John Hussman: The Danger of Inaction

Excerpt from the Hussman Funds' Weekly Market Comment (3/30/09):

If there is any good news at present, it is that the capital infusions of late-2008 have temporarily stabilized the banking system, and that the U.S. economy is presently enjoying a brief and modest reprieve from the financial crisis. This is largely the result of an ebbing in the rate of sub-prime mortgage resets, which reached their peak in mid-2008, with corresponding mortgage losses and foreclosures a few months later. Since this crisis began, the profile of mortgage resets has been well-correlated with subsequent foreclosures.

Unfortunately, the reset schedule above depicts only sub-prime mortgages. As the recent housing bubble progressed, the profile of mortgage originations changed, so that at the very peak of the housing bubble, new originations took the form of Alt-As (low or no requirement to document income) and Option-ARMs (teaser rates, with no required principal repayments).

A broader profile of mortgage resets is presented below (though even this chart does not include the full range of adjustable mortgage products).

This reset profile is of great concern, because the majority of resets are still ahead. Moreover, the mortgages to which these resets will apply are primarily those originated late in the housing bubble, at the highest prices, and therefore having the largest probable loss. Though many of these mortgages are tied to LIBOR, and therefore benefit from low LIBOR rates, the interest rates on the mortgages are typically reset to a significant spread above LIBOR, and this spread remains constant as interest rates change. Undoubtedly, some Alt-A and option-ARM foreclosures have already occurred, but the likelihood is that major additional foreclosures and mortgage losses lie ahead. If we fail to address foreclosure abatement during the current window of opportunity (early to mid-2009), there may not be time for legislative efforts to contain the resulting fallout.

Comments

[Aquater:]

A good alarming narrative with an appropriate timing factor to it. Hope the legislators take heed. And investors too.

Mar 30 11:47 AM

[Larry House:]

I don't think the government will throw enough money at the problems to prevent the deflation that is already well underway, and if they do, we will just have bigger problems down the road. There is no clear path out of this mess.

Mar 30 11:47 AM

[Socialism c...:]

Wrong. Excessive government in general, and its interference in housing, have precipitated this economic collapse. And government ACTION is setting up an even larger downfall!! You don't solve a problem of too much debt, by added massive amounts of additional debt!

Mar 30 01:33 PM

[mrmillergd:]

The bigger the bubble...the louder the pop. All government can do is somewhat mitigate or otherwise defer the pain. We are so 1931.

Check it out...the Dow dropped 90% from 1929 to mid-1932. Think it couldn't happen again? The similarities between the '20's and the 00's is striking. These are the only two points in the last century we were ever so in debt.

Mar 30 04:28 PM

[Carlos Lam:]

Mr. Hussman, are you suggesting, then that the losses of the banks be socialized across the taxpaying base? Can you provide me a single reason that the losses shouldn't be internalized by the lenders and borrowers of the debt that encumbers these properties? The losses should be borne by those who are most responsible. Said another way: who had the best opportunity to avoid the losses that have accrued? The answer: the borrowers and lenders.

Mar 30 04:49 PM

[CJJ:]

Those people don't have the capital to shoulder the losses. I love how people think if you just bankrupt a few people and a few banks everything will be honky dory.
Please stop saying socialized. Its a buzzword and it doesn't make you right just because you use it in your comments.
The world leaders at some point will realize, quicker than you silly people who can't comprehend things, that forgiving debt is the quickest and easiest way out of this mess. The damage is done, so eliminate the damage.
Of course a better framework and accountability are necessary to stop this from occurring again. But that is a far better outcome then a bunch of poverty and suffering in the name of sticking it to those who got us in this mess(when those people won't suffer anyway).

Its like getting through 20 levels of a video game, screwing up a level and instead of starting the level over and moving on you take the game console and punt it into the river. What's the point?

On Mar 30 04:49 PM clam75 wrote:

> Mr. Hussman, are you suggesting, then that the losses of the banks
> be socialized across the taxpaying base? Can you provide me a single
> reason that the losses shouldn't be internalized by the lenders and
> borrowers of the debt that encumbers these properties? The losses
> should be borne by those who are most responsible. Said another way:
> who had the best opportunity to avoid the losses that have accrued?
> The answer: the borrowers and lenders.

Mar 30 10:20 PM

[CJJ:]

The world can't go bankrupt chumps.

Mar 30 10:21 PM

[Raution:]

This is just another indication of some additional bad news to follow and a hit to the index. I am sure that its affect is not well calculated in the real estate and financial industry.

Mar 30 11:42 PM

[mac.barron:]

In trying to prop up the residential real estate market the Obama administration is shoveling sand against the tide. A lot of dollars are being flushed down the toilet and the end results will be an even deeper economic trough than was necessary. The market needed to correct itself, the speculation was beyond absurd in many places. Now we will have another period where the market is maintained by artificial means followed by a further crash with even more pain associated. Finally, watch what happens when the interest rates are goosed repeatedly to counter inflation a few years on.

Mar 31 01:28 AM

[Fighting Yoda:]

What the author is not telling is what the new reset rates likely to be. We know it is LIBOR + some constant. We can see LIBOR coming down (low interest rates + deflation etc etc). Will the net rates increase or decrease is the issue. If they increase (as they would for teaser or similar loans) – then we are in more trouble. However if it is a standard ARM then rate would actually decrease – that would be good for the borrowers.

Mar 31 02:15 AM

[Fighting Yoda:]

CJJ:
It is not so easy to write off the loans - the amounts are staggering. Who will take the losses, even the might US taxpayer can't handle 5 - 10 Trillion dollars. There is too much political backlash, would lead to class warfare (we might be heading that way anyway)
Yes I agree we need more accountability and punishments (debtor prisons), no recourse loans should be simply banned.



On Mar 30 10:20 PM CJJ wrote:

> Those people don't have the capital to shoulder the losses. I love
> how people think if you just bankrupt a few people and a few banks
> everything will be honky dory.
> Please stop saying socialized. Its a buzzword and it doesn't make
> you right just because you use it in your comments.
> The world leaders at some point will realize, quicker than you silly
> people who can't comprehend things, that forgiving debt is the quickest
>

Mar 31 02:21 AM

[Old Trader:]

tiger,

I agree with your point, but I think unemployment going forward will be the "wild card" in this particular game. After all, even if the rate were to drop to 0%, it doesn't help much if the mortgage holder is unemployed. There seems to be a near unanimous consensus that we're not done, as far as rising unemployment goes....the only question being how high the spike goes, and how long it lingers.


On Mar 31 02:15 AM SB-tiger wrote:

> What the author is not telling is what the new reset rates likely
> to be. We know it is LIBOR + some constant. We can see LIBOR coming
> down (low interest rates + deflation etc etc). Will the net rates
> increase or decrease is the issue. If they increase (as they would
> for teaser or similar loans) – then we are in more trouble. However
> if it is a standard ARM then rate would actually decrease – that
> would be good for the borrowers.

Mar 31 09:26 AM

[Allan Frain:]

Watch the battle between the attempt to keep rates near zero and Auction Failures.

If rates rise the resets will mean further housing devastation.

If rates can remain suppressed through the resets we get more of the capital destruction inherent with prolonged sub-market rates.

Twisting the markets to keep people in houses they cannot afford is economic "scorched earth" policy. We should have learned that by now.

Mar 31 11:48 AM

[ain't no fo...:]

miser clam, i would suggest you crawl into your shell shut it up nice and tight , and google "CDS" and read up on those neat little contracts for a few hours before you so glibly suggest that we ignore the "internalization" of the losses on a couple of institutions and borrowers.

And then google "Armageddon".


On Mar 30 04:49 PM clam75 wrote:

> Mr. Hussman, are you suggesting, then that the losses of the banks
> be socialized across the taxpaying base? Can you provide me a single
> reason that the losses shouldn't be internalized by the lenders and
> borrowers of the debt that encumbers these properties? The losses
> should be borne by those who are most responsible. Said another
> way: who had the best opportunity to avoid the losses that have accrued?
> The answer: the borrowers and lenders.

Mar 31 12:39 PM

[Lynn:]

I think a few of the commenters missed the fact that Option ARMs are interest-only loans until the ARM resets. So even if interest rates are lower after the reset, the payment will be higher because the principle will be added to the payment.

Mar 31 05:41 PM

[Ronald Pires:]

Seriously good analysis. Folks should really read the entire article over on your site. It's definitely worthwhile.

You make one point in particular that I've long believed but have not really seen written up elsewhere. That is, that the effort to save banks is misguided, and instead should be to identify and save critical investments (such as pension funds) within those banks. Certainly far less money, and much better directed towards general economic stability.

Mar 31 08:38 PM

[StanleyWD:]

And unemployment going forward being the issue would cause issues with mortgages whether they were fixed rate mortgages or ARMs. So the 'reset issue' is not really a 'reset issue' but an 'unemployment issue'.


On Mar 31 09:26 AM old trader wrote:

> tiger,
>
> I agree with your point, but I think unemployment going forward will
> be the "wild card" in this particular game. After all, even if the
> rate were to drop to 0%, it doesn't help much if the mortgage holder
> is unemployed. There seems to be a near unanimous consensus that
> we're not done, as far as rising unemployment goes....the only question
> being how high the spike goes, and how long it lingers.

Apr 01 10:15 PM

[rr0710:]

There is nobody better than John Hussman grasping this issue. They should be listening to him in Washington.

Apr 04 12:43 PM