All around the limbo world
Gonna do the limbo rock
All around the limbo clock
Jack be limbo, Jack be quick
Jack go unda limbo stick
All around the limbo clock
Hey, let’s do the limbo rock
Limbo lower now
Limbo lower now
How low can you go
The Limbo — Chubby Checker
These rollbacks are coming up so frequently these days, I am forced to wonder, “How low can you go?”
Asking Price: $651,900
Purchase Price: $735,000
Purchase Date: 5/4/2006
Address: 144 Saint James, Irvine, CA 92606
Beds: 3
Baths: 2.5
Sq. Ft.: 1,931
$/Sq. Ft.: $338
Lot Size: –
Year Built: 2002
Stories: 2
Type: Condominium
View: Park or Green Belt
County: Orange
Neighborhood: Walnut
MLS#: S498460
Status: Active
On Redfin: 15 days
From Redfin, “Spacious floor-plan in beautiful gated community of Parklane! Great curb appeal! A must see!!! Den or office off master suite! Corian counters! Center island! Clean white cabinets! Custom tile flooring! plantation shutters! enclosed patio! Best price detached home in the area for the square footage! Light & bright! sides greenbelt! Go direct!”
Three exclamation points: check.
No periods: check.
“Light and Bright:” check.
This realtor probably has an advanced degree in realtorese.
.
.
At first glance this seems like just another rollback, but wait… Check out the sales history:
Sales History
Date Price
05/04/2006 $735,000
07/11/2003 $667,000
This is a 2003 rollback!
I imagine this seller thought they were getting a good deal when they bought at the peak and only paid $68,000 more than the previous buyer. Oops! It doesn’t seem to have worked out that way. If they get their asking price, minus a 6% commission, they stand to lose $122,214 in just over one year of ownership. I guess buying on St. James street did not bless this transaction.
These rollbacks have clearly wiped out all of the market gains through 2005 and 2006, and we are working our way through 2004. Now we even have the occasional 2003 debacle.
To be honest with all of you, I did not expect to see the market deteriorate this quickly. I was expecting real signs of distress in the fall and winter (I still think it will get much worse.) Real estate markets typically do not turn this fast. Of course, this is no typical real estate market.
The market decline of the early 90’s was a slow deflation. There was no single period of intense panic selling; however, it really is different this time. These prices were bid up so high, with so little regard to fundamental valuations, and was played by so many people with so little to lose (100% financing) that it certainly appears as if it is going to behave like a traditional commodities market.
If you think it is bad now, wait until the crushing weight of inventory and the massive dump of REOs hits the markets this fall and winter. I predict we will see a full scale panic like the residential real estate market has never seen before. Watch for the psychological shift I described in Houses Should Not Be a Commodity. When we move from denial into fear, the bulls will go strangely silent. When we move from fear into panic and capitulation, we will see a massive inventory spike, and they will all be rollbacks. Watch for it. It is coming soon.
I hope you have enjoyed your week at the Irvine Housing Blog. I have enjoyed bringing it too you. See you next week as we continue chronicling ‘the seventh circle of real estate hell.’ Have a great weekend.
One word … ‘railway’.
This one overlooks the line at the Jamboree overpass near Edinger.
—–
From Dante’s Circles of Hell to the Three Stooges all in one week’s time. Keep this up, IR and I may have to make IHB my homepage!
It’s about time.
I swear that was available for rent about 18 months ago. I looked at it and did not like the fact the train tracks were so close.
I also never would have guessed that in a four day span last week Wall Street investors would stop buying virtually anything mortgage related.
The pendulum swings both ways.
I can see the rail line quite clearly in the overhead on Zillow.
Question is – how much noise does it actually generate to the surrounding condos and how often does it run?
Redfin only shows one pic of the condo…hmmmm? Does not look like “great curb appeal” to me, but aside from the rail-line, looks like a decent enough place at 400k.
I agree 400K sounds like a reasonable price.
At 2000 sq ft it isn’t a cracker box.
If I recall, that side of the tract is not as congested for parking.
Yeah, the sq footage is very good and the unit is detached with attached garage. I can’t complain about that.
Sure would like to see more pics.
There is quite a bit of noise when the train comes under Jamboree, and many times sounds its horn.
Also, this plan is quite weird in that the bonus room (above the garage) can only be accessed through the master bedroom.
How low?
Check out this guy, he goes under a flaming limbo stick lower than my shin.
http://youtube.com/watch?v=zobg1EyRFik
I got a feeliing that what we’re gonna see is the banks taking the place of the “home builders”.
In essence, the home builders will simply stop building new houses for a while, and they will become agents for the banks.
It doesn’t really matter where the inventory is at… it can be “new” or “late model previously owned”
Look at the “certified previously owned” programs from the automakers. Many artificially raised their sales by putting out cheap leases but eventually they get the product back and have to sell it. These sales compete against their own production because the returned leased cars add to the inventory.
So… expect Lennar and Co. to become selling agents for the Mortgage Banks.
This thing has gotta come back to 300/per sqt ft or less
I have an off-topic question for the board: my landlord just informed that he is putting the condo I am living in for sale. He said he would like for me to stay in it while it is on the market, and I am guessing it may be quite a while considering the market… In any case, I have told him that I want a concession on the rent because of my inconvenience, since there will be people coming and check out the unit. He was really surprised about my request.
My question is: was this really an unusual request? I don’t think it is, but I figured I ask… Also, any opinions on what may be reasonable to ask in terms of break on the rent?
Thanks for your input.
You should definitely get a concession. #1, it’s common. #2, he doesn’t have a lot of renters to choose from who would allow people to walk through all the time.
But I don’t know what’s reasonable in CA.
CA prices are insane.
here in nashville, you could find that same condo (attached) for $65000.
I did, just last month.
Eurominds,
It is far more complicated than you think. As far as I understand it, whatever you have for a lease, it must be honored by the seller as well as the new buyer. In addition, the seller must give you 120 days warning (if you aren’t month-to-month) by letter before putting the house on the market and 24 hours notice before showing the house. With regards to showing, it can only be shown during working hours M-F; no nights or weekends. There is a renters rights somewhere on the California website. Do not make concessions at this point. (If you aren’t in CA, then you will have to look up the rules for that state; they vary wildly).
SDChad,
my lease just ended, and I am now month-to-month. Clearly, he decided not to renew my lease because he was planning on selling the place. So, my options at this point are to either give him 30 days notice immediately, or take my time in finding a new place and live in here while he finds a new buyer. I prefer the second option, as it gives me flexsibility, but I feel that I should be compensated for my inconvenience.
Thanks for your reply, and thanks to NT also.
So much for subprime containment…
Central Banks Add Cash to Avert Crisis of Confidence (Update4)
http://www.bloomberg.com/apps/news?pid=20601087&sid=azTdsEgXnFOk&refer=home
`Spreading’ Impact
“The effect of U.S. subprime loans is spreading to financial markets around the world,” said Hiroko Ota, Japan’s minister in charge of economic and fiscal policy. “We need to carefully monitor how this will affect the economy.”
This blog kicks a$$! I read it every day.
I’ve been watching some North OC zips (Anaheim, Fullerton, GG, Orange) and the carnage is pretty bad up there, too. I have even seen a few SFHs going for $250-275/sqft. Lots and lots of short sale attempts. It appears that the crappy quality of some houses up there is finally getting priced appropriately.
I also have friends who bought a small condo in Costa Mesa (South Coast Metro) in 2005 for $340K, and told me that there is someone going into foreclosure in their complex trying to sell for $299K. I looked up their complex on ZipRealty, and there are actually 2 units like that.
Rollbacks for everyone!
This is an excellent question.
http://nolo.com will have books that answer this.
I think you are going down a slippery slope. If you are not comfortable with asking for a rent concession, I hope you have a document that clearly states when he can come in.
I don’t know where you are located or what your rent is, but I would think 10% is reasonable. He can’t have it both ways. In fact, he might rethink the idea.
If he does agree, make sure the discount is in effect as long as it is listed with any type of service.
Earlier this year I put my Irvine rental on the market and gave the tenant $250.00 per month concesssion (the lease was $2,175/mo). I also paid to have it “professionally cleaned” the day before any showing. It didn’t sell for four months 🙁 and I pulled it off the market. Tenant was happy to save $1,000 and thought $250 per month was fair. I thought it was fair, too.
Buckle your seat belts everyone. We’re in for a wild ride. When inventory in Irvine accelerate to 2500 – 3000, decent deals will start to appear. My guess is $220 to $300 per sq. ft. Depending on size, type of structure, location, etc.
Although a 1000 sq. foot cracker box condo in Newport Coast -beach, CDM, or Laguna Beach, may still be $350+ per sq ft., and a 1000 sq ft. SFH in these cities will be 450+ per sq. ft.
Property on 118 SAINT JAMES
Sales Price: $623,000 on 5/31/07
Previous Purchase Price: $660,000 on 8/5/05
144 Saint James say your prayers
From the launching article:
To be honest with all of you, I did not expect to see the market deteriorate this quickly. I was expecting real signs of distress in the fall and winter (I still think it will get much worse.) Real estate markets typically do not turn this fast. Of course, this is no typical real estate market.
First, thank you for your detailed analysis. One thing I’ve done that makes some of the other bears unhappy is predict an earlier start to the buying season. The #1 reason? Faster drop in prices to sustainable levels. Why? Credit tightening.
Irvinerenter, I believe the cutoff in jumbo mortgages will drop prices quick.
Let us consider the unit in the article.
With the sudden need for a 20% to 30% down payment for every mortgage above $419k (or is it $417k… I forget… doesn’t matter really)… this property’s value will be squished from above.
Now, I expect conformal mortgages to shoot up to $550k, maybe even $600k in an attempt to rescue this market. While I don’t like it, its part of my estimations as I think its certain to happen. 🙁
Thus Irvine detached homes with 2+ car garages will drop to the $500 to $600k range based on available loans for a 4 bedroom ~2500ft^2 unit.
That will push a condo like this down to $400k ($200 ft^2) just based off credit.
Now let’s talk affordability (love your graph).
This condo is below the median… so that suggests $350k assuming no undershoot.
I’m predicting an undershoot. 🙂 One reason is that all of my friends who were ready to buy in at $650k suddenly look at afford ability and have cut their range to 3.5X income. This is the sort of unit one of my friends would love.
But not at $651k
Not at $500k.
When it hits ~$410k, he might be the knife catcher.
Note: If the train noise is bad… forgedaboutit (for my friend).
Got popcorn?
Neil
Another one bites the dust, another flipper burned. Its turn for another flipper to get in and get burned now.
IrvineRenter,
Good chart.
I’d suggest that you should stamp or watermark your original material to prevent somebody to steal it and publish it somewhere else, a visible footnote in one of the corners should work.
Seeing some interesting movement on homes here in Orange County.
I think I’ve found the future bubble:
New Century Legal Fees May Reach $100 Million
Time for the lawyer bubble. They’ll be busy this year…
“To be honest with all of you, I did not expect to see the market deteriorate this quickly. I was expecting real signs of distress in the fall and winter (I still think it will get much worse.) Real estate markets typically do not turn this fast. Of course, this is no typical real estate market.”
Updated: New York, Aug 10 20:09
Bernanke Was Wrong: Subprime Contagion Is Spreading (Update2)
By Bob Ivry
Aug. 10 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke was wrong.
So were U.S. Treasury Secretary Henry Paulson and Merrill Lynch & Co. Chief Executive Officer Stanley O’Neal.
The subprime mortgage industry’s problems were contained, they all said. It turns out that the turmoil was contagious.
The $2 trillion market for mortgages not backed by government- sponsored agencies is at a standstill. That’s just the beginning. Other types of mortgages are suffering. So are firms and banks that package the debt for investors. The ripples were felt in Europe and Asia, where central banks offered cash to banks amid a credit crunch. And some corporations, from countertop makers to railroads, are blaming the mortgage meltdown and housing slump for earnings that fell short of analysts’ estimates.
Even a mobile-phone company, Dallas-based MetroPCS Communications Inc., says it’s feeling the pinch from customers facing foreclosure. And experts such as William Ford, former president of the Federal Reserve Bank of Atlanta, say the chance of a recession is growing.
“Housing created a lot of ancillary economic activity and jobs, and now we are in the reverse process,” says Paul Kasriel, chief economist at Northern Trust Corp. in Chicago and a former Fed economist.
Fed Intervention
The Federal Reserve today provided $38 billion of reserves to the banking system and pledged further funds “as necessary,” in a statement unprecedented since the aftermath of the Sept. 11, 2001, attacks. The Fed had released $24 billion in temporary funds yesterday, the most since April.
The European Central Bank today made a second loan to banks to alleviate a money shortage sparked by concerns over investments in U.S. mortgages. Today’s loan of 61.05 billion euros ($83.4 billion) brings the two-day total of money lent to 155.85 billion euros ($212.9 billion).
The ECB’s unprecedented move followed the freezing of three funds managed by BNP Paribas, France’s largest bank, because the bank couldn’t calculate how much the funds’ holdings were worth due to a lack of buyers.
Today, the Bank of Japan made similar moves to supply cash.
`Spreading to Banks’
“The subprime mess is now spreading to banks,” says Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts. “A lot of international banks, especially those in Europe, did invest a lot in the collateralized debt markets, especially the subprime situation here in the U.S., so they’re suffering.”
Peter Lynch, chairman of private equity fund Prime Active Capital Plc in Dublin, said the ECB was “treating this like an emergency.”
Bernanke told Congress on March 28 that subprime defaults were “likely to be contained.” The Fed chief, who declined to comment for this story, changed his assessment last month.
On July 18, he told Congress that “rising delinquencies and foreclosures are creating personal, economic and social distress for many homeowners and communities — problems that likely will get worse before they get better.”
Paulson Comment
Paulson said June 20 that subprime fallout “will not affect the economy overall.”
This week on CNBC, he provided a less definitive assessment, saying that markets have been “unsettled largely because of disruption in the subprime space.”
“We’ve had a major correction in that housing sector,” Paulson said. “It will take a while for the impact of that to ripple through the economy as mortgages reset.”
O’Neal on June 27 called subprime defaults “reasonably well contained.” Merrill spokeswoman Jessica Oppenheim said this week that the company is confident his words accurately reflected the market at the time. O’Neal declined to comment.
Among the other executives joining the chorus was Bank of America Corp. CEO Kenneth Lewis, who said June 20 that the housing slump was just about over.
“We’re seeing the worst of it,” Lewis said.
Within the week, he was contradicted by a team of Bank of America analysts, who called losses in the mortgage market the “tip of the iceberg” and predicted “broader fallout” from adjustable-rate loans resetting at higher interest rates.
David Olson, president of Wholesale Access Mortgage Research & Consulting Inc. in Columbia, Maryland, is blunt about his current outlook. He says a third of the U.S. home-loan industry will disappear.
American Home Mortgage
With last week’s collapse of American Home Mortgage Investment Corp., which sold $58.9 billion of loans to borrowers in 2006, the subprime contagion spread to so-called Alt-A mortgages, which are available to borrowers with good credit who don’t want to verify their income with tax forms or pay stubs.
American Home couldn’t find Wall Street firms willing to buy these mortgages and package them into securities because of rising defaults. The Melville, New York-based company filed for bankruptcy Aug. 6.
“This is just the first, because all the Alt-A guys are going to go,” Olson says. “This is the most difficult mortgage environment I’ve seen in my 40 years in the business.”
This grade of loan made up 13 percent of all mortgages last year, according to Inside Mortgage Finance. Combined with subprime, they account for a third of the market. Both types of loan are rapidly disappearing.
Housing Prices
U.S. housing prices will fall this year, the first annual decline since the Great Depression of the 1930s, according to the National Association of Realtors, based in Chicago.
The inventory of unsold U.S. homes in May was the largest since the realtors group started counting them in 1999. Defaults and foreclosures may increase because about $1 trillion of payments on adjustable-rate mortgages are scheduled to rise this year, hitting a peak in October, according to Credit Suisse.
Housing and related industries generate almost a quarter of U.S. gross domestic product, according to the Joint Center for Housing Studies at Harvard University in Cambridge, Massachusetts.
The mortgage fallout “ensures the economy will grow well below its potential through the remainder of the year and next,” says Mark Zandi, chief economist for Moody’s Economy.com in West Chester, Pennsylvania, who predicts GDP growth of 2.5 percent this quarter and next. Second-quarter growth was 3.4 percent.
Lowered Forecast
Demand for loans to bundle into mortgage-backed securities came to a halt, crippling the subprime and Alt-A lending businesses. The exception was prime loans conforming to rules set by the biggest government-chartered agencies, Fannie Mae in Washington and Freddie Mac in McLean, Virginia.
Doug Duncan, the Mortgage Bankers Association’s chief economist, says he’s lowering the group’s forecast on the total dollar value of new U.S. mortgages.
The association said July 12 that the value of mortgages sold would decline 7 percent this year to $2.6 trillion and 18 percent in 2008 to $2.3 trillion, from $2.8 trillion last year.
“Most of the market has shut down,” Duncan says. “This is not a normal event.”
Peter Hebert, a broker with Houston-based Allied Home Mortgage Capital Corp. in Ellicott City, Maryland, says it’s getting tougher to find mortgages for his clients.
`Use a Credit Card’
For one self-employed borrower in Pennsylvania, with a 626 credit score, just above what’s considered subprime, Hebert says he contacted three lenders. Last year, the borrower would have qualified for a 7.99 percent loan, Hebert says. This week, he received one offer for a 10.5 percent loan with a three-year prepayment penalty, meaning that if the borrower refinanced during that time he would be required to make six months of payments to the original lender.
“It would have been cheaper to use a credit card to pay for his house,” Hebert says.
When it came time to lock in the rate, the lender pulled out, Hebert says.
“It was a hard thing to do, an emotional thing, to tell my borrower he was turned down for a rate that was high to begin with,” he says.
The market is shifting, too, for firms that package loans into securities and sell them to investors. About $11.2 billion of private-label, or “non-agency” mortgage bonds — those not guaranteed by Fannie Mae, Freddie Mac or Washington-based Ginnie Mae — were sold in July, according to Michael D. Youngblood, portfolio manager and analyst at Friedman Billings Ramsey Group Inc. in Arlington, Virginia. That’s down from $41.6 billion in June and from a monthly average of $86.6 billion this year.
Margin Calls
Luminent Mortgage Capital Inc., a San Francisco-based firm that packages mortgages for investors, cited “a significant increase in margin calls” for canceling its dividend.
Such firms borrowed money from banks to buy loans to create securities. When investors stopped buying the securities, the banks that made the original loan demanded their money back.
Many such firms that package securities will leave the business this year, says Guy Cecala, publisher of Inside Mortgage Finance.
“If you’re an investment bank and you’re losing stock value every week because of your connection to the mortgage industry, isn’t it easier to cut ties?” Cecala says.
Bank Stocks
Shares of the top 12 U.S. banks have declined 17 percent since June 1.
Yesterday, Countrywide Financial Corp., the biggest U.S. mortgage lender, said in a filing that “unprecedented disruptions” in the U.S. home-loan market may crimp its ability to lend. The company said it may be forced to retain more of the loans it makes to homeowners rather than selling them to investors and that it may have difficulty obtaining financing from its creditors.
Corporations outside the mortgage industry are taking a hit, too, as housing slumps. Burlington Northern Santa Fe Corp., the second-biggest U.S. railroad, said it shipped less lumber for homebuilding in the second quarter. DuPont Chief Executive Officer Charles O. Holliday Jr. said July 24 that the housing recession eroded demand for Tyvek weather barriers, used in 40 percent of new homes, and Corian countertops.
Steak n Shake
Steak n Shake Co., an Indianapolis-based fast-food chain, blamed a 4.3 percent decline in same-store sales in the third quarter partly on credit markets. “Some segments of Steak n Shake consumers continue to be sensitive to high gasoline prices and mortgage interest rates,” the company said in a statement yesterday.
Shares of MetroPCS, a prepaid mobile-phone service, fell 20 percent Aug. 3 after second-quarter sales missed analyst estimates. Chief Financial Officer J. Braxton Carter blamed customers’ “short-term economic disruptions,” such as defaulting on their subprime loans.
As for the faulty initial predictions by Bernanke and others, go easy on them, says Josh Rosner, managing director at the New York investment research firm Graham Fisher & Co.
“There’s no model for what’s happening now in the housing and mortgage industries,” Rosner says. “We have to give Bernanke a chance. He is a reasoned and traditional central banker. He knows how to manage crazies.”
To contact the reporter on this story: Bob Ivry in New York at bivry@bloomberg.net .
Last Updated: August 10, 2007 17:46 EDT
http://www.bloomberg.com/apps/news?pid=20601206&sid=abxvzZgdV5.I&refer=realestate
Funny: Cramer on the Colbert Report
http://howardlindzon.com/?p=2418
On zillow, the tax for this property was little over $4000 and there was no 2003 sales history. According to the 5 yr price history, 2003 roll back price should be around $450k. That makes sense cause I sold my irvine 2 bed 1.5 bath condo at $290k which was about 1200 sq ft.
I think we still have not seen a ligitimate 2003 roll back. If I start seeing that for the SFR around 2000 sq ft (shich should be $500k), I’ll jump on it but who knows when that would come…
Article from Yahoo Biz tonight, found on Housing Doom : Regulator rejects Fannie Mae’s plea…The OFFEO (hope that’s the correct acronym) has (for now) rejected Fannie’s request to increase the conforming loan amount. It was rejected until legislation to protect against fraud is in place.
I’ll share that popcorn now.
Spreading impact, indeed.
Here in Germany, the government had to bail out a mid sized bank that had gambled too heavily in subprimes:
“Jochen Sanio, president of Germany’s banking supervisory agency BaFin, was pessimistic: If IKB folded, the failure might spread to other institutions, and maybe set off the biggest bank crisis since the Great Depression in the 1930s. Bundesbank President Axel Weber was less bleak, but made another troubling prediction: A chain reaction could endanger Germany’s banking reputation. The gathering of bankers and government officials decided to undertake the biggest rescue operation for a single bank that Germany has ever seen.”
http://www.spiegel.de/international/business/0,1518,499160,00.html
But there are still rumours that one of our big banks holds a too-large-to-ignore position in subprimes, too. 🙁
I wouldn’t be very surprised if this was true. Generally, our banks are quite conservative regarding investments, but at the same time, mortgages are considered an unproblematical investment, because of the real estate equity behind them. Just yesterday, I read a leading banker stating they’re expecting 20% defaults in subprimes, but that this doesn’t mean 20% loss, because about half that money will be returned after foreclosure. Thinking of the examples here, where there’s nothing in it for the subprime lenders, I am deeply concerned if this isn’t overly optimistic. And, as IrvineRenter’ wrote, the worst is still ahead.
I understand that the banks invested in bundled subprime contracts, making it difficult for them to correctly asses the risk involved in such an investment. Does anyone here know what’s in such a bundle? Is it possible that such a packet consists only of 2006 Ca mortgages, for instance, or is the risk reduced by bundling contracts of different age and from different states?
Gray – If the bundles you are speaking of are collateralized mortgage obligations, the risk is assessed by the rating of each mortgage in the MBS. But you are probably thinking of collateralized debt obligations, for which the underlying assets are MBSs, but do not have specific mortgages assigned to them. CDOs are more of a contract listing MBSs as collateral, but specifying who gets paid how much and who forgoes payment in the event of default. I can not think of a good analogy, so I will make one up.
Suppose I am holding a mortgage on Mr. Smith’s home and that mortgage pays me 6% interest. And I make a contract with you, IR, and Graphrix. And that contract says that you, IR, and Graphrix each pay me so much up front and I will pay you 10%, and I will pay IR 6%, and I will pay Graphrix 2%, but if Mr Smith does not pay the full monthly payment, you will only get 20% of your normal payment, IR will only get 70%, and Graphrix will get 99%. You are holding the BBB tranche, IR the AA tranche, and Graphrix the AAA tranche.
Does that make it any clearer, or worse?
Did anyone see this post in LA Land:
http://latimesblogs.latimes.com/laland/2007/08/the-darkest-mom.html
Among the examples; appraiser Michael Mathis (pictured) sees his income drop from “mid-six figures” to “less than $75,000” and wonders how he’ll pay for renovations on a 9,000 square foot house; the Long Beach mortgage broker who can’t refinance his own house and “has been holding off paying property taxes on his own home;” and the Guatemalan day-laborer who sees work drying up: “I used to get four, five calls a day,” he says. “Now I go four, five days without a call.”
How is an appraiser of residential homes making mid 6 figures? That’s absolutely ridiculous: no eduction requirement, no special skills and this fool’s gold economy is paying these guys that much money. The same guys who have been shown to basically be rubber stamps approvals for ridiculously overpriced homes? This tell you exactly why this is a bubble.
It’s all too clear.
Worse set, say that Mr. Smith’s mortgage is subprime and rated BB. However, Graphics is getting an AAA tranche!
That’s the problem.. isn’t it? Taking a high risk investment and somehow splitting it so that some of its derivatives are “lower risk”.
In reality, the highest risk of the derivatives should be no higher than that of the underlaying security. You could make a point that in the case of a mortgage, some money is garanteed to come back, so the risk to Graphrix is lower than that for Gray, but this is so deeply hidden that it becomes very problematic to figure it out.
Of course, then you have other types of unsecured debts…. were these also bundled with the CDOs?
My wife and I were discussing all of this stuff plus the price of homes in Irvine. In her opinion, she doesn’t understand why someone would go to Portola and buy a 1.6M home when you can have much nicer, older homes for 1M elsewhere.
She’s right.
The realtor on msnbc TV this morning was also very wrong… This is the second “interview” in a week where I’ve seen some such “interview” about “is it the right time to buy?”. Which of course it is, according to the realtor -even though there are a “few” foreclosures out there!
Agreed!
Six figure income for an RE appraiser? Insane.
When an appraiser makes more money than a longshoreman in the LA Port, or a doctor, or a lawyer, then you have some serious dislocations of economic value.
9000 sq. foot home? Again, insane.
The RE “sales” industry does NOT add value to our national net worth. If anything, it’s a pure service that takes money off the table and is a COST. I won’t call them leeches because someone has to provide the service, what will all the legal mumbo jumbo, and the pyramid of brokers, agents, bankers, appraisers, all taking their self serving cuts and fees, it makes RE ownership just that more expensive for no justifiable reason I can see.
…as the summer buying season draws to a close, the desperation will become as certain as night sweats.
The AAA tranches get paid first. That’s how they can be rated higher. The lower tranches get paid junior. There’s nothing wrong with the theory. It’s the rating agency default assumptions that have proven too generous. I think the bigger issue is that the bonds have lost market value, which is very different than losses in the underlying collateral.
This whole thing rests on something called “overcollateralization”. Let’s say you have a CMO offered at $100,000,000. I don’t know the exact numbers, but you might see mortgages of $120,000,000 backing it. Of the $100,000,000, let’s say that $92,000,000 is in AAA position. That would mean that the $92,000,000 gets paid first from the $120,000,000 collateral.
True when we talk about CMOs. But here we’re talking about CDOs. And who knows what else went into the pot.
There’s a correlation between different types of debt. For example, credit card debt, car debt, RE debt etc all depend on the ability of the underlaying debtor to pay.
If the debtor starts to default in one their debts, it’s possible that he/she will default in others. That is, they may not be able to pay their mortgage and get into credit card and car loan problem too.
If that happens then all bets are off. And the complexity of the underlaying notes for the CDOs and the uncertainty of the RE market make it so bad that I can see why CDO holders have no idea of what their paper is worth.
The whole thing thing runs on trust and some level of predictability and right now there’s very little.
I think the fix out of this would be for the Federal Reserve to print a lot of money and send every tax payer five times what they paid in taxes last year. Sure it would create inflation, but who cares? It would instantly cheapen the dollar (so what by now), pump tons of money into the economy and make it easier to refinance.
First why am I only getting 2%? I think awgee is ripping me off even if I am rated AAA.
The only difference between a CMO and a CDO is the CMO is only mortgages and the CDO is probably 40% mortgages and 60% of other debt obligations from credit cards, car loans to equipment leases. Both are diced up in tranches from AAA down to M-1.
M-1 would take the loss first on the defaulting payment if there wasn’t a credit enhancement in place to begin with like over-collateralization or if there wasn’t any excess spread available. When a ratings agency drops the rating on a tranche or the entire pool the issuer has to add a specific amount of credit enhancement such as cash or over-collateralzation. Over-collateralization would add more mortgages or debt to the pool take would take a loss after any excess spread is gone. AAA will get paid first until there is a trigger set off by the defaults and AAA could get only 99% like awgee said. CDOs are more likely to set off a trigger since people could pay off their credit card and prepayments like this of the lower tranches can do that.
Now we shouldn’t get collateralized debt obligations/CDOs and derivatives confused with each other. You can have derivatives on CMOs and CDOs but they are not CDOs.
I have a great pdf file on all this and I will see if I can find it on the web again if you guys want.
Thx everybody,especially awgee, for making this much clearer too me!
Still, I’m a bit confused because of the complexity of this issue, with the degree of different levels of financing involved. how. I get it that the idea is, there should always be enough equity backing the AAA contracts. However, there seem to be high risks in it regarding the cash flow. The problem seems to be, how do you make guaranteed payments to your investors when at the start of the line, the debtor defaults? Sure, the mortgage institution will eventually recover a high percentage of their investment, and then again have the liquidity to pay at least the guaranteed rates to contractors down the line. But foreclosure takes several months, and what happens in the meantime? If too many home owners default in the same time, there simply isn’t enough cash coming in from ‘good’ mortgages to cover all obligations. And then the house of cards starts to shake dangerously, right?
After eading this, one question remains for me: What happens if the company responsible for MBS payments goes into bancruptcy? Do the investors have ownership of the original mortgage contracts as a security, so they at least can try to find someone else doing the collecting part for them? If not, they’re doomed and the subsequent holders of CDOs, too…
🙁
Gray,
The answer to your first question is credit enhancement and insurance. Once these pools get downgraded they must add some sort of funds to make sure all payments are made. They will have insurance on the highest tiers to make sure the payments are made. Additional problems start when the insurance becomes more expensive than the payments going out.
For your second question there is always a third party collecting the incoming payments and there will almost always be a buyer for a MBS pool albiet at a deep discount. If a debt is somehow completely wiped out then yes the investor is SOL. But like you said there is an underlying value when it comes to mortgages so they couldn’t be wiped out. Again this is where credit enhancement and insurance come in. Not only that but do you think that the two oldest companies in America The Bank of New York and Morgan Stanley are going to go BK? The companies who issue these things have only a small portion of their business in them. They can and will get hit hard but they will survive.
Hmm, thx for answering graphrix,and you may be right that I’m a bit too pessimistic. Yup, those big players SHOULD be a ble to compensate their losses. However, nobody would have thought that Barclay’s Bank would go bankrupt, too, right? And I think the risk lies in the problems not only being in the subprime sector, but other financing businesses as well, and that investors are starting to panic. Sure, you can try to sell MBs’s and other investments at a loss, but what if it’s the same as in the housing market, and there are no buyers because the risk is perceived as being too high? It doesn’t matter if the risk really is too high or if this is irrational, this is a mass psychology issue. This article in Forbes supports such fears:
“The sensitivity to debt issues has become so significant that even a slight tremor in the trading of middling-quality securities can spark a worldwide run on equities. Although BNP Paribas’ Prot did not hide the bank’s exposure to subprime debt, he may not have realized the extent to which any bad loan-related news could affect investor confidence.
“Some investors do not realize there’s a difference between collateralized debt obligations with low quality and normal asset-backed securities,” said Andreas Plaesier, analyst with M.M. Warburg. “I think these products are illiquid, or can be illiquid, if investors do not trust them.””
http://www.forbes.com/facesinthenews/2007/08/10/baudouin-prot-bnp-face-cx_ll_0810autofacescan02.html
And this story in the Houston Chronicle shows hidden leverages at work that make the panic spread to other markets:
“”What matters is who owns what, who is under pressure to sell, and what else do they own,” he said. People with mortgage securities found they could not sell them, and so they sold other things. “If you can’t sell what you want to sell,” he said, “you sell what you can sell.”
It appears that securities backed by subprime mortgages were owned by people who also owned securities backed by leveraged corporate loans. With the market for mortgage paper drying up, and a need to raise cash, they sold the corporate securities, and that market began to suffer.”
http://www.chron.com/disp/story.mpl/business/5047108.html
Not exactly a promising outlook. And if too many markets are hit, imho this will affect even the big banks seriously. This sure isn’t simply a tempest in a teacup.
gray,
I was just making the point on how CMOs and CDOs work. How much or how little they trade for is a whole other story. The credit enhancements save the investor from possibly losing money if they stay invested and of course the defaualts can exceed the enhancements and then the investor would lose money.
The problem that is currently happening is what you pointed out the inability to sell these things. Then it spreads to other debt instruments like corporate bonds and those corporate bonds could be packaged in those CDOs.
I don’t think you are being pessimistic but you see the reality of it like I do. The subject can be confusing and I am always learning something new about it. If you haven’t already joined the forums here I recommend that you do. There has been some great discussions on subjects like this and to have another person join in would make it even better.
Tomorrow will be an interesting day. If you are up late enough 1am like me I will be posting in the forums on what is happening overseas.
what is your source(s) for the depreciation graph? and is it coyrighted?
also, I have a Q – when Houston real estate tanked in the 80s, condo owners had the additional problem of their condo fees going up to cover the missing residents’ fees (if half the units are vacant due to foreclosures, the remaining owners’ fees double). Is this also an issue in SoCal or is there some regulatory protection?
Thx for your time. Great blog.
I assume that someone had to own the “missing residents'” condos, no? (i.e., the bank) Why wouldn’t they have the pay the condo fees?