Winners and Losers from the Mortgage Mess

It's very hard to find winners from the mortgage mess that we are currently in. Losers are well known - they are:

1. Mortgage lenders, e.g. Indymac (IMB), Countrywide (CFC). Majority of them are gone.

2. Homebuilders, who started to go under.

3. Regional banks who made a large quantity of loans to homebuilders and land developers. They cut their losses and exited the business.

4. Investment banks who specialized in securitization of mortgages, e.g. Bear Stearns (BSC), Merrill Lynch (MER) and Citigroup (C). They need constant life support in the form of equity infusion or buyouts.

5. Mortgage insurers: Ambac (ABK), Radian (RDN) and MBIA (MBI) etc. Business model broken, many of them teetering on gone.

6. Many industries that have direct exposure to the housing industry, from Home Depot (HD) and Lowes (LOW) to furniture sellers, etc.

The winners are hard to find at this moment. Who do I think will likely emerge as a winner? I think it will be the credit card issuers. Let me explain.

Card issuers were the losers during the housing bubble. As home prices skyrocketed from 2002-2006, it reduced the need of borrowing from credit cards. Many homeowners tapped their home equity line of credit to pay off credit card balances. Card issuers had to choose either maintaining their credit standards and risk their managed loans dropping year on year (MBNA and Discover (DFS)), or easing up lending standards to grow their loan portfolios, (AmEx (AXP), and Capital One (COF)). The result was not much fun, as overall industry loans barely grew from 2001 to 2006, with the growth rate was below nominal rate of GDP. The primary reason that MBNA had to sell itself in 2005 was the fact it saw its loan portfolio decreased year over year in both 2004 and 2005.

Simply put, during the bubble year card-issuers faced new forms of competition called home equity lines of credit. They lost some of their best customers to home equity. Now the housing bubble has started to unwind and getting a home equity loan will be increasingly more difficult and expensive, and sometimes downright impossible. As mortgage lenders disappear, competitive pressures are easing; therefore card issuers can charge higher rates and fees. Less competition is good thing in this case.

The bursting of the housing bubble should not be construed to be entirely negative - it has plenty of positives that the media does not even bother to report:

1. Property taxes and insurance are lowered since property value drops, thus more discretionary spending power.

2. New home buyers don't have to pay exorbitant prices, thus lower monthly mortgage payments and more consumer spending on other things.

3. American consumers are still in good shape. Many of those people who bought homes at the peak never put down any money. They did not lose that much either.

Despite all the drawbacks, free market capitalism works. Recession is healthy and essential. It cleans up the system, takes out the cyclical white elephants. The bursting of the housing bubble will make homes much more affordable. That's a very positive thing. During the 80's, oil prices crashed, 9 out of top 10 banks in Texas either went under or got bought. The U.S. economy survived and thrived afterwards. The money American consumers saved from oil was spent on other things.

It's not much different this time, home prices will continue drop; therefore, American consumers will spend much less money on housing than they did during the bubble years. The money they saved from lower housing will get spent on something else. The beauty of American capitalism is that the Free Market has this self-correct mechanism.

If you are still not convinced, just answer this question: are lower energy prices good or bad for the American economy? If your answer is yes, then the next question will have to be yes too: Are lower costs associated with owning a home a good or bad thing?

Sure some banks and some people might get hurt because of some price drops, but lowering the cost of things (including homes) will eventually be a very positive thing for American consumers and the overall economy.

Disclosure: I am long DFS and the U.S. market in general.

Comments

[Brian A. Davis:]

For many consumers, the credit card is the last line of defense before the street. And there is plenty of anecdotal and hard evidence. This situation can also be a catch 22 for credit cards. This article appeared to over-look a few other issues.

Assuming that is the case, it seems the expectations of a boom or bust for credit card companies is in the works. Remember, credit card debt is not secured. Should a party fail to pay, go bankrupt, lose their house, etc. the credit card company will be left holding the bag.

Depending on inflation, it should also be noted that if... if credit card and other revolving debt is serviced, there is also a risk of being repaid in inflated dollars.

Last, Congress plans on addressing credit card issuers and other forms of loan sharking in the fall. At the end of the day, when re-election is near, it is easy to vilify credit card companies.

P.S. MBNA was sold for several reasons including the death of Al Learner President and Founder of the company... It would also appear that MBNA was sold when the getting was good... consider the performance of financials since MBNA was sold... at its premium price. Last, MBNA was not selective as to who was issued a card... BAC has not fostered the growth of that company, and does not understand the family values that Al Learner used to create the empire. The MBNA division of BAC is a mere shadow of what used to be. At the end of the day, more will shake out of credit card companies. This could very well be the next financial shoe to drop on Wall Street.

2008 Aug 05 06:47 AM

[Jimmy Lathrop:]

This was a very interesting article. One point that I must disagree with is the claim that lower property taxes and lower insurance costs will be a result of lower property values.

Homes are generally assessed for property value purposes once every five years. Tax assessments are usually made at 70 percent of market value. Municipalities have a strong incentive to appraise properties at high values in order to maintain tax revenue. An example is a home that was appraised at $895,000 in April of 2007. The home is put on the market and there are no buyers at that price. Two offers for 500,000 are made in September. The municipality goes to the home with their appraiser in October. The house sits on the market over the winter, a seasonal period where there are low home sales because people tend to buy in the spring and summer. In April of 2008, the house sells for $685,000. Almost simultaneously, the municipality announces the house is assessed at $685,000 and will be taxed at that rate for the next 5 years. Notice that I have written the word "assessed" and not "appraised". Even though the home was on the market for a year and not one person offered the April 2007 appraisal value, the municipality used an inflated appraisal value in order to generate property tax revenue. The homeowner is forced to appeal the municipality's decision, where the homeowner has a high standard of proof to overcome. Even if the homeowner brings in the broker and shows that the market would, and could not sustain that inflated value, the municipality will fight to maintain that high rate because of the other properties which are vacant.

While property values may have skyrocketed from 2002 to 2006, they will not recover as quickly from 2008 to 2013. Many homeowners in cash strapped municipalities will have assessment rates at or above the market value of the home. This will result in further driving down property values, as the tax burden of homes will higher than what they should actually be.

As far as the author's claim to insurance being lower, the post-Katrina and post-Mississippi flooding is still being felt by the insurers. Many insurers have stopped writing flood policies altogether, leaving many seaside and riverside developments vacant. A look at the recent stock prices of the insurance companies shows massive losses off of their 52 week highs, which means that capital will be used to shore up the balance sheet as opposed to bringing growth, as Meridith Whitney would say.

I also would like to mention that the new administration and Congress may amend the Bankruptcy Reform Act which MBNA bought, I mean, lobbied heavily in favor. Certain congressional committees will look very hard at the prior claims of the credit card issuers made in favor of the bill, in that credit card rates would go down if the bill was passed. I don't have to say anything more than that.

2008 Aug 05 07:26 AM

[tilut:]

DFS is already priced for the end of the world, so I see only upside for this stock BIG TIME.

2008 Aug 05 08:38 AM

[Skip Olinger:]

With all due respect, as the comments above point out, this was not a well thought out article. I have never heard before that it is OK for someone to lose their house so long as they never put up a down payment. I would not look at that as an indicator of personal financial strength.

2008 Aug 05 09:04 AM

[TonyCinTX:]

The winners from this fallout are builders that are not involved in the housing boom or credit markets. For commercial builders of shopping malls, government buildings, theaters, apartments, office buildings, medical buildings, warehouses and factories and replacement and renovation of all these, labor and materials are getting cheaper. There is an oversupply of both and reduced demand. For a solid investment backed by logic and experience, money is there to be loaned. I wouldn't bet on credit cards.

For investors with capital, there are some desperate people and banks that cannot afford to wait two or three years for prices to recover, and that may mean a profit. I am not doing it, but it may be possible to find houses selling cheap, at auction or otherwise, that could be rented to cover 90-95% of the mortgage, and will appreciate in value 25% or so by 2012. That is far more than a respectable investment. Suppose I have to put 15% down and pay 6.25% for a mortgage and the rent only covers 90% of the mortgage payment. If the property appeciates 25% in the next four years, my total investment is 22.5% of the paid value, maybe 25% with repairs, while my profit is 25% of the paid value 100% in four years. That is an annualized compounded return of 19%.

As with all booms and busts, the winners after the bust are the people with the capital and judgment to acquire good assets cheap. As people lose their houses they must live somewhere and if it isn't the street, apartments and rentals are the only place left. I expect a new boom in trailer parks.

2008 Aug 05 09:21 AM

[tom Andersen:]

Ah - taxes on real estate are about to sky rocket - along with service cuts, etc. Cities need the same amount of money year to year. So if you get 5% of houses paying no tax, and property values drop 40%, tax rates have to roughly double. In addition, tax shortfalls at other levels of government will continue to passed down to real estate - it can't move out of the way. This will become apparent soon.

2008 Aug 05 09:26 AM

[notsosmart:]

the govtsfrom local to dc better start constraining their budgets. the people better start paying attention & not reelect the folks that allowed this mess. stop thinking of your political rep as your friend. he is a legal pickpocket.put in new people.remember to vote & remember the congress has a 9% approval.neither pres. candidate will do much for the middle class.sad.

2008 Aug 05 10:38 AM

[rm:]

[1. Property taxes and insurance are lowered since property value drops, thus more discretionary spending power.]

For whom?

New buyers?

Maybe.

In our state, most homeowners are "locked in," with taxable values that won't decrease... they just won't continue to increase.

2008 Aug 05 11:32 AM

[Still Renting:]

People forget that a recession affects people, and people are not machines. They are emotional beings. I think of the recession as an armour piercing round shot at an economy/culture that is a tank with armour plating. Now, if the plating holds, there is not much damage. If, however, the round has enough velocity, and the plating is not thick enough, the round penetrates the armour, incinerating everyone inside.

We have had many recessions in my lifetime and many before. One particular one actually allowed the round to penetrate the armour, giving us the great depression and WWII.

That risk is always there. The question, every time, is, will it penetrate this time?

This affects families. Families will suffer hardship. Money may not buy happiness, but the lack of it can bring a lot of misery. Misery brings an increase in divorce, domestic violence, substance abuse, murder, crime, etc. We have yet to see how this will play out. I'll be watching the alt-a fallout with interest.

2008 Aug 05 11:43 AM

[Tom Lindmark:]

Winners:
1. Investment bankers and bankers who individually made a ton of money securitizing loans.
2. Homebuilders who sold boatloads of new homes.
3. Homeowners who bought early and sold into the boom.
4. Federal, state and local governments who saw their tax revenues soar during the boom.
5. Realtors, mortgage brokers, construction workers, anyone in industries related to the boom that took the money and didn't reinvest their profits in the housing industry.
6. Anyone currently in the business of managing foreclosed assets.

Remember, there are two sides to every trade. A winner and a loser. There was a lot of money changing hands and a lot of people are very comfortable today because they took their profits and didn't double down.

2008 Aug 05 11:57 AM

[jackooo:]

In Ca. our property taxes cannot be raised more than 2% a year.
Thanks to it's sponsor Howard Jarvis. It's called prop. 13 and has been in effect for many years.
I can not believe the rest of the country does not have the balls to pass a propisition like this but instead gets ripped off by the politicians.

2008 Aug 05 12:18 PM

[User 68127:]

What happens if mortgage rates go up?

Standards are already being radically tightened, meaning that many who are still able to get a loan will be forced to pay higher rates and/or fees.

2008 Aug 05 01:22 PM

[maz:]

Poorly researched article full of careless errors - since when were MBIA and Ambac mortgage insurers? How about the largest mortgage insurer MGIC Investment (MTG) and PMI Group (PMI)?

I could go on but this article isn't worth it

It's plain Rong :-)

2008 Aug 05 02:39 PM

[xsuddensam:]

The real winners have yet to realize their winnings.

The S&L failures of the late eighty's and early ninety's created a huge inventory of commercial real estate. The Resolution Trust Corporation was created to dispose of all these foreclosed properties and they went out the door at bargain basement prices to those who had CASH available.

When this current mortgage mess washes out, there will be huge inventories of single family homes and condominiums that will sell for pennies on the dollar. There will be so many homes for sale that a similar agency like the RTC will have to handle these sales. Those with cash will be winners this time around.

2008 Aug 05 08:04 PM

[soughtalpha:]

You say: If you are still not convinced, just answer this question: are lower energy prices good or bad for the American economy? If your answer is yes, then the next question will have to be yes too: Are lower costs associated with owning a home a good or bad thing?

-Huh? The typical consumer does not hold oil as part of their wealth- networth, as opposed to their house which they universally do. The consumer has nothing to lose when oil prices fall and everything to gain, the same can not be true of an asset they already hold that has been devalued.

2008 Aug 07 01:52 PM

[Umm, yeah:]

Lol, pure entertainment...

Let me get this straight: so if someone went and bought a home for $250k in 2005 with no money down, only to see it now worth $50k, then no harm done?

This must be the Bizzarro universe or something?

2008 Aug 07 04:14 PM

[Schumia:]

> ... For investors with capital, there are some desperate people and banks > that cannot afford to wait two or three years for prices to recover, and that may mean a profit. I am not doing it, but it may be possible to find houses selling cheap, at auction or otherwise, that could
> be rented to cover 90-95% of the mortgage, and will appreciate in
> value 25% or so by 2012. That is far more than a respectable investment.
> Suppose I have to put 15% down and pay 6.25% for a mortgage and the rent only covers 90% of the mortgage payment. If the property appeciates 25% in the next four years, my total investment is 22.5% of the paid value, maybe 25% with repairs, while my profit is 25% of the paid value 100% in four years. That is an annualized compounded return of 19%.

Hi TonyC-SA,

Can you help explain how you arrived at the 22.5% total investment above considering a 15% down plus 90% mortgage coverage from rent? I'm just starting out investing and would appreciate if you can lay out the math =) Thanks

Jeff

2008 Aug 09 09:39 PM