Friday, September 29, 2006

Automating 4506-T Form application

Head over to and I saw a story on a new automated process for income verification. Anyone want to guess how long until MBS buyers *require* this. The best comment I saw is that brokerages *need* people to buy their Mortgage backed securities. MBS buyers don't need mortgage brokers; there are other places to invest.

While this will take a few months to change the rules (maybe as much as a year...), this will end the practice of no-doc "liar loans" pretty quickly.

Original link:,0,5083108.story


Wednesday, September 27, 2006

What happens when credit tightens

The end of suicide loans

There has been speculation on the web as to what happens when bond holders lose their appetite for the high risk loans. In reality there are only a few scenarios:

      1. An end to “no-document” loans (better income, savings, and employment verification).

      2. Tighter qualification requirements for exotic loans (e.g., qualify for the maximum payment not the minimum).

      3. Higher interest rates

      4. Fewer mortgages being offered

      5. Higher down payments (risk reduction)

I've been reading at some blogs I respect how they expect interest rates to spike as the 1st choice response. This I disagree with. Why? There is to much money looking for a “safe return.” Thus, I would expect that instead investors would want to minimize risk. Thus, ensure the FICO scores are high enough to qualify, triple verify income and savings via 24 months of documents (or even more time?).

The easiest risk management would be to increase the required down payment back up to 20% or 10% + PMI. I can even envision a return to the old standard where, except for a starter home, the bank expected a 20% down payment and a payment of the home's last year's appreciation. So if homes went up 6% in a year, a minimum 26% down payment was due. That would be true risk reduction.

The likelihood that bond buyers will have an appetite for mortgage backed securities (MBS) backed by exotic loans is pretty low. In fact, I expect bond buyers to be shy of these loans for 5 to 7 years.

Thus, do I expect interest rates to go up on mortgages? A little. But mostly for risk aversion processes to creep back into the mortgage system.

This will still stop about 1/3rd of home sales. Thus the upgrade market will thus stall...


Monday, September 18, 2006

Pushing on a rope

Fed expected to hold interest rates

At what point does it not matter what the Federal reserve does with interest rates? While they can choke an economy easily by raising rates, when do they have trouble stimulating the economy? What I'm referring to is the US economy's need for capitol inflows to sustain our economy. What happens if the fed pauses on interest rates again?:

  1. We can expect the dollar to weaken versus foreign currencies.

  2. Foreign capital inflows to the USA will slow

  3. Inflation risk edges up

At this moment I believe the risk of deflation is greater than inflation, so I'm going to make only a few comments on inflation. Due to the eventual devaluing of the US dollar that is going to occur, imported goods will get more expensive and thus we are going to have consumer retail inflation due to that. But I still think deflation is a greater risk due to the abruptness with which credit can be cut off.

This brings us to point #2, the reduction of foreign capital that feeds our insatiable need for cheap imports. Inflation in the low interest/fast growth world was avoided by the integration of the world economy. Each country has found its niche to fulfill in the global supply chain. The problem is the US has done a much better job putting off paying the bills than is healthy. Like an alcoholic college kid, eventually its time to sober up and pay the bar tab.

We currently borrow 2 billion dollars a day to feed our import habit. We've gone beyond being a casual user to credit junkies. And now we find out in July the Capital inflows were short (google capital inflow July and you'll find your favorite news service has the article).

So let's say the Fed drops rates yet foreign interests still cut back the capital inflows. That would lead to the USA printing money to keep the economy going. But as foreign buyers purchase most of the mortgage backed securities right now (MBS), its going to seize up the home buying market.

Thus, another reason why I wait. Oh, this scenario probably will happen by degrees. But someone explain to me why there are 984, 773 properties for sale on (nationally) when during the summer selling season there were 2/3rds that number?

Anyone who thinks homes will land softly hasn't looked at the fundamental numbers. Shiller just noted that we now have more home inventory for sale than anytime since 1955. And this is with the economy still “going strong.”

During the Japanese recession, real interests rates were zero percent and they were stuck in a decade long deflationary recession. They were pulled out by the global economy. The US? We'll pull everyone else down. Is Asia and Europe ready to support the US? Their citizens will stop throwing money at us to borrow. So how will be pay for their exports?

I think the Fed's rate hold and soon to be future decreases will not do much to stimulate the economy. It will be like that sailor trying to move the boat by pushing on the rope.


Thursday, September 07, 2006

State of the market

Stagnant or declining home prices?

There are two theories to how homes will hold up for the next few years. Some suggest homes will hold their value or possibly inflate along more traditional lines, others like myself believe prices will not only decline to fundamentals but over-shoot to the low side.

Let’s look at the drivers of home prices:

1. Wages. One has to pay for that home

2. Inventory How many homes are for sale?

3. Job/population growth If homes are selling fast, sellers will try for “a little more.”

4. Optimism/Pessimism

5. Inflation If money is going to be worth less… seek stability!

Wages: With homes going for 10X to 11X median salary, there is a total disconnect with affordability. We’re seeing job losses from the south bay (e.g., Boeing is talking about closing Long Beach, No one I know can afford to hire, etc.) This indicator points to homes not appreciating. Declining? One indicator won’t answer that question. But it certainly points down.

Inventory: Its huge! We will be at record levels soon. Ok, it might decline in the Fall and winter… but when we see the traditional spring run up in inventory… The market is going to collapse under its own weight. This driver points to declining prices. This is also the driver that resulted in prices getting out of sync with fundamentals.

Job/population growth: We’re seeing good job growth in California, but its at or below the median wage. But United van lines is reporting they’re carrying a lot more weight out of California than into California (see my U-haul index article too). So I’m going to call this one a downward driver, but low intensity.

Optimism/Pessimism: This is herd mentality. We’ve been *very* optimistic on housing for years. So this can only cool. I’m calling this one a minor driver to declining prices. Beware, this driver could cause a rout in home prices if it goes too negative.

Inflation: We run a strong risk of inflation right now. But… If people cannot afford homes, it doesn’t matter what inflation does, people will not buy. I’m calling this driver neutral.

Overall? In order Inventory, Wages, Jop/Population growth, and Pessimism (or declining Optimism) all point to declining home prices. Inflation will get run over. I expect that with declining home prices the speculators will run for the doors thus making the inventory and Pessimism drivers all that much stronger.

In fact, I’m going to make a prediction. Declining home prices will drive down rents. This will pull down the core inflation in 2007 and 2008! Thus, I expect that by 3Q2007 the Fed will drop rates. Will we see inflation? Yes, I expect imported goods to ramp up in price pretty quickly by 10% to 20%. But the core’s largest component is rent. A declining economy also has a good chance of driving down oil prices… Personally, I believe deflation is of greater risk than inflation, but I lack the data to prove such a statement.

My vote is for a strongly declining market, and soon. Some have predicted a Post Labor day massacre in home prices. Judging by the huge number of new signs along PCH… I believe it. Remember, we’ve exited the summer selling season. Inventory should be tight this time of year. Some have noted with all of the homes on the market that the summer rentals will have a hard time getting school year rents… Thus the inventory driver will only grow.

We live in interesting times.