I’ve surfed the net, listened to news programs, searched SDMB GQ (no results), and read the newspaper, and I still do not understand fully about the so-called mortgage credit crisis (I didn’t even know what to call it till I saw that phrase on one site). This is what I know (or think I know): the subprime lenders are in trouble and going belly up. (“Subprime” meaning they offer interest rates below the prime established by the Federal Reserve Board). Lenders are laying off lots of their employees. People aren’t buying houses.
Why are the subprime lenders in trouble, and why does this affect the whole housing market?
From what I’ve seen in my neighborhood, this is a buyer’s market; so why aren’t people buying? (We’re shopping around for a 2nd mortgage and haven’t had any trouble finding interested lenders.)
How does this affect the stock market (I’m in mutual funds). It seems the market is still volatile; how does the mortgage credit crisis affect it?
What does this portend for the next year or so?
Our current lender has offered 6.89% on a second mortgage; we think we can do better… or should we take the money and run?
For the past several years mortgage lenders have used accounting gimmicks such as option ARMS, negative-amortization loans, and interest only loans to get borrowers into a house in which they couldn’t afford in traditional 15 or 30 year fixed loans.
These loans offer the option of lower early payments which are affordable to these borrowers, but in a few years, the payments must rise, either due to higher interest rates in the ARM (after 1 or 5 years) or the negative amortization reaches a certain threshold.
The ill-informed buyers cannot make these higher payments (in the last year is when the piper came calling, so to speak). Now the houses are being foreclosed on, and there is a glut of these houses in the market. The banks can’t sell the house for what they loaned out on it (or anywhere near) so they are losing their a$$es.
Lenders played hot potato by creating subprime loans in a rising housing market to entice people that couldn’t really afford what their mortgage would become once the sweet adjustable rate period expired a few years down the road (now). For some reason, other financial companies still thought it was a good idea to buy these loans in the secondary market. Now, people are dumping their houses or getting foreclosed outright and that isn’t good for anyone involved. It also boosts the supply of housing which may cause price decreases or just cause houses to sit on the market for unacceptable periods of time.
Its still not really a buyers market in many areas. Prices are stagnant or dropping slowly here in the Boston area but houses are still very expensive historically and a buyer today cannot even be sure that their new house won’t lose 25% of its value within 5 years. Prices went up much more than that in the last decade and they could fall far and fast given the right conditions.
There is no way to know for sure. The stock market isn’t directly tied to the housing industry. Instead of sinking money in houses, people may start pumping money into stocks and that could make it rise. It could also be seen as a necessary correction in the housing market which could also be a good thing.
No one knows at least not for the whole country.
I got 6.5% a year ago but 6.89% has been a good rate historically.
That’s not what subprime means in this case. It means rather that the credit risk of the borrowers is higher then what might be considered a “prime” borrower. (On preview, what Patty said.)
The major problem, as Shagnasty said, is that no one is buying up these loans anymore. The lender doesn’t keep the loan, but packages it, with other mortgages, and sells off pieces. The interest rate they had to offer on these depended on the quality of the loans. By packaging the subprime loans with better quality loans, they could get somewhat better rates while still having the bonds get rated as safe. If you have tiny chunks of 1,000 loans, you don’t care of one goes bad.
It turned out that the rating agencies didn’t quite get how bad the loans were, and that borrowers could not afford the loan when it reset. They were sold with the expectation that interest rates would be low, so the borrower could refinance when the rate ballooned. That didn’t happen, and, stuck with much higher rates, the foreclosure rate is soaring.
I think the reason the mortgage companies are dying is first, they can’t get rid of the loans they wrote, thus they can’t write subprime loans anymore. I’m not sure how much they get hurt by the defaults.
A refi or a home equity loan? If your loan is insured by the gummint, it is still possible to get. Some of the subprimes were too risky to be. Jumbo loans are going up a lot, because they are too big to be insured.
Around me, the prices actually went up a bit last month, but the number of sales went way down. I’d expect DOM is way up too. I suspect prices will be falling soon. Remember, many of the buyers from last year are out of the market now, and since it is hard to sell there will be fewer moving up.
First, there is the scare factor as companies are getting hit by this when it is not expected. Second, if you can’t sell paper, liquidity is down, and you can’t look for better opportunities. The banks who did the Chrysler buyout can’t sell the loan, and are stuck with it. That’s going to limit the number of deals which is going to impact the market. Then there is the problem that a lot of growth has been financed by borrowing on equity. If that goes away, consumers will cut back, which will shrink the economy. Then there are business segments, like hardware stores, which get a lot of money when people move into new houses. They’re going to suffer also.
I suspect there are a lot more complicated things going on also.
I’m still looking for economic articles I read several months back stating the sub-prime issue would manifest itself in October as ARM rates would be readjusted to reflect higher interest rates, along with the strong possibility of higher rates of foreclosures as a result. Now that we already have a sub-prime crunch, the rate adjustment in October could take on greater significance than first thought.
Ultimately though, you have to decide what is best for you, based upon your wants/needs/desires balanced against the level of risk you are willing to take, within the market you wish to play.
Granted, CitiGroup’s problems may be attributed to management issues and the ouster of the CEO. However, their exposure in the mortgage crisis is having a direct effect.
Let’s just hope the Domino Theory isn’t being tested here.
An answer to the second part: Because house prices are set on the margin. At any given time, relatively few houses are for sale. Since a substantial fraction of subprime mortgages are going into default and being forced to sell, they start to have a major effect on the market.
Basically, the housing market is overbuilt and overpriced. During the years of easy money, the prices rose quickly. Not just the prices on houses that people bought with subprime money; all the prices. Now that the easy money is gone, the prices are going to drop. Not just on the foreclosed houses, but on all the houses. In addition, home builders have built record numbers of new homes (many of which are sitting vacant), which puts further downward pressure on prices. However, housing prices are much stickier on the way down than on the way up. It’s easy to sell a house for more than you’ve bought it. You’re happy, your bank is happy, and the buyer’s bank is happy. One the way down, you either have to take a hit to equity (you’re not happy) arrange a short-sale or be foreclosed (neither you nor the bank is happy) or have the buyer find a bank who’ll lend more money than the house is worth (they’re not happy). So prices fall slowly, but they will fall (in real terms. Right now it looks like we’re going to achieve that correction by inflating our way out of it :mad: )
I don’t know about your neighborhood, but I’ve heard lots of claims about it being a “buyer’s market” that don’t hold up to scrutiny. Inventory is up, sure. That means that there are more houses to choose from. But prices are dropping, and most people think that they’re going to continue to drop in the future. Hey, that inventory’s got to go somewhere, right? Call me crazy, but I’m not excited about jumping into buying a house (even if I get my pick), when its going to go down in price for another few years. That sounds like a market where a lucky seller is going to limit his losses by selling to a greater fool. Not exactly a buyer’s market.
And in a lot of places, people can’t buy. Part of that is that housing prices have been driven up way beyond what the fundamental income of the residents can actually support, and banks have decided to stop giving out really bad mortgages. Most places in Southern California, the payments on a 6.5% fixed 30-year loan on the median-priced house amount to something like 120% of the median pre-tax income. So who’s buying all those houses? Not the people who live there, certainly.
Certain people will have to buy houses, even now. They may be moving into a neighborhood from a job change, or they may have grown out of an apartment. In any case, they have considerably more clout than they did a few years ago, where, in my neck of the woods at least, you debated how much over the asking price to go. So, while the market is weak, it is a buyer’s market. I agree with you that it might become even a stronger buyer’s market later.
You should be asking how this affects the credit market and why that is important for the economy.
Voyager discussed the securitization of the loans a bit. Essentially all of these subprime mortgage lenders borrow truckloads of cash on short term credit facilities to make the loans. Then they package the loans and sell them to investors. Well once it became clear that the market was in meltdown, these lenders could no longer sell their loans. Boom! They will never be able to pay off their short term credit and they are through. Big banks haven’t gone under, but they are taking losses and shutting down subprime lending units.
You would think that the buyers of these loans are all high risk/high return types of folks. But securitization allows the risk to be re-adjusted such that investors like banks, pension funds and insurance companies can buy into the ‘AAA’ and ‘AA’ bonds and higher risk investors can buy into the B-pieces which are low or even unrated.
Anyway, these investors all have bright young men and women who understand mathematics and statistics in a way that I never could. Many of them also wouldn’t know a sub-prime mortgage from a cheese doodle. So they came up with all kinds of neat looking models that forecasted default probability, loss severity based on some historical data, the data tapes from the bond issuers and a healthy dose of educated guessing.
So when the default rates came out way ahead of what they had modeled, rating agencies downgraded bonds and sellers started panicking. The value of the subprime bonds were written down all over the place. Banks that made conforming loans and commercial property loans also had problems finding buyers for their securitizations now that the market was spooked.
Long story short. if a seller can’t find a buyer, the seller has to lower the price. With bonds, a lower price means a higher yield (interest rates).
Some lenders have come back to the market place. However, since they can’t sell their loans for the same prices as before the crash, they cannot offer interest rates that are as attractive as they were.
Net result is that the cost of credit has increased across the board. A loan that might have been priced at 1.25% over the five year treasury is now perhaps at 1.80%-2.00% over treasuries.
Why does this affect the stock market? Because banks are getting the shit kicked out of them writing down all their various investments in mortgages. If interest rates are higher, people cannot spend as much and companies cannot invest as much. If people in real estate, mortgage lending or construction lose their jobs then they don’t spend lots of money at stores and restaurants. Investors are nervous that profits will fall at retailers, manufacturers, etc.
Depends on your perspective. If you live in Phoenix and need to sell a house, life will probably suck. If you live in the Orange County, have a fixed rate mortgage and a secure job, then you may not even notice. There will probably be some excess inventory due to speculators and foreclosures. But other investors who want to buy up vacant condos and homes to use as rentals will probably provide some sort of a floor. Properties in better locations with amenities, good schools and that nonsense will do better than properties in marginal locations.
There are still people who may feel some pain in the coming months. But banks are more likely to try and work out a mortgage than take homes since the last thing the banks want to own is real estate.
The buyers market depends one where you are and what you are buying. Its not a buyers market if the sellers don’t have to sell. If there are distressed sellers around, you might be able to negotiate yourself a great deal. There can be a very large spread between asking prices and what you actually pay.
If you want to test the market, go visit some homes for sale. Compare prices to what houses in those neighborhoods sold for last year. Ask how long certain homes have been on the market. Ask the selling realtor how much wiggle room you have in the asking price.
In the Times today, it says that what happened to Merrill and Citibank was that when the bonds went down a bit, they decided the market was going to recover and kept a lot of paper. It didn’t, and they lost their shirts - and their CEOs. So it seemed that it was less the market and more stupidity than I had originally thought.
My understanding is that the way these loans were bundled together was improper. From what I can see this is the part of the process that went clearly wrong, everything else was possibly foolish but clear and aboveboard.
Moody’s and the like would take a bunch of AA loans, a bunch of B loans, a bunch of C loans, and call the aggregate an AA loan. Someone would buy that package based on the AA rating, even though it was self-evidently not an AA package in terms of the aggregate risk/reward. The packages had a false bill of sale.
These packages were the basis of investments and securities which were the basis of further investments and securities and so on and so forth in the beautiful dance that is our modern financial world. If you own mutual funds, the odds are good that you owned some of these loans, whether you knew it or not. No one really knows who even owns all these things, and what it is exactly they own, so you can’t trace the interactions easily. This is why the housing crisis affects the economy at large, and no one knows what will happen.
The recent Northern Rock crisis in the UK, one of our largest mortgage lenders; another victim of US sub-prime fiasco (and its own bad planning). And it’s going to extend to other UK banks, according to the pundits.
That’s true. What’s also true is that many of the mortgage lenders used enormous lines of credit with other financial institutions to fund the loans that they wrote. After the loans were funded they were sold on the secondary mortgage market and the original lender recouped the money that they “lent”. These mortgages were purchased on Wall Street and used to back up certain securities. Many of these loans were poorly written and became a liability to the Wall Street firms and the original mortgage lender was forced to “buy back” the loan. This happens from time to time, but when it happens on the scale that we’ve seen over the last few months the lender no longer has either the room on their lines of credit to continue lending, or the solvency to continue to make their monthly payment.
No line of credit, no loans can be made, the business goes from being in the black to being in the red overnight. Things quickly dissolve from there.
The line of credit used to originate loans is called a “warehouse line.” http://www.loanuniverse.com/warehouse.html Warehouse credit is short-term; the bank funds the loan, taking a security interest in the chattel paper (mortgage and note); the loan is sold to an upstream investor, who gets the note, and pays the lender off. Not only is there insufficient room on a warehouse line, but that credit isn’t even available for repurchases.
I get what you are saying here, but the way it comes out is not quite right. The loans weren’t poorly written (no more than usual), they were bad investments in the first place. For the most part, nobody violated any underwriting guidelines. Predictably, most of the people who took out “stated” or “no doc” loans inflated the income that they listed on the application, but because the loans were “stated,” that doesn’t really change anything. If the lender wanted to know how much the borrower really made, they’d get back up documentation. Stated loans were made for liars.
Defaults tend not to be a problem for the originators of the loans, they’ve got limited repurchase obligations. Typically, a loan purchase agreement requires the originator to repurchase the loan only if it goes 90 days down in the first three or four payments. And it’s still fairly rare for an investor to require repurchase, usually the originator only has to surrender the premium it received for the loan plus an administrative fee (which runs between $500 and $2000).
Most simply put, the subprime lenders are in trouble because they underestimated the default rate on the loans they’ve written over the last several years.
That affects the housing market, because now they have to write “more realistic” loans, and those more realistic loans can’t be made at the current price level.
Yes, they sold a lot of the loans off, but they still hold some, and they certainly can’t grow the business if they can’t write more and more loans.
It’s not a buyer’s market if prices increased 100% over 3 years, and have only fallen 10%. Realtors want you to believe it’s a buyer’s market. That doesn’t make it so. People realize this.
That’s hard to say. The most obvious effect is that the share prices of exposed banks, and mortgage companies, and home builders are taking a beating.
Next obvious is that with fewer people getting new homes, furniture stores, and home improvement stores might take a beating. Home Depot (HD) and Lowes (LOW) are off 25% this year.
On top of that, it’s widely believed that a lot of consumer spending has been driven by the ability to borrow against increasing equity (like you want to do). This could affect ALL non-essential spending. . .clothes, electronics, new cars.
That can creep into the performance of everything, Wal*Mart, Circuit City, the loss of revenue from their advertising can affect media companies.
Who knows. Housing slumps can last a LONG time. The one from the late 80’s lasted a few years, and the late 80’s bubble wasn’t nearly as severe as our recent one. They say that Japan has basically had about a 15 year housing slump. I think it CAN happen here.
The fed has hinted at raising rates, and that could affect mortgage rates.
Just keep in mind, that if you take out a second mortgage, and your house declines in value, you could owe more than your house is worth. NOT an enviable position.
If you need to pay for your kid’s education that’s one thing. If you’re looking to add on to the house, or take a nice vacation, I might try saving for a couple more years.
You are right, but not really. The tranching of these deals restructures the risk such that one investor can seek out a lower risk bond, while another can seek out the higher risk stuff.
The notes at the bottom of the class are first loss pieces. The person that buys that first loss bond (lets call it class Z) will literally take every loss on the bond until the class is completely extinguished. Then losses start hitting class Y until it has been wiperd out and so on and so forth. As a result, the guy with class A which will carry the ‘AAA’ rating has a ton of credit support beneath it. Let’s say that the required credit support pre-crisis was 30%. I don’t know for sure as I have never dabbled in RMBS. That would mean that 30% of the principal balance has to get wiped out before ‘AAA’ loses his principal. Class A will start taking prepayments early though which does reduce yield if it can’t be reinvested at an equivalent yield.
So Moody’s and S&P (who hire their own set of math whizzes, they just don’t pay them as well) concoct some elaborate model determining where credit support for each class should be. Over the years, the defaults have been so low and issuers (who really control the rating process) have gotten more aggressive and the level of credit support has fallen pretty substantially. This was aided and abetted by pretty strong demand from hedge funds who wanted to repackage the stuff into CDO’s and other such structures.
Obviously, what happened is that the credit support levels got too low to cover the defaults that ultimately occurred. And then of course, those useless jackasses at the rating agencies came out and announced that they had found religion and downgraded the deals.
In the last recession, there were certainly investors who might of taken some hits, but at the time, credit support was a lot higher and there was less risk. Now the guy sitting on the ‘AAA’ may not ultimately not take huge losses from the cash flow side, but the market has put such a low value on the bond that it is marked down anyway.
The lesson is that these types of notes are not just some random set of cash flows that you plunk into a model and produce a result. There are real assets underlying them and if you don’t understand those assets and their fundamental behavior, you are going to be the guy left holding the bag.
Whether or not an offer is made over or under an asking price is immaterial to whether the market favors buyers or sellers, because the asking price is arbitrary. It was quite common in boom times to set asking prices low to generate a bidding war (and I’ve heard of some places trying that sort of thing now, too). How many offers there are and how they relate to the asking price are interesting statistics, but they don’t directly tell you anything about whether it’s a good time to be a buyer. And, quite simply, it is not a good time to be a buyer. Any house you buy is likely to decrease in value over the next year or two. How can that be a buyers market?
Here is the define Google page for buyers’ market.
One is
Nowhere does the future value play a part. In a sellers’ market, the price may continue to rise, so the seller would get more if he waited.
The buyer is likely to wait out the decline in prices in any case, while still having the benefit of the house. We bought into a buyers’ market - I don’t know if the effective value of our property declined after we bought it or not (we didn’t check, not caring) but we certainly got a better deal than we would have if it would have been a seller’s market.
As the definitions I’ve just posted show, a buyers market is when a lot of sellers chase a few buyers, which is exactly what is happening now. It doesn’t say anything about value. In general, as the prices decline more buyers should come, and things will even out, but that is in the long term. Additional factors may be involved also. I’d say the market for remaindered books is a buyers market, but the books might still be garbage.