Credit Suisse: Economy not dependent on MEW

[powayseller]

I had to put this up for all to see. Credit Suisse’s 9/15/06 report (subscription required) reassures us that MEW is nothing to worry about. The economy is strong: unemployment is low, retail sales are holding up, and wages are growing.

These are their main points, along with some further questions they would need to answer before I buy their story:

1. The economy is driven by jobs, wages, and tax cuts (the cake). MEW is merely the icing. In 2000-2005, MEW was only 11% of the growth in spending. (My question is: what are the absolute numbers so what is the percentage of MEW compared to wages; how much are consumers depending on that MEW to fund their consumption since flat wages and negative savings already prove that wages just don’t pay for the current consumption; what happens when housing-related employment crashes and wages continue losing ground to inflation.)

2. The media makes too much of the MEW slowdown, since up to Q2 06, MEW is still rising. (My question: how much of the refinancing is due to consolidation of upward-adjusting HELOCs and ARMs, and how much is new cash out? They do raise a point I have been wondering about: why is MEW still rising? With interest rates so high and home values dropping, I would expect fewer people to qualify for loans. Large layoffs at lenders, and reduced purchase and refinancing application data shows that the number of loans is down 30% vs last year, so why is MEW still rising?)

3. Media makes too much of sob stories of Joe Homeowner who loses his home as his Option ARM adjusts. In reality, ARM payments this year went up only $20 billion, a small amount in an economy with $9 trillion of disposable income. In a large economy, there will always be a few who have economic hardship, but these are the exception. (My question: what will happen next year, when $1.5 trillion of ARMs adjust? The data doesn’t yet include Q3, and this thing is unwinding rapidly; how does Q3 look for homeowners. Foreclosures and NODs are up all over the country, a trend that I think will continue and get very bad by 2009. Instead of realizing we are at the beginning of a new trend of rising foreclosures which should be projected out into the future, they just look at today’s low numbers.)

[rseiser]

I just have glance across the Credit Suisse’s arguments, and I can already tell that it is garbage. Jobs, wages, and tax cuts, huh? I just read a few pages on Ben Anderson, and even there he said that nothing is that simple. He mentions for example how credit creation can help the economy only in instances where there is missing capital and available workers who put the credit into productive ventures. If not, credit will just withdraw important capacity from somebody else (or just end up in speculation). The same questions I could ask: What jobs? What wages? And what tax cuts? Jobs are in real-estate, financing, hedge-funds or other nonsense. Wages keep hardly pace with inflation. And tax cuts, useless too, if we can’t afford them. Yeah, I am happy about a 15% tax on my investments. Now I don’t have to work so much, haha. It’s all magic, just drop the tax and economy will soar. Why haven’t all countries dropped the tax rate to 0%?
It’s about using your brain, and stimulate where there is drive to improve our future, not add fuel to an already burning fire.

[SDbear]

“next year, when $1.5 trillion of ARMs adjust?”

PS,
Is that the ARM payment increase or the loan amount? If it is loan amount total arm payment increase might be around $50 bil, probably not as significantly more than $20 bil that credit suisse is quoting for this year. I would think $50 bil out of $9 tril disposable income is small.
If it is arm payment increase, I would agree with you.

[powayseller]

It is the dollar amount of loans that will adjust. I’ve done the math on that before, assuming each loan averages $400K. The problem is not the amount of additional credit or interest paid, but the number of people affected. With high debt and negative savings, we Americans are just not equipped to handle 50% – 100% increases in our mortgages. I expect a huge swell in inventory, from current 25,000 to 50,000 or even 80,000. Most of them will be in foreclosure.

Oh, and for those from the other thread who need clarification of fact vs. opinion: the inventory and foreclosure estimates are opinions.

[woodrow]

PS – your assumption that each loan “averages 400k” is way, way, way off base. The average mortgage is probably half that. Not everyone lives in San Diego.

Love your posts, but after reading you for awhile, it seems that your mistakes always happen to support your side of the argument. I like it better when you stick to the facts and leave assumptions out of it.

[powayseller]

I used $400K to be conservative. If I use your $200K figure, then the number of people affected by mortgage resets would double. That brings the number of borrowers hit with rate shock to 7.5 million. (Under my assumption, only 3.75 mil were affected.)

woodrow, I also like it better when I stick to the facts and leave assumptions out of it, lOL. The hardest part is getting all the facts that I need. The entire exotic loan data is secretive and/or difficult to get. I lay out all my assumptions, and thank you for bringing to my attention that I was way too conservative.

[powayseller]

What concerns me is that some people don’t know that they have a loan that will reset.

“John G. Walsh, a senior official at the federal Office of the Comptroller of the Currency, recently described his agency’s concerns about poorly informed borrowers who don’t realize that their artificially low monthly payments won’t continue indefinitely.

“We’ve had consumers tell us they didn’t know that after making 60 minimum payments on [a payment-option loan], they would owe more than they did when the loan was brand-new. They should certainly understand the basic bargain: the price of a low payment now is a much higher payment later,” his statement said. “

[woodrow]

What’s the average price of a home in the US, ~ 240k? How in the world do you come up with the average mortgage being 400k?

I’m a bear, but I think it hurts your argument(s) when you use unrealistic numbers. Everyone with a reseting ARM will not be hit with “rate shock”. While a significant number will no doubt be in trouble/forclosure/bankruptcy, your analysis suggesting that every single household with a reseting ARM will face rate shock is absurd. There are plenty of people who are well aware of their loan responsibilities and will be in position to make their new payments with ease.

Again, I’m a bear (my wife and I rent) but I think your analysis is far, far better when you’re being realistic. Saying the average mortgage is 400k and that 7.5M people are going to experience “rate shock” is sloppy and unbecoming of someone with your analytic and writing skills. In my opinion, of course.

[SDbear]

“The problem is not the amount of additional credit or interest paid, but the number of people affected.”

PS,
This in itself shows that U can’t use this argument against Credit Suisse’s statement. The statement says that the arm increase amount is small compared to net disposable income and hence would keep money flowing in the economy. Which is true. Whether this affects n% of people is not their concern.
Consumer spending demographics may change due to this but the economy as a whole might not be affected much. I’ve seen quite a few people who knew this long back and moved their investments in favour of this eventuality. It is up to you whether U see this and take advantage in your investments or be completely -ve about it.

[powayseller]

woodrow, you are right. I should have used the average U.S. home price in Q2 2006, $300K.

I actually used a $200K figure in my July 6 post, where I explained the problems with resetting loans:

” This story has an example of a 50% increase in payments.
I forgot that the going ARM rate was 3.5%. A $300K loan at 3.5% had payments of $1300. They will go up to $1800 to $2100 this year. This is the $1 trillion of resets they keep talking about. It’s the glut of 3/1 ARMs, made at very low rates 3 years ago. If each ARM is $200K average, that’s 5 million people whose mortgages will increase, mostly at 50% increases. That is a huge deal. 5 million homeowners will see their mortgages go up 50% next year. ”

If Americans lived below their means, or saved more than 5% of their income, I would say this is not a problem. However, national data is showing that the personal savings rate is negative, wages have been flat for at least 5 years, and borrowers are spending 35% – 45% of their pay on mortgages. This doesn’t sound like a society that can easily take on a 50% jump in mortgage payments.

Lenders used to qualify borrowers based on their abiilty make the maximum capped payment, but a few years ago they started qualifying people on the initial teaser interest rate. That’s why those loans are more risky now.

The branch manager at my bank, World Savings doesn’t even understand that his loan can reset. How does that bode for Joe Sixpack? Here’s the conversation:

He said, “I have an adjustable rate mortgage, and my payment hasn’t gone up. Why do you say they go up?”

My reply, “That’s because you haven’t hit your adjustable period yet. Your 4% rate can go to 6%”

He responded, “But that’s only a 2% increase”.

I tried again, “It’s a 2% increase in the rate, but a 50% change in the payment. Your $2,000 payment would go to $3,000 if your rate changed from 4% to 6%.”

He: “OOOOOhhhhhh……..”

Woodrow, what assumption would you use? How many borrowers can handle a 50% , 70%, or 100% increase in their mortgage payment?

[technovelist]

The issue is not the size of the average mortgage, but the size of the average Option ARM mortgage. Since those mortgages make up the majority of recent mortgages in some extremely high-priced areas such as San Diego, they are undoubtedly much larger than the national average mortgage. I wouldn’t be at all surprised to find out they averaged over $400K, or even over $600K, given that the median house price for the last couple of years in San Diego is higher than that, and that these mortgages have recently been used mostly for “affordability”, i.e., for people who couldn’t afford those houses and had almost no money to put down.

[woodrow]

Good post PS. I agree with most of your predicitions, and believe the ARM resets in ’07 and ’08 along with the availablity of information will make this downturn steeper and quicker than any in history. I think that the internet tools now available to buyers/sellers is helping to accelerate market changes as sellers can now monitor their competition on a daily basis, and buyers can watch sellers fight it out via reductions/incentives unlike ever before.

In the 90s, you had to talk to your realtor to get this information, and he/she had to do a lot of leg work to gather the data and keep it up to date. Now, it’s a simple click of the mouse, and boom, anyone following a local market or zip code via Ziprealty can get daily reports with their own eyes.

It’s facinating to watch this unfold. The historical disconnect between buyers/sellers and current market information is eroding, and we’re seeing the market be much more reactive. It’s still a slow process, but we’re seeing an industry change before our very eyes.

[greekfire]

10% or 11% of something is not an insignificant number! I came across the chart below from the Bank of England website. Although it's not America, England has gone through a similar, more-pronounced housing bubble; which some feel may foreshadow what's to come in the States.

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[bubba99]

If we start to analyze the 1.5 trillion in debt that is at risk next year, the fallout raises some interesting questions. Making conservative assumptions about the number of loans that will go into foreclosure still leads to banks holding a lot of bad paper.

Say for arguments sake that only 25% of these highly leveraged loans get foreclosed on. And that the banks can recover 50% of their losses by reselling the foreclosure on what will be a very glutted real estate market. (Think sales costs, market loses, foreclosure exenses, and eviction costs) This leaves the banks holding .25*.5*1.5 trillion = 187.5 billion in loan losses. You can play with the numbers and say only 10% get foreclosed on, that is still 75 billion in losses. And this is the first of the bubble bursting years, with bigger losses the next year.

You can argue that 10% with a 50% recovery is too negative, but with a glut of inventory already, banks looking for a quick sale are going to take big losses. If 7.5 million people are in the 1.5 trillion dollar basket, and only 10% are unable to stand a 50% increase in loan payments, then 750,000 houses hit the market – either because the owners try to sell in advance of a foreclosure, or the bank forecloses. Cut that number in half, and it is still 375,000 new homes on the market.

If any of this comes to pass, the banking system and real estate markets will have a hard time absorbing the losses.

[powayseller]

That is exactly what will happen (in my opinion)!

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