Bear Market Soon to Go to Final Phase
By Comstock Partners, Inc. | 7 August 2008
On Monday [4 August] the New York Times had a front page article about how homeowners with good credit are falling behind on their payments in growing numbers. They discussed the increases in the percentage of mortgages in arrears in the Alt A mortgages. These are mortgages that are just above the subprime mortgages that everyone knows about by now. Of course, no one ever heard of subprime, much less Alt A a few years ago. Alt A were loans made to people with good credit scores without proof of income or assets.
They blame this on the weak economy and the fact that the unemployment numbers announced Friday climbed to a four year high. We have been predicting that the housing market decline, that will probably be over 45% from peak to trough, will have very negative repercussions for the better quality mortgages and the holders of not just Alt A but even the prime mortgages. The article did touch on the prime mortgages, which make up most of the $12 trillion market, just had a doubling of their delinquencies to 2.7%. We have been writing for the past year about the mortgage delinquencies spreading to the high quality borrowers if the market declines as much as we expect. And we expect the home price to continue declining another 30-35% from here.
The comp retail sales for the retailers were reported this morning and they were as disappointing as we expected. The reports confirm that the years of trading up to the higher priced and higher quality stores like Saks and Nordstrom is not continuing and they are struggling with weaker sales as even the affluent shoppers are pulling back. With the benefits of the stimulus checks fading and jobless claims at a 6 year high, the big worry is how much shoppers will retrench in the critical months ahead.
We expect the government to initiate another stimulus package when the recession becomes as obvious to them as it has been to us. The problem we have with this is that the reason we are in this mess now is due to excess debt and excess consumption. These stimulus packages encourage more consumption and debt (we will explain this next). Encouraging more consumption and debt doesn't typically solve excess debt and consumption problems.
The other problem we have with these programs is that the money that was sent out to the public does not really come from the government because they don't have the money. In fact they don't have any money. They will be spending much more than they have and are receiving in tax revenue over the next year (they estimate $482 billion- we think much higher). We are spending enormous amounts of money (that we also don't have) on a futile war that no one is able to articulate what a "win" means. The only way to send out more money to the poor suffering public in this country is to sell more government bonds to the same U.S. public, U.S. institutions, and foreign governments that are already loaded up with Treasury securities and dollars they've accumulated by selling U.S. consumers their goods and services. If we allow this government to initiate another stimulus package we suspect the deficit will head towards $1 trillion and even though this is no joke, we have attached a cartoon (at the tail end) that is indicative of the problems we are experiencing with debt in this country.
There are also negatives coming from abroad. As most of you know, the central banks of the ECB and UK did not raise their rates today and made much more dovish comments in the news conference. In the past they only discussed the one worry of controlling inflation. They now finally realize that inflation is not their only problem and they had better start worrying about the global recession we have been discussing for many months. The next move for the central bankers of every developed country will be to lower rates to protect their economies, as well as to keep their currencies low [[against the dollar: normxxx]]. This is all depicted on the chart we show constantly of the "Cycle of Deflation" (chart at left) under the title "competitive devaluations". This chart is not in any textbook since it was developed by Comstock to indicate to you what we believe is evolving.Finally, there is the insanity of the Auction Rate Securities (ARS) where Citicorp just settled a lawsuit. These are securities that are typically municipal bonds, corporate bonds, and preferred stocks with long-term maturities (usually 30 years). ARS investors receive interest rates that are periodically reset at each successive auction that are held every few days from 7, 14, 28, or 35 days. In an ARS auction, a bidder will submit the lowest interest rate he or she is willing to accept. Traditionally, the interest rates available to ARS investors have far exceeded rates available from money market funds even though they were sold to be as liquid and safe as money market funds.
Does it make any sense to buy securities with 30 year maturities backing them and high interest rates and actually believe they are as safe and liquid as money market funds? What is this country coming to that the investment bank's financial advisors would sell these things as safe and as liquid as money markets? And maybe worse the buyer believed it. It is similar to packaging all those CDO's that were sold worldwide and were filled with toxic mortgages where nobody knew anything about the borrower who was responsible for paying off the mortgage.
Obviously, we continue our very bearish position on the stock market as well as a negative view on commodities and a spreading global recession. We should soon enter, or maybe we have already started, the last stage of the bear market, "Fear & Capitulation".
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A Second, Far Larger Wave Of U.S. Mortgage Defaults Is Building
By Vikas Bajaj | 6 August 2008
NEW YORK— The first wave of Americans to default on their home mortgages appears to be cresting, but a second, far larger one is building with alarming speed. After two years of upward spiraling defaults, the problems with mortgages made to people with weak, or subprime, credit are showing the first, tentative signs of leveling off. But with the U.S. economy struggling, homeowners with better credit are now falling behind on their payments in growing numbers. The percentage of mortgages in arrears in the category of loans one rung above subprime, so-called alternative-A, or alt-A, mortgages, quadrupled to 12 percent in April from a year earlier. Delinquencies among prime loans, which account for most of the $12 trillion market, doubled to 2.7 percent in that time.
While it is difficult to draw precise parallels among various segments of the mortgage market, the arc of the crisis in subprime loans suggests that the problems in the broader market may not peak for another year or two, analysts said. Defaults are likely to accelerate because many homeowners' monthly payments are rising rapidly. The higher bills come as home prices continue to decline and banks are tightening their lending standards, making it harder for people to refinance loans or sell their homes. Of particular concern are alt-A loans, many of which were made to people with good credit scores without proof of their income or assets.
Much will depend on the course of the economy, particularly unemployment. A weaker job market would push more homeowners toward the financial brink. The U.S. Labor Department reported Friday that the unemployment rate climbed to a four-year high in July. Other downbeat reports last week documented another drop in home prices, slower economic growth than expected and a huge loss at General Motors.
"Subprime was merely the tip of the iceberg," said Thomas Atteberry, president of First Pacific Advisors, a investment firm in Los Angeles that trades mortgage securities. "Prime will be far bigger in its impact." During a conference call with analysts last month, James Dimon, the chairman and chief executive of JPMorgan Chase, said he expected losses on prime loans at his bank to triple and described the outlook for them as "terrible."
Delinquencies on mortgages tend to peak three to five years after loans are made, said Mark Fleming, the chief economist at First American CoreLogic, a research firm. Not surprisingly, subprime loans from 2005 appear closer to the end than those made in 2007, for which default rates continue to rise steeply. "We will hit those points in a few years and that will help in many ways," Fleming said, referring to the loans made later in the housing boom. "We just have to survive through this part of the cycle."
Data on securities backed by subprime mortgages show that 8.41 percent of loans from 2005 were delinquent by 90 days or more or in foreclosure in June, up from 8.35 percent in May, according to CreditSights, a research firm with offices in New York and London. By contrast, 16.6 percent of 2007 loans were troubled in June, up from 15.8 percent. Some of that reflects basic math. Over the years, some loans will be paid off as homeowners sell or refinance, and some will be foreclosed and sold.
That reduces the number of loans from those earlier years that could possibly default. Also, since the credit market seized up last year, lenders have become much more conservative and have stopped making most subprime loans and cut back on many other popular mortgages. The resetting of rates on adjustable mortgages, which was a big fear of many analysts in 2006 and 2007, has become less problematic because the short-term interest rates that many of those loans are tied to have fallen significantly as the Federal Reserve has lowered U.S. rates. The recent U.S. tax rebates and efforts to modify more loans have also helped somewhat, analysts say.
What will sting borrowers more than rising interest rates, analysts say, is having to pay interest and principal every month after spending several years paying only interest or sometimes even less than that. Such loan terms were popular during the boom with alt-A and prime borrowers and made sense while home prices were rising and interest rates were low. But now, payments could jump 50 percent or more for some borrowers, and they may not be able to sell their properties for as much as they owe.
Prime and alt-A borrowers typically had a five- or seven-year grace period before having to start making payments toward their principal. By contrast, subprime loans had a two- to three-year introductory period. That difference partly explains the lag in delinquencies between the two types of loans, said David Watts, an analyst with CreditSights. "More delinquencies look like they are on the horizon because so few of them have reset," Watts said about alt-A mortgages.
The wave of foreclosures is still rising in states like California, where more homeowners turned to creative mortgages during the boom. From April to June, mortgage companies filed 121,000 notices of default in California, up nearly 7 percent from the first quarter and more than twice as many as in the second quarter of 2007, according to DataQuick, a real estate data firm. The firm said that the median age of the loans increased to 26 months from 16 months a year earlier.
The mortgage-financing giants Freddie Mac and Fannie Mae, which own or guarantee nearly half of all mortgages, are trying to stem that tide. Last week, the companies said that they would pay more to mortgage-servicing companies that they hire to modify delinquent loans and avoid foreclosures. Delinquencies in prime and alt-A loans are particularly challenging for banks because they hold more such loans on their books than they do subprime mortgages. Downey Financial, which owns a savings bank that operates in California and Arizona, recently reported that 11.2 percent of its loans were delinquent at the end of June, a big increase from the 6.1 percent that were past due at the end of last year.
The bank's troubles stem from its $6.2 billion portfolio of so-called option adjustable rate mortgages, which allow borrowers to pay less than the interest owed on their mortgage in the early years. The unpaid interest is added to the principal due on the loan, so over time borrowers can owe more than when they first got the loan. Eventually, when loans grow by 10 percent or 15 percent, the borrowers are required to start paying both the interest and principal due.
Many borrowers who got these loans during the boom had good credit scores, but many of them owe more than their homes today are worth. Analysts said they believed that many would not be able to or want to make higher payments. "The wave on the prime side has lagged the wave on subprime side," said Rod Dubitsky, head of asset-backed research at Credit Suisse. Resetting the option adjustable rate mortgage loans "is a big event that will drive the timing of delinquencies."
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Normxxx
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