A short pictorial of the coming pain.
This is why there is no bottom in Southern California in 2009 or 2010:
Reason 1:
Reason 2:
Reason 3:
Reason 4:
We haven’t even seen the worst of what is to come here. Coastal areas are the next to be hit; look at the map of misery.
Let’s try to be objective.
- Do you know what’s really shown on the map?
It shows the share of option ARMs among all mortgages issued during the first five months of 2006. It would be highly misleading to think that 35% of all outstanding mortgages in San Diego and 32% of all mortgages in Orange County are (or ever were) option ARMs.
- How many option ARMs were ever issued in Southern California? I tried to find out, no one seems to know for sure. I managed to come up with an estimate of 20,000 to 25,000 option ARMs issued during the bubble in San Diego County. Compare with 56,000 Notices of Default recorded in San Diego County during 2007 and 2008.
- Minimum payments of option ARMs increase by approximately 10% every year. Isn’t it possible, indeed likely, that many 2005 vintage option ARM holders have already defaulted and either lost their homes to foreclosure or completed short sales?
- How many option ARMs are still left?
Nameless,
1. 60% of all Option Arms are in California. (per Credit Suisse)
2. Per June of 2008 there were 500B outstanding Option ARMs (Per Businessweek from same article stating above)
3. Estimates range that between 90% and 96% of all Option ARM holders pay the minimum (negatively amortizing) amount.
4. Option ARMS are unlikely to default without a recast due to the negatively amortizing option since it would in most cases be cheaper than all other options to continue paying them. Let’s assume that 5% have defaulted. Most economists expect more than 50% to default in total. That means that one could expect a wave of at least 150B in California alone and up to 250B (some pessimistic estimate a 90% default rate on Option ARMs. The average Option ARM is 600K. If we assume that SoCal is Half of Cali’s total (it’s likely to be greater), you have 300B/2 in SoCal = 150B*50% default rate = 75B/600K average = 125K defaults over the next few years. Yes, some will cure, but that 125K is an optimistic scenario (in my humble opinion)
5. Credit Suisse sees the above as a problem.
6. SoCal had 140K sales last year in total from Santa Barbara to San Diego. If no other loans default, prime, Alt-A, subprime, etc, we’d have over 10.5 months of sales in defaults by the estimates above.
You can quibble over details, and perhaps it might vary somewhere between 8 and 14 months, but it doesn’t change that there is not going to be a turnaround until these toxic mortgages are through the system. That’s not going to happen in 2009 or 2010. That’s what the graphs above say.
I’d like to see the source for your first two statements. In particular, if we still have 500B of option ARMs outstanding nationwide, why do all bars from your chart #2 in the original post add up to less than 200B?
5% default estimate for 2005 vintage option ARMs is unreasonably low. If the buyer could only afford the minimum payment to begin with, and the minimum payment goes up 7.5% to 10% each year, and the house is worth half what they owe on it, and they could reasonably expect to live 8 months or longer rent free before the bank comes and kicks them out – why should they continue paying?
http://www.businessweek.com/li.....526168.htm. Much of what I stated above can be verified there and was written June 2008.
Why would 5% be unreasonably low? With only reset period being on average 5-7 years, a vintage 2005 OA would likely begin a reset in 2010, with a possible recast in 2009 if conditions were right.
I doubt that most could “only afford” the minimum payment. They were likely used to give some cushion at the time, but a fully amortized payment could cause the payment to jump twofold or threefold. That would be unmanageable for most. Not only would the principal need to be paid back, but the principal has now grown 15 to 20%. Couple that with a 50% drop in value, and any equity that was built into the OAs are now gone.
Most do not know this, but OAs were one of the most secure loans because they were required to have usually 20% equity (although many piggy-backed with a HELOC) The 2nd will be wiped out, and now the OA has grown to greater than the value, that’s what will dump many of them. Until that recast comes, most neg-am payments will still be cheaper than rent. Why would you walk if your cheapest option is to stay?
The proof is in the pudding. If you think the defaults are mostly behind us, you’re more than welcome to go back into the market. I’m very confident that we’ve got at least 2 more years of actively falling prices for now.
Chuck
Nameless — the map is one of four items. Its the other three (particularly the last two) that show the pain to come in the next few years.
Nameless — the map is one of four items. Its the other three (particularly the last two) that show the pain to come in the next few years.
Like I said – the last two items assume that all option ARM holders are still paying and will be paying till the day of the final recast, which is an unsubstantiated assumption.
Besides, the “billion dollar” scale is not very meaningful.
All we can say is this. If 100% of option ARM holders are still paying, and 100% of option ARM holders stop paying on the day of the final recast, we can reasonably expect that option ARM REOs will constitute around a third of all sales in Southern California in 2010-2011.
Chuck P.,
Where did you get the data. I see the #4 slide is Credit Suisse, what about the others?
#1 Businessweek
#2 Fitch
#3 Credit Suisse (actually came after #4, and further explains why the dip in 2009 will not actually dip due to accelerated recasts, not waiting for resets)
#4 Credit Suisse
Could you post direct links to this information? I would like to see the direct source of all your information. Thank you.
What’s with all the demands for links and supporting documentation. First, Chuck isn’t a journalist and doesn’t claim to be. Sure, he should link when possible and cite sources.
But more importantly these demands by “nameless” and mutiny sound to be like people in desperate denial, grasping at straws for any reason to believe that facts might instead be conjecture.
Time will prove Chuck right. Just as it has thus far, along with CR and IR.
Time will prove those in denial bankrupt.
Yes,
some people must think I have time enough to manufacture statistics.
I added links to my original comment. Many of them came from paid subscriptions which you’d need to foot the bill for but are also posted in many other places around the web (I picked up a link to other articles/blogs that featured these before)
Just like when I started the blog, there are those who can ignore the facts and get hit by the train. If you think I’m wrong, go prove it. Buy a house.
Chuck
Regarding the last chart, I know Credit Suisse issued a similar chart at the beginning of 2007. The two charts actually look quite different even though not that much time passed between the two, so they do continue to evolve. I’m sure an updated chart would also look strikingly different than what is reflected here.
You need to remember that housing prices didn’t really begin to fall until 2008. In addition, I believe that underwriting didn’t really change much until late 2007; both of which essentially shut off the spigot to additional fraud that was keeping the housing markets alive in much of Southern California.
some were able to postpone the inevitable, but only kicked the can down the road 1-3 years. Nobody knows for certain how bad the future’s going to be, but the trend is your friend.
Chuck Ponzi
Even if the data is not quite as accurate, it still communicates the magnitude of the problem that faces California. We are not done here yet.
The million to two million market is only starting to adjust and I think it will be the most painful adjustment because there are significant amounts of money involved.
People over leveraged their incomes by getting themselves in option arms to buy million to two million dollar homes.
in 2004-2007, it was not unreasonable for a double income professional middle class family to pull in 250k-500k a year. In 2009-2011, they would be lucky to get 200-300K. That’s a significant decrease in income.
Is there more detailed information at the county or city level?
If so, I would love to incorporate it into my MapBook of Orange County: OC MapBook