Friday, November 9, 2007
This has been a dramatic week on Wall St. We have seen multi-billion dollar losses disclosed from almost all global banks. CEO's at Citigroup and Merrill Lynch have been sacked because of mortgage losses and unacceptable risk management. The shoe dropped when the $100 billion dollar M-LEC super conduit that CITI and other banks were working to setup with the US Treasury dept stalled. I wonder why. Heard in the back alley of Wall St,"Psss, hey I have a box here of mortgage paper that we modeled to be worth $20 billion. Would you loan us money against it? We are a little low on liquid cash because we are investing so much in these great mortgages. Oh no, you can't look inside, but trust us we have more PhDs calculating the value of these holdings than any other bank. We are CITI after all." The idea was to package all the junk mortgage paper in a massive pool and have other banks buy the paper. The problem continues to be that everyone is valuing the paper according to some rocket science model not what the market price is. Granted their isn't a real market for subprime or ALT-A, aka scratch and dent mortgage paper. To get an idea how bad it is inside the belly of mortage lending, here is a chart of 2007 Prime HELOC loans. These are perfect credit borrowers. Known as the ABX-HE-AAA. What this means is that the average current value of these loans is .70 on the dollar. This is largely because of an illiquid market, foreclosures, defaults and the great unknown of how these loans will perform in years to come. In the foreclosure wave sweeping the nation HELOCs are completely wiped out. Total loss. So the market believes right now that a third of the money lent will never be paid back or recovered in foreclosure. Gee, no wonder it is very difficult to find a HELOC to turn on the household ATM above 80% loan to value.
Credit will continue to get tighter until the losses stop. It could be years of bank confessions as the unwind occurs and the bubble deflates. I would expect to see residential real estate to fall in the bubble markets through 2011 because of all the resetting paper. The foreclosures that are on the market now are people who stopped paying in Feb/Mar, well before the credit freeze, high gas prices, and the fall of real estate price declines really gathered momentum. It's called creative destruction. The weak hands give up assets to the strong buyers. Houses in bubble areas continue to get more affordable for people running the make sense economic calculations. The buyers that are circulating now at open houses are putting 15-20% down payments, getting fixed rates and fully documenting income. Sure prices might drop but they are in it for the long haul and they can easily make the payment on their $500k home that some fool bought for $700k in 2005. This decade won't soon be forgotten for it's massive excess and dramatic belt tightening following the bubble.