by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
An excerpt from one of my recent posts on The Active Rain Real Estate Network:
The sub-prime mortgage market is falling apart. Wall Street firms are being stung by the bad sub-prime loans they bought and have demanded that the sub-prime lenders buy those loans back. The sub-prime lenders didn’t have the money to do so. Those Wall Street firms simply swapped the debt for ownership in the firms. Once the camel got his nose underneath the tent, he didn’t like what he saw.
The sub-prime mortgage market is completely tightening its lending standards. The wholesale account executives, once compensated like a proven reliever for the Padres, are applying for night gigs as bartenders to supplement their income. The words “stated income” are becoming more politically incorrect than a racial slur. The NEW AND IMPROVED sub-prime lender will emerge as the prostitute who found God.
Here were some excerpts from some of the comments:
From Mikey:
Right now the lending standards are just taking out 100% subprime financing. Watching the rate sheets, low LTV stated deals are still plentiful. I think hard money can be a profitable niche, but it will remain a niche. The other thing limiting its growth potential is just the slowdown in real estate market in general.
From my buddy, Jeff Belonger in New Jersey:
Brian… some good points. But sub prime will always be there, in my opinion. I remember when it started hitting the streets hard back in 1994-’95. The strong will survive…
… But there will still be those few sub prime lenders that have been positioning themselves the last 2 years, not taking every piece of crap. Names like Equi First and Decision One will be around and they still have good products that Wall Street will invest in. Why? Because of their performance records and lack of loans that go into default
More importantly. Some of the e-mails I received today:
From a colleague in the Midwest:
Hey, do you know of something going on at New Century? Rumors are flying right now…
Unsolicited e-mail from my post:
i’m an account executive for a major subprime lender. i am seeing fear and panic in the faces of everyone here from the ceo on down. wall street is breaking our balls hard over early defaults and forcing us to buy back bad paper. the other shoe hasnt dropped yet – the resetting arms that are due to explode and will be unable to refinance due to diminished home values.
morale is low here. the ARM bloodbath is about to begin, taking the us and global economy with it.
Jeff Brown says:
>…the ARM bloodbath is about to begin, taking the us and global economy with it.
What’s your take on that Brian?
February 13, 2007 — 9:35 pm
Brian Brady says:
A bit like Chicken Little.
In fairness to the commenter, I think it’s more the remarks of a man (or woman) worried about his/her livelihood; I don’t blame him (or her). The mortgage business can be quite an ego boost. When it’s good, you think that you, solely, are propping up the economy. When it’s bad…well…you feel the weight of the world on your shoulders.
The challenge with the “employees” in the markets is that they FEEL unemployable (at their baseball superstar comp). The hustlers survive.
February 13, 2007 — 9:52 pm
NVmike says:
From where I sit, any changes are 9-12 months too late. The Subprime Dead Pool is up around 20 or 21 now, with ResMae filing Chapter 11 yesterday.
Is the sky falling? I hope not, but the news is all bad and getting worse: three major subprime lenders have now gone toes up in just the last 10 weeks and rumors are rampant about many others.
February 13, 2007 — 11:16 pm
NVmike says:
HSBC’s Decision One won’t be around much longer if the subprime unit loses another $10.6 billion in ’07.
February 14, 2007 — 12:11 am
Brian Brady says:
NV MIKE SAID: “Is the sky falling? I hope not, but the news is all bad and getting worse”
BRIAN: Think of the opportunities revealing themselves these next 12 months (think RTC bonds)
February 14, 2007 — 2:06 am
Franz says:
Yes, the subprimes are falling apart pretty bad. NVmike is right, 21 have kicked the bucket in the last 2-3 months.
The next Enron, though? No, I think that title will go to Fannie Mae, or “Fanron” as Bill Fleckenstein has nicknamed them.
February 14, 2007 — 7:49 am
NYCJoe says:
Brian,
I’m absolutely astonished at the speed that this is happening. The thing that remains to be seen is how much this removes from the demand side of the equation.
Then I came across this:
February 14, 2007 — 12:31 pm
Brian Brady says:
Joe, Do you remember Marty Zweig? One of his principal rules of investing was “Don’t Fight the Fed”.
I am thoroughly confused this week. Every event suggests asset deflation, arrested nominal GDP growth, and an impending capital crisis. Oil prices have dropped.
Why are the Fed governors changing to a hawkish bias?
February 14, 2007 — 12:45 pm
NYCJoe says:
Oh man, do I remember Marty.
The thing is, it’s hard to tell if you’re actually fighting the Fed these days – it feels like shadowboxing sometimes.
The only reason I can think of that the Fed clings to this hawkish bias is to control the dollar. They seem to be OK with the orderly decline that’s happened so far, and they have to be privately worried about what would happen should the dollar drop precipitously.
Unfortunately, the Fed has nobody to blame but themselves for this. Greenspan actually received an award on some CNBC show the other night – I thought I was going to vomit. I actually had to turn the TV off.
February 14, 2007 — 2:02 pm
NYCJoe says:
The North County Times:
Ouch.
February 15, 2007 — 11:56 am
Franz says:
Make that 22
February 15, 2007 — 4:30 pm
Brian Brady says:
I’m actually hesitant about submitting a sub-prime loan for fear that it won’t be funded. I’m only submitting to Wall Street owned entities right now (WMC, First Franklin, and Encore). The challenge is that they’ve raised their rates to reflect their newfound stability.
This is an awfully weird time.
February 15, 2007 — 7:05 pm
NYCJoe says:
Um, I think you’ve got that backwards.
It’s the fallout from the subprime lending market that is affecting the real estate market. Cheap money made it possible for people to spend more on houses, which drove prices up. As more people couldn’t afford houses using traditional loans, they turned to subprime and ARM lenders, which began offering money with little underwriting standards, which began to cause defaults. This caused underwriters to tighten standards, which meant that fewer people could get loans. When people can’t get loans, they can’t buy houses. When people can’t buy houses, the market slows down.
More news from Bloomberg today:
February 16, 2007 — 2:21 pm
NYCJoe says:
By the way, I’m beginning to strongly believe that this problem will not be limited to subprime.
I think it’s just a matter of time before standard loans start defaulting as well. Probably not to the same degree as subprime, but there will be some trouble in standard as well.
February 16, 2007 — 2:28 pm
Charleston real estate blog says:
Joe, I wrote a post and mentioned Brian’s post with a link and only the first sentence got here. To read it all, please go to http://www.charlestononlinehomes.com/blogs/howard_arnoff/archive/2007/02/16/subprime-mortgage-meltdown.aspx
but there is a little of the chicken and egg in this.
February 16, 2007 — 2:29 pm
NVmike says:
[Feb 15]Make that 22
23 now. RIP Silver State Mortgage.
February 18, 2007 — 9:56 am
Diane Cipa says:
Trying not to be chicken little because this isn’t global, but it’s likely to be the biggest nationwide correction in the real estate market I have seen.
Subprime is the weakest part and thus the first to go. Expect more. Fraud and low standards built this city – even A paper isn’t safe.
We had a cultural degradation in standards and ethics that began with the formation of affliated business relationships in the 80s. The conflicts of interest inherent in ABAs bred a culture of fraud and while that was incubating we had the first couple of big refi booms.
Everybody and their mother got into wholesale mortgage lending, figured out how to buy servicing released product and securitize it. This was big time and lenders got hooked on the servicing income fed by product originated by mortgage brokers who were popping up all over the country. Suffice it to say mortgage lenders and mortgage brokers got hooked.
Feed me! said the servicing portfolios when they waned during the next refi wave.
Everybody got used to the volume and when it wasn’t there got creative. Lender’s loosened guidelines. Predators and those unfortunates caught in the ABA conflict of interest vice, turned to fraud. Some went the whole way and did big time fraud. Most just engaged in what they considered little time fraud.
All of it weakened the structure and integrity of our real estate market.
There are always opportunities and I expect most people will be safe, but there will be much heartache and it’s a shame because this will be the first self induced real estate market crisis I have ever seen.
This is what happens when an industry refuses to police itself and forgets the faces of its fathers.
February 18, 2007 — 3:12 pm
NYCJoe says:
Diane,
It’s also an example of what happens when there’s no place left for the buck to stop.
Back in the day when lenders actually had to hold onto their loans (because that’s how they made money), it was in their best interests to make sure that suitability was their primary concern. After all, if the borrower defaulted, the lender got burned.
Once securitization came along and MBSs became all the rage, there was no culpability anymore. All you had to do was pass the paper along and collect your fees.
Kind of funny, isn’t it? When the incentive is to watch your paper quality because your income depends on it, then that’s what lenders do. When the incentive is to generate fees because your income depends on it, then that’s what lenders do.
Plenty of people out there saw this coming, by the way. But it’s tough to be heard over the din of the ringing cash register.
February 19, 2007 — 11:02 am
Diane Cipa says:
Well, I rest my hopes with the ultimate money watchers. I trust that you all will consider the suggestions many have made to add a self-policing body like the NASD with a voice powerful enough to be heard. 😉
February 19, 2007 — 11:17 am
NYCJoe says:
I normally take what Bill Fleckenstein writes with several grains of salt, because he’s sometimes overly bearish for me. But this caught my attention:
The housing ATM rot is just the beginning
February 20, 2007 — 6:11 pm
NYCJoe says:
From the voice of san diego:
Whoa – sounds like the NOD rate is substantially higher than 3%.
March 8, 2007 — 3:21 pm
Brian Brady says:
Joe,
The foreclosure rate and default rate are two related but different animals. Higher default rates do lead to higher foreclosure rates…maybe.
Remember an NOD isn’t filed until the borrower has missed three payments. So, the VoSD’s stats would lead you to believe that one out of every ten homes in SD county will be sold at foreclosure.
The VoSD is hardly an unbiased source.
March 8, 2007 — 6:20 pm
NYCJoe says:
Brian,
I agree the VoSD does make it sound worse than it probably is (though to be fair, it’s not the VoSD’s credibility in question here – they’re just quoting First American’s data, and I’ve seen that data reported elsewhere, not just in VoSD).
Some of those houses won’t go into foreclosure, obviously, but still may be sold against the owners’ wishes in some cases.
In any case, though, 11.3% of loans being 60 days past due is pretty unbelievable.
March 8, 2007 — 10:31 pm
Brian Brady says:
>In any case, though, 11.3% of loans being 60 days past due is pretty unbelievable.
No, it isn’t good at all. That’s for sure, Joe.
I can’t get a read on our market. Stats like these tell me that we’ll be buying condos on the Pacific Ocean for $300K but buyers keep stepping up to the plate every time there is a dip.
March 9, 2007 — 12:55 am
Franz says:
If anything, I’d bet delinquincy rates are higher than reported. Lenders are using accounting trickery to keep bad loans off the books as long as possible.
March 9, 2007 — 7:34 am
Diane Cipa says:
Looking at subprime from a different perspective…
I’ve been hashing out the notary signing agent and signing service issue on Radical Title Talk and as part of my research, I’ve spent some time perusing notary forums.
The experience reminded me of an old time construction lender who routinely walked construction projects and chatted with the guys while they worked. He said that’s the best and only way to know what’s really happening. Are they being paid? What’s the vibe?
These notary folks are scared and they are having more trouble than usual getting paid. It’s a unique perspective of the market I hadn’t considered before.
Industry players who have made or expanded their business model to serve the subprime market, VMCs, some pretty big title underwriters, title agents, are about to take a big hit along with the lenders.
This is a very interesting development and one that only really crystalized for me this week.
We have a fairly swift collapse in the affiliated business structure and subprime providers happening at the same time. The twin towers of greed, keep your eye on them.
March 9, 2007 — 7:45 am
NYCJoe says:
Wow, Franz, great find.
It’s pretty frightening to think how deeply Freddie and Fannie are involved with this, but it’s even weirder that nobody has blown the whistle on such an obvious ponzi scheme (or, the whistle has in fact been blown and the mainstream press just doesn’t want to print it or doesn’t understand it).
March 9, 2007 — 1:57 pm
Brian Brady says:
Okay, let’s get a reality check, folks:
1 out of 10 loans are not in default; the number is closer to 1 out of 20 loans originated in the last 3 years. MAYBE one third of those go to trustee sale.
It ain’t good BUT it ain’t that bad, either. Misery loves company and the press and bubble bloggers feed on little stories. How about a big picture statement for you?
Over 95% of the loans originated in the past ten years will NOT go into default! Over 97% of Americans will NOT lose their home! Close to 20 million people will realize a six-figure gain on their primary residence in less than 5 years.
March 9, 2007 — 2:22 pm
Greg Swann says:
> Okay, let’s get a reality check, folks
Indeed. And we need to remember that all of this is a wave, a span of months on the origination side that will manifest itself as a span of months of bad news, all to be fogotten soon thereafter.
March 9, 2007 — 2:29 pm
Franz says:
NYCJoe,
I think the whistle is being blown now. Of course the horse is not only out of the barn, it’s already been run over by a truck.
If you’ve never seen it, rent (or buy, beg, borrow, or steal) the Enron documentary “The Smartest Guys In The Room”. The similarities are eerie.
If Fleck is too bearish for you, Mish may be over the top, but here are a couple other telling posts from his blog:
– Avalanche of Lawsuits
– New Century Criminal Probe & Fantasy Land (they borrow $1 billion for 1 day every quarter so that they can show it as cash on their balance sheet… sound a little fishy?)
Brian, I agree that most loans are going to be just fine. However it’s the ones at the margin that drive the market.
Greg, if years of bad loans can be cleaned up and forgotten in a few months, I’ll eat my hat.
March 9, 2007 — 7:22 pm
Greg Swann says:
> Greg, if years of bad loans can be cleaned up and forgotten in a few months, I’ll eat my hat.
That’s the point. There aren’t years of bad loans, there are at most 18 months of bad loans. The older loans, no matter how stupid the underwriting guidelines, are supported by equity. A small number of loans made over a small number of months _may_ go bad. As with everything bubble related, the sturm und drang by far outstrips reality.
March 9, 2007 — 7:45 pm
NYCJoe says:
Greg,
The evidence points to significantly more than 18 months of bad loans. It’s certainly not more than a few years (I would guess maybe 3 years tops, and the early ones around 2003-2004 are probably in the vast minority – less than 10%).
But the problem is that run-ups are not necessarily symmetrical. Just because it took 3 years for prices to explode and for all these loans to get into place doesn’t mean that it’s automatically 3 years to wind down. There are all kinds of impedance mismatches that will cause the unwinding to take longer as people try to either stave off foreclosure, run through their savings, take second jobs, take renters, etc.
March 9, 2007 — 8:27 pm
NYCJoe says:
Brian,
To be clear, I never said that 1 out of 10 loans was in default – just that the rate was probably higher than the widely reported 3% to 4%.
I’m not trying to sound like an air-raid siren, so I’m sorry if that’s how it comes across. But remember that just 9 months ago it was widely being debated that subprime mortgages were even in trouble. That debate has now shifted to how bad it’s going to be – quite the perception shift.
In fact, it’s now being suggested that even Alt-A and prime loans could be affected. If that starts to happen, it will cause even more problems. Of course, right now this is just being debated, just as subprime was last year.
PS: By the way, I’d hardly consider Michael Shedlock to be a “bubble blogger.” He’s got some very solid economic analysis to back up what he says, and he’s not always bearish.
March 9, 2007 — 8:33 pm
Brian Brady says:
>Greg, if years of bad loans can be cleaned up and forgotten in a few months, I’ll eat my hat.
I like where this discussion is leading. There are bad loans that were made in the last 12-36 months. It will be a drain on the economy.
In the fifth comment in the thread, I mentioned RTC bonds. Let me offer an idea to consider.
1- The bad loans came from mostly the 80/20 financing. Most of the “80s” in the 80/20 scenarios are safe. The “20s” are going to be in trouble.
2- Those “20s” could be repaid over time by the borrowers and repackaged as collateral for securities, and sold at a deep discount.
Someone very smart will figure this out, provide a solution, and make a killing.
March 10, 2007 — 8:39 am
NYCJoe says:
Ain’t that the truth – someone always does.
Greg, here’s a case in point about why it’s not just subprime loans you have to worry about (and see my earlier comment about problems spreading to higher quality):
From Marketwatch:
Subprime mortgage woes may be spreading
Losses are creeping up on so-called Alt-A home loans
March 10, 2007 — 9:18 am
Brian says:
I work for Citifinancial in Canada. There has been little to no evidence of this disaster here. Definately not a global issue.
March 14, 2007 — 11:53 am
Tom Johnson says:
I just have two questions.
1. How do you take subprime mortgages and reissue them as AAA rated MBS’? I am waiting for the little old ladies who bought AAA rated MBS unit trusts or mutual funds to appear on the 6 o’clock news having to eat dog food because of GW BUSH and his evil sub prime loans (It’s always Bush’s fault). I guess the guys on Wall St that figured out how to turn junk paper into AAA paper while extracting 4 or 5 points deserved their $ billion bonuses.
2. Do they have to give it back when these securities all blow up and force huge losses in pension plans and bank reserve accounts? Just asking.
March 24, 2007 — 7:09 pm
Brian Brady says:
Good questions, Tom.
1- You don’t. You issue them as “junk” asset-backed securities.
2- No. You blame Bush.
On a more serious note, there is a place for deeply discounted non-performing loans; they’re traded daily
March 24, 2007 — 8:29 pm
Tom Johnson says:
The bad loans came from mostly the 80/20 financing. Most of the “80s” in the 80/20 scenarios are safe. The “20s” are going to be in trouble.
The “80s” are considered safe until there are so many foreclosures flooding the market that the values are lower than 80% of the old 100% where the loan was underwritten. Once that happens the AAA paper(the “80”) will be damaged. At that point the AAA buyers cannot hold the security without a fiduriary violation on their part. It only has to happen at the margin to force ratings cuts which would force a wave of formerly AAA rated MBS’ on the marketplace where the only buyers would be the high risk investors who will get a huge discount. I don’t think very many people know where the “80” pool in their union pension plan or their IRA,401(k) came from and what the underlying mortgages in those pools look like. This meltdown is all Bush’s fault due to Halliburton and global warming.
March 25, 2007 — 8:12 am
Diane Cipa says:
“This meltdown is all Bush’s fault due to Halliburton and global warming.”
Thanks for the chuckle.
March 26, 2007 — 5:52 am
graham Cole says:
The Savings and Loan debacle didn’t sink America. The NASDQ tech crash didn’t sink America and neither will the current sub prime road bump sink America. In pre Internet times the doomsayer bloggers would have not had a voice to spread their folksy home spun panic theories. This sky is falling garbage is nonsense. So what if a few people default on their rip off rate mortgages? The other 97% of the population will not be affected. Get a grip. Wall Street creates money out of thin air. Haven’t you go it yet? The system is rigged. A little lose here and there is part of doing business. It’s the American way. Sit back, flick on the TV, watch a game and open a Bud. Life is wonderful if you’re one of the 97%.
March 31, 2007 — 1:29 am
Brian Brady says:
>Life is wonderful if you’re one of the 97%
I’ll talk big picture here. If you’re one of the 3%, life is temporarily bad. You may lose your home which is a traumatic experience. Americans get “do overs” every 7-10 years on their credit reports.
A foreclosure and trustee sale is a good reason to:
1- start a budget that includes saving a few hundred bucks a month.
2- stop spending more than you make
3- plan for a home purchase down the road.
Forgive the flag waving but you’re never down and out in the USA
March 31, 2007 — 10:11 am
Diane Cipa says:
We always recover, that’s a fact. Compared to many of life’s tragedies, an economic bump for most isn’t that bad. The loss of a house and loss of a job and perhaps for some, incarceration or heavy fines, or bankruptcy, are not the end of the world.
Comparatively, jihad is a much bigger threat. I’d much rather lose a house than have my head chopped off or sister blown to bits.
So, yes, everything is relative. We hope to learn from mistakes, but alas each generation thinks they know better and history does repeat itself.
For now, I am confident that the wheels are in motion to correct systemic malfunctions such as crappy underwriting in mortgage and title, layering of risk so that originating lenders can’t divorce themselves wholly from investors, conflicts of interest inherent in affiliations, joint ventures, and the like, as well a restoration of fiduciary duties owed to consumers in title, real estate and mortgage lending.
Truth is breaking out all over.
March 31, 2007 — 11:07 am
Sam in Austin says:
There were two problems that started this. Mortgage brokers who just wanted their fees before selling to investors AND investors who threw conservate investments to the wind.
December 30, 2007 — 9:16 am
Everett says:
The banks and brokers who generated all these subprime loans make the individuals involved in the Enron scandal look like choirboys. If there is an once or moral fiber in our government, every single CEO and executive of these companies would be thrown in jail. The bail out of Bear Sterns sends a clear message to all these bankers that Uncle Sam will rescue them no matter what their predicament is.
April 2, 2008 — 3:30 pm