Monday, March 10, 2008

Prime lons are next/Fannie's new game

Happy Monday everybody. One of the guys on the street that I love to read is Bill Fleckenstein of Fleckenstein Capital. I wanted to comment on a column he wrote over the weekend titled "Next shoe to drop: Prime mortgages". As usual you can find the link at the bottom.

I have been blogging recently about how the banks pulling back on lending is one of the major issues facing housing and the fact that the money supply is drying up which will put severe pressure on housing prices because their simply isn't enough money supply out there to keep prices going higher. Bill reiterated my feelings in his column this week noted below:


"According to a friend I've dubbed the "Lord of the Dark Matter," credit is
rapidly being withdrawn across a broad spectrum -- especially for the major
brokers, giants like Goldman Sachs (GS, news, msgs)
and Citigroup (C, news, msgs),
which have served as enormous financial intermediaries. This is now raising the
costs for nearly all credit-oriented hedge funds. And, my friend said, the pace
of massive de-leveraging could accelerate further. That in all likelihood would
feed on itself."

As you can see the word on the street is the big boys are pulling away from credit availability and when they stop the money flow and start to de-leverage the housing game will come to a screeching halt. I had noted Citi's announcement last week of cutting mortgage lending by 50% taking $45 billion dollars out of the housing game. These slash of money supply is what will ignite the time bomb. Bill further goes on to talk about how this will effect alt-A and eventually PRIME loans:

"I believe the next area of the credit sector to implode will likely be Alt-A -- loans granted to people who didn't want to document their income, also known as liar loans -- which will help illuminate the fact that our mortgage problems were never just subprime. Rather, they sprang from one big credit bubble, thanks to which mortgages were handed out to anyone who could fog a mirror. Most people took on more than they should have. (Some are now walking away from their obligations, a development recently highlighted in the media.)
In time, it will be clear that prime mortgages are also vulnerable.
"You can almost draw (the credit unwind) out in a diagram," said a managing director at the Economic Outlook Group in Princeton, N.J. "With home prices going down, consumers cut back on spending. If consumers cut back on spending, the economy weakens further. If the economy weakens further, fewer people are able to afford mortgages, so home foreclosures increase."

You see as Bill explains this all becomes a vicous cycle that feeds on itself. People in all loan categories stretched to buy houses they couldn't afford. Once the 15-20% annual increase in home prices stopped and started dropping, the economy started to have trouble which puts enourmous pressure on homeowners to continue making their payments. The fact that 58% of foreclosures in the 4th quarter being alt-A/prime loans means its already starting to show up in the numbers.

Bill then talked about Fannie Mae's new tricks:

"Knowing the complete scope of this credit disaster is impossible because of the absurdly pliable accounting treatment accorded to financial institutions.
Case in point: Fannie Mae (FNM, news, msgs). Before excerpting one of the relevant passages from the company's latest quarterly financial report, let me cut to the chase with this explanation from a friend: "They take a delinquent mortgage loan and replace the delinquent part with an unsecured loan in order to circumvent the buybacks and mark-to-market consequences." That is the reality.

Here is how Fannie goes at lengths to sugarcoat it:
"We recently introduced a new HomeSaver Advance initiative, which is a loss mitigation tool that we began implementing in the first quarter of 2008. HomeSaver Advance provides qualified borrowers with an unsecured personal loan in an amount equal to all past due payments relating to their mortgage loan, allowing borrowers to cure their payment defaults under mortgage loans without requiring modification of their mortgage loans. By permitting qualified borrowers to cure their payment defaults without requiring that we purchase the loans from the MBS (mortgage-backed security) trusts in order to modify the loans, this loss mitigation tool may reduce the number of delinquent mortgage loans that we purchase from MBS trusts in the future and the fair value losses we record in connection with those purchases."

This type of stuff reminds me of the Enron like accounting we saw after they were exposed and torn down. As these foreclosures mount Fannie will only be able to play these games for so long before it blows up in their face.

It will be an interesting week on the stock market. Rumors are already flying that mighty Goldman Sachs might miss their earnings for 4th quarter. I guess you can't trade yourself to profit every quarter when you have billions of bad loans on your books. Time will tell.

Link below:

http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/NextShoeToDropPrimeMortgages.aspx



2 comments:

Avl said...

Jeff, give us some scenarios on what this brave new world , the post-delevergaing world, will be like.
I learn much from your blogs...it feels like a travelogue of what we're passing thru...but where are we going and what will it be like to conduct business as a typical white-collar guy looking to sell/buy a home, use his credit cards, and help his kids get student loans.

Jeff said...

avl

I am glad you enjoy the blog. I would like to think we are going through a correction and a purging of excesses that will bring us back to a more realistic quality of life.

What we are going through now is very painful and we still have a ways to go. I think in the future assets like cars, homes will all be smaller but affordable. Loans will be done by banks not brokers at 20% down and good credit scores. Selling a home requires beeing realistic and in tune with the market you are in. Many will end up walking away because they cannot afford to short sell it but they will get their credit back later.

Student loans are a tough one. The credit crunch is killing that area of the market. College costs have gotten way out of whack with incomes and colleges need to start sharing more of their endowement on students. College is as bad as housing. It cost me 9000 my first year of college and the same school is now 34000 22 years later. You going to try and tell me their costs are up that much? I am not buying it. Demand will fall and hopefully so will costs as incomes suffer the next few years.

If colleges remain unaffordable then state schools are a great alternative at 1/4 the cost. There is really no difference out in the job world unless your child has the opportunity to go to an Ivy.

I am positive overall that we will recover. I will be bullish on the markets again at some point We have gone through tough times as a nation before and we will get through this just like we got through WW2 and the great depression. GL