and leveraging them at 10 to 1. They buy a pool
of mortgages at 8% and they borrow against it in yen for 3% and
then lever it at 10 to 1so you have a lucrative profit And the
hedge fund you are running, the manager is going to get 20% of
the gain---so even if it’s a year before you go broke; you get
rich until the fund is shut down”.
Heebner added this instructive comment: “The brokerage firms
created “securitization” they know the products are toxic. I
don’t think they are going to suffer losses; they simply passed
them on to everyone else. The only impact this will have is the
profits that flow from it will get less….But it is less than 3%
of revenues in even the most exposed brokerage firm so THEY’RE
NOT GOING TO GET CAUGHT.”
Although Heebner believes the brokerage houses will do fine; the
same is not true for the small investor. Nearly 70% of subprimes
have been securitized. That means that the vast number of shoddy
“no down payment, no document, interest-only” loans (that are
headed for default) have been transformed into securities and
sold to hedge funds. As the housing market continues to falter,
these funds will plummet at an inverse rate to the amount of
leverage that has been applied. That may explain why, (according
to Bloomberg Markets) the “wealthiest Americans have been
bailing out” of hedge funds at an alarming rate. A report in
last Thursday’s New York Times stated:
“Americans with a net worth of at least $25 million, excluding
the value of their primary homes, reduced their exposure to
hedge funds in 2006”-- The amount of money held by wealthy
investors in hedge funds has dropped dramatically-- “The average
balance, which was $2.8 million in 2005, was just $1.6 million
last year, a 43 percent decline”.
So, what do America’s richest investors know that the rest of us
don’t?
Could it be that the over-leveraged hedge funds industry is
about to get hammered by the subprime implosion?
If so, it won’t be the brokerage houses or savvy insiders who
get hurt. It’ll be the little guys and the pension funds that
take a drubbing.
In Henry C K Liu’s “Why the Subprime Bust will Spread” (Asia
Times) the author states that the bursting housing bubble will
trigger a major pension crisis. After all, who are the
“institutional investors? They are mostly pension funds that
manage the money the US working public depends on for
retirement. In other words, the aggregate retirement assets of
the working public are exposed to the risk of the same working
public defaulting on their house mortgages”. (Liu)
The origins of the housing bubble are complex, but they are
worth understanding if we want to know how things will progress.
The housing bubble is not merely the result of low interest
rates and shabby lending practices. As Liu says, “the bubble was
caused by creative housing finance made possible by the
emergence of a deregulated global credit market through finance
liberalization. The low cost of mortgages lifted all US house
prices beyond levels sustainable by household income in
otherwise disaggregated markets” The deregulated cross-border
flow of funds (via the yen low interest “carry trade” or the
$800 billion current account deficit) have played a major role
in inflating the US real estate market.
Liu adds, “Since the money financing this housing bubble is
sourced globally, a bursting of the US housing bubble will have
dire consequences globally.” Since nearly 50% of “securitized”
mortgage debt is owned by foreign investors; the subprime
meltdown is bound send tremors through the entire global
financial system.
The housing decline is further complicated by Wall Street
innovations in derivatives trading which has generated trillions
of dollars in “virtual” wealth and is affecting the Feds ability
to control inflation through interest rate manipulation. As
Kenneth Heebner said, “You have hedge funds buying these
subprime and Alt-A loans and leveraging them at 10 to 1. They
buy a pool of mortgages at 8% and they borrow against it in yen
for 3% and then lever it at 10 to 1so you have a lucrative
profit.”
In other words, low interest foreign capital has flooded US
markets and contributed to distortions in housing prices.
In her recent article “War Drags the Dollar Down”, Ann Berg
refers to Wall Street’s “swirling galaxy of exotic finance”
which has “worked magic for the government and the elite”, but
has yet to weather a severe downturn in the economy.
But how will market deal with sudden downturn in the hedge fund
industry? Will the dodgy subprimes and shaky collateralized debt
obligations (CDOs) trigger a crash or has the risk been wisely
dispersed through derivatives trading?
No one really knows.
As Berg says, “Derivatives numbers are staggering. The Bank for
International Settlements estimates that the notional amount of
derivatives traded on regulated exchanges topped a quadrillion
dollars last year and that the outstanding unregulated
off-exchange (called over-the-counter – OTC) amount stood at
$370 trillion in June 2006. Because the OTC market is composed
of endless strings of bilateral transactions – the systemic risk
is unknown.”
The comments of the President of the New York Fed, Timothy
Geithner, help to clarify the abstruse activities of the modern
market:
“Credit market innovations have transformed the financial system
from one in which most credit risk is in the form of loans, held
to maturity on the balance sheets of banks, to a system in which
most credit risk now takes an incredibly diverse array of
different forms, much of it held by nonbank financial
institutions that mark to market and can take on substantial
leverage.
Geither’s right. The markets now operate as unregulated banks
generating mountains of credit through massively leveraged debt
instruments---a monster credit bubble larger than anything in
the history of capitalism.
So, where is all this headed?
No one really knows. But when the housing bubble crashes into
Wall Street’s credit bubble,; we can expect the “big bang”. That
may explain why America’s wealthiest investors are running for
cover before the whole thing blows. (A number of investors have
already cashed out and put there holdings into foreign funds and
currencies)
One thing is certain ---time is running out. With $1 trillion in
subprimes and Alt-A loans headed for default the system is
facing its greatest challenge. US- GDP has been revised to a
measly 1.8%, foreign investment is down, and the dollar is
losing ground to the euro on an almost weekly basis.
Falling home prices have already precipitated a number of other
problems. For example, Gene Sperling reports in “Housing Bust
Meets the Equity Blues” that “The Fed data showed an amazing
expansion (in Mortgage-Equity Withdrawal). In 1995, active MEW
had been $37 billion. By the fourth quarter of 2005, it soared
to $532 billion annualized, a 14-fold expansion”. These equity
withdrawals have translated into consumer spending which
accounts for at least 1 full percentage point of GDP. Declining
house prices means that extra boast for the economy will now
disappear.
Foreclosures are soaring and expected to get worse for the next
two years at least. In California foreclosure filings jumped 79%
in March alone. Other “hot markets” are reporting similar
figures.
The glut of new homes for sale on the market has slammed sales
of the nation's major builders; most are reporting profits are
down by 40% or more.
The collapse of the subprime mortgage market is also pushing
some big U.S. homebuilders toward Chapter 11. According to
Bloomberg News, “Some builders are staying out of bankruptcy by
relying on the profits they made when sales boomed” in 2004 and
2005. Starting next year they must begin to repay $3.6 billion
in public debt in what will certainly be a falling market. The
prospects don’t look good.
Also, Credit card debt is way up (nearly 7% in one year) and
economists are predicting that the trajectory will continue now
that home equity is vanishing. Americans savings rate is in
negative numbers and the steep increase in credit card debt
(with its high interest rates) only compounds the problem. The
American consumer has now compiled more personal debt than
anytime in history.
The Grim Reaper Meets the Housing Bubble
Those who follow developments in real estate have heard many of
the wacky anecdotes related to the housing bubble. Stories
abound of young people buying homes just to pay off tens of
thousands of dollars of collage loans with their “presto”-equity
---or low paid construction laborers securing 105% loans without
any proof of income and a poor credit history. One of the
stories that got national attention was about Alberto and Rosa
Ramirez, who worked as strawberry pickers in the fields around
Watsonville each earning about $300 a week. They (somehow?)
qualified for a loan of $720,000 which paid for a "new"
four-bedroom, two-bath house in Hollister.
It’s sheer madness!
Obviously, those days are over. The speculative frenzy that was
generated by the Fed’s low interest rates, the banks lax lending
standards, and the deregulated global credit market is drawing
to a close. The fallout from the collapse in subprime-loans will
roil the stock market and hedge funds, but, as Heebner says, the
investment banks and brokerage firms will escape without a
bruise.
Where's the justice?
Despite Hank Paulson’s cheery predictions, we are no where “near
the bottom”. In fact, a recent survey showed that only 1 in 7
Americans believe that house prices will go down. Even now, very
few people grasp the underlying issues or the potential for
disaster. We’re on a treadmill to oblivion and they think it’s a
merry-go-round.
As housing prices tumble, more homeowners will experience
“negative equity”, that is, when the current value of their home
is less than the sum of their mortgage. This is the very
definition of modern serfdom.
We can expect to see an erosion of confidence in the market, a
rise in inventory, and a steady increase in defaults. More and
more people will walk away from their homes rather than be
hand-cuffed to an asset that loses value every day. This could
transform a "housing correction" into a nation-wide financial
calamity.
Many peoples’ futures are linked directly to the "anticipated"
value of their homes. It is impossible to determine how shocked
they’ll be when prices retreat and equity shrivels. The housing
flame-out has all the makings of a national trauma—another
violent jolt to the fragile American psyche.
So far, we're still in the first phase of a process that will
probably play out for 10 years or more. (Judging by Japan’s
decades-long decline) None of the bailout plans are large enough
to make any quantifiable difference. The numbers are just too
big.
Housing prices are coming down and the real estate market will
return to fundamentals. That much is certain. The law of gravity
can only be ignored for so long.
Just don’t count on a “soft landing”.
Special thanks to
http://patrick.net/housing/crash.html (Housing Crash
News)
See entire Heebner interview at
http://patrick.net/housing/contrib/future.html )
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