Topic: Federal Reserve Bailout
The Next Round of Mortgage Shocks There is a new wave of exotic mortgages that dwarf sub-prime mortgages, and all the government-mandated refinancing in the world probably won't make any difference.by Walt Thiessen
(libertarian)
Monday, December 15, 2008
If you were watching 60 Minutes last night, you saw a segment about the next wave of mortage defaults that is coming. That link takes you to an online video of their segment, which I urge you to watch. This is the best concrete evidence I've seen so far that validates what many of us here at the Nolan Chart have been saying or suggesting for months now. The worst is not behind us. The next round of failures will come over the next 3-4 years, and they will more than double the losses created by the sub-prime lending market.
The one thing the 60 Minutes segment did not mention, just as no one else mentions it, is the role that the Federal Reserve played in creating this financial crisis. Again, both myself and other columnists here have written extensively about this, so see the many other articles here for details about that.
What it did acknowledge is that the next round of mortgage defaults is coming from two classes of mortgage lending that are slightly (but barely) more financially responsible than sub-primes. There were nearly $1 trillion in sub-prime mortages, but these new (to most Americans) forms of mortgages, the Alt-A and Option ARM mortgages, total roughly another $1.5 trillion. Given the fact that the banking industry has already sustained some devastating shocks, there is increasing doubt about the continued viability of many of the largest banks still left standing. Worse, it's going to take another 3-4 years for these loans to default, because that's how long it's going to take for the interest rates on these loans to reset to higher levels. Given the fact that a large segment of these loans are already defaulting even before the interest resets take place, the expert interviewed on the program claimed that he expects roughly 70% of these loans to default based on current, pre-reset default rates!
So all the efforts we've heard about to have the big banks renegotiate existing loans so that homeowners can afford them is likely to be largely wasted motion in most cases.
According to the chart they showed, some of these loans are already defaulting, and there will be peaks in default rates for these loans. The first peak comes at the end of 2009. The second, higher peak, comes in mid-2010. The third, and highest peak comes in mid-2011, when the default rate will exceed the highest peak in sub-prime default rates which occurred in August of this year.
Numerous reports say that more than 10% of all homeowners are already defaulted or are currently "under water," meaning that they are behind in their mortgage payments and in danger of defaulting. It will not be surpring if that number doubles or even triples over the next 3-4 years.
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Posted By: Jahfre Fire Eater
Date: 2008-12-15 15:12:41
Hi Walt,
Thanks for the link. I'm not a TV watcher so I'd have missed it otherwise.
I know why the mortgage meltdown is interesting and why so much is being written and reported about it but I have a hard time caring, personally. The only time I'd be really interested is if I were in danger of losing my home. Then none of the statistics matter. When ruin comes it isn't better for those who came by one path versus another.
Some people have been caught with no buyer when the music stopped. Some will lose jobs or get divorced and find no buyer for their home. These things have nothing to do with questionable lending practices arising from fee-derived profit models. Mortgage defaults resulting from job loss alone will be an accelerating trend in its own right.
I think the whole mortgage crisis is a distraction from the really big problems such as the collapse of the house of cards also known as "the service economy". In a free market, the cost of labor would be going down these days relative to the finished product. Our minimum wage and union laws prevent this from happening.
We have deliberately stopped up the engine of prosperity that is the free enterprise which enables pursuit of the American Dream. Until Americans are re-situated in jobs where they add value to a finished product we cannot begin to rev this engine up again. There is an astounding re-purposing of the labor force in the US that is required but our leaders will do everything they can to prevent that from happening. In the end, it will happen. There is no other way.
Posted By: Walt Thiessen
Date: 2008-12-15 16:14:32
You're welcome, Jahfre.
The mortgage crisis isn't just interesting. It actually affects all of us. It doesn't matter whether you're a distressed homeowner, a homeowner who is having no problems meeting payments, or a renter. The crisis affects all of us.
Renters are affected because what really drove the mortgage crisis (the Fed) is also what has driven rents to record levels. Thus, while property values are falling across the country, rents are not falling...and won't fall anytime soon.
Homeowners having no problems meeting their payments are also affected. The're seeing their home values dip seriously in value. True, the new values are more "real" than they were before, but there can be no doubt that even homeowners with solid incomes and financial situations are concerned, and rightfully so. Home equity has long been considered one of the best forms of investment individuals have. The crisis has already wiped out huge amounts of equity, and it's going to wipe out a lot more before the dust is settled. There's really no reason to believe that the decline of home values is going to end anytime soon.
The liquidity crisis caused by the mortgage mess is affecting business. People are being laid off left and right, and businesses are entering chapter 11. If you're really concerned about the service economy, then you need to realize that the mortgage crisis is driving that service economy crisis.
It's also spilling over into the commercial real estate market. I didn't go into any details about this in my article, but commercial realtors and investors are finding that no one is leasing these days and few are buying commercial property, because they can't get the financing.
If we had a free market with free enterprise (which we don't) then this would be a minor mess that would soon be cleaned up. But as we both know, that's not the case. Worse, the mortgage crisis is accelerating the coming demise of the fiat monetary system. While that's good on the surface, it's also going to mean very nasty times for everyone, because fiat money and its backers are not going to give up without a huge fight. We are seeing wealth transfers coming out of this situation that are dwarfing anything that has previously happened in history, and those wealth transfers are now encouraging the newly elected Democrats to engage in their own versions of wealth transfer. Both sides are going to continue to engage in wealth transfer behavior in an attempt to "set things right," and we both know what the consequences of that will be.
Also, let's not overlook how all the liquidity (instantly created money) that has been dumped into the banking system by the Fed to counter the mortgage crisis is going to be affecting us in the years ahead. I've heard and read reports that suggest that the money supply has increased by anywhere between 35% and 60% in just the past three months alone! That's eventually going to come roaring back at us in the form of inflation...probably double-digit.
Meanwhile, the Fed is moving toward massive devaluation of the dollar. If that happens severely enough, it will probably undermine the dollar's role as the base currency of world economics. When that happens, watch out as the flight from the dollar starts to shape up. That flight will literally end up dumping huge amounts of previously withheld dollars by foreign investors, adding to the inflationary situation dramatically. As one pundit put it, it will teach America the real meaning of inflation.
The mortgage crisis didn't create this situation, but it's the leading indicator of what's going on below the surface. It has people panicked, and when people are afraid, that's when the government is most successful at destroying liberty and increasing its grasp on the rest of us.
So I suggest you rethink your idea that the mortgage crisis doesn't affect you just because your house isn't about to be repossessed.
Posted By: Jahfre Fire Eater
Date: 2008-12-17 17:18:42
Hi Walt,
Point taken. I didn't mean to imply that I wouldn't be effected. I actually said that I didn't care rather than saying the mortgage crisis doesn't affect me.
I don't care what other people or some statistical analysis says my home is worth. I plan to stay here for the rest of my life. I value my home at least 10 times what the market says its worth. So I can't ever imagine leaving for any reason.
I fully expect the dollar to collapse dramatically and disappear in my lifetime or in the next 40 years, whatever comes first. :-) I have been conducting my financial business as if the dollar were worthless for the past 5 years. I seldom have more than a couple thousand dollars in any dollar denominated account. If they disappear entirely, I'll still have most of my original purchasing power stashed away in non-dollar assets like gold, food, whiskey, ammunition and medical supplies.
We'll see what the historians eventually say but I think the calamity would happen with or without the mortgage bubble crisis. I think the mortgage crisis is a mere consequence of bad thinking leading to bad policy leading to bad legislation.
The engine of US production was tuned to run as if growth were inevitable and accelerating. The hype was sold to the average American because the engine needed to tap every bit of the individual reserves it could reach in order to keep up the pace. I think we are seeing the equivalent of vapor lock in our credit markets not because of the mortgage crisis but because the engine sucked the fuel dry. America is tapped out, over extended and unable to sustain productivity into the future.
Several futurists have written about how having an economy that relied on accelerating consumption of credit would fare once the baby boomers started recognizing their mortality and tightening their belts, often for the first time in their lives. This is the perfect storm.
Those baby boomers who are retired or about to retire are not going to suddenly begin consuming like they did 10-30 years ago. No amount of "stimulation" can turn back the clock for those folks. As time marches forward they will rapidly become more stingy.
I believe home prices will continue to lose value until they return to their historic mean and even undershoot a bit. I'm predicting a bottom much lower than most reporting I've read on the topic so far. Bailing them out now is like giving someone a parachute that only works the first part of the way down. Eventually their value will collapse some more and the maximum number of current home owners will lose their home. There may be several levels where bail outs are tried on the way down. The goal of such actions is not really to help the homeowner but to ensure that the homeowner absorbs as much of the loss as possible before the bank has to take over the property. I think most mortgages made since 1998 still have higher balances than the homes are worth and it is only going to get worse over the next 3-4 years until the bottom of the job loss crisis is reached. I think the problem is immensely larger than the current mortgage crisis appears to be.
I did think of one scenario where I'd leave this home. In the event that it made sense to live somewhere I could grow my own food I would head back to upstate Pennsylvania. If things get that bad I wouldn't even worry about finding a buyer for my house. I don' think markets would be functioning at that point for lack of a trusted currency. I'd just leave.
I plan to just watch all this unfold without having much skin in the game; biding my time, continuing to prepare for a tomorrow that is nothing like yesterday. Eventually things will get better. I want to be ready.
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