Seth Chalnick

Banking Sector: Worst Is Yet to Come

dragonpaw, my friend, I am publishing a SA article dedicated to you :)

Banking Sector: Worst Is Yet to Come

I think Reggie does a good job of intertwining facts and informed opinion.

I rarely do this, but I'm going to cut and paste here a comment I made last night on another thread... which shows another whole perspective of why the worst is yet to come in the financial sector.

You can find the SA article posted by Zacks if you search for ("Mortgage Delinquencies Rising").

My comment addresses a two-fold question posted by another reader... paraphrased as follows: "what is there to worry about my 5yr rate re-set if the rates are lower these days?" and "are option arms really that bad if the rates are lower too?"

First, in your scenario, yes you are better off if rates stay low compared to what will happen when they inevitably climb, but there still exists a major problem for many folks who are making less income than they did at time of purchase or who took on additional debt since then.

When the rate switches to adjustable... about 50% of these loans also switch from i/o to p&i... the other 50% keep the i/o option for five more years. The ones that go p&i now, reset the amortization to 25 yrs... the ones that go p&i in five years will switch at that time to 20yr amortization.

On a loan size of $800k if the rate is the same now as it was at time of purchase, this creates a payment increase (or payment shock as the case may be) of approximately $1,000/mo.

This may be easily absorbed by many households, but the marginal ones will look for other options. They will try to refi, and they will get rejected. Then they will attempt to short sale and only 15% will succeed. The rest will ultimately walk away, thereby creating a downward spiral in home values for the next marginal household.

The option arms are worse because they pay (or accumulate) anywhere from 8% to 11% on their balance just for the option to pay less than interest only. Most of the folks who have these loans have not even been paying the i/o... they have been paying less than i/o. When the negative amortization reaches 115% or 125% (varies by lender) of the original balance, the loan implodes by becoming due. A recipe for disaster.

Meantime, the prime pool is three times larger than subprime and, as this article points out, the average loan size is also larger. The subprime problem loans have not been absorbed into the market yet. They have merely been put on hold. The bankerment has (successfully?) used smoke and mirrors until now… since at least the prime consumers have been paying their monthly payments, but when they start defaulting (and they already have started)... the banks will start to falter. This will create another credit crunch and it will accelerate the problem.

The imminent prime crash is going to make the subprime crash look like a little footnote in history.

Shadow Inventory: Conspiracy Theory or Real?

I'm really surprised that this article didn't get more kudos from SA readers, and also that the first comment was actually taken seriously, which unfortunately diluted focus from the main point highlighted by the author.

This is a terrific piece... one of only ones I have seen that puts substance behind the excellent point that user 463618 makes, and which astute observers have been talking about for some time now.

Overlooking this “shadow inventory" or whatever the heck you want to call “that which should be on the MLS but is not”… and taking the banks and the government at face value about how they've been dealing with the situation, or even acknowledging it in the first place, is a mistake that I believe will catch both Main and Wall Streets by surprise... the consequences of which will be devastating.

How on Earth most people are willing to rationalize that the fundamental problems don't exist when technical data temporarily suggests otherwise is simply beyond me. Add to this that the prime re-sets have not even started yet, that interest rates are artificially being kept at bay, that there is no market for jumbo paper, and that unemployment is still a huge factor... and wtf are people thinking??

Mortgage Servicers' Perverse Incentives

I guess the confusing part for me has to do with these questions:

-Why would banks take a relatively larger loss on non-performing loans in comparison to the junk fees they cold collect? …and can fees and insurance come even close to offsetting such huge losses?

-Are the individual incentives of bank managers not aligned with those of the broader institution?

-Are the banks simply reluctant to approve short sales (or take back homes) because it triggers balance sheet losses they need to claim officially, which in turn pressure share prices lower?

-Are banks attempting to delay things in hopes that the market rebounds or the government cushions the fall?

-Are they afraid to lower valuations further by flooding the market with more supply?

Obviously there is some reason, or combination of reasons, the banks are not taking action. In California anyway, the moratoriums play a role, at least superficially… but my understanding is that many of the banks have loopholes they can exercise to foreclose on homes if they really wanted to do this.

There is still sooo much of this (non)inventory out there. And more coming behind it. So I’m grateful for thought provoking articles like this one that point to the questions we should be asking. Anyway, it is a lot better than other pieces that say, “hey, homes are selling… the recession must be over”.

Mortgage Servicers' Perverse Incentives

Thanks for this really good article. This coherent arguement backs up what a lot of people seem to get intuitively, but have a hard time expressing.