San Diego Housing Bubble News and Analysis

We are all trying to figure out how to short *prime* mortgages now! Shhh....

Option-ARMS are the next elephant in the room that will be getting lots of press soon.

This "creative" financing scheme was once limited to higher net worth, primariliy independent business owners and consultants who had high seasonality in their incomes. It morphed during the bubble years as a widespread financing option.

They have an interesting features, if you continue to choose the lower payment option and your mortgage balance reaches a preset limit (say 5% larger than your original balance) your ARM resets early. Who reads all the fine print in these exotic mortgages and really understands them?

I bet a large # of those folks have negative equity, they will be walking away in droves.

By the way, on the ARM reset chart, what is the typical lag between ARM reset and eventual foreclosure? 6 months? By shifting this graph to the right you see that the peak of the foreclosure tidal wave is still ahead.

Bubblesitter

In all seriousness, you are hearing talk of the 2nd wave of mortgage resets. It's all the 'walk away' talk.

Unless there is some serious cram-down action 100% of these loans are going to fail.

There is talk about it.

On Bloomberg

On Piggington

On Businessweek

Never thought I would here the term "jingle mail" being talked about so much again. It was a common term in the 80s.

The big worry among those in the finance circles is that "just walking away" will become socially acceptable. I personally don't see a stigma.

If I was hopelessly underwater, knowing that housing prices are heading down and we're going into recession, I would be very tempted to walk too!

This housing downturn may last 5 years, maybe even longer. The downturn last one in the 90s was at least 4 years. Most folks thing the peak around here in SD was late 2005/early 2006. We're probably not gonna see any real housing appreciation for a long time.

By the time this whole housing bubble shakes out, you would have time to get your credit back up and buy your next house.

In America, entrepreneurs and investors take big risk and fail all the time. Sometimes you gotta take your losses. Walking away from mortgages may be the best financial decision for your family. Throwing good money at a depreciating asset is usually not a good thing.

Bubblesitter

That is a very good point. I figured they would continually trinkle in over time.

What I would mostly like to know is what percentage of homes in San Diego were bought w/subprime loans for each year from, say, 2002 to 2006. That will give an idea what we're in for here. Some people were saying only 10-15%. I can't accept that. I'm thinking closer to 80%. I read, maybe on Pig. that some people who owned their place for years, had equity and did HELC w/subprime loans. Crazy.

I also think no one is saying anything because they're in denial. But also they are very shortsighted. They were extremely shortsighted and in denial during the boom. Houses were going to keep going up to infinity, remember? Two-three years ago I was hounded by lenders, friends, etc to buy and I thought, "Are you crazed?" I'm surprised it went as long as it did.

The same shortsightedness will happen w/these loans adjusting. They're just going to worry about today. It will be too overwhelming to think about the next few years. But as I said in a previous post, the interest rate reduction must be helping w/some of those loans resetting. Their rate might not go so high. Not sure. Some people who aren't upside-down can refinance into a fixed.

Maybe it won't be so bad.

It was my understanding that San Diego had a much larger than average share of these types of ARMs.

Coming after the results of the current wave, which is only now peaking, I think the results of the second wave will really grind the market psychology down. It's the knockout blow of the one-two combination.

On the flip side, after a bad spell that lasts this long, the rebound could be stronger than the conventional wisdom would otherwise indicate. That wisdom consisting of "everybody learned their lesson and won't make that mistake again". Beware of that one - I thought that way after the bust of the 1990s and I was exponentially wrong.

These loans are doing horribly - something like 90%!!(yes - I was shocked to see that) of the loans are only having minimum payments made, thus acquiring negative amortization. These loans are then expected to default EARLIER than the CreditSuisse table above.

So - no capital investment in a house = smarter to walk away. The former "owners" were really only renting the house, and they have no equity in it. This is going to be really bad here in California, where 50% of the jumbo loans are made.

I expect future bank behavior will require a minimum 20-30% down for future loans, to prevent such behavior happening again. An investment will tie the owner into the house (I worked hard for it - I don't want to lose it), making them them much less likely to walk away.

the only way to rescue the Option ARMs is for the govt to provide mortgage debt forgiveness to the FBs holding these toxic loans

here's an example: FB buys a low-quality tract home for $780K and finances almost 100% of the price - current market value in a forced sale is $599K or so - the monthly payment after the OptionARM resets will double or triple - there are no conventional mortgage products available to help this FB at reset time unless he has $180K available to buy down the mortgage

the govt rescue comes by offering the FB $180K in debt forgiveness and a low interest rate mortgage for $600K - the banks currently holding the mortgage(s) are made whole and the national debt grows by $180K - the FB continues to be a wage-slave chained to a house and everyone is happy (as long as they remain asleep)

~

that would be the rescue plan that politicians and the banking cartel would like to facilitate but there's a catch (isn't there always?) - some (many? most?) of these FBs can't afford the payment on a fixed-rate, fully amortized mortgage even at a below market rate - that is why these people took an OptionARM in the first place!!!

we have to understand that these are people who should NEVER, EVER been allowed to 'purchase' residential real estate and they don't have a chance in hell of retaining 'ownership' of these properties long term - providing the FBs handouts from the taxpayer's pocketbook will only prolong the misery - the result will be the same: short of the taxpayer giving these properties to the FBs, they will end up as NODs, NOTs, foreclosures, REOs, etc until they reach a price where the mortgage can be supported by local rents/wages

the 'investor' is another category of OptionARM holder - this person is also going to walk away from their property and mortgage when it resets because they can't afford the monthly payments that their 'investment' will require - the only way they will continue to pay on the property long-term is if the mortgage can be supported by the rents - without some kind of mortgage debt relief there is very little incentive for this 'investor' to continue supporting an upside-down property with negative cashflow

~

we have discussed the ARM reset chart several times - search the archives on 'arm reset chart' and 'credit suisse' and you will find them

I think that people did learn from the bust of the 90's. I did. Problem is that now you have a batch of new people to the game, people who were not benefitting from the experience of the 90's.

I put 20% down in the 90's and I did NOT walk away, but did everything I could to hold on until the market got better and then I got out. Aged a lot during those struggling years. Won't bite off more than I can chew now. That is the main reason I wasn't suckered into the subprime loan this time around. But believe it or not, people were telling me to walk away back then. And I had a lot of money into it.

ortho - you're right. If people put money down, harder to just walk.

I know there are charts for percentage of subprimes, but I thought it was nationally. I think San Diego is a different animal.

I know someone who bought a condo in La Jolla in about '98. In 2002 bought another condo. Flipped that in 2005 and made $$$. Last year bought an expensive home from bank. Now trying to sell for more. Not moving. That person makes very good money (dr.) I just don't see him going under. Wouldn't the bank on the new house attach a lien on the condo he owns in La Jolla? I don't think he can walk. He even has $$ down on the house. Tough situation. Probably can last a year of making payments. After that, it's going to hurt.

First off, I believe the lag time is longer then 6 months regarding a reset and then a foreclosure. I think in reality it is closer to 9 months. The banks are so overwhelmed that it seems NODs don't even go out until the 4th or 5th month after the first missed payment. Then there is another 3 months for the NOT. It is now becoming commonplace for NOTs to get postponed. I have a listing right now and we just received our 4th postponement while the lender reviews another offer.

So I think the shift to the right is greater then suspected.

*****

I give odds of at least 50/50 that we WILL see a socialization of housing coming with the next president. If it is Billary then those odds are higher. If it is Mcopentheborders the odds are a little lower. The program arraya posted about is a perfect example. Don't be surprised if YOUR government subsidizes these homes.

The BEST CASE will indeed be if this second wave hits. In the end yeah we would see another 2 years of very nice price declines in areas that most of us want to live in thus pushing a bottom out until 2012.

4plex your example is a good one however don't underestimate the establishment to get around the catch you posed. If the gov and banks can simply change the rules. Why not amortize the loan over 50 years, 100 years? Why not just have the taxpayers suck up more then the 180k that is owed in your example where they continue to subsidize the difference between what the owner can afford and what the real payment should be?

Don't underestimate our next president.

Realtor

good point SDR - there will always be some combination of debt relief and subsidized interest rates that will allow all the FBs to remain in their homes - perhaps there will be a sliding scale based on income - the lower the income, the more relief / subsidy the FB qualifies for

the effect of stretching the loan past 50 yrs is minimal - the Japanese went down this road and were offering 100 yr mortgages at the height of their mania

payments on $400K @ 4.5% (assuming govt subsidized rate):

30 yr $2026
50 yr $1677
75 yr $1553
100 yr $1516

$400K on 30 yr fixed, fully amortized at 5.75% is $2334 / month

This was briefly touched on above, but to refocus the thread (if I may), the key metric for the option arms is how many people are paying the minimum. It is my feeling, backed up with a little data (don't remember the sources, but I've been short DSL for a year so picked it up via them) that the vast majority of option ARM borrowers only make the minimum and that after the balance goes to 115% - 120% (depends on the loan) it "resets" and you pay it off as if it were fixed (full balance, regular/high rate).

So, the real question is, looking at the chart, when were the loans made, and when will the FORCED resets occur. If you've been making 100% payments, you do have some past payment skin in the game, but these I believe will be the minority.

Here's some data:

"According to a Fitch Ratings report, nearly 90 percent of the borrowers who took out an Option ARM in 2006 were suffering from negative amortization. At least 60 to 80 percent of Option ARM borrowers make just the minimum payment each month, according to industry estimates."

http://www.multi-housingnews.com/multiho...

FB: Dammit Jim, I'm a renter not a buyer (even though I technically bought)! This is definitely going to get uglier. The housing market we had in 2005-2006 resembled the young, hot Britney. Today's housing market resembles the current Britney. The housing market we are going to see in a couple of years will be more akin to Britney 20 years from now.

Congress just passed the whole stimulus-mortgage thingee. Bush is expected to sign it this week. However, Fannie and Freddie currently only allow refis up to 95% of Loan-to-Value. Thus, it doesn't look like to me that any of these neg-am, Option ARM folks are going to be able to take advantage of the higher conforming loan limits.

Since this is an election year and much of Congress will soon be out campaigning, I wouldn't expect another mortgage bill this year. I think it'll be next year before Congress passes some new bill in an attempt to put this whole mortgage fiasco to the taxpayers. By then it may be too late. At least I hope so.

But yeah, with only 30% or so of Option ARM folks making more than the minimum payment ... it's definitely going to get uglier.

I do believe TheBreeze gets credit for all Britney metaphors on this blog from now on. Apt comparison, by the way.

Oh believe me... I agree with the data you are presenting Breeze.

So do you really think when Hillary is prez that she will let all those people negaming to go down with the ship?

Do you really think so?

It just seems there is and has been a grave miscalculation by many as to how much of a fight the industry and politicians will muster up to keep the consumer buying.

Do you guys really think this stimulus package is the last salvo?

I look at it as more or less the first shot across the bow.

Oh yeah it will get uglier all right. I absolutely agree with that point. If you really think our government has the cajones to let the market correct itself in the way that it should, then I would say I we agree to disagree.

SD Realtor

Oh yeah it will get uglier all right. I absolutely agree with that point. If you really think our government has the cajones to let the market correct itself in the way that it should, then I would say I we agree to disagree.

You little inflationist you! The bond markets already don't like the stimulus package.

Josh

For an idea of how many ARMs are in SD compared to the rest of the country, go to http://www.fhfb.gov/Default.aspx?Page=53 and look at 5. Quarterly by Metropolitan Area. This only reports from 4th 1/4 2006 to 4th 1/4 2007 but I think I might have data from previous 1/4's saved on my computer I can post tomorrow hopefully.

Josh one liners are pretty easy to write.

So I take it that your contention is that the market will correct itself unencumbered? That there will be no measures taken by our government at all? That this stimulus package will be it? Poof that is all she wrote?

You have to come with something better then that. Agreed there is a fine line to walk... that the feds cannot bite those hands that support our unsustainable debt....however I would be quite willing to wager a steak at Donovans that this is not the last of the life preservers that the government will throw to FBs.

Don't get me wrong, I am not saying this will save things or turn the market around. All this will do is to prolong the agony, cost more money to the taxpayers, and piss off investors aka those who support our debt.

Again, you have to look beyond a foreclosure. That is short sighted. You need to look at who will go belly up if we resurrect the old RTC and let all these obligations die of natural causes. Just who do you suppose has investments in these vehicles? Perhaps, county and state governments? Perhaps many many pensions? 401ks? unions? The list goes on and on. This isn't the S&L debacle where a couple hundred banks go under and everyone is okay. This cancer is pretty much spread through the entire lymphatic system and I am more and more beginning to think that our government may not be entirely sure that they could handle a systemic purge of the system by natural causes. I think they want to at least throttle that purge back by any means they can.

SD Realtor

SDR, I agree that govt efforts to support inflated house prices are just warming up, and there is lots more to come. Comparing house prices now to what they were 10 years ago, I see a reduction of 50-65% being very possible in a completely free market economy. But most homeowners, and therefore most voters, would be furious with their pols if the pols allowed this to happen, or anything even close to it.

We assume on this blog that the free market influences will, mostly, win out. But what is there, really, to prevent the pols from opening the throttle all the way, and blowing past any free market influences? For example, simply offer to insure against default any new mortages made to people who can fog a mirror. Just dial down downpayment and income and credit requirements to get home prices as high as voters want them to go. Sure, inflation might result, but most homeowning voters will take inflation any day over declines in home prices as big as the prior home price increases.

Home price increases are what maybe half the population of this country have decided to make the linchpin of their future financial wellbeing, and they will just about kill to prevent it being taken away from them.

Patient renter in OC

So do you really think when Hillary is prez that she will let all those people negaming to go down with the ship?

I don't know. I'm hopeful that this whole thing will blow up before the government has time to act again. Wishful thinking on my part, perhaps.

The fact that the House voted 330-30 for an increase in the conforming loan limits is not encouraging. It makes me wonder if there are any true fiscal conservatives in the government anymore. The fact that the GSEs own or guarantee 40% of the mortgage market now and can own or guarantee up to 80% with the conforming loan limit increase is not encouraging. I've also heard that NAR is going to help Fannie and Freddie write the guidelines for the new conforming loan limits. Again, not encouraging.

Fannie is currently guaranteeing something along the lines of $2.6 trillion in mortgages on $40 billion in capital. If those mortgages were to be marked-to-market I think Fannie would be insolvent. Fannie's next quarterly report is due out soon. Hopefully the next report will show that they are tapped out and can't buy or guarantee any more mortgages. Probably more wishful thinking on my part.

I know things are going to be bad. I'm just hopeful that the private sector bears a significant portion of the pain as opposed to the taxpayers. I guess we'll see as this whole mess unwinds.

Well put patientrenter, very well put.

SD Realtor

"On the flip side, after a bad spell that lasts this long, the rebound could be stronger than the conventional wisdom would otherwise indicate. That wisdom consisting of "everybody learned their lesson and won't make that mistake again". Beware of that one - I thought that way after the bust of the 1990s and I was exponentially wrong".

Bugs,

That's because the younger generation (14-16) will have forgotten in another 10-12 years how bad things are today and will probably chase prices again at some point. There will be the typical "it's different this time" mantra going around but the results will be the same. The next time won't be as bad because I don't think we'll ever see the feds let things get away like they did the past 5 years.

don'tfollow - that is what happened in the 90's. I remember and this time around was financially conservative. It's not that they will forget. If they didn't experience it first hand, they won't know better.

Actually SDR, I don't make that argument at all.
We assume on this blog that the free market influences will, mostly, win out. I do agree with this, the question is, what time frame is, "in the end."

Our illustrious host is an inflationist as well. I believe whole heartedly that the govt will TRY to inflate our way out of this, thats what its doing right now by re-lowering interest rates quickly. I'm just pretty sure it won't work.

So far the bond market hasn't told Congress to go fuck itself, but its getting closer. You are right that there are large institutional interests that will do anything to keep the game going, but as the system is currently run, its all credit dependent. That being said, I believe the sh*tty asset crisis thread will give you insight into why I don't think lowering of interest rates will help even short term.

I'm a deflationist because I think a sea change is occurring. I think there is a critical mass of people (albeit still small) that realizes that the inflation that has already occurred is hugely damaging. Those same people buy the way are the ones with the real hard money who will demand credible collateral to lend against.

What really bothers me about the inflationist argument is that it requires two parts, a willing borrower and a willing lender. There are lots of willing borrowers out there, they are being foreclosed on in droves. There just aren't willing lenders who will take crap collateral for their money any more and its going to get worse.

The fed can lower rates to zero and the banks aren't going to be willing to lend at the levels of the last few years.

Sure Congress can fire up the printing presses and start the bailouts in earnest, but would you lend the US govt money if it did that? Already interest in long dated treasuries has slacked off significantly because buyers of said debt realize they are getting corn holed by the borrower. The only path along which the inflationist argument works is the one in which we can say screw you to our creditors, domestic and foreign. Now thats a bet of a steak at Donovan's I'd take (At least over the next couple of years.) No way will we do that, short of dropping the dollar and creating a new currency.

Josh

Didn't Japan lower their rate almost to zero and it didn't help them? I don't know the details of how similar we are to what they went through, but I see some resemblance.

Japan's case is a quite different actually. Seniors consist of a bigger and bigger faction of the population. The domestic spending was shrinking because more people relies on the pension ... that's why Japanese gov lowered the interest rate to boost the spending. Japanese use those cheap money to invest on US, Europe and East Asia's stock market to make profit, which sort of compensates the loss in real estate. But the purpose of lowering interest rate is not to save the price of RE.

Didn't Japan lower their rate almost to zero and it didn't help them? I don't know the details of how similar we are to what they went through, but I see some resemblance.

That they did and no it didn't help. They had 12 years of falling RE prices. It's really a shift in perception, once buyers realize RE is over-sold there is a paradigm shift in pricing.

Something that is *very* different over there is they have no social concept of debt-defaults (other than suicide). There are a great many people there still locked into crazy mortgages from the pre-bust years.

The 'walk-away' effect should cause prices to correct much faster here.

Good Post

I would like to hear your opinions on these upcoming mortgage resets nowadays on my article where I have the bullish cases and bearish:

http://www.nakedhedgefund.com/finance/ne...

Thanks in Advance

The Option ARM reset argument faded into the background, as the recession took the driving seat. Some say lower rates have lessened the effect of resets. However, there has been talk of a large new wave of foreclosures starting this month (April 2009). BTW the Glen Beck video was a classic. Did you see the CIA operative in the corner of the screen with a syringe just as the theory that Treasuries are now full of toxic loans was being hammered home? I felt a distinctive cool breeze blowing in from the East :)