Line ‘em Up, Knock ‘em Down
Chuck Ponzi March 13th, 2007
Word is out. Subprime is folding faster than previously imagined. Next casualty: Accredited Home Lenders (LEND)
Credit Crunch meets Wall Street:
Accredited Home Lenders is facing a liquidity crisis that analysts say could leave it following in the footsteps of New Century.
Accredited, a San Diego-based mortgage company, said early Tuesday it is exploring various strategic options, including raising additional capital, as much of its cash has been used up by margin calls and forced loan repurchases. Shares plunged 62%, dropping $7.06 to $4.34.
Accredited said it has met $190 million in margin calls this year, most of them in the last month. The company said it is seeking waivers on its credit lines and cutting costs through moves including layoffs.
This is how the Credit Event Happens. Hello layoffs, hello lower housing prices. 2007 Spring Smackdown happened exactly as I forecasted.
I am now completely confident in my prior predictions that this is exactly the “Credit Event” that I have been calling for since April 2005. It will continue to spread like wildfire… risk has not been properly priced in and once cross-defaults start happening, we will likely see much more pain.
Back in October 2006, I stated:
The last 10 years were an abberation caused by Easy Al’s credit bubble expansion. It all started in 1995 with the reduction of reserve requirements, effectively quadrupling the money supply without increasing reserves. In fact, banks are in a much more precarious position today than the S&L’s were in the late 80’s. And, this is why I believe we will still see a “credit event” that will cause global liquidity to evaporate quite abruptly.
That prediction would be fulfilled in less than 6 months. It’s not often that you get that lucky. Frankly, noone could know exactly when it would happen, only that it would happen. Next, the contagion will likely spread into other areas including Alt-A and even prime. While some apologists would have us believe otherwise, the reality is that never before has so much been lent on so little.
I’ll leave you with the thinking from the opposing camp:
The subprime sector is too small to have such a big impact, according to Robert Froehlich, who is chairman of the investor-strategy committee at DWS Scudder, a division of Deutsche Bank AG.
“For all this to occur, the subprime-mortgage collapse has to be big enough and important enough to set the wheels in motion. And the fact is that it isn’t,” he wrote in a market commentary Monday. “It will be the most hyped disaster that never occurred since Y2K.”
Froehlich said Monday that, like Y2K, investors are worrying too much about a subprime-fueled disaster that probably won’t happen.
“The subprime-mortgage market is big, but it’s not big enough to push the U.S. economy into a recession by causing a credit crunch,” he added.
During the peak of the industry’s growth in 2004 and 2005, about 3.2 million homes were purchased with a subprime loan, Froehlich estimated. That’s about 2.8% of total U.S. households, he wrote.
If 30% of those subprime homeowners fail to make their payments, fewer than 1 million households would be “out of luck and out on the street,” Froehlich projected.
Just one problem with your reasoning, Chuck. Credit may be tightening (mainly high risk and subprime for now), but that doesn’t translate into a reduction in liquidity. Quite possibly the opposite will be the result. To fend off a panic, the fed can easily lower rates again, and flood the market with even more liquidity. The liquidity bubble caused stocks to balloon and collapse, then housing. Maybe stocks will soar again, or maybe more and cheaper money will reinflate housing again. Imagine if 30 yr fixed mortgages fell to 3%. And maybe some government grants to offset down payment requirements.
Hey, why not? In fact, why doesn’t the government just give every man, woman and child $1 Million for free. And instead of borrowing it, we could just PRINT IT! Talk about solving all the problems: everyone could pay off their high-interest credit cards; the poor could buy nice homes (and plasma TV’s of course) outright– WHICH WOULD SOLVE THE SUBPRIME LOAN PROBLEM. Heck, a simple 15% national tax on the $1 million payments would RETIRE THE ENTIRE NATIONAL DEBT, with money left over for social security and medicare(which wouldn’t be needed because everyone would have plenty of money)!!! (by the way, Dave Chapelle did a hilarious bit about just such a scenario)
Okay– back to reality. On a national scale, the only risk of rampant credit expansion and liquidity is inflation–which our government tells us is totally under control. But is it? If you INCLUDE housing and energy (stuff we normal people MUST PAY!) we’ve been having severe double-digit inflation the last several years! However by redefining what “inflation” is, the fed can claim that it is still under control– just like redefining how employment is calculated can keep unemployment numbers looking healthy.
Credit crunch, Chuck? NOT GOING TO HAPPEN! The government is perfectly happy pouring money into the system. Prosperity looks just as real whether earning real money or just taking cash advances on your (ever increasing) credit line.
Yes, it will eventually spiral out of control and collapse one day, but when? Next week, next year, next decade? Who knows. I think the governent can and will extend the bubble.
And who will pay for it in the end when it does collapse? I believe there will be a massive government bailout of everything (also known as monetizing the debt) along with the accompanying hyperinflation. Those of us who live conservatively and save money will get destroyed. Only the super-rich with their overseas wealth will survive intact. The poor who have nothing, will have even less (reduced or eliminated social programs). I fear for the middle class and what hyperinflation can do to them. Yeah, I know, it’s a doom and gloom scenario.
THANK GOD OUR GOVERNEMNT WILL SAVE US BY POSTPONING THE COMING DISASTER FOR A WHILE LONGER!
It is difficult to tell if you believe what you are saying or if you are being facetious. You followed your own line of reasoning to its absurd conclusion and realized that the government is not going to try to pump this bubble back up. They didn’t with stocks in 2000-2002, and they won’t with real estate from 2007-2011.
I agree with what your saying about stealth inflation. The FED will allow that to run wild if they can because it will devalue the foreign held debt. However, I will say the risk of a credit crunch is very real.
Lenders will demand higher risk premiums, and borrowers may become risk adverser (wouldn’t you after losing your house?) At that point, there isn’t much the FED can do. They can’t make people borrow money. The Bank of Japan has been trying for years with a 0.5% interest rate, and the Japanese won’t do it. It’s a bit like pushing a rope.
Kurt is obviously making a funny.
FED controls liquidity about as much as we control hurricaines.
FED also controls money supply about the same.
Believing anything else is funny. If he truly believed it, maybe Kurt is actually Gary Watts incognito. Just Kidding.
It’s a good rant, but doesn’t sell many newspapers.
Chuck
BTW, if the FED does try to reinflate, I don’t believe much of that money will go into housing. Lenders control the money supply there, so I’m guessing that it will go to precious metals. We could have a late 70’s return.
Chuck.
I have been thinking about “Helicopter Ben’s” idea that deflation can be averted with the printing press (or threat thereof). The Japanese experience would seem to refute the idea. They have been giving away money (0.5% interest) for years. Instead of that money flowing into the Japanese economy which would require the Japanese to borrow it (which they haven’t), the money has gone oversees and flooded the world’s capital markets with liquidity. This has devalued the yen about 30% and made a mess of several of the world’s capital markets.
Like you said, why would the money necessarily flow into real estate? Why not stocks or precious metals? I don’t think it is possible to target a specific asset class for an infusion of liquidity. If someone can explain to me how it could be done, I would like to hear it.
IrvineRenter:
Japan, even at a zero percent interest rate, suffered a decade long decline in housing prices. I’m not sure why folks in the mainstream media think that all that Ben needs to do is lower rates and we’ll be okay again.
The problem lies in the fact that lending standards are now going to be tighter. Even if rates are lowered to 1% in one or two years, I’m sure the lending market will be forced to be more conservative; this is what is occurring in the subprime debacle.
Like you mention, you cannot increase or decrease liquidity by targeting a specific industry. If anything, it is not an exact science. Many industries boomed in the last few years simply because they benefited from the halo effect of housing. For example, Home Depot and Lowes; last week Lowes issued a warning that a housing decline would hurt their industry. REALLY???!!! Hah, sometimes I feel that I’ve been drinking crazy juice for the past few years.
Dr. Housing Bubble
This is exactly the most important point.
No bank is going to loan out money if it makes 3% per year (credit spread) and loses 10% per year in equity.
Chuck
I don’t think anyone predicted the next bubble would be RE after the dotcom debacle. Who freakin knows what’s next. Could be gold, could be tulips.
There is some truth to what Kurtv says.
First the Fed can provide liquidity not as much through rates as through money supply. This requires the current foreign appetite for our debt to remain high and not much indicates a change there.
Second, the Fed can’t direct where this liquidity goes. If lending standards are tightened increased liquidity has a smaller effect on lending but it does have some effect.
The main point is that the Fed has managed to reduce the risk premium to almost nothing. Now with the subprime fallout the risk premium appears ready to explode. But the Fed may pull a rabbit out of the hat as it did with LTCM and the debt crisis in the late 90’s
What kurtv is saying is that the Fed has some control.
I have been short lenders since mid Jan and recently closed my positions. One thing I’ve learned is to never bet against the Fed. You could argue that the market would have been more efficient, but the Fed did a pretty good job of cleaning up the LTCM fiasco (or sweeping it under the rug).
The big crash that all of you are waiting for may not happen. What you may get is 10 years of slowly declining real estate and stagnate GDP just like Japan.
I hate to rain on the parade. I know it’s more fun to blog about a crash in real time than to blog about 2-3% annual declines for 10 years, but I think that well may be the reality.
My advice to anyone trying to capitalize on this is to be very patient. If you think you should buy real estate in 1 year wait two. If you’re short the real estate machine sell the the upturns and take profits. There will probably be some fairly strong moves to the upside. I’m expecting a fairly strong one from now till early summer for lenders and builders. The trend is down and contraction will happen but I think it will play out over a LONG period of time.
It really seems like CH Smith was correct. We really pushed in to the exaustion of debt scenario.
The foriegn investors fired a warning shot by diversifying currency holdings. The next more forceful warning will be bond prices pushing upwards.
The Fed is flirting with the dangerous line where currency collapse can occur though. Those three trillion dollars in reserves floating in BOJ/China. Real real dangerous situation.
Better to let the market crash and correct. Or set up the a different bailout.
We are close to third worlding the ourselves here.
Its best to back carefully away.
Mozilo and Co. are already talking rate cut…
Not if BOJ doesn’t do it with us… What, already at .25%? Nope, guess there’s no way out of this one without angering the Asian dragon.
China could stand to dump a few hundred billion dollars and still not feel anything but bloated on our treasuries. If Japan dumps USD, they won’t need as much to maintain the peg… that could mean serious inflation at home.
May be time to go long Gold if the FED signals a cut. There may be yet some serious gains.
Chuck Ponzi
Neither Japan and China want to dump dollars. The more they dump, the less competitive their exports become. With little internal demand (I still don’t buy the BS that China’s “booming” middle class can pick up anything even close to the slack) these economies will wilt. Hence, I believe we’ve been seeing an ever so slow move out of the Dollar. Its the Chinese water torture. Will the rate of this diversification increase dramatically? It is quite the conundrum for the East.
The Asian Dragons are in just as bad a position as we are. They can’t keep toxic dollars and they can’t afford to dump them.
Unless they (china/Japan) keep buying debt/dollars then a FED program of credit expansion will lead to fast inflation that they can not hide.
Additionally China will notice that the dollars they purchase will be devalued and worthless.
I can’t help but see visions of Weinmar Republic in my head.
Was watching a PBS special on history in LA.
There were some striking things. You see a few remaining buildings in the Art Deco style left in great los angeles area. Also if you look at the 1920-1933 era housing, you see a lot of large houses. Then houses and buildings got simpler and smaller for a long period of time.
I think a lot of the McMansions will go this route. Too gaudy and expensive. Symbols of a time of excess and greed than will be scorned. Too expensive to maintain…. empty homes will be filled up with homeless and evicted families scraping by. Falling in to disrepair and then torn down. You see this in old cities in the east coast all the time.
In 80 years people will be looking at the occasional odd McMansion areas of slummy South Bay town Manhatten Beach. The odd decaying old over sized homes with no yards for childern.
Seems like its here. Kind of funny but we will be gone and unable to warn everyone. Just like the depression era people were unable to warn us.
You know the site is good but we are too late to stop this thing. Only to try to survive as best we can.
I can’t help but see visions of the fall of the Roman Empire. Over-extended, saddled with corruption, excess and greed. Collapsed by the weight of it’s own power.
One of those McMansions will rot on a hill someday as school children and tourists take pictures and tour the grounds learning about the decline and fall of the greatest empire the world has ever known.
I love your correlation between the depression and today.
Oddly enough, the building boom is going full steam ahead just outside my window.
Hammers and nails, big trucks, and illegal aliens tearing down ten buildings, putting up 3 huge condo units going for 750,000 to a million 1/2. Who can afford that?
When it blows, and it will blow - heads will roll, and the little guy will suffer because the money men have already removed their profits… our elected officals are to blame, but we are not holding them accountable..yes, it is too late!
Found this on CNN blog about subprime. The guy is very chalant about 1 Trillion dollars in subprime going south.
Defaulting subprime loans themselves are not much of an issue– the total value lost is not all that large compared to, say, a few airlines and auto manufacturers losses over a few years– but the lemming problem could be an issue. Lenders get pressured by the investment banks and other funding sources; the lenders tighten credit; interest rates rise and causes more defaults; which results in a virtuous downward spiral. This could indeed be a problem. Especially if everyone stops investing to see what happens.
But the root magnitude of the loss simply isn’t very great. The subprime loans are backed by something real which has value, so for example:
suppose there is usd1000Bn in subprimes.
suppose 30% defaults
suppose 1 year of payments was made at 5% simple before default
suppose 60% gross average recovery after expenses (property liquidation, lower return for 2nds, legal fees, etc.)
So, assuming they get back 60% which would be great compared to how bad it will actually be
Very broadly, this is a real loss of usd100Bn, a significant amount of which is born by investment banks and other financial institutions which only cry crocodile tears for something that small (they are well aware of the risk/reward, and if they weren’t they are in the wrong line of business. A few tears helps distract the unwashed masses from the huge bags of money accumulating elsewhere).
Regardless, the loss is too small to be really significant to the economy compared to the past losses withstood such as Amaranth, GM, Ford, Delta, …. The real risk is the lemming effect of everyone running for the exits at once and being crushed in the resulting recession.
The latter panicy response is why it might be a very good investment to buy the “distressed” subprime portfolios (as has been observed to be happening), which may be underpriced. Or may not. How much risk can you take for what reward?
We already have an inventory overhang. What are the estimates? Hundreds of thousands of empty homes. Top that off if 300,000,000,000$ worth of housing (loan value or another million homes) gets dumped on the market.
What will that do to the housing market? Do you think there might be a slight recession in housing from this?
And you think they are going to be able to recover 60%?
Duh.
Good Fuzzy math
LAEF2:
Someone went to the David Lereah school of Mathematics. In California for example, there was a study stating that 30 percent of all economic growth in the last five years was directly or very closely directly to real estate and housing. That seems like a rather large connection to me. In addition, many folks forget the basic concept of the wealth effect; that is, when the economy is doing good folks tend to spend and buy more. Conversely, if the economy is contracting and housing prices go down people tend to become more reserved in their spending habits.
Considering the American savings rate is negative, we must have had a booming market the last five years. The scary part of this is what will happen to a society that is so dependent on easy credit via credit cards, car loans, and mortgages and a sudden turning off of the spigot occurs? If we look at the subprime market as a microcosm of society, the answer isn’t good. They are imploding because of margin calls. This has eaten away at their cash reserves (aka Savings) and they being the prudent investors, have little to no reserves thus leading to their demise.
Easy come easy go…
I did a search in the MLS for residential lease properties in Rancho Cucamonga two months ago. There were about 5-10 listed, I can’t remember the exact number but it was few. Today: 76. I wonder if that number will continue to rise.
If the Fed lowers the rate in response to the subprime meltdown (among other things), does this not spur inflation?
Hasn’t the Fed stated over and over that their primary responsibility is to hold inflation in check?
Won’t a lower rate in the near term only prolong and worsen the eventual comeuppance?
Subprime is big news these days, but few people are talking about loans in the prime sector going bad. Having a credit score above 660 isn’t going to save a person/family if they borrowed 100% LTV and face a reset soon. I know a few people in WestLA/Venice/Valley who bought in the last year or two whose credit is great. This doesn’t mean they’re not at risk of default if they have a toxic loan. Subprime is shaking up the world markets, but when the percentage of prime loans going bad starts to escalate, the real panic will begin. I’m with Chuck if the Fed abandons its supposed mission and starts in effect printing money…I will buy gold.
Not Necessarily.
Inflation is affected by more than the FED. In fact, I would argue that the FED is irrelevant when it comes to inflation. It seems that the only thing Central Banks are good at is creating carry-trades.
If you see inflation as a monetary phenomenon (not price), we have had 8-10% inflation for about 5 years now, which is why everything is so D*** expensive now. (who woulda thunk?) Anywho, if banks stop lending and is calling loans, that is credit (and monetary) contraction. That’s deflation. In effect, BOJ was pushing on a string, and all it did was fuel a massive Yen carry trade.
Serious inflation could come if/when china or Japan decide to stop purchasing our treasuries and start selling them. Of course, the government could just kick up the “debt monetization” and “retire” that treasury. Voila, 20% devaluation. Lucky us.
Chuck,
I am not sure how much more we can do of that. I think the other central banks fired some warning shots. The Fed was talking about rate cuts if needed and China talked about diversifiying currency reserves a day later.
It seems more like we are at the long end of the infaltionary spiral and dangerously close to hyperinflation.
Chuck - I’m a little confused. If inflation is the expansion of money and credit (as defined by Mish) and the Fed is irrelevant re: inflation (as stated by Chuck and also Mish), why did so much credit expansion come as a result of their slashing the rate from 2000-04?
(Disclaimer — I do tend to think in terms of inflation as a monetary phenomenon. Inflation to me means being charged $7 for a pint of Stella Artois at an alleged “alehouse” last weekend.)
There’s the simple answer, and then there’s the complex answer, but largely it has to do with loan loss reserves, and reserve limits.
Our banking system is a fractional reserve… basically banks need to keep some of the money that they lend out for loans that go bad, and for regular use. That was substantially lowered in 1995.
Secondly, (and some of it gets a little fuzzy with this part because noone has been able to confirm or deny exactly what reserve requirements for loan MBSs and packages are for me) with the derivatives market and repackaging of loans, banks could buy loan pools and insurance instead of individual loans. With loan pools and insurance, the reserve requirements were much, much lower since it was theoretically backed by the insurance (CDOs). Please don’t ask me to explain CDOs, Barry Ritholtz has a better explanation today:
http://bigpicture.typepad.com/.....arket.html
So… along we go. Banks were able to “create” nearly infinite amounts of money to lend out through repackaging the loans and getting “insurance” for them.
However, that was only part of the problem. Because China and Japan have been buying our currency as fast as they can at the low rates in order to keep their currency low against ours (this is the much bigger culprit), we have been able to enjoy low rates with foreign banks picking up the tab. Japan and China now have far more USD than they could possibly ever need (but China needs a favorable RMB/USD rate to continue the growth story through sales of trinkets to us), but they cannot get rid of them, nor can they really rebalance without a revaluation of their own currency (up) and ours along with it (down). If this ever unwinds, we are for some serious inflation (ok, not Weimar style, but more like the late 70’s) Everyone is hoping for a gradual revaluation, but it’s looking more and more suspect that this is even possible since we are getting farther, not closer.
If the “credit event” occurs, then China and Japan can start dumping treasuries without significant price inflation, but then the FED is going to have to raise rates for people to actually buy more treasuries… and this is where debt monetization comes in. If you don’t know what it is, please look at this link:
http://en.wikipedia.org/wiki/Debt_monetization
All of this is generally inflationary (from a price standpoint). However, there are some great deflationary forces at work such as productivity and outsourcing to underutilized international human resources, code word for jobs going overseas. All in all, we’re going to probably have monetary and credit deflation with CPI price inflation.
OK, so that was a fairly long answer.
Chuck Ponzi
I put this remark over at CR too.
We know subprime is dead. That is obvious to everyone.
The second wave will wipe everyone out.
What is your exposure to Alt A?
That is the question now.
The other question is:
What is the exposure in the under writing community? Everyone that sold MBS/CDO/Derivatives will be under a microscope soon after Alt A goes boom.
The dollar volumes in AltA/Sub are even higher than their percentages.