Dear Mr Cramer,
I am upset at the story you put out over the weekend regarding housing and yet another prediction of a bottom, this time in seven months.
I believe you are intentionally deceiving people. Calling the bottom to housing using a variety of bad indicators and rampant speculation is wrong. I am giving you the benefit of the doubt by saying you are ‘deceiving’ people because there is no way you are this naive about the housing and mortgage markets.
In your research story published yesterday in RealMoney and TheSreet.com, you use the fact that 14 million homes were “purchased” between 2005 and 2007 and those being the ‘bad lending years’ for the basis of a hypothesis that the housing market will bottom seven months from now. You also talk about new home builders reducing their supply, the FDIC offering mortgage modifications and FHA being the savior.
If you are a headline reader, perhaps these things do sound great. But, in reality very little of your analysis or conclusions have substance or are likely to come into play in any significant way.
First, you are overly attached to ‘subprime’ when anyone following the story knows that the Alt-A and Prime universes are beginning to blow and they dwarf the subprime universe.
Second, you overemphasis ‘fraud’ when we all know that while fraud is a big factor, lender negligence and negative-equity are the leading contributors to loan default especially among higher grades of paper.
I should have stopped reading after the ’14 million homes purchased’ statistic was thrown out. This is because purchases were only about 33% of the market at any given time and millions more refinanced into exotic loans than ever purchased a home using them. In addition, prices are down near 2004 levels and approaching 2003 levels quickly. There were exotic loans during those years as well, so only focusing on homes ‘purchased’ from ’2005-2007′ captures a small portion of the at-risk market.
But of course, due to my distaste for much of your shotgun-approach research that costs so many so much, I thought I would spend a couple of hours and prove once again that these problems are very deep and throwing out a quick-read story citing a couple of low-level statistics is absolutely worthless when trying to dissect the future of housing and mortgage finance.
8/22/08 – 2:11PM EDT
“I am kind of amazed at some of the things that no one seems to care about. When the FDIC seized IndyMac, it was a godsend — get that crummy lender out of the picture. Then the FDIC announces a radical plan to allow homeowners who borrowed from them to get off the toxic 2-and-28s and teasers and go into fixed-rate loans with some forbearance. We got that this week. No one cared! No one!”
First off, it is not the ‘2-and-28’. It is the 2/28. Who cares about the 2/28 Cramer? And at the time IndyMac was seized they were a good lender focusing on Prime and FHA.
The market has by and large solved the subprime problem on its own. Most of the 2/28′s that will default have defaulted but not all by any means. What you forget are the 3/27′s, which were not as popular but still about 33% of all subprime ARMs. They are currently resetting now and that should peak late this year.
Also, the recidivism rate among all subprime modifications is higher than 50% so the original 2/28′s that were worked out and perform fine for the first six months will continue to default at a 50% clip going forward. Subprime defaults reached a high a few months back and have declined some, but will likely not decrease significantly for a long time.
That being said, Alt-A and Prime defaults are surging. The ’Alt-A Implosion’ is being led by the Pay Option ARM, which is a subset of the Alt-A universe. As a matter of fact, despite the subprime default rate dropping, overall monthly default counts have remained at all-time highs (up 800% in the past two years) from Alt-A and Prime filling the void.
The problem here is that the Alt-A and Prime universes dwarf the subprime universe. There are estimates that just the Pay Option ARM’s should default at 50% clip, which is higher than subprime.
Their peak resets do not happen until Dec 2009 then they flatten out for 10 months before dropping. So, the Pay Option Implosion will be with us for at least two years. These loans know no socio-economic boundaries and were the favorite in more affluent cities across the nation, especially in CA. So far in CA, we have only felt the Subprime Implosion and that has had devastating effects. The state can’t handle subsequent implosions of even greater magnitude but that is what we are going to get.
More defaults from even higher paper grades mean more pressure on the distressed asset market and ultimately the housing market. The banks in their overwhelming desire to hide their losses had been taking much longer to foreclose than they could, selling foreclosed homes very slowly so as not to take the hit.
Your beloved FDIC has kick-started what will be massive bulk liquidations by banks, which presents a clear and present danger to housing. Recently, the FDIC’s Bair said she would liquidate IndyMac’s portfolio quickly. Since then, Merrill did sell, Fannie said they would sell 54k homes in bulk and Lehman is shopping $40 billion in ‘assets’, much of it residential.
The great ‘asset’ dump is upon us and this represents only a portion of real estate assets these banks will get back over the next many years.
“How can that be? The FDIC is offering us a plan that would make it so we can root against Washington Mutual (WM – Cramer’s Take – Stockpickr) and know if that scourge of all lenders went under, we would have far fewer foreclosures because of the FDIC takeover. Also, once the loans are all under fixed rates or sent to the FHA for rehab — as the housing legislation makes clear will happen — we are going to see a dramatic decline in the rate of foreclosures.”
The new FHA Bailout Law is not all its cracked up to be Cramer. Quit reading the headlines…please.
The recidivism rate among modified subprime ARMs is so high because non-profits and servicers are just bad at qualifying people for mortgage loans and the borrower is even worse. There are professional loss mitigation firms out there such as Green Credit Solutions, who we at ML-Implode endorse, that have very high success ratios and very low recidivism rates. Private loss mitigation could help but there are not enough qualified firms doing this.
The new FHA Bailout Law will not make for a significant decline in foreclosures. The current FHA default rate is approaching 20% and that is from the good FHA borrowers! This is before the new Bailout Law and all the worst of the worst borrowers are allowed to be run through FHA.
There is already a push back going on with the new FHA Bailout Law anyway. First, by the banks that are learning very quickly they will have to discount notes by up to 60% at least to get to that 90% LTV level or low debt-to-income ratio required. Second, by the FHA lenders who will be watched closely by FHA for default rates with this new group of loans and judged by ‘Compare Rates’. For example, if defaults exceed 150% of their historical average, they could lose their FHA approval!
As troublesome for this new Law is the fact that most of these defaulted loans have a second mortgage and the second mortgage lender has to actually waive the debt in exchange for future equity in the property.
In addition, people still have to qualify under relatively tight guidelines. My guess is less than 15% of all eligible borrowers can be helped through this new Law.
You also have to consider that many may not want a new 8.5% FHA fixed rate loan with a 3% up-front and 1.5% annual mortgage insurance premium. With a home still comes property taxes and insurance and it most cases the borrowers will learn that they can rent cheaper. For many, their payment will be going up even with a principal reduction.
Why would they not rent when they are giving away 50-100% of the future appreciation in their home to the FHA and 25% to the second mortgage holder? Best case if they stay five years, they will get to share in 50% of the upside; 25% if they have a second mortgage the bank agrees to wipe out. It is simply better to rent.
“Now, right now, when we see this, we are skeptical. When Wells Fargo (WFC – Cramer’s Take – Stockpickr) decided to give its borrowers more grace — the same grace that other banks give — we immediately figured it was a canard to mask things. But John Stumpf, the CEO, said it seemed like the right thing to do, and the bank would do better trying to work things out with lenders than throw them out on their butts. Instead, of course, the rate of foreclosures went down, and I bet ultimately the number of foreclosures will go lower.”
Cramer, he lied to you. THEY CAN’T FORECLOSURE. Think about it. He extended the definition of ‘default’ from 120-days to 180-days on his massive $84 billion Home Equity portfolio, not on the first mortgage portfolio. Second mortgages are in second position 95% of the time. Values are down 35% on the median in CA for example, which is where Wells Fargo has the most exposure. Therefore, the vast MAJORITY of his Home Equity portfolio is in a negative-equity position and is unable to be foreclosed upon! If they did foreclosure, the first mortgage holder gets it all.
Last month in CA another foreclosure record was set with nearly 30k people losing their home. This is up from 3k two years ago. Behind 80% of those foreclosures is a wiped out second mortgage and belonging to Wells, WaMu, Countrywide, CITI, Chase or Bank of America. These are TOTAL wipe-outs through foreclosure where there is no recovery through foreclosure.
“We need time. We need time to solve the housing depression. The elements of time play out positively, because we are a growth nation that cannot have as few homes built and as few homes bought as in 1991, when we had 248 million people in this country. We now have about 310 million people. We have more than 60 million more people in this country, and we are buying as many homes as we did back then? How long can that last?”
It can last many, many years Cramer because between 2002 and 2007 most who could buy did buy. A large percentage of those who had been owners before the bubble refinanced into risky loans or pulled all their cash for investments or to buy a second or rental home. By 2007 it seemed everyone was an owner. Ownership rates were at an all time high. Now, all these people are stuck. Most that bought since 2004 are underwater and can’t sell or refi.
The only way to get all the inventory out of the system quickly is to unlock the boarders because of the American’s who did not buy from 2002-2007, a large percentage will never buy and a large percentage can never buy.
We do not ‘need time’. We need values of homes to fall to so that they become ‘affordable’ again and those who never bought can. They are far from it now especially since we have gone back in time 20-years in the mortgage finance arena.
Who is going to buy all these homes? Now, the target market for home purchases is the first time home buyer segment, which has always been historically the weakest segment of the market. The all-important ‘move-up’ buyer is almost non-existent.
“The answer, of course, is that given the dramatic overbuilding and the foreclosed homes, the oversupply will take months to burn off. But not years. The trick is to restrict supply, which wasn’t being done by the homebuilders until last year, when they finally cut back the numbers — they are now building about half the homes they did in 2006. Then we need to make it easier for people who bought homes to stay in them, so far the hardest part of the equation. Given that 14 million people bought homes between 2005 and 2007, and half took exotic mortgages to pay them, I figured there was no way that more than 3.5 million people could lose their homes (half of the half that took the 2-and-28s and the pick-a-pays and all the other nonsense). That was wrong. I am now thinking that all — that’s right, 100% — of the people who bought homes between 2005 and 2007 are going to default. All of them! It makes too much sense not to given the home price declines.”
(I should have stopped reading after this one argument but decided to write this up anyway because by this point my jaw was hanging on the floor.)
Cramer, home builder supply is insignificant. Bank shadow inventory, coming foreclosure inventory already in the pipe, existing Ma and Pa Homeowner inventory and higher grade paper defaults beginning to surge now is where the real supply comes from. Home builder supply is a very small single digit percentage of the aforementioned supply, has always been ad will always be. The oversupply will take years if not a decades to burn off.
You base your conclusions off of 14 million people ‘BUYING’ homes from 2005-2007. The purchase market was only part of the mortgage market and the SMALL part. What about all of the refinances? Someone that refinanced into an exotic loan and perhaps pulled all of the cash out are at even a greater risk of default than those who bought and didn’t cash-out.
Remember, around 50% of all subprime and Alt-A loans during the bubble years were cash out refinances. Of the remaining, the majority were high-LTV rate and term refinances that are equally at risky due to values falling so much.
Also remember that interest only loans, stated income for wage earners and high-LTV deals were abundant in 2003. Values have fallen to such a degree those that bought in 2004 are in a negative-equity position and at an exponentially greater risk of loan default. So, you have to back up your time line to cover 5-years and not 3-years.
Your 14 million loans from 2005-07 covers only ONE THIRD of the mortgage during that time. When you add in 2003 and 2004, your 14 million only covers 20% of the loans made. Granted many of the 70 million total loans made were to the same borrower in a refinance transaction but this just proves the point that your numbers are totally off base and not representative whatsoever of the at-risk mortgage universe.
MASSIVE SUPPLY ABOUT TO HIT
Then there is the massive bank owned supply about to hit. The FDIC is dumping IndyMac’s foreclosures in bulk. Merrill just dumped $30 billion in CDO’s much with residential assets. Fannie just said they would bulk 54k foreclosed housing units. Lehman is selling $40 billion in ‘assets’ much of which is residential mortgage and housing. All banks are going to want to get ahead of these giants and sell. This will reduce prices of mortgage assets in the bulk market in turn reducing prices on the street when these homes make it to the market.
“That’s why we need the FDIC to own more banks and more banks like Wells to work it through and more money from the FHA. You can see how the system is being overwhelmed by the simple equation of demand vs. supply. In 2006, for example, 7 million homes changed hands. Slightly more than 2 million were new homes. In 2008, we get half the number of new homes being built, but we are going to regurgitate 3.5 million homes that foreclosed. That gives us 3.5 million more homes on the market than we need.”
I agree with you, banks need to do a 35% principal balance reduction at a minimum to get this problem solved over time. But in reality all existing home owners need to be re-qualified at 28/36 debt ratios going forward and be given a principal balance reduction, low fixed rate or combination of both to ensure this problem solved fast. Either that or bring back all of the exotic mortgages we lost and let the borrower lever up again.
If you only modify those in trouble, it puts pressure on those better borrowers who did nothing wrong. All around the nation, people who put 20% down and got fixed rate loans are sitting in their homes while values plummet around them and their neighborhood turns into a foreclosure zone. Over time foreclosure zones turn into neighborhoods that even the police won’t patrol. This is what will set off the ‘Prime Implosion’ that I feel is less than one year away from beginning in earnest.
“Historically, we get about 800,000 new homebuyers naturally in this country because of household formation demographics — marriages, divorces, kids and the like. If you believe they all bought new homes we would still have 3.7 million more homes than we need. That’s the real issue.”
Nobody cares about ‘new’ homes Cramer. We need to burn through and bank REO and ‘existing’ homes and let Joe and Jane Homeowner out. New Home Sales are a small part of the market and always have been. When Joe and Jane are stuck in their home and can’t sell or refinance because they owe so much more than the property is worth they are at an exponentially greater risk of loan default.
“So, if you attack the problem that way, you can see that anything that keeps people from getting foreclosed will cut back that 3.7 million, and anything that gets people to want to buy — tax credits for buys, lower prices for homes and perhaps a nationalization of Fannie (FNM – Cramer’s Take – Stockpickr) and Freddie (FRE – Cramer’s Take – Stockpickr), which would reduce the price of money to buy homes — will work off the problem over time.”
Why again would nationalizing Fannie and Freddie make mortgage rates cheaper? Remember, if they nationalize these two and put their $5.2 trillion in exposure onto the US Gov’t and tax payer’s balance sheets, there is a strong chance Treasury yields will soar making borrowing costs higher for everyone across the board. I see where you are going with this ‘reduce the price of money’ but I don’t think you have fully thought it through.
“If you really wanted to get granular, you can chart out what happens rather easily. The default rate on homes spikes in the first two years, particularly these years, because of all of the fraud and recklessness. Two years ago was the height of the fraud, and it continued unabated for seven more months. Right now I would venture — we don’t have hard figures — that maybe a quarter of the defaults that will be part of the 7 million have already occurred. We’re going to get the rest of the three-quarters in the next seven months. The maximum pain is in these next seven months. Once the two years that began tolling at the end March of 2007 — the last of the really bad lending practices period — occurs, you simply cannot have more increases in homes being foreclosed on, because you didn’t have nearly as many purchases, and many of the corrupt lenders were flushed out.
Or in English, the problem peaks over the next seven months even without any intervention or stimulus or plans.”
Cramer, please remember that Subprime was only the ‘canary in the coal mine’ to the overall ‘Mortgage Implosion’. Arguably fraud is more pervasive in Alt-A, as 83% of the Alt-A universe was limited documentation loans such as stated income vs. 45% of subprime.
Besides that, we have learned very quickly that ‘negative-equity’ is the leading cause of loan default across the Alt-A and Prime universes, which dwarf subprime.
Seven months from now as we enter the spring selling season supply will be so out of control and values down so much that housing may not be viewed as anything but sticks and stucco. Given building costs, land is already free in most of the harder hit areas in the nation.
Also remember from the time a borrower ‘defaults’ to the time the bank takes it back into foreclosure and its back on the street can be as long as nine months to a year. Just because a loan goes into ‘default’ does not mean the borrower moves out and the home can turned around. Far from it. Therefore, even if you are right and actual defaults stop in seven months the foreclosure overhang from that would last for another year at least.
I have to give you kudos though. Most of your ‘bottom’ calls over the past year have quicker time lines than seven months. At least this time you gave the readers seven months to forget this story was ever written. –Best Mr Mortgage