The big discussion on Wall Street today is whether or not the problems with sub-prime will impact alt-A and prime loans and if all of this will impact housing markets and the economy as a whole. I want to examine why and how sub-prime’s implosion will impact the housing market.
It is estimated that tightening lending standards are going to eliminate 21% of the buyers from the market.
We all know intuitively this sounds bad. But what is the impact?
For a deeper understanding read The Plankton Theory Meets Minsky.
This will result in lower prices. If prices are lower and standards are tightening, serial refinance will come to an end. Many, if not most of the borrowers needing to refinance over the next 5 years will be underwater when the loan resets resulting in more foreclosures.
As you can see, it will take 5 years for the existing ARM’s to reset. For these people to be able to refinance, they must either have enough cash to buy down the loan (do you think any of them will?), or their house must be worth more than the loan amount. For the latter to happen, there must be a lot of buying in the market. Given that 21% of the buyers were just removed. What do you think is going to happen?
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In order to have a bubble, you need 2 “ingredients”:
1. The availability of easy/cheap credit
2. The psychology (the belief in continual appreciation)
For most of 2006, credit was still easy/cheap. But speculators disappeared because there was little upside potentials and much downside potentials. So, prices went down because of the absence of ingredient #2. This is why prices in the high-end segments started going down first.
Currently, ingredient #1 is going away. So, the downward pressures on prices will come from the low-end.
IrvineRenter is right on the money.
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Oh you guys…. don’t worry about the subprime market… our senators… Dodd in particular… are going to find ways to keep our subprime borrowers in their cushy homes.. Isn’t America grand… act in an irresponsible manner and the government is there to bail you out! Why on Earth would anyone act responsibly anymore? Nice message by our government… OK rant off.
so the government is gonna bail out the sub-prime market-
damn where do they come up with all the money to do these
great deeds- like provide social security/medicare/wars in iraq/
hell the list goes on and on- oh thats right they take our hard
earned money through taxes- then when they need more they just make more taxes – hell why didnt I think of that–
Those Credit Suisse numbers are pretty amazing.
I think with all the ruckus coming from the sub-prime market, people forget that the Alt-A and traditional mortgage sectors are tightening of standards as well. At a 21% reduction of the total buyer pool, one has to believe that the impact is going to be significant.
The graph with the reset periods is priceless.
I’ve had conversations with a neighbor who is a realtor who has claimed that the sub-prime loans have inflicted all the damage they are going to inflict. Like I said, he’s a neighbor, so I smile and nod and think to myself “is he f@cking kidding me”? But, based on this graph alone, I would think ANYONE considering buying a house would be foolish not to wait 12-15 months before buying.
Not being savvy in ARMs, could you please give a brief definition of each one so I know the difference.
Jason,
Read this post, it may help:
https://www.irvinehousingblog.com/2007/03/01/financially-conservative-home-financing/
Well, anecdotal reports are suggesting that credit ISN’T being ‘tightened’ (e.g. where a loan officer tells the borrower, “sorry, you cannot get this loan. Go save up a down-payment and improve your credit score and then come back”). Instead, the borrower’s pocketbook is being squeezed MORESO, putting them into a higher-rate (and thus more expensive, and thus riskier) loan:
http://origin.mercurynews.com/news/ci_5459859
As that article shows, the borrower (a Hispanic lady who cleans houses) was turned down for a 100% no-down loan on a $500k house because lending practices have turned away from stated income loans for prime borrowers. So she’s STILL getting a stated income loan, just at a higher rate (paying more points for the same money)!
Will she default? Who knows: notice how she’s got other adults who will be helping her with the payments using money that’s off the books (that’s just as “real” as money that’s verified by a 1099/W-2). Seems fair, to be honest, since she’s probably not paying taxes on the ‘off the books’ money (although I have misgivings with the mortgage bank getting the income money instead of the IRS).
So despite all the talk of lenders tightening standards, in reality it’s not really much different nowadays, and the credit bubble is not being reduced as quickly as some of us bubble watchers would like.
I suspect it won’t happen quickly: despite the narrower margins in lending, apparently the business is STILL profitable for the big lenders who have taken a long position on their extremely profitable business. The whole sub-prime “meltdown” was primarily designed to shake out the “little guy” lenders who didn’t have the financial backing and liquidity offered by being aligned by the banks with deep-pockets; it was just a bump of the ride to shake off the little guys/parasites…
Don’t believe it? See what the headline here says (from a few days ago):
http://www.nationalmortgagenews.com/
Rulemakers Told to Slow Down
Regulators and legislators should not go too far in reining in so-called “toxic loans,” the chairman of the Mortgage Bankers Association said at the group’s nonprime conference.
Now why would the chairman of the Mortgage Bankers Association warn regulators to “slow down” in reining in “toxic loans”? If they weren’t profitable, do you think mortgage bankers would be urging restraint?