Expecting the Worst, Trying Their Best

Let's start out here by giving credit where it's due – no, wait, unfortunate phrasing... there's been too much credit out there for a while.

Let's congratulate our elected leaders and the quasi-governmental overlords of our financial system. They know that the storm is only just getting started, and they are trying to get some pieces in place to get the public ready and set up emergency services, just in case the storm hits hard. "Subprime," they know now, was like the whipping winds at the leading edge of a storm that looks to be on the horizon. No sense spinning the story now.

We'll check in here with the Treasury Secretary, the Fed and the U.S. Congress. They're all trying to help.

Paulson and the 'Hope Now Alliance'

Here's Henry Paulson, former Goldman Sachs CEO and current U.S. Treasury Secretary, at Tuesday's news conference, responding to a reporter's question:

Q: Sir, is the worst over? Will 2008 have fewer foreclosures and some rising home prices, compared to '07?

Paulson: Well, I would say this, in terms of subprime, and the resets, the worst isn't over, it's just beginning. We all know that.

There's close to 1.8 million, 2 million adjustable rate mortgages where the rate is going to be reset, and the ones that are being reset over the next couple of years are that vintage of mortgages where there were the most lax underwriting procedures. So, this is the biggest challenge. That's why this is so important.

And I also said that the housing correction – what's going on with the housing market – is not over. It's going to take longer.

Paulson must know that his old firm now projects March 2008 as "the worst" month for subprime resets, with plenty of other nontraditional loan products expected to go bad on their own schedules through 2010. (Consistent with this BofA chart we published in Aug. 2007 [click to enlarge].) Of course, the impacts of resets (defaults, foreclosures, REOs, losses & writedowns) follow over several months afterward.

Quick tangent – if you think securitized residential mortgages were a kick in the arse, Goldman warns, get ready for flareups among securitized commercial mortgages next. Frightening fact, via Goldman: whereas about 20% of commercial RE loans were interest-only in 2000, that share rose to 86% of those issued in 2007. Can you say "increased default risk?" Now, who holds those loans in bulk?

Back to Hank. The cause for Paulson's news conference Tuesday was to announce a new "lifeline" that 6 major banks will offer to home loan borrowers in default. Here's how it works:

In an effort to get the attention of defaulting borrowers, the banks will send them a letter.

Really. A letter – that was the point of the news conference. (If you think we're diminishing the real program, click here for the press release or here for the "overview" of "Project Lifeline.")

Borrowers who get the letter need to call the lender within 10 days, profess a desire to keep their home, and supply financial information so the bank can assess what kind of a workout is possible. If foreclosure is under way, the banks might pause it for 30 days.

This is not much of a rescue plan. In fact, it is pointedly not a "moratorium on foreclosures," the materials note. (Certain presidential candidates have demanded that.)

Paulson and the 6 banks (the "Hope Now Alliance") were criticized for ignoring defaulting homeowners with The Freeze, a plan announced in December to put off rate resets for certain deserving borrowers. (See MBC's "The Freeze & The Hope.") So this is the bone they're throwing – oh, sorry, "lifeline" – to the bad-news borrowers.

Now they've got 2 press conferences and 2 plans that might help a little portion of the people whose loans are going bad. They're trying. We can't say they're really doing much.

MBC is especially skeptical of the new plan because folks in default have often made a psychic break long before the first Notice of Default arrives. By the time the bank calls or sends a letter, the borrowers are hearing from all sorts of would-be rescuers (foreclosure sharks, mainly) and they can be immune to the sort of "hope" this "lifeline" plan is supposed to offer.

The best that can be said for all this hype from "Hope Now" is that it might help to reach a few more borrowers in trouble, and inspire them to work with their lenders. On a case-by-case basis, that matters, but it doesn't change the fundamentals much.

The Fed

Some of the other big news out of D.C. is the Fed's ongoing rate-cutting campaign. (Thank you, sirs, may we have another?) The market expects another 0.5% cut at the next meeting, and that would put the Fed's rate inarguably below the rate of inflation.

The Fed cuts are having all sorts of impacts, but they're not affecting rates on new mortgages much. (Some borrowers with adjustable-rate loans will benefit.) As is painfully apparent, mortgage rates are driven by other factors – long-term notes and inflation expectations among them.

In a worst case, the Fed's efforts to stimulate the economy with easier credit cause price inflation and higher mortgage rates, making home-buying even less affordable. The result would be downward pressure on home prices. That's OK if the Fed doesn't care about the housing market, per se, but it is clearly reacting now to the ripple effects of declining house prices. Do you get a better result by tamping down home prices further?
Back to Paulson for a moment. As we noted in a recent story, the Treasury Sec'y believes that the "housing correction is inevitable and necessary." We'll take that as his vote for tamping down home prices further.

The U.S. Congress

A new economic stimulus package passed by Congress has a critical housing-related provision. The GSEs (Fannie Mae, Freddie Mac) will be able to buy much bigger loans – up to $730k for loans issued in the second half of this year (July 1 '08-Dec. 31 '08). That's up from $417k.

The move will redefine "jumbo" loans this Summer as those loans over $730k. Buyers who need less – at least for a 1st TD – should have readier access to home loans than they do under today's regime of skittish lenders and nonexistent secondary-market buyers (for packaged mortgages). Translation: Come Summer, it might be easier to get a loan than it is now.

But a lot depends.

There's fear that rates will increase across the board, even for lower-level borrowers, to account for the risk of higher-priced, GSE-targeted loans.

No question these new loans will reflect tougher standards than private lenders have recently begun to adopt. You'll need great income and LTV ratios to get a benefit here.

It seems to MBC that, with so much of the recent housing market runup being tied to lax lending standards (see Paulson, way above), tougher standards plus a declining-price environment translate rather naturally to the need for a broader and deeper drop in home prices. Potential buyers can only tap the promised stream of new liquidity if they can truly afford the homes they're purchasing.

In the end, the actions by Hope Now, the Fed and the Congress all sound like efforts to fix the housing market and stabilize prices, but not one of them provides a clear path to do so. Indeed, both Paulson and the Fed seem to be selling out the housing market in favor of bigger concerns. Let's see what that storm really looks like. Batten down the hatches, just in case.

Jumbos Mostly Risky

We are intrigued by this post at Calculated Risk, which features a graph of mortgage loan originations in the first half of 2007. Here's the graph (click to enlarge):

This comes out of a new report by the Office of Federal Housing Enterprise Oversight that discusses the implications of raising the conforming-loan limit, now $417k, meaning that Fannie Mae and Freddie Mac could buy bigger loans.

What the graph shows is that the vast majority of jumbo loans (>$417k) in the subject period were of the types generally considered to be more risky. A third are interest-only ARMs, while almost 20% more are interest-only fixed-rate loans. Another 13% are negative-amortization loans.

Every one of those loans is designed to allow a homeowner to pay substantially less than the normal monthly cost on a given loan balance. These sorts of loans became essential as home prices peaked beyond normal ranges of affordability. Half of all jumbo loans issued in America in Q1 and Q2 of 2007 were issued in California.

Every one of the non-traditional loans is subject to a degree of "payment shock" when the lower-cost period expires. Only on a fixed-rate, interest-only loan does the homeowner know exactly what the new payment will be.

We can chat all day about how home buyers often know what they're getting into, that ARMs can be part of sound financial planning, etcetera, but the reality is that vast numbers of people holding these loans won't be able to afford them after the payment shock.

The graph already feels a bit like a historical artifact. The OFHEO report notes that, by Q3 of 2007, lending standards changed. Likely the mix of loan types among jumbos is changing now, too. So this may be our last good window on what was going on at the peak.

There's much more in the report (click here to download) – your insights are welcome.

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UPDATE: MBC has twice previously featured graphs indicating the "reset" dates for bulk numbers of ARMs. The first story was in March 2007, and the more recent story was in late August.

Treasury Sec. Goes Bearish

The Bush administration is not known for its downcast assessments – quite the contrary.

So today's remarks on housing and the economy by Henry Paulson, the treasury secretary, are indeed "sobering," as the Wall Street Journal puts it. Paulson said (all emphasis below is added):

The ongoing housing correction is not ending as quickly as it might have appeared late last year. And it now looks like it will continue to adversely impact our economy, our capital markets, and many homeowners for some time yet.

How did we get here?

The housing correction has its roots in an eight-year period of exceptional home price appreciation which was fueled by an increased demand for, and an abundant supply of easy credit. Speculation also played a significant role, as the share of buying activity by investors or individuals buying second homes more than doubled from 2000 to 2005. Homebuilders responded to the extraordinary demand for more and larger homes as if it would last forever.

It seems we all agree on that.

What's on the horizon?

[D]espite strong economic fundamentals, the housing decline is still unfolding and I view it as the most significant current risk to our economy. The longer housing prices remain stagnant or fall, the greater the penalty to our future economic growth.

Uh-oh. It's widely acknowledged that the one thing that poses the greatest future risk of major home price declines is the possibility of a recession. (A word not mentioned in Paulson's speech.) Here, the Treasury Sec'y is saying home price declines could lead us to a recession, which in turn could lead to home price declines, which in turn... uh-oh.

You might find it a little bit surprising that the administration is open to a series of new regulations:

We also need to make some changes in our laws and rules in order to prevent some of the excesses and abuses of the last few years from happening again.

Among the issues Paulson addresses:

• the possibility of federal regulation of mortgage brokers (to bring a "higher level of integrity to the mortgage origination process," achem);
• tougher rules for credit rating agencies (the unseen facilitators of the CDO and subprime messes); and
• more federal regulation of mortgage disclosure and other issues.

Click here for the full text of Paulson's speech. It's not all that different from analyses by independent commentators over the last 2-3 years, but it's the fact that this comes from the Treasury that makes this big. It appears we may be living in interesting times.

More Info on ARM Resets

Two problems with adjustable-rate mortgages (ARMs) began the mortgage meltdown earlier this year: rate resets and payment "recasts."

Resets are simple enough to understand: a low interest rate (sometimes an ultra-low teaser rate) expires, and homeowners' payments shift to an adjustable rate, typically higher. That's one payment shock.

Payment "recasts" often occur at the same time – when the "interest only" period on the loan expires, the homeowner must begin to make fully amortized payments. This can boost the monthly payment by 15% or more.

So, this year's meltdown began with resets and recasts on a whole lot of recently issued "subprime" mortgages. Unable to refinance and unable to afford their new payments, many new homeowners stopped paying at all.

The big question for MB and other non-subprime markets is: When do the loans in our neighborhood start resetting/recasting, and then, what do the homeowners do in response?

MBC visited this subject a while back, when Credit Suisse published one chart (right; click to enlarge) showing the resets upcoming over the next 6 years. (Click here to download the whole Credit Suisse report [PDF].)

Our conclusion then: If there's going to be trouble from resets, it starts in 2-3 years.

By Spring 2009, the number of "Prime ARMs" resetting each month nationwide gets big. Presumably that means the phenomenon becomes more common in MB then, too.

A new chart (click to enlarge) by a Bank of America analyst, published Wednesday at Calculated Risk – one of our favorite housing & economics blogs – largely agrees with that conclusion on timing.

(Nerdy notes: If you compare these, note the different scales – the new chart goes up to $120b, while the older, longer-term chart goes up to just $60b. Also, BofA includes non-securitized loans.)

BofA's chart says that a surge in "Jumbo" and "Alt A" resets begins in earnest in March 2009. That would reflect 3-year locks from 2006 purchases as well as 5-year locks from 2004.

All over MB, people who can actually afford the amortized payments are making I/O payments. They'd like to refinance at some point, but it's not urgent. Others who can't really afford the amortized payments may need to refi to avoid the payment shocks.

But today you have to worry that the refi option won't be available. Whether it's the credit crunch, interest rates (in '09), your initial LTV, or the LTV in 2009 if the market declines, there might be no refi "safety valve." If that storm comes together, it could mean more forced sales, and presumably lower prices. (Did you notice the ifs?)

This is a long way of saying that most of the recent crop of MB buyers got better terms – especially longer locks – than the subprime buyers who are now in so much trouble, and all over the news. But when the locks expire here in droves, even upper-income homeowners could feel a lot of pressure.

We'd be remiss not to mention the screaming headline from the BofA graph.

Look at the orange bar in Jan. 2007. Those subprime resets were just taking off as the mortgage meltdown began. Now look at Jan. 2008, and March 2008, and beyond. That orange bar swells up nastily.

You think the "subprime debacle" is big news today? What happens 3-9 months from now?

More Choices in the Trees

A little over 2 weeks ago, 2822 Ardmore was all alone in the Trees, the only listing below $1.585m.

Having watched everything else get snapped up, they raised their price a second time to $1.399m. MBC speculated that this might be the first successful use of the price-increase tactic.

Things have changed. Current listings:

• 1409 Oak ($1.225m)
• 1732 Pine ($1.295m)
• 3504 Maple ($1.299m)
• 2822 Ardmore ($1.399m)
• 637 13th ($1.450m)

Of these, the first two fell out of escrow and re-joined Ardmore. Maple is a new listing and 13th dropped from $1.585m this week.

All of these have challenges. Oak is, well, on Oak, and interestingly it's made of adobe. Sharply remodeled, but different. Pine and 13th are probably best as lot sales, but are overpriced as such.

Maple and Ardmore are move-in ready, but they're both on the smaller side and each has location issues. Actually, Ardmore buyers may have to wait for the sellers to find and close on their new home, which could be a wrinkle.

This segment was very hot for the last several weeks, but it's paused like everything else due to the mortgage mess. If you need to buy in the Trees now, these are your options at the lower end, but wouldn't it be nice to see some improvement in price and inventory?

Waiting for New Escrows

We're sure homes will sell. But the mortgage market mess has clearly disrupted the local real estate market.

It has been 2-3 weeks since a new deal was made, depending on which part of MB you're looking in. (Remember we track only SFRs west of Sepulveda.) Here are the number of days since a new escrow last posted:

Hill Section: 21 days

Sand Section: 16 days

Trees <$2m: 12 days

Trees >$2m: 20 days

As we continue tracking, going forward, here are our starting points. MBC's records show:

Hill Section: Last escrow began July 30, for 877 8th ($3.7m).

Sand Section: Last escrow began Aug. 4, on 469 27th ($1.6m).

Trees <$2m: Last escrow began Aug. 8, on 3108 Poinsettia ($1.65m).

Trees >$2m: Last escrow began July 31, on 2104 Palm ($3.3m).

Corrections/additions/news are all welcome.


UPDATE 1: The first version of this story had a small math error, now fixed above.

UPDATE 2: A Hill Section home that we simply never saw on the MLS (1008 11th; new contrux at $2.9m) went into escrow Saturday. So there was a sale, but not from the homes MBC is tracking from the MLS. For now we're going to leave that 21 day figure above.

In and Out (of Escrow)

We all know escrows can fail for any number of reasons. But MBC is watching this sub-segment of activity more closely in the wake of last week's hullabaloo over mortgage credit, terms & rates.

So far, in just a few days, we have seen no new escrows begin, and two fail.

Quite possibly these are unrelated to the mortgage mess, but we'll discuss them anyway.

1409 Oak is the slickest 1,000-sq.-ft. home west of Sepulveda. The fact that it is barely west of Sepulveda calls for a discount, and it's at $1.225m, a lot-sale price. Word is they accepted an offer at $1.250m. But that fell apart. If you're up for Oak living and $1,200/sq. ft., this is your place.

217 9th is new construction on a corner-lot/half-lot between Manhattan Ave. and Highland (at Bayview) right near downtown. The house is modernist and has some appealing features. It has also been on the market for 418 days (including pre-construction phase). A correspondent reports:

It borders parking lots, a teardown rental and the alley behind Sidedoor bar/900 Club.

What? A location downtown with issues?

The sellers are quite firm, however. They began at $3.250m and increased to $3.350m on July 16, 2007. We're told they dropped in this language (which we don't see now):

Seller will not take less than asking price. Right now is a great time to write an offer!

Instead, we read this:

This is a very unique and special property with state-of-the-art green construction is over loaded with fabulous amenities. Buyer has to understand the extra value of construction cost and less deferred maintenance in the future and the longevity of this Eco-Conscious home.

Hey, we're all for eco-conscious, but aren't you dis-inviting offers with this sort of lecturing?