Subprime Revelation: Early Payment Default-ers Just Don't Care

Reading through more information about the "subprime mess" I think I finally realized what happened. I've had this thought before, but this time it hit me more forcefully. But let's back up and review the data first.

The subprime mess has been caused by a peculiar circumstance: Early Payment Defaults, primarily of users with no income documentation nor any collateral on the house for year 2006 loans. They're getting two loans, one for the 80% for the bulk of the loan and one for the 20% down payment. An Early Payment Default (loosely defined) is an owner who defaults on their payments within say four months of the close on the loan. The problem has not been with owners having their loans reset. EPDs as a problem seems kinda screwy, I mean, why default on a loan only a few months after getting it? Credit worthiness doesn't deteriorate that fast.

To check more information about the coming credit storm, I figured I'd start with credit cards, since that's the first to thing people are going to let go of, right? Always hold on to the house, right? I haven't really spent much time at this, but let's see what we can find. OK, Capital One (COF) has a delinquency rate lower than all years back to 2002. Citigroup (C) - basically same deal. Bank of America (BAC), no upticks either. So, dump the house and keep the credit card!?

Q: So why would people who show no documented loans, borrowing the full equity amount of the house, skip on their mortgage payments before a few months are out? And why would none of this "mess" seem to show up on seemingly the first thing that should show a problem?

A: Because they're houseflippers who realized the game is up with nothing on the line. They just don't care.

Obviously a sign of a bubble, but it doesn't seem to me to be a real sign of massive credit deterioration. Real credit deterioration would come on top of resetting loans and should be felt in other sectors.

Comments are most welcome, especially if you have data too.

Comments

[Lukas Bux:]

Greg...are you serious? The collapse of the subprime market is being caused by subprime houseflippers? Low income, immigrant, two-job working, low FICO houseflippers? Why do you assume that this population of houseflippers can even get credit cards from Citigroup and BAC?

Maybe they are not bothering with delinquency and going right to bankruptcy:
www.cardtrak.com/news/...

As you errantly report, "The subprime mess has been caused by a peculiar circumstance: Early Payment Defaults...." No, the subprime mess has been caused by standard-less underwriting that put people in houses they realized, after four months, they should never have been allowed.

The early defaulters are the tip of the iceberg. Your real houseflippers haven't even been touched yet, but after this failed Spring selling season the squeeze will be on.

2007 Apr 12 07:51 AM

[kdo:]

Okay a couple of things.

1) I'm sure my case is overstated. The root cause is obviously lending standards and the EPDs are the symptom, but some part of this also seems to reek a bit of people hoping to cash in a lottery ticket. The owners of subprime borrowers are not just immigrants and I wonder if you and I showed up looking for a no-doc loan for no down payment what kind of loan we'd get. Plus, when even the shoe shine boy knows he should buy a house, did he? The problem seems to be is that he was allowed to.

2) Bankruptcies: Great data - exactly what I'm looking for, except for one thing. Bankruptcies took a huge nose dive in 2006 because of the new bankruptcy laws that went into effect in 2005, because of the spike to file before Oct 2005. Over a million filings would actually be a normal number with no root causes other than a reversion to the mean, even north of 1.5 million filings would too. papers.ssrn.com/sol3/p...

3) The primary point of this post is what exactly does the mess mean? There is a theory that this is the coming collapse of the consumer and the economy and it will run straight into Alt-A and all ARM mortgages, so everyone should stuff their money in Europe or something (which has it's own real estate bubble, but who cares about that!). My main point is, as a canary in the coal mine, it's looking more red herring to me, because EPDs are not resets. If this is going to hit all ARMs and people higher up the tree, this should start showing up elsewhere. The federal funds rate change was mostly complete a year ago now. If this is all the start of a disaster, it seems to me there should be more signs of strain. I'm still open and looking for all data which would show it.

4) Rightfully, the lenders are getting slammed. I'm sure you and I can agree on that.

5) If the economy turns, I do believe this can turn into a disaster. But as a foregone conclusion I don't agree and it's an important question, because sometimes it's opportunity that's really staring at you in the face.

2007 Apr 12 01:45 PM

[donald_colvin:]

Folks,
If you want to read about early payment defaults and examples of rampant flipping with mortgage fraud, go to:
bubbletracking.blogspo.../

You'll see it all: flippers, RE fraudsters, etc.

2007 Apr 13 10:53 PM

[amricons:]

Right on, anyone who has dealt in RE has done it, I remember the last cycle we would put down 2K on a brand new home not yet built and by the time it was completed, it would be worth $ 5- 10 K more. Is there anything wrong with that ? Basic capitalism 101 it seems to me. I helped a friend get out of a house in Manteca CA last spring he had no right to be in, and he made a ton of money. A 4 Bed 3200 sq ft house, and he was single. I know buyers that had 4-5 houses using different family members to buy them. And of course you have heard of the brnad new, empty grass crop growing houses, opps, nobody will be making those payments, they are in jail. Ever wonder how a buyer with a rap sheet can get a loan ? We have always had these kinds of buyers around. ( No down payment) This time the stakes are a bit higher thats all, instead of $160 K houses from past times they are now $400 K homes. Heck, the house next door to us, which we tried to buy, was financed 110%, and the woman we talked to that was in title, had no clue, she was a shill for some mystery owners. The people that lived in the house tols us they kept getting mail for some unknown party. Anyway, as long as the lenders kept giving away money, there were plenty of takers. It would not be surprising that a lot of the buyers of those 100% financed homes did not have a clue as there were a lot of groups out there filling out paperwork for them.

2007 Apr 15 11:25 PM

[hcustodio:]

Perhaps the flippers financed more than the purchase price, walked away with the extra cash, and never had any intention of making payments to begin unless the property value kept going up. If values kept going up, they could always refinance and get more cash out.

2007 Apr 12 10:13 AM

[kdo:]

I've never heard of anyone financing $500k (or whatever) for a $400k house.

2007 Apr 12 02:02 PM

[d61345:]

You have obviously never never run into a mortgage fraud closing.

House value $400K
Purchase Price $550K
Appraisal $550K (MAI Appraisal - Made As Instructed)
100% Financiing - 80% First Mortgage 20% Second Mortgage
Closing disbursements $550K mortgage proceeds as follows
$15K Pay Closing Costs
$5K or so for Appraiser
$5K For Real Estate Closer (Prepares 2 HUD-1 closing statements, one for seller showing $90K kicked back to buyer and one clean, without kickback, for lender.
$435K to seller - they are happy they got more than house was worth
$90K Kicked Back Under Table to Buyer (I know this can't happen, yeah right, currently have ONE real estate closer indicted for over 60 closing like this in Minneapolis. This is the standard "Cash Back to Buyer" at closing good for 5 to 10 years per count in a Federal Pen.)

The above scenario is approximately the closing numbers from 3, yes 3, closings by the same buyer that took place in one week (buyer made application at 3 seperate lenders the same day so no lender knew about the other 2 lenders) for 3 homes next to each other on a block in a North Minneapolis suburb. A buyer with big $$$$ in his or her pockets can either make a few payments (see where values are going) or just say the heck with it and NEVER make a payment which = EPD.

So Greg it does happen and way, way too often. This type of mortgage fraud and EPD is just one of numerous housing scams that have been around for years. The biggest I have heard of was a $1.9 million house flipped as above at $5 million, you can only guess how much cash changed hands in that deal?

2007 Apr 12 07:41 PM

[Austrian Sc...:]

You've hit the nail on the head here. Its the perfect "free money" fraud. At first I was thinking, who would sell there credit for $90k, maybe a bum or someone terminal, but then I realized, if you do this scam on half a dozen places at once, you'd have enough money to live until your credit cleared itself. If anyone asks, you just say you were an agressive investor and the market didn't go the way you were hoping, and you lost your investments.

The losers in this scam are first the holders of the MBS that contain these bad loans, and secondly, too a greater degree, the multitude of later legitimate buyers that then over pay based on a comps loaded with an exta $100k cash back.

For flippers they look at the intro payment as a monthly option fee to retail right to sell at a later date, but to fraudsters it was just an up front cash payment. No intention to ever pay.

The RE "professionals" complicit in these deals probably figure the worst that will happen is that they'll be barred from practicing for a period of time, a slow period that they don't want to be part of anyway. These types need hard time. The formula I suggset is to take the amount of money misappropriated, divided by the avergage yearly pay of the people it was stolen from, and thats the sentence.

2007 Apr 14 11:04 AM

[kdo:]

Thanks for these posts. In a lot of ways, this type of stuff just strengthens the theory I put forth in the first place. That a big part of what's happened in subprime has nothing to do with the strain of the borrower, but has everything to do with the direction of the market. Excess can work in many ways and I'm sure in this case it has. Thanks for the information.

2007 Apr 15 02:20 AM

[Old Trader:]

Greg,

I'm with you regarding the puzzling lack of correlation in credit card delinquencies. Have WM stock, which has caught some of the subprime "down draft", but my main concern is the fact that they bought Providian last year....(who marketed credit cards to "subprime" borrowers).

Jan

2007 Apr 13 02:33 AM

[kdo:]

Looking through WM doc's seems to show that credit cards is kind of a small aspect of the overall business. The extremely high ratio of people using their Option ARMs to negatively amortize would be the thing that worries me most glancing over. Hmm.... WM is now yielding 5.6% though. Interesting.

It's funny, I used to think that Option ARMs were kind of a red herring - just because you can negatively amortize doesn't mean you do. Looking at CFC and WM it seems, most people do. I guess I shouldn't be surprised, but I'm kind of shocked. I used to have one, but we certainly didn't use it that way.

2007 Apr 15 03:16 AM

[Paula Rush:]

I don't know the statistics, but I will venture an educated guess that early payment defaults are also occuring because aggressive lenders were targeting homeowner already in trouble to refinance into some crazy products like the option arm loan. THey promise a lot and deliver very little. So quickly the person realizing that they are not going to be in better shape after the refi, but much worse with a pre payment penalty, refinancing costs added into their balance and negatively amortized interest added on the balance every month. They realize they are doomed. Prices are falling and balance on principal is going up. SUICIDE. So the broker who did the deal he should have never done in the first place makes a bundle, the loan got sold up the food chain to investors, and now the SH_ _ is hitting the fan. Investor in the beginning were willing to overlook a few here and there, but as the housing slump has continued and people are trapped in these homes, more and more are walking away. Investors are now saying, "What's this crap you sold us. Buy it back." But in most cases lenders can't buy it back. New Century for example. So the law suits are flying. But what many people don't realize, now that the SH_ _ is hitting the fan and lawyers are examining consumers loan docs, surprise surprise, they are finding all kinds of laws were broken in the selling of these loans. Everything from RICO, TILA, RESPA, ECOA, DPBA, UCC, and many other violations of federal and state laws. Many of these companies were operating as no more then white collar criminals figuring a multitude of ways to milk consumers and investors dry. So there you have it, the rest of the story and my explanation why many may have, and may in the future just walk away. AND SUE!

2007 Apr 14 06:49 PM

[kdo:]

Thanks for everyone's comments. I've found it very helpful in refining my thoughts.

2007 Apr 15 03:18 AM

[harris_curtis:]

We have some interesting information on our website: www.harriscompanyrec.c...

Cochise

2007 May 15 08:38 PM