The US sub-prime tremors
It sounds like the title for a movie but the tremors in the US (and wider) sub-prime market could become something very nasty.
During the last few days a number of my fellow attendees have been checking market updates every hour or so. Lots of directors of banks and other financial institutions, so when these guys look a bit worried, you know it is time to start taking notice.
Brian Fallow has a story in the Herald on some of what is happening.
Also a cause for nervousness is the fact central banks have had to inject US$323 billion into the money markets over the last 48 hours. And yes that is billion – around three times the entire GDP of NZ.
It sounds like this episode won’t go pear shaped, but nothing is for certain. People are waiting for the US to open again on Monday morning.
August 12th, 2007 at 3:55 pm
For me, here is the ‘stand out’ quote from this piece:-
‘Swiss-based global bank UBS estimates that about US$1.2 trillion of the United States’ $10 trillion mortgage market is “sub-prime”.’
12% of the book is HUGE! ! ! Makes the whole US residential mortgage book look a bit like Bridgecorp.
David, what exactly is the definition of a ‘sub prime’ loan? I assume it is one with either adverse credit rating, higher than 90% LVR, no proof of debt servicing ability or combinations of all these factors?
August 12th, 2007 at 4:06 pm
Yes, but 12% of the book, of which 10% might be at risk of default, of which 70% might still be recovered (for example). So the likely loss is less than 1% of the book.
Cool heads should prevail, I hope.
August 12th, 2007 at 4:12 pm
http://article.nationalreview.com/?q=Y2Y5NGVmODQzNTEwOGZmMzExNzRkYzBkMzA4OGI1ZGM=
might help you Adolf
WFC BPOP WM C are been given away. Buy buy buy
August 12th, 2007 at 4:13 pm
kd I hope you are right.
What I don’t understand is why these loans are not insured. In NZ they are (and you pay the extra feee of 2% or so of the principal sum) or you don’t get a loan. Have the Yanks been lending to these very high risk borrowers with NO LENDERS PROTECTION insurance?
August 12th, 2007 at 4:20 pm
Please please please could there be a 50% drop in Auckland house prices Yay!
I wonder how the council would riggle out of have to reduce rates if that happened aye???
August 12th, 2007 at 4:33 pm
Thank you Simon.
I see the increase of 35,000 foreclosures was over one quarter. Annualised, that’s 140,000 increase over 219,000 last year. Hardly gives one encouragement to be sanguine. What does it take to tip the next level of borrower into foreclosure? No wonder the Fed left interest rates alone. How many sub prime loans come off low fixed rates ove the next two quarters?
Interesting times indeed. (Pun intended.) I won’t be rushing out to buy. 8.2% on term depost just gets better every day.
August 12th, 2007 at 4:37 pm
Dr Grimes of Motu presented his research groups finding of the impact of the Metropolitan Urban Limit on the price of land in Auckland at a seminar on Friday. Local government politicians and officials have been insisting that the MUL has no impact on the land price and that removing it would make no difference.
HOwever, after correcting for all the independent variables (Distance from coast etc) Motu found that land just inside the Auckland MUL was 10 times (that’s right ten times) higher valued that land just outside the MUL. No government can allow such distortions to continue especially given the imact the assett bubble is having on interest rates and the export sector. Secondly Auckland city is now exporting New Zealanders – it lost 15,000 net over the last census period to other parts of NZ.
Once cities depopulate prices drop. Look at Europe. Some major corrections are coming. And when values fall below the mortgage into negative equity there will be some sales pressure on prices as well.
I have not seen the Motu findings reported so far – which surprises me.
August 12th, 2007 at 4:44 pm
Good idea, remove the urban limit and let people keep building further out and then sock all of us billions to pay for “infractucture” so they can assert their right to work across town.
Anyway if we’re depopulating then there is no need to keep sprawling.
August 12th, 2007 at 4:47 pm
Adolf, one of things that makes the subprime loans in the states more prone to default is what they call 2/28 mortgages.
you get the first two years at a substantial discount, and then the rates or repayments jump from year two onwards.
like a harvey norman no interest for two years on a larger scale.
the theory is that you are supposed to be able to sort your crap out in two years and refinance to a bank.
however people that need subprime for credit issues tend to stay like that, they don;t change their habits. even clients i have helped locally out of PLA notices by going 2nd tier (what we call subprime), seem determined to lose money, i had one client who i ended firing, who kept getting new cars (by trading in the existing one, having the outstanding loan added to the new loan etc), and then trying to get a top up as his house went up in value, despite the fact he was paying 11.95% (3 years ago). i ended up refusing to do any topups after the 2nd one, as he was never going to learn.
Locally, i don;t know if Liberty or bluestone (our subprime lenders) reinsure, in fact i am certain that they don;t (as noone would), however they don;t offer the types of loans that the US does, they are pretty strict on approvals, and they have a pretty full on team of people whose job is to pounce the moment you miss a payment. ie they call the day you miss, and work on it immediately, which keeps the chance of a defualt lower as they don;t let things get past 1 missed payment if they can.
August 12th, 2007 at 4:56 pm
Thank you Allan. I have brokered loans for about fifteen years but kept clear of the residentil market so I haven’t been up with the play in that area. But you are right. New Zealand is but a village and the same names of the same cockies would crop up every four years or so.
Hey, you need to do something about your semi colon key! Put a grape seed under it.
August 12th, 2007 at 5:15 pm
Essentially the whole economy is based on speculation. Some new share floats generally warn of speculation. The property developer speculates that he will make money when the deal is completed. The buyer taking on a huge mortgage speculates that the economy will remain strong, and that he can continue to pay his interest and mortgage repayments, and that the deal will benefit him in the long run.
You may well say that the Labour-led Government, in tinkering with the Electoral Act is speculating that this will assist in returning them to power?
Unfortunately history shows that a strange phenomenon called “A correction” in the financial and political world occurs from time to time, and we are back in the real world that already exacts it’s toll by way of natural disasters.
Well managed economies and companies, recover and continue to flourish.
August 12th, 2007 at 6:05 pm
adolf said:..
“..How many sub prime loans come off low fixed rates ove the next two quarters?..”
november is going to be a crunch-month..
a big load of them come up for roll-over then..
(incidently..ahem..!..at whoar we have been all over this story like a rash..for about a year..
(so the information/warnings have ‘been out there’
the rest of our media are just getting around to explaining to our punters just what a sub-prime is..
just as the shit comes dowm..eh..?
good to see they have done their job so well..eh..?)
phil(whoar.co.nz)
August 12th, 2007 at 6:19 pm
Phil’s right on this. The US subprime issue is a slow motion tsunami that has been building since last year. The situation could become very interesting if assets here have to be sold quickly. Enjoy the show folks.
August 12th, 2007 at 6:27 pm
Every crash has had its own reason. The property market has been grossly overheated for some time.
August 12th, 2007 at 7:22 pm
All good. Lots of opportunities to buy.
Funny thing is, when housing is “unaffordable” everyone cares about the people trying to get entry into the market. When their own house price starts dropping, it suddenly turns out that really they weren’t that interested in affordability at all.
August 12th, 2007 at 8:10 pm
This might have something to do with it.
http://www.richmastery.com/shop/products/ClubRM/clubrm.html
and
“So who is taking out this debt? The US Federal Government for sure is responsible for a good portion of it, but they are in the enviable position of being able to create money from nothing.
The lion’s share of debt is owed by the US consumer, particularly through the mortgage system. With all due respects to Joe Sixpack, we have to conclude that the consumer is the dumb money. By racking up unprecedented debt within an economic slowdown, the average consumer has set himself up for crisis. There is simply insufficient growth in income to manage the increased debt service load. People should know that they are in over their heads, but they refuse act responsibly and slow down the credit machine.”
http://tacticalinvestor.com/contrarian6.html
Funny how theres always Jackals and Vultures willing and able to take advantage of other people’s misfortune.
“Rising subprime mortgage delinquencies and pulled leveraged loan deals are roiling global credit markets, but some big hedge funds are preparing to buy and others have already begun stepping in to scoop up distressed assets.”
http://www.jpost.com/servlet/Satellite?cid=1186066382698&pagename=JPost%2FJPArticle%2FShowFull
Interesting times indeed.
http://news.independent.co.uk/business/comment/article2816715.ece
August 12th, 2007 at 9:23 pm
Been writing about this for a while on my blog.
It is a slow burning fuse. The issue remains whether there is a pile of gunpowder at the end or just a small keg. At this stage think, to quote a US commentator, “Main street will save Wall street”. In other words the base economies around the world are in good shape. It just bad lending and derivative spreading of risk that has come unstuck. There is no reason for the Fed to cut US interest rates. I still think it will eventually blow over, but there is no way of estimating how bad it could get yet.
It’s like an iceberg…how much can’t we see? With all the cash injections, the sharemarkets should stabilise…at least until the next failure anyway.
August 13th, 2007 at 4:48 am
Kiwi Trader
Good analysis. The “Main St will save Wall St” quote comes from respected market commentator Lawrence Kudlow and he’s right. Stock markets are fundamentally underpinned by basic corporate profitability which is strong and growing in the US. With continued strong GDP growth, record (US that is) low unemployment and a plunging federal deficit with low inflation – these are the things that keep small – large businesses in the US profitable and lower taxes leading to higher net take home pay.
The default rate on US mortgages is a meagre 1% so this is a derivatives market correction and one that the market can take in its stride. Many in the mortgage industry (I have a business partner here heavily involved in residential mortgages) believe Wall St has over reacted because default rates are not that high. It is adding to the real estate market correction due to many sub-prime borrowers being unable to get favourable loans right now.
Alan – Bluestone and Liberty do not insure their Australian or NZ sub prime loans. They each run a complex pricing matrix that adjusts according to the more precise nature of the applicant’s poor credit history and they manage their loan book more aggresively. In the US, home loans are funded differently from Australasia as almost all are sold in bulk on wholesale markets and the higher returns on securitised sub-prime loans led to an unnatural explosion in this type of mortgage investment.
My colleague’s mortgage banking company is still thriving and even prospering amidst the chaos as the industry shakes out the lazy loan officers, broker firms who didn’t build long term mainstream credit risk client loyalty and any lenders who got over exposed to this market and didnt factor in any sub-prime credit crunch. Like in any free market, stronger and smarter operators will come in and take up the slack. The surviving non-bank lenders who have kept their powder dry will soon be able to offer in-house boutique sub-prime products and have the market to themselves until the competition sees the killing and re-enters the market. Over time equelibrium of sorts will return. The US capital markets are too deep to be toppled by this needed correction. Real estate markets are frequently cyclical and this current correction will bottom out once market values for property drop below the replacement cost of building a new home – the same cycles that have been going on in housing markets for well over a 100 years
August 13th, 2007 at 8:12 am
Kiwi In america: Kudlow keeps saying this is contained, but they keep making bigger containers.
Look the biggest injection of funds since 9/11, they are freaking out, gossipers thisnk goldman sacks hedge fund is in trouble.
Bank nerds go here:
http://calculatedrisk.blogspot.com/
subprime is the start, commercial loans in the US are very similar and are next. the US consumer spending has grown 1% for the last three months, they are debt exhusted.
I have my tinfoil hat ready, and some cash and dry goods, look out below.
August 13th, 2007 at 9:23 am
I do not understand why people believe that letting people build where they like will generate an infrastructure burden. To begin with if your development imposes a load on the roading network you have to upgrade it and the additional rates take care of the maintenance. The developer (even when its just a family like mine) provides all internal roading, all stormwater management, all sewage treatment, and of course we collect and treat our own drinking water.
Councils only have to provide infrastructure to the development area and they only do that if they want to support higher density development.
Central sewage plants are now much more expensive than on site treatment.
IN spite of all these costs the land remains cheaper than behing the urban limit and these developments do not contribute to excessive interest rates and exchange rates by inflating house values.
August 13th, 2007 at 9:49 am
Back to this sub-prime if it is so small why is it so big?
August 13th, 2007 at 10:02 am
Kiki: Subprime is part of the problem, Hedge funds bought the subprime mortgage securities. The first time thses securities were ‘marked to market’ as opposed to mark to model, the value was far less than realised. Also in the case of forclosures hedge funds own the debt not a bank, or many investors own parts of one mortage, so who owns the forclosed house??
this has alot left to play out and if the central banks a putting this much cash into the sytem now, wait till november when the reset subprime storm begins..
this issue is very complicated and murky and will take years to play out.
“Don’t allow money-supply growth to spiral out of hand.” greenspan 1977
“But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums”
greenspan again 2005
August 13th, 2007 at 10:10 am
It’s not just subprime, “Alt-A” loans are the next to hit the rocks. Together with subprime they make up a third of the US mortgage market. A lot of them are on ARM mortgages that reset to a higher rate over the rest of this year and next year. Low-doc loans also feature in the NZ mortgage market (though not to the same extent) and I expect we will be hearing a lot more about them over the next 12 months.
August 13th, 2007 at 10:11 am
Because, the forms of securitization being used to parcel up these mortgages have meant that there is a lot of opaqueness appearing in the bond markets, people are having trouble working out what is risky and what is not, causing lenders to demand higher interest rates to compensate for higher perceived risk, UK LIBOR ( The inter bank rates), rose around 1/2 a percent in the last couple of weeks, ( without any move from the BoE),
Basically international credit is going up in price, and the concern is that this will halt much of the private equity ( read corporate raider) activity dead, Private equity plays have been pushing up stock prices recently as they sniff around large companies, ( Auckland airport, TV3, Tourism holdings, Qantas,Chrysler), so there is concern this might dry up.
Hence this is becoming a fear is more important than greed story for the next wee while.
August 13th, 2007 at 10:24 am
Kiwi in america, thanks for the reminder, i’ve sold quite a few bluestone and liberty loans, but it was the weekend and i don;t tend to dwell on the reinsurance.
No probs Adolf, i am only just wetting my toes with commercial lending, having been involved in residential lending for 5 years now. completely different game. Have you seen Bluestones credit impaired commercial lendingg products? very nice.
i would be surprised if we had the same effect here on our subprime that they are having in the states. as i said the lending companies have put quite strong restrictions on their lending (including a LVR:risk matrix for determining rate), so that they can sell their debentures with the right gradings.
also i would be even more surprised if NZ got into a massive lo or no doc problem.
sure i can see some people losing their properties becuase they individually self certified they had an income that they don’t, but thats not the whole market. currently lo doc is tagged to 80% LVR max (some do 90% but its very hard to get through), and no doc is usually tagged at 70% LVR. this gives enough fat that if there is a market drop they are not overcapatalised.
i can see the banks having a bigger potential problem as they lept into this market just to compete with the Pioneers, Sovereigns et al, and its not their target market, so i would not be surprised if one bank got burnt and they pulled out of their subprime and lodoc products int he next couple years.
while its important to watch the US market, and see the potential impact, i don;t think its viable to say that it will mirror here. our lending practices are a lot different to the states.
AL
August 13th, 2007 at 12:19 pm
AL I think there are a couple of holes in your logic. The first is that what we are seeing is all the signs that were about the place pre 1987 and the biggest of those is profligate and imprudent lending by banks and mortgage securitisers. The second is that it is now 20 years since 1987 so we have a whole new generation of clever young buggers with masters degrees in finance and accounting who think they know best.
For example, you talk about a 70% LVR giving sufficient fat but what you miss is that the LVR does not matter when the interest rate goes up and the monthly repayments increase by 30 or 40% and the stupid pricks who did no docs loans because they (and their brokers) knew the real problem was debt servicing suddenly are unable to make the payments on the 70% LVR loan.
Nobody will refinance them now because all the lenders have got the wind up.
I’m aware of some real shoehorning of dubious loans on the part of some sectors of the investment property sales industry.
I think we are in for an extremely bumby ride as this generation learns the lesson of it’s predecessors.
August 13th, 2007 at 12:20 pm
Porcupine – it would make no difference to your council rates if every property went down in price by the same percentages.
Come revaluation time (every three years), those that fell by MORE than the average percentage drop would get a rates reduction, those that fell by LESS than the average would get a rise. Property prices going up and down don’t affect Auckland City’s spending plans, which is the main factor in how much is taken in rates by council.
The way to stop wild and unpredictable swings in rates is to have more of the rates bill apportioned from uniform annual general charges, and less on peoples property values. For example, North Shore City has UAC’s around 4 or 5 times Auckland City Council. UAGCs are considered to be an equitable method of user pays philosophy for council services.
August 13th, 2007 at 12:38 pm
AL, on re reading my last post it would seem I am accusing you of being a clever young bugger with a masters degree. Such was not my intention, old chap. Apologies if you only have a batchelors!
August 13th, 2007 at 1:43 pm
Adolf, you are right that if the interest rates rise and the initial problem was lack of servicability then the client is buggered LVR low or not.
the advantage of a lower LVR is that you are able to get a topup easier, i know its a bit of putting more fuel on the fire, but my experience with self employed clients (the clued up ones) is that often this is just want is needed to overcome a blip, due to slack clients not paying them etc. and since i don’t deal with clients who won’t take advice, its not as much of an issue for us, anyone shopping simply for a topup for cashflow (and no advice) can go elsewhere.
Now of course if we have a double whammy of both rates increases and value drops people will be in trouble, but thats the risks they are aware of going in, and i think that while its possible, a drop of more than 30% in property values would imply a bigger problem than just NZ property.
i like your analysis of this being a generational thing, most of my clients who need this sort of service are well and truly not my generation, they are mid 40′s plus
i may be too trusting, but certainly i have not seen as much imprudent lending with my clients, we do a full needs analysis and cost/benefit discussion, but not all mortgage advisers are like us. not too say they can;t still go under, becuase they don’t always follow our advice anyway.
also, i was 10 in 1987, so can;t really comment on what happened then other than from what i read.
and i don’t have a masters, i have a post grad diploma in Financial planning
AL
August 13th, 2007 at 2:27 pm
Servicibility is heavily influenced of course by our full employment rates. When that rate goes the other way watch out.
August 23rd, 2007 at 7:28 pm
Home Loan House Refinance Mortgage Rates Us…
Hm, I\’m not sure how it\’s related?…
November 19th, 2007 at 3:30 pm
I hope this surfaces because it appears that kiwiblog has not discussed this matter for a few months … but here goes ….
Out of the mouths of babes comes wisdom … even if this babe is in his eight decade.
The whole subprime crisis which is inflicting great pain on millions in the American market is based on the concept of f… you jack I’m allright.
If a householder defaults on their mortgage it his hard luck, he should have thought it out and realised he couldn’t afford the increase rates of a ARMortgage. There is also the problem that many were reassured that they could refinace at rates they could afford but cannot now there is a need along with other cons. Then there are the crippling charges that banks make when re-financing as described in various articles in the New York Times of late. It all appears to me to be screw you mate.
So the FYJIAR ethic lets them go to the wall, not appreciating that if this happens to too many the whole house of cards falls down as is happening.
Meanwhile like Nero as Rome burned GWB twiddles his thumbs in the White House and does nothing.
I appreciate that a lax system encourages recklesness in the punters but surely just freezing the ARMs at their opening rates for perhaps a four year period would save the human crisis of foreclosures and the lack of confidence in the financial systm and with just the loss of some profits by the banks than the whole basket. It gives time for everybody involved to work their way out of the mess and learn from their mistakes and blissful trust of others in the system.
But for a little bit of common sense as expressed by this babe the whole country goes down, though fortuneately not the rest of the world with the States no longer the prime force in world ecconomy.
November 19th, 2007 at 4:15 pm
And the sorry mess involves another group .. the landlords who have to evict their tenants when they face foreclosure on their rental properties.
NYT today
http://www.nytimes.com/2007/11/18/us/18renters.html?_r=1&th&emc=th&oref=slogin