Tuesday March 13, 2007
Bill Cara submits: For several months, some of the U.S. homebuilder
companies acknowledged abnormal supply as well as pricing pressures
in the marketplace.
More recently, the sub-prime mortgage companies that recklessly
financed the bulk of the industry’s business discovered
a problem with delinquencies and foreclosures. This is the
story that will finally push the stock market from Bull to
Bear, and the economy into recession.
Traders are nervous, with the upshot being a swing to cash
and gold. Why gold? Under the circumstances that exist today
in the financial marketplace, any rise in interest rates will
certainly pass the tipping point to where millions of Americans
will be forced from their homes and put out on the street.
The whole world watched TV images of the inhumane treatment
of the poor of New Orleans following Hurricane Katrina. With
great respect to those couple hundred thousand disadvantaged
souls (as my readers know I have), I believe those ugly TV
images may even look mild compared to the scenario that would
follow angry mobs across America, if market interest rates
rise beyond the tipping point that would collapse the entire
U.S. mortgage market.
Yes, I believe there will be a U.S. economic recession, but
the elements are now in place for the first time in 80 years
for America to sink into a depression. Should a depression
unfold, there will be big name financial houses that will fail.
Accordingly, the owners and managers of wealth ought to be
researching today how to protect themselves beyond FDIC-insured
accounts. I shall write a lot about this in the next month.
Yesterday, there was much talk of the Sub-prime and Alt-A
mortgage industry problems. One report I received today came
from Credit Suisse, whose analysts opined that the problems
will get much worse. I agree that this is a situation we must
watch closely.
In the past five years, subprime purchase originations have
more than doubled in share to approximately 20% of the total
in 2006. Over this time period, subprime lenders eased underwriting
standards in an effort to gain market share. Loans were made
to first time homebuyers with little or no down payments, as
2006 subprime purchase originations posted an alarming 94%
combined loan-to-value, on an average loan price of nearly
$200,000. Even more distressing is the fact that roughly 50%
of all subprime borrowers in the past two years have provided
limited documentation regarding their incomes…
Given the recent credit deterioration in the subprime and
Alt-A markets, and the likely fallout throughout the entire
housing chain, we are of the opinion that there is a very real
threat of “pent-up supply” that will hit the market
in the next six-to-twelve months as a result of the lax underwriting
standards of recent years.
The first two sections of the Credit Suisse report focused
on providing a backdrop of the mortgage market, and how it
has evolved in recent years. The authors discussed the mortgage
products that are at greatest risk for increased scrutiny from
regulators and highlighted some recent events and potential
courses of regulatory action. They concluded that “while
much of the focus in the next few months for the builders will
likely be on credit tightening and how that will impact homebuyers’ ability
to get financing, we do not want to underestimate the impact
that rising foreclosures and delinquencies will have on the
supply and pricing dynamics of the housing market.”
But rather than point to specific comments in the Credit Suisse
report, I decided to pull a number of exhibits that hopefully
will open your eyes as to the seriousness of the problem.
In a recent blog, I remarked that this data will come out
and, unlike information that is produced by the U.S. Administration,
it is the type of data that cannot be easily manipulated.
From the list of the top sub-prime lenders of 2006 above,
with over 80% market share, I created the following charts.
Several lenders are units of other companies. Two of them (New
Financial (NYSE: NEW - News) and First Franklin (NasdaqGM:
FFHS)) ceased trading in the past few days. I suspect that
the others will be examined closely, and some will also cease
to trade.
From the chart below, I recall the 1990-91 period when North
American banks pulled any and all non-performing loans during
a similar period of credit contraction. My parent's neighbor
had a country home valued at $1.1 million with a $950,000 mortgage.
When he couldn't pay, the property was listed at $950,000,
then $575,000 as I recall, and then my parents bought it for
$300,000. I suspect the same type of thing is just starting
today.
Before this period is over, it will be remembered for many
years in history. Long-time readers will recall what I wrote
about CNBC's Real Estate Roadshow in 2Q05. I said that was
the cycle top and I called myself the Rat Catcher. Look at
what's happened to the homebuilders since.
America is in deep trouble because it loves a good story -
Goldilocks, Pied Piper and all. For some reason, the people
trust these story-tellers. Well, listen and weep.
For more charts, see Bill
Cara's blog.
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