The Credit Crunch and The Insolvency Arena

A natural consequence of any failure the size of the mortgage debacle will be an outcry for more oversight and regulation. In this case, folks are already calling for uniform Federal licensing for mortgage companies and related jobs that reside outside the banking system. Sounds good – but historically, these programs and others like it don’t work very well. Anytime hard walls are placed in highly complex systems, people figure out ways to sidestep those walls. The only way to fix the sidesteps are more hard walls. Just look at the Federal Tax code.

In fact, Florida has a much more onerous licensure process than Tennessee for Mortgage Brokers and Mortgage Lenders; fingerprinting, mandatory 2 day classes, mandatory tests, continuing education requirements. The results are bogus classes that teach only how to take the test, a test with no relation to the real world, and continuing education classes done on line with a 10 minute click-and-pay-and-diploma process. The businesses supplying the system make money, but the system itself is strained and made more cumbersome and costly than ever. Even with all that regulation, Florida still has a far higher instance of mortgage fraud and abuse than Tennessee.

There is absolutely no doubt that major changes need to take place – but those changes need to address the source of the problems rather than the surface. Start with a massive reform of the bloated Federal RESPA guidelines. Change the accounting regulations to make mark to market accounting more sensible. Simplify the loan process and make it more transparent for consumers. The solutions are greater clarity and less regulation.

The facts are these: A massive credit expansion was caused by domestic monetary policy and congressional fiscal policy (avoidable) and the evolution of new investment debt instruments that effectively increased the money supply, increased leverage and hyper accelerated credit extensions (partially avoidable). These factors created manic behavior with investors around the world and rational people/markets behaved irrationally (unavoidable). The system collapsed under its own excesses and because of the extraordinary connectivity of the global markets in the modern era, penetrated deeply and broadly (unavoidable).

Of course, none of this will keep people from trying to name a human villain to string up – but we will most certainly come to regret having played the blame game in the coming decades.

Respectfully,
Steve Curnutte
Finworth Mortgage
Borrow Wisely

‘Superfund’ sure sounds good. Any self respecting buzzword needs a little pith and punch in order to get press, right? In fact, The Wall Street Journal headline read “Fund Aims to Avert banking Crisis.” At 100 billion dollars, it certainly seems like it might fix the credit crunch, right?” But why should a real estate agent care? Or a homeowner? Or a financial planner? Or a builder? Let’s see…

Citigroup, JP Morgan Chase and Bank of America say they will set up a 100 billion dollar fund that they hope will act like a defibrillator to the arresting commercial paper world. The fund would raise money, and then use the cash to buy a bunch of failing or struggling Structured Investment Vehicles (SIV’s). Overly simplified, SIV’s are recently deployed financial instruments that BUY LONG DEBT by SELLING SHORT DEBT and take the spread for profit. If you are in this game when the spreads tighten, you are very unhappy. And if you are unhappy, you may want to dump other things you are holding at a fire sale price in order to get your hands on some cash. If some of the things you dump are stocks, it could hurt the markets. So the Superfund is supposed to keep SIV’s from stumbling. The strangest part about the news is that the Treasury Department backs the idea. Huh?

Here are some things that the Superfund IS NOT…

This IS NOT a deal that includes all the big banks. Goldman, Morgan Stanley and Lehman Brothers are not yet on board and so far there is no indication they will join.

This IS NOT a clean deal. Citigroup and Bank of America have a bunch of SIV related business, so they would benefit from a little love in the SIV world. Added to that, the participating banks will earn ‘Hamptons-sized’ fees to sell the pieces of the Superfund.

This IS NOT a bailout of the investors who bought all the terrible loans that were booked. In fact, if the Superfund gets set up in the next 90 days as they say (we think is highly doubtful), there are no plans to buy any of the CDO’s and SIV’s that have bad loans from the subprime world and the Alt-A world. In fact, they really can not buy any of the bad loans in order to ‘bail out’ investors, because they would be forced by regulators to immediately write off the bad debt and that would be ugly for shareholders.Here are some things that the Superfund IS…This IS a very clever way for banks to buy drastically undervalued assets and turn them for a profit. Most of the SIV’s (this term of course includes CDO’s, etc.) are garbage of course. The financial world will find this out in the next 12 months. But there is really nothing wrong with some of the SIV’s – and these are the ones the superfund architects want to buy. They are comprised of good loans that are performing well. It is just that no one is consistently buying their short term debt offerings to keep them chugging along. Think about a car dealership with a lot full of BMW’s. The only way they pay the bills and stay in business is to keep selling all the BMW’s that keep coming off the trucks from the auto maker. If all the BMW buyers vanish for a few months – it means the BMW dealership is not going to be sending out any Christmas turkeys. In fact, they would be desperate to sell any warm blooded person a BMW even if they had to take a loss. Well, the buyers for SIV’s are gone, but the SIV’s have to keep moving along. This is a great time to get a couple of ‘em. Have a few million? This IS sending mixed signals. Believers in the free market think this will be seen by many as a bail out, as an intrusion, or as flat out dumb. The fact that the Treasury is somehow asking for this to happen, or that they are somehow arranging the deal really smells strange. The Treasury has never really done this in the past and for some it makes the Big Government litmus paper start to turn colors. Our fear is that this financial crisis will deepen, and that the government will get more and more involved. We have not seen the end of this bailout typ mentality!

Back to mortgages, and to you. The 10 year Treasury is in pretty good shape right now so regular 30 year fixed rates are still in decent shape. Even 30 year fixed loans that are jumbos (more than $417,000) are coming back into line a little. Of course, getting 100% financing is much more difficult than before, and getting any loan if your credit is bad is nearly impossible, but overall it is not a bad time to convert your ARM to a fixed rate, or combine 2 mortgages into one at a fixed rate. However, there is a rub. A big one….property values are still easing and it is not over by any means.

When we predicted more than a year and a half ago that the housing market was much softer and much deeper than anyone was willing to admit, it sounded like we were striking a panic bell. Now, those predictions are unfolding. We still look for values to drop at least through the end of 2008. Following that, the real estate market nationwide is likely to remain anemic for another four or five years. That does not mean real estate is a poor investment. Nor does it mean that all areas will follow the same line. Real Estate Markets are fractured, localized, and extremely difficult to quantify. We simply believe that the bottom is not yet here, and that the recovery will be longer and more difficult than the current opinion seems to indicate.

If you are selling you home, please be realistic and listen to your agent when they ask you to drop the price. They are not trying to make an easy sale. They are trying to save you from riding the market down to the bottom and hemorrhaging carrying costs along the way. Agents, stay vigilant with the approval letters – some are virtually worthless. Start talking to your buyers about other options like gift money. Don’t just use any old mortgage person right now – there is little room for error these days. Find the very best and most knowledgeable mortgage professional in your area and stay in constant contact.

Builders, talk to your bank now about extending your construction financing because you may not be able to talk to them in a few months. Many of them will be announcing plans to force principal reductions and still more are going to force you to drop the price in order to renew. Work with them now to set things on longer terms before they implement the plans to restrict lending and reduce exposure.Financial Planners, if your clients have investment properties or second homes, talk to them about restructuring the debt in a sensible way, perhaps even squaring the loan amounts with the current appraised values (like structuring all investment properties at the sweet spot of 75% Loan to Value). In other words, the comparable sales may not support a value that will allow your client to refinance it 1 year. Now is the time for them to get the debt house in order so to speak.And last – here are a few quick bullets:Yes, the press as a whole has been a prophet of doom on the whole mortgage crisis. Yes, it would be better sometimes if the whole thing were not blown out of proportion. But it is bad, and it is getting worse. We have been talking about some pretty bad scenarios in our articles and on the blog – and we are not happy to say that most of it is coming true. We still believe that values will fall more, that underwriting standards will continue to tighten, and that ripples will be felt for years.

At the beginning of October, the U.S. House of Representatives approved legislation that would exempt mortgage debt forgiven by lenders from income taxes. The bill would offset the estimated $650 million in lost tax revenue by imposing new restrictions on capital-gains tax exemptions on second homes. The bill is supported by both the Mortgage Bankers Association and the Bush administration, though the latter is pushing for a three-year exemption period instead of making the measure permanent. So if I have a loan for 200 on my house, and I am in foreclosure, the bank might agree to something called a short sale. That is to say, they might let someone come up the sidewalk and buy the thing for 180, and agree to let the 180 settle the debt and release the 200 lien. The 20 difference is bad debt that I might have to declare as income. If I am in foreclosure, it is not likely I can foot that bill. This measure gives these folks a hall pass.

A new report from employment firm Challenger, Gray & Christmas states that mortgage lenders have eliminated 69,664 jobs this year, accounting for more than half of the 130,000 positions that have been eliminated across the financial industry. The total number of mortgage jobs lost to date if you include the little guys is probably closer to 100,000.

As of last week in Nevada, 1 person out of every 185 is in foreclosure. About 6000 more people each month are loosing their home to foreclosure in that sate.

The big rating service Moody’s put three new executives in charge of global ratings. Rating agencies are becoming the whipping post for the crisis because they rated the CDO’s and the SIV’s pretty high so investors thought they were safe. Whether or not you can pin on the woes on them is another story – but it is good to see that they are at least making moves that appear to be in the right direction. 

Bernake told the New York Economic Club in the last few days that the housing downturn is likely to remain “a significant drag” on economic growth through early 2008. We think it is more like late 2008. In fact, we predict that the DOW may loose as much as 1000 points (it opened today around 13,800) in the next 30 days. The decline in residential construction has directly shaved three-quarters of a point off economic growth for the last year and a half. Wow.

Hope this information helps in some small way to clear the murkiness of the issues a bit. Take care.

Respectfully,
Steve Curnutte
Finworth Mortgage
Borrow Wisely