John Hussman: The Second Wave Begins

Excerpt from the Hussman Funds' Weekly Market Comment (11/9/09):

“RealtyTrac today released its Q3 2009 Metropolitan Foreclosure Market Report, which shows that cities in California, Florida, and Nevada accounted for the 10 highest foreclosure rates in the third quarter among metro areas with a population of 200,000 or more. But five of those Top 10 metro areas reported decreasing foreclosure activity from the third quarter of 2008, while many other metro areas with Top 50 foreclosure rates reported sharp increases in foreclosure activity.”

“Rising unemployment and a new variety of mortgage resets continued to gradually shift the nation's foreclosure epicenters in the third quarter away from the hot spots of the last two years and toward some metro areas that had avoided the brunt of the first foreclosure wave,” said James J. Saccacio, chief executive officer of RealtyTrac. “While toxic subprime mortgages drove much of that first wave of foreclosures, high unemployment and exotic Alt-A and Option ARMs are spreading the foreclosure flood to more metro areas in 2009.”

While the news itself is no surprise in the sense that we have expected and written about this situation repeatedly in recent months, the phrase “sharp increases in foreclosure activity” is notable in the context of widespread views that credit difficulties are abating. Below is a reminder of where we stand in relation to the reset curve. This news of a shift in the character of foreclosure activity comes precisely in tandem with the beginning of the predictable second wave. The pleasant lull in the reset schedule is decidedly behind us.

I should also note some features of the resets we are now beginning to observe. It is tempting to think that with Treasury yields fairly low, mortgage resets might be fairly benign in terms of their impact. The problem is that these Option ARM and Alt-A structures were specifically designed as “teasers” – allowing loans to be made without documentation of creditworthiness, in return for post-reset interest terms that were generally higher than a documented lender would have paid. The mortgages certainly do not reset at Treasury bill yields or even at standard spreads over LIBOR. Instead, they reset to a “premium” spread above those rates. That “yield spread premium” is precisely what the homeowners agreed to in return for the undocumented loan, and is particularly obnoxious at the point of reset if the mortgage itself is underwater (loan amount in excess of home value). Given that these mortgages were written during the last stages of the housing boom, at the highest prices, it is reasonable to assume they now sport very high loan-to-value ratios.

Comments

[peterthepai...:]

yes...another wave...

Nov 09 11:57 AM

[Stefan Sida...:]

Good article.
Do you have any data on the current foreclosure overhang and what are the projected effects/write-downs from all these re-sets?
This really complicates the Feds exit strategy (if there is one). How will they ever get to raising interest rates? If they don't, inflation and the big asset bubble will keep going. If they do raise rates, the re-sets talked about in this article get ugly for the banks. And, the treasury will eat more agency writedowns.

Nov 09 01:36 PM

[user396040:]

I would like to see an analysis of this problem in terms of cash flow. Presumably, the banks have been collecting the low teaser rates of interest prior to the reset. If the lender agrees to let the borrower extend this teaser rate, presumably there would be no effect on cash flow; if lenders can get a somewhat higher rate of interest but not the contract rate, cash flow would improve. It will be interesting to see if there is a pattern of renegotiation.

Nov 09 02:39 PM

[User 353732:]

This is a wave but the CRE defaults will be a tsunami. The destruction that awaits, I suggest, is greater than what has already been experienced.

Debt financed real estate construction, monetization of real estate, chiefly, residential, equity by second mortgages, and credit card debt financed consumption were major drivers of economic expansion for a decade. These drivers are now gone. The accelerator has become the brake.

Business investment and increased consumption by the top 5% of households by income cannot replace these drivers. Indeed, investment by small and new businesses is being deliberately strangled by credit suffocation and big business is more interested in cash conservation and cost reductions than in investments to finance innovation.
Exports are not going to increase much because much of what the Global South needs America cannot or refuses to sell competitively .
Govt spending at these demented levels has a negative multiplier.

in 2009, there no engines of growth in the US economy except ,of course, Statistical Growth manufactured in the dark mills of deceit and propaganda that The Regime is so very good at operating.

......And the response of Wall St?
Well, proclaim a boom, raise bonuses , use vast amounts of free credit coerced from the taxpayers via WashDc to invest in Govt and agency debt at a guaranteed spread to secure the gift of undeserved income and
, in one of the greatest acts of financial malignancy in economic history, raise the spread between bank cost of debt and small business( about zero) and household credit to the high teens to institutionalize organized theft on an epic scale(with the total complicity of Big Govt and the applause of Big Media)

No engines of growth; organized pillage by Wall St; destruction of the Middle class by WashDc....Not economic waves but towering tidal waves; not financial tremors but financial earthquakes lie ahead.

Compared to what may be coming THESE are the good days.

Nov 09 04:14 PM

[mkttrdr:]

Thanks John,
The stimulus will eventually trickle down and create jobs. But, Not enough to get the economy back on it's feet. My concern is when the Fed decides to raise rates. How much impact to housing will this cause? After July 4th 2010 is about when I expect this troubling hike!

Nov 10 10:24 AM