Tuesday, December 11, 2007


Mucking Through The Mortgage Middens

Why does "Wall Street" exist?

Looking down from the bozosphere where theories live, its function is to finance innovation in exchange for higher average returns. Dig deep in the trenches, though, and you savvy up fast. You realize Wall Street's real job is to generate the most important thing in the universe: your bonus. Which should be an ample bounty borne on a padded carpet of minimal risk. That's what Wall Street is from the inside, when it works: a carpet ride designed to cushion you from banality, from boredom, and from risk while fleecing insufferable suckers.

People who want to live large are constantly seeking to engineer a popular sting, to hucksterize a wave of investors into waddling in and parting with their dough. Part tent revival, part holy temple, once a good scam is rolling, nothing can stop Wall Street from riding the wave until it really starts to crash. When the bodies pile up and the cops start to show up. Then the perps go look for a new wave. A lot of Wall Street types should be looking for a new wave right now, because like the S&L, junk bond, and dot-com crazes did before, the beautiful mortgage pipeline is going banzai.

The mortgage craze differs from the priors in an important respect. This time, they got people to bet their houses. Although the easy credit climate wasn't confined to housing, not hardly, housing is more or less the basis of broad prosperity. So when I hear the Fed say yet again that subprime write-offs won't spill over into the general economy, I think, "Hahahaha! These jokers should die."

Like ships with too little ballast, borrowers relying on top-heavy ARMs and exotic new payment schemes are more prone to capsize. Many mortgages are already "upside down," or value-negative, and exponentially more go upside-down every day. As credit naturally tightens across all borrowers, and banks have less money to lend because they've lost it, the process becomes self-accelerating. Even in a white-hot market like the San Francisco Bay Area, easy credit is gone: it takes $175k in household income to buy a million-dollar house, as it always should have. The problem, to quote (via Herb Greenberg) veteran mortgage salesman Mark Hanson, "...we have 90% fewer qualified buyers for 5 times the number of homes." 50x more homes on sale for every qualified buyer in the Bay Area. That's some powerful negotiating leverage.

Union Bank of Switzerland just wrote off $10 billion in quarterly losses and went to Singapore, the government of, for a cash infusion. 6,000 people in Cleveland just showed up to apply for 300 Wal-Mart jobs. These events are connected as directly as strands stretch across a spider's web.
What we're staring down isn't a subprime crisis. It's not even a housing loan crisis. It's a systemic global credit crisis, a cancer on the entire financial body which cannot be excised, but can only be induced to recede by either steady or severe credit adjustment. How bad? Hard to tell. At least property has implicit value, unlike many of the financial instruments based upon home mortgage loans. But even in relatively unscathed Seattle, my house's real value could drop up to 50%. The bright side? We like the neighborhood.

5 comments:

stilllifeliving said...

Two points (and I don't mean slamn dunk!):

1) This is a negative sum game. The "loses" are not offset by "gains". Just because a bank loses $10B, homeowner's loans don't drop by $10B. The originally over-priced strips are finally being recognized for what they were -- high risk. Their accountants allowed them to carry them on the books at par, without correctly categorizing the risk (fore).

2) The real culprits are the same guys who brought you the savings & loan debacle: the Bush family. Wages were able to stay flat, taxes were able to be cut, and we were allowed to beleive we owned the Middle East -- because homeowners were able to spend faux capital gains (Go forth and shop). Boy did it feel good, like smoking crystal meth in a Texas Trailer Park. Only now our collective teeth are falling out. And we have lost the trailer.

Zoey & Me said...

Interesting post. I too thought bad things about Wall Streeters pulling the wool for a cool $246 Million, in your pocket, the dude that started all this. But here in Florida where we rode high in the bubble, prices adjusted since June show a new market emerging with a ton of money people from the north showing up, cash or heavy down payments. How 'bout $609,000 for 2600 square feet direct ocean which held a price of $800,000 in 2005? I'm in real estate and I can tell ya, 2008 might end up being a huge year for the Realtor community. Look at the Spokane market . . up a third in one quarter. WOW!

MarcLord said...

Still Life,

Not sure I understand point 1), except that losses are non-linear. Kinda depends on what the banks lost money on, the non-perf loans or the CDOs. Either way their reserve capital is eaten up. As a lender, at some point it makes more sense to negotiate with your borrower at 30 cents on the dollar and pay off your CDO at 10 cents on the dollar.

On point 2), well there you go blaming the Bushes again! Pass the crack pipe, Ulysses, it was sweet.

MarcLord said...

Zoey & Me,

NYC has staggeringly high value still along with continuing wealth/pop influx. Smart people sell early there and arbitrage into the obvious plays, and some friends of mine on Wall St. are looking precisely at Spokane. They know their game is time-limited, and Spokane is where they went to college.

If you can flip out, into parts of Florida and obvious places like Spokane, it makes wonderful sense. Still underbought by comparison. Hell even Cleveland or upstate New York looks great at some point, if you've got cash. At the micro and landlord levels, buy low sell high works. Especially scooping up foreclosures in mild climates. FL has enjoyed probably the highest continued rate of population influx over the past 50 years of any state in the US. An aging demographic isn't hurting that, and Miami is now the capital of South America.

For macro, though, a sinking tide sucks most boats, and far fewer people have the cash, credit, or the ability to maneuver to the above-water outcroppings.

We could still sell here into a relatively nice market and get a mansion somewhere else where it crashed or doldrumed. But like most people we aren't immediately prepared to do that. The switching costs, intangible or not, are pretty high. We toy with the thought, but we didn't make a killing it demands re-allocatin. Not insubstantial equity, but not enough to buy a castle free and clear.

For example we could sell our house and move to Kentucky, Croatia or BC while the getting's good, take the extra and it makes tremendous financial sense. We might yet do that but none of those scenarios is simple. We don't have the cash advantage your buyers in FL have, and I've been to Spokane enough to last me.

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