I agree that there is some fear of the unknown in play right now and we may be looking at a bit of a temporary spike. However, that which is currently unknown will eventually become known, and at that point the pricing on financing will reflect the perceived risks. I think it’s possible that the fear of the known may eventually prove itself worse than the fear of the unknown.
Foreclosures lag the Notice of Defaults (3-4 months minimum), which in turn lag the time period in which borrowers stop making payments (3 months minimum), which in turn lag the ARM resets as some borrowers attempt to make a go of it or unload their albatross. In other words, it takes at least 6 months before an ARM reset turns into a foreclosure and 4 more months before the total loss from that foreclosure can be tallied in the form of the REO sale.
The foreclosures we’re seeing at this moment are the results of ARMs that reset at the beginning of the year. These lenders won’t even see what their real rate of losses from this wave are until this time next year at the earliest. Up until then it’s all projections and guesswork. In other words, it will continue to be unknowable – and hence deniable – for another year yet, after which it will be knowable and undeniable.
The first wave of resets fluctuates a bit on the back end but it mostly doesn’t recede below it’s current level until July 2008, which means the numbers of foreclosures: a) will go up tremendously in the next 9 months, and b) will not drop below the current rate until mid-2009.
No matter how agressive the lenders get on their REOs they CANNOT clear all these properties out before the end of 2009, which overlaps the beginning of the second wave by about 6 months. The second wave is smaller than the first wave but it has a higher percentage of the most toxic loans, which I would assume would result in an even higher rate of loss (more of those borrowers defaulting) than that of the first wave.
At the same time the pricing structure is under pressure as a result of these distressed sellers, the buyers will also be making decisions of their own. People are slow but eventually they do tend to figure it out. More buyers will hang back further reducing the demand in the market – this will register on the demand side.
Increased seller motivation + decreased buyer motivation can only turn out the one way, which is declining prices on the transactions that do go off. It almost won’t matter how many people can pay, because those distressed transactions that do go off will be the ones that drive the bus.
Here’s my soundbite for the day:
Market value is not determined by the owners who can hold, it’s determined by the owners who sell and the buyers who buy.
The investors have to take that into account when pricing the financing. A constantly declining market increases their risk for losses no matter how good those borrowers look at the moment.
To sum it up, because of the damage to investor psychology resulting from their losses in the first wave, they’re going to see the damage that will ensue from the second wave coming before it hits and that “foresight” will subsequently be reinforced. I don’t think a lot of these investors will be back any time soon; at any rate, not with out requiring some significant returns to justify their risks. That’s going to cost.
