I disagree completely with this video’s conclusions. I will explain why in my next post. Still, it’s pretty darn creative and worthy of posting here.
Perish the thought. Between them the two companies back well over $4 trillion of residential mortgages in the U.S. Underneath this pile of debt the companies have a tiny capital cushion of about $40 billion each. And that counts the $6 billion Freddie recently raised in a preferred stock offering.
Two good quotes from Wednesday’s news. The first from the NYT Op-Ed page:
While the bubble was inflating, self-serving explanations were offered for why traditional formulas of home valuation no longer applied. As it turns out, the laws are still in effect. These traditional measures, like the relationship between home prices, rents and income, indicate that prices need to fall at least 30 percent more nationally. The sooner this balance is achieved, the sooner lenders will again commit capital.
For anyone who thought commercial real estate was going to escape the subprime mortgage meltdown, time to wake up and smell the roses. This article from the WSJ doesn’t have a lot of new info so much as juicy tidbits describing how easy credit blew up a commercial real estate bubble the same way it blew up a residential one.
So my buddy at Lehman who thinks losses could top $450 billion (see previous post) is looking bullish. The article below says the folks at Barclay’s are now saying $700 billion. And that’s before factoring in losses in commercial real estate. Lest we forget there was a bubble brewing there too, with cap rates at record lows, we would be remiss to forget there will likely be hundreds of billions in additional losses there.
Last week the WSJ published a great article about vulnerable California borrowers who’d been taken advantage of by a shady lender. A similar story in the NYT a month ago described how Countrywide deliberately steers borrowers into “high cost…unfavorable” loans in order to maximize their own profits. These stories are variations on the same theme: informed lenders taking advantage of uninformed borrowers. Yet they don’t tell the whole story. Borrowers share blame for taking on mortgages they couldn’t afford in the first place.
BKUNA (see post below) isn’t the only bank with low quality earnings that rely on negative amortization. Remember: negative amortization is the amount of interest due on a mortgage that the borrower defers to future periods. Accounting rules allow banks to count these “deferred payments” as current income. But if borrowers default on their loans, if they never make payments in cash, then “income” previously recognized has to be reversed.
And now for something completely different. From time to time, we at optionARMageddon like to talk about subjects besides real estate. Below a piece about immigration. Your editor will share his own views on the matter in a comment to be posted in a few days.
I love 10-Ks. You know those annual filings that public companies are required to make with the SEC? BankUnited Financial (stock ticker: BKUNA) published theirs last week and it makes for some fascinating reading. BKUNA’s loan book is clearly a real estate disaster story worthy of an optionARMageddon post. And, according to the 10-K, they claim not to have been involved in subprime. That is an interesting theme developing of late: plenty of lenders that avoided subprime debt entirely are still in deep trouble. American Home Mortgage? Bankrupt. Fannie and Freddie? Cutting their dividends and “hurrying” to raise capital. Even “prudent” lenders are getting hammered by real estate’s implosion. Did BKUNA lend “prudently?” Check out the 10-K for yourself. Forthwith: my favorite nuggets.
A delicious theme of the subprime debacle is that otherwise smart people, who ARE PAID TO KNOW BETTER, got themselves and their investors involved in dodgy debt. Like Florida’s Local Government Investment Pool. Money fund managers who put investor capital in CDO debt, SIV commercial paper and similarly sketchy instruments deserve their own circle in mortgage hell. Investors like a good yield in a money market fund, sure, but at the end of the day, do we care so much about that extra 25 basis points that we’re willing to put our capital at risk? Money market funds are supposed to be ultra safe. That’s why people buy them. We’ve heard fund managers argue that Moody’s rated this stuff ‘AAA.’ It’s not their fault if the paper turned out to be unsound. Come on: take some responsibility guys. Investors don’t pay you to outsource investment decisions to Moody’s!
This is an op-ed, but no doubt the WSJ editorial page doesn’t stray too far from this opinion themselves…..one thing we have to worry about is becoming the next Japan. Remember their real estate bubble in the late ’80s? When the land underneath their royal palace was worth more than the state of California? That bubble burst, but instead of forcing the financial system to digest all it’s bad debt, the Japanese authorities allowed them to continue carrying it on their books. Here we are 17 years later and the Nikkei is still half what it was back then. If we prevent the real estate reckoning from cleaning up the mess we’ve created for ourselves, in the debt markets, in home values, etc., we risk long-term stagnation ourselves. The short-term pain will likely be greater, but at least we will have taken our medicine.