Orangecrest Riverside California Real Estate Blog
Orangecrest Riverside California Real Estate Blog

Scott Chappell and Brian Bean
Monday, August 20, 2007

Fed steps in to help lenders, but is it too late?

Friday, August 17, 2007

Commentary: Credit crunch will likely hurt 'bubble zones,' economy

By Lou Barnes
Inman News

"Agency" mortgages are as available as ever, about 6.75 percent, finally showing signs of decline toward ultra-safe Treasurys. High-quality jumbos are available but pricey, about a half-percent above agency, low-doc underwriting scarce. Piggyback seconds and PMI are available for low-down borrowers, but full-doc only. Appraisal underwriting is ferocious, arbitrary and late in the process.

The Fed's action Friday morning has firewalled the mortgage panic from the rest of the banking system, and brought a short-covering rally to the stock market, but will do nothing whatsoever to solve the underlying problems.

Something on the order of $4 trillion in nominal mortgages outstanding (give or take a trillion) are not worth that much anymore; perhaps half have lost value in the range of 5 percent to 10 percent, the other half ... nobody knows what they are worth.

This wild swing at an estimate of troubled loans outstanding is based on $11 trillion in total residential mortgages. One trillion is second mortgages, roughly half in trouble. Then there's about $1.5 trillion in subprime and about the same in Alt-A (numbers hazy because of overlap), and maybe another trillion in lower-quality non-agency (bad adjustable ideas, 95 percent and 100 percent no-doc ...).

These troubled mortgages (together with the good ones) are always held with borrowed money. Some borrowed from depositors or owners of life, pension or annuity policies, most from institutions; some borrowed long term, some short; some borrowed on prudent leverage, some on high leverage. Most of the troubled mortgages are held in securitized form; absent an agency guarantee their credit attested only by S&P, Moody's and Fitch, and most of the structures new since 2000 and untested.

The rating agencies grossly overrated the securities. The light of this cold dawn came gradually, beginning in late 2006, and the market reaction was a gradual withdrawal of the worst mortgage ideas. On Aug. 7 the Fed met, and pronounced the economy in good shape. Two days later the mortgage market froze solid. The Fed has injected cash every day since, to no effect, panic spreading to other markets.

If you were a short-term but highly leveraged holder of non-agency loans -- a big mortgage bank -- your capital was gone, and so were you. The mortgages had only to fall in market value a few percentage points. If you were a long-term holder, leveraged, you are in terrible trouble. There are lots of you. New buyers do not wish to join you.

By Thursday, the 90-day T-bill, the ultimate safe-haven, fell to 3.45 percent -- a gap so wide below the Fed's 5.25 percent rate indicates systemic collapse in progress. Friday's cut in the "discount rate" allows banks to borrow from the Fed against AAA-rated assets, which put a floor under the financial system, in particular commercial paper and corporate finance, but did absolutely nothing to thaw the mortgage freeze (which is oh-by-the-way spreading to commercial mortgages).

The bubble zones would have survived the removal of the bad ideas, as of the end of July, and probably found a way to muddle through the subprime resets ahead. They will not survive this degree of credit starvation. They have a month, maybe two; and this time the economy will not be spared the consequences.

The solution is going to require federal intervention, and that's going to require a victory of prudence over market-solution hard-heads. One idea: re-underwrite the $4 trillion to common-sense Fannie standards (forget size and details: is this "A" paper, or not?). Lord knows, there are plenty of underwriters standing around with nothing to do. Then the loans could be valued and traded, but running the securitization sausage machine in reverse may be impossible. Another idea: form a modern version of the Resolution Trust Corp. (which '88-'92 received and re-sold the wreckage from S&L portfolios, a tremendous success) to buy and re-market illiquid loans and securities.

Whatever: get going. Two weeks of Fed band-aids have burned precious time.

Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.

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# posted by Scott Chappell and Brian Bean @ 10:37 AM


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