The Contrarian: Give investors what they want

Guest blogger James Waggoner, host of "Real Estate Radio"
on KCLA-FM in Los Angeles, makes a modest proposal tonight: If investors in mortgage-backed securities insist on expecting the worst, then why not give them what they seem to want?

"First it was Countrywide. Then, one by one, each of the Wall Street banks trading mortgage-backed securities took ever larger write-downs. Now, in one single transaction, the fifth-largest firm on Wall Street, Bear Stearns, is wiped out of existence, literally overnight, erasing over $3 billion of shareholder money (almost $20 billion in the past year) and possibly putting as many as 14,000 hard-working people out of jobs.

"This all happened not because some Wall Street robber baron ran off with cash but from the market's belief that as many as 30%-50% of publicly traded mortgages would either be delinquent or default altogether. The current level of delinquency or default is about 8%. If all that I have just stated is true, then it follows that the only logical buyers of these securities are investors who expect the very worst and will be perfectly content with a default rate far higher than the current 8% level. 

"So I say let’s all give investors what they want. Let’s all stop paying our mortgages for 60-90 days and renegotiate a loan that is not only one-half to two-thirds the original amount, but with one other consideration -- LOWER INTEREST RATES! After all, while mortgage-backed security prices have been falling like a stone, so have interest rates.

"Is all of this absurd or perhaps impractical? It is actually a modest proposal. The damage to the financial system has already been done. Why should only a very small minority be bailed out while the rest of us continue to pay unrealistically high sums that will only deepen the current recession? The time to act is now."

Thanks, James.

Your thoughts? Comments? E-mail story tips to peter.viles@latimes.com.

Comments

[Bill]

James,

They let you speak in public?

Look up the definition of "moral hazard" and you'll have your answer.

Ask someone who didn't buy an overpriced house and you'll have your answer.

Bill

[Laker]

Think the other way around. The mortgage people know EXACTLY what is the value of the homes backing the mortgages...
So based on that, they can pretty much calculate the number of mortgages that would default...
You see, 90% of the people that bought in 2002 and on, overpaid for their house....Yes i did say 2002, and overpaid.
If you take that into account, you will see why they value 40 cents on the dollar and the current 8% of the loans in default or late are nothing compared to what will be once 90% of the loan past 2002 will start defaulting...
"30%-50% of publicly traded mortgages would either be delinquent or default altogether. "
Since people still have mortgages that they took prior to 2002, they will most likely not default and even if they will (out of traditional reasons like divorce, death, illness.etc), the value will be more than the loan, so these houses will be sold and not foreclosed.
That is how you get 30-50% of all loans to default...

[Geek Seek]

Here's a slightly more modest proposal: Read David Leonhardt's article at NYTimes. "Can't Grasp Credit Crisis? Join The Club" http://tinyurl.com/37lopv

Highlights:

"Raise your hand if you don’t quite understand this whole financial crisis. It has been going on for seven months now, and many people probably feel as if they should understand it. But they don’t, not really."

“We’re exposing parts of the capital markets that most of us had never heard of,” Ethan Harris, a top Lehman Brothers economist, said last week. Robert Rubin, the former Treasury secretary and current Citigroup executive, has said that he hadn’t heard of “liquidity puts,” an obscure kind of financial contract, until they started causing big problems for Citigroup."

"I spent a good part of the last few days calling people on Wall Street and in the government to ask one question, “Can you try to explain this to me?” When they finished, I often had a highly sophisticated follow-up question: “Can you try again?”

Do we believe Rubin? "Geez, I didn't understand what I was selling?" Either way, it's bad. New rule for our now telephone book fat book of new rules: If you sell something, you must understand what it is, AND you must be able to explain it to federal regulators AND regulators must be able to pass a quiz on what they learn so they are prevented from saying later, "Geez, had no clue that thing even existed."

[Inland Empire]

"So I say let’s all give investors what they want. Let’s all stop paying our mortgages for 60-90 days and renegotiate a loan that is not only one-half to two-thirds the original amount, but with one other consideration -- LOWER INTEREST RATES! After all, while mortgage-backed security prices have been falling like a stone, so have interest rates.

Sure this will work! Just like trying to get people to boycott gas stations to make the price of gas come down! Go ahead and be late on your payments for 60 -90 days and let me know if you get anything other than a damaged credit score.

[Mark Too]

92% paying on time sounds pretty good. In school a score like that would get me an A-.

But why would an investor buy an assett at face value, 100% of the loan amount, if only 92 cent on the dollar is going to be paid back? They wouldn't! Why would they even pay 92% of the face value when all they are going to do is break even? They wouldn't! An investor is going to want to make a fair return on their money so maybe they are willing to pay 85 cents on the dollar to buy the loans. They'll only do that if they are sure that loans will perform at that 92% rate or higher. The fear right now is that the 92% performance rate could go lower. How low, nobody knows right now.

And how do you factor into the equation any sort of government bail out? Is this going to encourage more people to quit paying in order to get some free money also?

[Susan]

> Let’s all stop paying our mortgages for 60-90 days

Um, NO! My mortgage is perfectly reasonable, and I can afford it until it's paid off. Plus, since my house is worth three times the mortgage (yes, even now), the bank would be thrilled if we walked. Why should I do them any favors?

[tom borland]

Peter
here's a question i have had for a while that i haven't seen answered:
When my wife and i bought our house, we got a 5% down 30 year fixed rate mortgage (which we are still paying by the way). Because of the 5% down we had to get PMI. This was explained to me as an insurance policy for the lender in the event that I walked or couldn't pay the note. So my question is, with all of the foreclosures, are these policies being paid? I am sure there are millions of people who took out loans with PMI, but yet all you hear of is defaults with major consequences for the banks. Where does the PMI fit into all of this? Should these policies negate a lot of the bailouts? Are the companies who wrote these policies having problems? It would seem as if they should be in a similar position to a homeowner's insurance company after a major disaster

[amir]

And now, as I predicted, the real trouble starts: Crime. Up 35%.

Let's face it. Half of our recent prosperity was due to the bubble. Now, tens of thousands of unemployed men who used to work in real estate businesses, construction, or related services like restaurants, are struggling. If only 1% turns to crime, we'll have a crime wave. There's nothing that takes real estate down faster than neighborhoods becoming dangerous.

Let's see, 1989 the last bubble pops, 1991 prices drop across the board in all neighborhoods in LA. 1992 - riots.

Anybody else see the connection?

[Tim K.]

Not to advocate this activity, but the original proposal does have some merit. Unlike a boycott of gas prices, you don't need (nor want) your neighbors to also be late on their payments. If you do it, this is probably the best time to force a negotiation of a lower interest rate and/or principle reduction.

The only reason banks are willing to reduce principle is because they are panicked. If you wait until the panic subsides, you will lose your opportunity, and this appears to be a rare one at that.

[GDC]

Amir,

The 1992 riots were instigated by the not guilty verdicts for the LAPD beating of Rodney King not the housing bubble.

Laker,

To suggest that majority of people that bought in 2002 or before then will default is going too far. The majority of people that buy (yes even in CA) can afford the current morgage payments and didn't overextend. It's the small percentage of fools who bought in 05-07 and overpaid that are currently underwater.

[tew]

This is probably the most inane post I've seen on this blog. Complete muddleheaded populist nonsense.

[Laker]

GDC,
I'm not going far. As of today buyer that bought after mid 2004 are underwater. TODAY. But prices are sliding down as we speak. There is nothing to prevent prices to slide to 2001 level - afford ability was inline in LA. As prices will get to 2003 levels, all 2004 vintage will be underwater and thus include high pct of default. Going another year down to 2002 prices, will bring the 2003 vintage under...

Now, i haven't even started to talk about the people that bought prior to 2004 but refinanced the sh*t out of the house. There were A LOT of these and that essentially takes a 2002 mortgage and makes it a 2006 mortgage....and you all know what is happening today to 2006 mortgages...(default...and go to foreclosure in mass)

[the problemwithcaring]

Amir,

The 1992 riots were instigated by the not guilty verdicts for the LAPD beating of Rodney King not the housing bubble.

Posted by: GDC |

GDC, I am frustrated when I hear you and others dismiss any notion of the root causes of the riots that contradict the media caricature of it as the "Rodney King Uprising"

The historical facts are extremely clear to anyone who wants to review them. The violence of the LA Riots didn’t ferment during the 30 minutes between the time jurors announced their verdict and the first Molovo cocktail was thrown.

When a Korean grocer had been found guilty of voluntary manslaughter in the death of a young black girl, but received a sentence of probation, poor Blacks could no longer tolerate the humiliation and indignities associated with the economic colonialism perpetuated by city leaders, state officials, and police who continued to ignore the abject poverty that operated in South Central and other black neighborhoods.

Again, for the slow folks out there - the real culprits of the LA riots was "government and corporate neglect of poor and underrepresented areas." (And we all know that LA doesn't have THOSE problems anymore, hoho!) Race was, is and always has been the duplicity used to distract (as usual) from the brisk feeding of the rich on the carcasses of the poor.

The acquittal of of those police may have sparked violence (like LAST SUNDAY's outcry over the harsh tactics by LAPD in East LA) but ultimately, working, well-off people don't burn down stores and loot luxury goods.

[amir]

GDC,

So in your opinion one wrong verdict and the whole city goes to waste? I disagree.

There is a difference in history between a reason and a cause. Yes, the verdict was the cause of the riots, but a healthy city does not explode in riots because of an upsetting verdict. The city was in serious financial trouble and the riots were a violent spasm that was part of that reality.

Meanwhile, we are seeing economic decline and 35% more crime. Yes, I do see a connection.

Finally, piling on with Laker, you fail to realize we're now in an economic negative feedback loop.

[GDC]

I have read the many "underlying" roots behind the 1992 riots. I agree with some and disagree with others. The verdicts were the trigger. You can intellectualize it all you want but looting/rioting occurs after high profile soccer games in Europe and happens in hoods across America when their NBA teams win or lose. By definition, it's an illegal act by a bunch of hoodlums terrorizing the public. To compare these people to real activism is to insult and trivialize the heroes such as Dr. King, Jr., Cesar Chavez, Ghandi, etc. who devote their lives to making social and political change.

If the disenfranchised blacks were that upset, why not trash government buildings? Why not demonstrate in front of City Hall? Why not loot other more expensive shopping areas like Beverly Hills but which have much greater police protection. I happen to think some were very pissed at the verdicts, said the heck with it and started trashing and looting anything that was nearby. Btw, I happen to know many storeowners who were impacted; most of the looting were done by hispanics in the area not by blacks. So how does that fit into the Korean liquor store shooting the black girl?

But this blog is about housing. What I said was the 1992 riots were not caused by the housing downturn of the early 90s. Not even close.

Laker,

Can you give me some ACTUAL examples of home sales right now that are at pre-2004 levels? Not the ones in the subprime dump areas (Lancaster, Palmdale) but in normal areas in Los Angeles. I, like many others on the sidelines, will jump in. Right now, for "decent" areas, I think we are back to late 05/early 06 levels and about 10% off the peak in early 07. This is based on my seeing actual sales go through for the past 4 years (I can't believe I've been waiting that long to buy a house) Don't quote me medians; they are worthless stats. Show me actual sales.

I think when everything is said and done we have about 10%-25% drop more to go. But it's nothing near what you are predicting of pre 01 levels. That's just wishful thinking (but if it happens, I'll be one of the happiest person on this blog).

[Laker]

GDC and Amir, the problemwithcaring,
Listen, I think you all have something here.
Back in 1992, the riots by black people were a combination of poor neighborhoods, lack of jobs, poverty. All this provided the gas in the air, and Rodney King was the igniter (not the gas itself). Pay attention to the population that participated in the riots - Blacks or if you wish African Americas.

Let me point something important here...
Today we have and are going to have a bad local economy with loss of many manufacturing and building jobs. Do you know who is (or was) working in that industry??? Mexicans - or if you wish (illegal) immigrants.
That is boiling to the point that we ARE going to have very similar riots in LA. However this time, it would be the illegal aliens out of jobs, AND out of their sub prime homes. Look at areas like Riverside county and places like Pacoima in LA country to be centers of the problem. However, we still need the igniter...

[desmo]

So my question is, with all of the foreclosures, are these policies being paid? I am sure there are millions of people who took out loans with PMI, but yet all you hear of is defaults with major consequences for the banks.

Tom, What happened in the last couple of years that one bank would loan the buyer 80% (1st)and then a second bank would loan 20% (2nd)= (100% loan), and guess what? no PMI needed. Now it is coming back to haunt the banks.

[Michael Snyder]

the problemwithcaring
It must be hard being so well off yet still needing to be a victim. I realize you were still in preschool, but as I told you last month and other posters have told you here, the 1992 riots had nothing to do with a housing bubble. They were triggered by the verdicts in the Rodney King trial and fanned by months of an irresponsible media using inflammatory footage as wallpaper.

I watched coverage of a good and decent man who wouldn't risk pedestrians to save himself drug out of his truck cab and beaten half to death while his assailants danced around his body. Nobody used that shot for wallpaper. After all, showing footage of a dozen black men assaulting a white man may be construed as racist. In the end these "heroes" beat a man who was only vulnerable to their attack because he cared for their safety.

Your hypothesis is rejected out of hand because it has no basis in fact.

[I Am Not Dead, So This Must Be LA]

the problemwithcaring,
Can we please not get into political discourse (on this forum) of what you or anyone else thinks the root causes of the riots were? There are many different OPINIONS and THEORIES out there, just like in the real estate market, but I GUARANTEE you that the reasons for rioting were different depending on geographic area and of course skin color, and not one individual idea will be correct or incorrect. People rioted where I live and TRUST me it had NOTHING to do with Rodney King, or rebellion against the government, or anything of that nature. But that only covers the 2.5 miles of my surrounding area, so I know that what we went through is still not similar to what you or anybody else may have been through. To suggest that you or anyone else has the unequivocal reason for the riots is a little disingenous to say the least and pompous at worst.

Laker,
Why is it assumed by you and others on this blog that once people are upside down they HAVE to foreclose? Since when did house value become the barometer on across-the-board ability to pay? Are homes overpriced? Yes, but it depends on area. Can people afford to purchase overpriced homes? A percentage of people can, but some, if not most, are still waiting for prices to go down and be a smarter consumer. Just because an owner or recent purchaser is upside down will not necessarily mean that they will go into foreclosure. MOST people do not buy houses for investment, they buy to LIVE in, so monetary value will not affect them (unless they try to sell or refinance). Your post makes it sound like the LA area was a barren arrid desert before 2002, and most people bought their house from 2002 - 2006. What about the millions of people who already lived here from __________ (insert date here). ALL of them rented? So to suggest that "90% of mortgages will default" is just ridiculous. Yes, a good many mortgages and refi's made during a certain period of time will probably default, and some will foreclose, but that is not 90% of the market. The majority of people who bought a house before 2004 will keep their homes (underwater or not) because they actually bought to LIVE there, not flip it or invest, so the TOTAL number of households will actually be relatively small (now I did say RELATIVELY). But please DO NOT equate less value with automatic foreclosure.

[tealeaf]

RE: I Am Not Dead, So This Must Be LA | March 19, 2008 at 04:46 PM:
"Yes, a good many mortgages and refi's made during a certain period of time will probably default, and some will foreclose, but that is not 90% of the market."

And to GDC, who indicated that only a small fraction will default...

This whole bubble happened on the margin, and it is actively defalting on the margin. You sat at the water cooler at work and justified your house being worth $1M because your neighbor with the 3BR sold for $900K. Isn't it crazy what suicide financing will do values?

Now the new neighbor is foreclosing, bringing the value of your place back down to earth.

Call it a measly 4% all day long... It all happens on the margin, friends.

[Laker]

I Am Not Dead, So This Must Be LA,
Let me explain; once people are upside down, they feel that it is stupid to continue paying for a depreciating asset. Actually it starts to look like liability. The same force that made people buy houses and over bid each other when they heard that Joe bought his 3 bedroom for $900,000 and then its value went up to $1,000,000...This time, people under water hearing the Joe sent his key to the bank, not before living rent free for 9-12 month. And add to that, Joe just bought a new house next street using his wife/friend/relative credit for 30% less...and you poor are still making full payments for $1,000,000 loan...
Also, pre 2002 LA was not desert. However the prices pre 2002 WERE based on people's ability to pay. I'm not saying that there was only 30 year fixed. There were ARM loans, but not 100% 80/20 loans and sure not Neg AM with Stated income!
You see, the mortgage products coupled with teaser rate AND lack of income verification enabled huge amount of people to be able to bid AND (temporary) BUY houses. So the supply was pretty much the same. The population was the same (maybe growing slowly). The incomes were sure the same (or growing very slowly) But the demand was maybe doubled. If you know ECON101 so that means price need to double...AND SO IT DID DOUBLE. Now crazy mortgage product is gone, and demand is probably cut by half. You can see that in the inventory numbers. Using ECON101, price will be reduced to HALF. Now if you check the pricing of houses for example in the valley, you will see that 2001 price levels match that very nice.
If it is not clear, I'll try to elaborate in other ways.

GDC,
My friend, i can give you at least 10 houses that got sold for pre 2004 prices! But please before i do that, you sound like a nice guy so DON'T make the mistake of your life...as you say "I, like many others on the sidelines, will jump in..."
If you jump in just because price is at 2004 levels will be like jumping right in when NASDAQ was 4000 (after it was 5000...)In that case you will still be sitting TODAY in your NASDAQ at 2300...waiting for 4000....
Try to follow my reasoning, and you will see that prices will decline much more than 2004 levels. I am NOT TALKING about lancaster and palmdale. I AM TALKING about Tarzana and Woodland Hills. OK?
1) 4339 Natoma Ave 91364 sold last month $790,000 using zillow graph this was the price in 2nd Q of 2004. Or since this specific house was not sold in 2004 look at next door houses. 2004 price was 700,000-800,000
check next door 4406 Natoma Ave that sold for $760,000 or 4500 Natoma Ave that sold in 2004 for $800,000 and smaller....
2) 6040 Calvin Ave 91356 sold 1-2 months ago for $600,000 price in mid 2005 was $737,000
3)19336 Topham St sold in jan08 for $485,000. In 10/2003 it sold for $535,455....

The post's getting to long, be trust me there are many more, i can dig that if you'd like.
Prices are now at mid 2004 levels and you need to understand that there was a major jump from 2003 to 2004. That is when the liar loans and option arms started to kick in. I believe that by end of summer, we will know if we are headed to 2001 prices or not.
btw: i was not predicting pre 01 levels but actually 2001 levels. If inflation really kicks in as Helicopter Ben desires, that we will have price of 2001, adjusted for inflation (real) and not nominal 2001 levels....

[GDC]

Good points Laker,

I hope you're right that prices will head to 2001 levels. I really do. I just don't think it will go there for two reasons.

First, people's mind-set has changed. As I posted on this blog on another recent topic, many people I know are using interest only loans to get into houses in the $600k - $1.5m homes. Before 2001, not many did that. Now, it constitutes the majority of the purchases in these areas. People just don't care about building house equity and don't plan to live there beyond 10 years. This mind set may change but it will be awhile. Because of this, they can "afford" 20-30% higher prices thereby pushing up prices.

Second, 2001 was 7 years ago. I think a reasonable housing price growth for SoCal housing in desirable areas is 5%/year. In other parts of the country or less desirable SoCal areas, maybe 3%/year. That's 35% in simple interest (although it should be compounded) since 2001.

Finally, it depends on what area you are focusing. In Beverly Hills, Bel Air, Pacific Palisades where the prices have tripled in 7 years, I agree that it has a long way (but slow) to fall. In areas that I've been looking at, prices doubled from 2001 so with the 35% natural growth, I think it'll fall about 15%-20% more, which I think is 2004 levels adjusted for inflation. I've been going to many open houses in these areas for the past 4 years and I can tell you, the decent homes have fallen but not by that much. And demand seems to be growing and growing as I see more and more people preparing to jump in.

One final point, many people who bought in the early 90s were upside down by 1997. Most of these people did not walk away because they bought these homes to live in and were comfortable making payments. They also did not want to destroy their credit and had steady jobs. Obviously, this downturn is more severe. But 90% of homeowners in desirable areas did not buy post-2002. They are very comfortable with their payments (some refied and locked in 30 year fixed loans at 5% in 2003), they have mucho equity and their incomes have gradually increased. To suggest that these people will walk away or are desperate to sell is a stretch.

[the problemwithcaring]

So how does that fit into the Korean liquor store shooting the black girl?
Posted by: GDC

I am not trying to be disagreeable, but its impossible to explain the history of south central LA in a blog comment.

But take for example, the situtation in some warring regions across the globe. While there are sometimes real ethnic and religious tensions that may have been going on for years, what usually sparks violence is a lack of options for legal recource and political redress (usually at the expense of the minority or less powerful faction.)

And such ascedancy is often grounded in economic disparity. In the shorthand, though, this information gets mediated as "race warring".

And hey - if it makes some old half-dead, former drywaller with a dictionary sleep better to think that it was all about race and not poverty, then feel free. Just as I feel free to continue correct the record.

[GDC]

"And such ascedancy is often grounded in economic disparity. In the shorthand, though, this information gets mediated as "race warring"."

Huh? You need to get out and have a little more fun in life.