Housing Doom

Here is Housing Doom’s fourth installment of our unauthorized annotated transcript of the American Enterprise Institute’s October 30, 2008 seminar "The Deflating Mortgage and Housing Bubble, Part IV: Where Is the Bottom?" [1] This is the presentation by Tom Zimmerman. He makes use of an extensive slide deck.[2] There is now an official transcript at the event site There is a video and an audio-only recording of the event at the event site.

Highlights

• "… the housing market’s going to go down, but I think there’s some data that says there may be some turning points not that far away."
• "Believe me, I would be selling everything in New York …"
• "Here’s a statistic for you. For the past six months the number of subprime loans in 30, 60, 90 day delinquencies has been going down."
• "… but we have this balance between foreclosures pushing more properties out there, these Augustine home sales taking them out of the system."
• "In addition to that, we’ve got this situation that, where that big securitization that no longer exists — that was 40 percent of our home lending back in ‘06 … ‘05 and ‘06."
• "It sounds like first somebody is going to figure out what it takes to keep [Freddie & Fannie] reasonably solvent, then go back and figure out what kind of loans they can make. If they do that, then they’re not going to be any help going forward."
• "… if you want to stop this next year of really terrible pressure on the housing market you have to intervene some way."

Tom Zimmerman: [40:13] Thanks Alex. Good afternoon everyone. [slide 0 -- refer [2] below] I must say I speak at quite a few conferences, and over the past several years I’ve usually been viewed as one of the most bearish commentators at the mortage and housing conferences I go to, but one of the reasons I enjoy coming here is that [laughter] I am not, by far, that — this is a pleasure. So … a little scary, but it is a pleasure.

So, Alex, that light at the end of the tunnel, it may not be a train. I’ll show you a few glimmers of hope here. [slide 1] We had — at lunch we talked about — is there any good news out there. Well there’s not really any good news, but the thing about markets, they do look a long way away, and I’m going to present some data which — keep watching the next 6 months and maybe some of it will help us get through this.

It’s not conclusive, the housing market’s going to go down, but I think there’s some data that says there may be some turning points not that far away. Not in the global — I agree with Nouriel in terms of the global disaster we’re facing, but in terms of the housing market that triggered this, there are some minor, minor positives. So let’s take a look at this. Believe it or not, I see a couple of small positives. I’ll qualify them, but they’re small.

Existing home sales [slide 2] — these things for …. 10 months they were flat, they popped last month. Now … housing market is in a shambles, it will be for a while, but what’s happening is in some spots like Cleveland Ohio, Stockton California, Riverside — the year-over-year sales — unit sales — are up substantially from what they were a year earlier.

So what’s going on? Well, a third of these, or 40 percent of this is foreclosed properties. But somebody wanted to buy that property, and somebody felt that after the prices had been knocked down enough, say 50 percent on average, they could buy that house, rent it to somebody, and make 15 or 20 percent on their money. So there are some investors out there who think there’s a bottom, at least in some of these areas. Now I’m not saying it’s in New York City right now. Believe me, I would be selling everything in New York, but there are certain areas of the country that led this collapse are stabilizing at a level — I suspect the prices will not go down much further there — and I suspect that we will see this sort of a bottoming out when prices — I’m not saying the rest of the country does this — but in some areas where high flying properties are off 50 percent, somebody thinks it’s a trade. So there is some bottom fishing, bottom buying of properties going on.

Inventories are still high. [slide 3] They haven’t risen a whole lot. I think they’ll stay quite high for some time, because the defaults are going on. That’s going to weigh on the market. Prices will still sag across the country, but we have this balance between foreclosures pushing more properties out there, these Augustine home sales [3] taking them out of the system. My guess is that these inventories go up some more, but not dramatically more.

This is the good news. There is as lot of worse news coming. This is not bad, though. I saw — there is a different way of looking at price data. This is Case-Shiller and this data is month-over-month change annualized. [slide 4] So the real … the worst … this may not be over, but at least in this chart, the really severe part of this collapse in the housing market may be behind us in terms of the prices.

At the beginning of January this year, through June, those prices were falling like 20 percent annualized rates. We’re only falling 10 percent now. Now that’s not good, but falling at 10 percent is a hell of a lot better than falling at 20 percent.

Now the year-over-year numbers keep going down, but the monthly change — the monthly changes annualized — look like this chart right here. [still slide 4] So we’re not falling … and if you took these 20 metropolitan areas you’d find 8 of them have been in a positive area for quite some time. And the ones that were sharply negative are not nearly as negative.

So I think the housing market is going to go down. It’s down 20 percent. It’s got at least another 10 or 15 percent to go. Maybe the 20 percent that Nouriel’s talked about. Yeah, it’s going to go down further. But I think that acceleration thing you saw the early part of this year is not going to increase. I think it’s going to stabilize, maybe slow down a little bit, continue to grind down. At least some of that shocking decline in the housing prices may be behind us.

Are we still at risk? Well, let’s see. Here’s State-by-State Case-Shiller data. [slide 5] [45:00] House price changes quarter to quarter.

Alex Pollock: Let me point out we used to call this HPA. [House Price Appreciation]

Tom Zimmerman: Exactly.

Alex Pollock: … and now it’s HPD. [House Price Depreciation]

Tom Zimmerman: Yeah, HPA went to HPD. So here, in the last year or so, almost every State’s a bit negative. But if you take a look at a 5 year period … This is back to the earlier chart [second slide there] that Alex showed, over a 5 year period, many of these States are still positive — significantly positive. And these are annualized numbers. You multiply them by 5 plus and you’ll see that they’re still up from where they were 5 years ago.

So I’m not saying the housing market decline is over, but I’m saying that the acceleration part I think is behind us, but we’re still elevated prices in a lot of parts of the country — just by looking at this chart there’s still a ways to go, believe me.

This next chart is affordability. [slide 6] It’s kind of a mixed picture. It’s up from where it was, but it’s not fantastic. It’s on a national basis. I don’t want to spend too much time with that.

The next chart is [slide 7] — still shows us that the price of homes has come down, but compared to incomes it’s still very elevated compared to historical norms. There’s no doubt about that.

But that’s a few slight positives. Negatives we’ve got a lot of those. [slide 8] And some pretty significant ones. For the short term, the very next 6 months, the next 9 months, I think it’s going to be really ugly. Delinquencies have moved beyond subprime to the rest of the sectors. The roll rates, which are — in mortgage statistics we measure what percentage of a cohort moves from current to 30 days late, and from 30 days late to 60 days late and 60 to 90. Those are up sharply. Severities continue to climb, and prepayments are very slow because no one can get a mortgage.

Let’s take a quick look at this. [slide 9] Here’s the subprime disaster is that red line, and it’s been going up sharply for quite some time. These are 60+ days delinquencies — these are serious delinquencies. The bottom two lines are all Alt-A and the prime market. What’s interesting is they lagged a lot. They’re just now really kicking in. So I think what’s really happening is that sharp decline in the housing appreciation we saw earlier — that what’s triggering some of this … this stuff is really hitting other people now, where before, the subprime is primarily underwriting — just terrible disgusting underwriting. Now we’re seeing a more broad-based kind of a thing.

You take a look at this next chart. [slide 10] This is Freddie / Fannie, and this is the good stuff. There’s 2 parts of Freddie / Fannie’s portfolio: the bad line is the loans with MI [Mortgage Insurance] on it, about 20 percent of the portfolio has mortgage insurance because it’s more than 80 percent LTV [Loan-to-Value]. The bottom line down here is the good stuff, less than 80 percent LTV. We did an average for Freddie / Fannie, but the high LTV stuff really kicked in back here. It was doing fine until the sharp decline in the housing market, and now it’s going up. So the bad news is it’s spread well beyond subprime. This is Freddie / Fannie, which is supposed to be the best of all possible loans.

The roll rates we talked about for the non-Agency market [slide 11] — and these are quarter versus quarter — a year ago versus 2nd quarter of this period — and if you take a look what’s interesting is subprime is always the bad guy, which is still bad, but the other sectors of this non-Agency market — Jumbos and Alt-As — have started to perform pretty ugly as well. So this problem we saw mainly in subprime has certainly moved over into other sectors of this mortgage market.

Loss severities are climbing like crazy. [slide 12] It’s a combination of the housing prices going down and these loans staying in foreclosure longer and more problems being associated with those long foreclosure time-lines.

The next chart says it’s going to get worse before it gets better. [slide 13] See I started with the good stuff. Now here’s what’s really bad. And I agree with Desmond that these are the things that are going to drive it lower in the next 6 months — the next 9 months, next year.

Foreclosures — foreclosure wave will peak some time in the middle of next year, or toward the end of next year. The recession’s going to cause a lot more problems than we’ve seen so far, and the credit crunch just destroys the ability of people to finance.

This is the most important chart, I think. [slide 14] This is the number of loans — in units — number of homes that we expect to see in foreclosure and REO — and what you see is a hump that peaks somewhere near in the middle of next year. Then it starts to go down. This is sort of the light at the end of the tunnel. And what’s also important is this line right here. This is the sum of all these 5 or 6 different areas. This big hump is the subprime world. And the subprime world will peak at some point in the middle of next year or late next year, and then it’s going to start going down.

[50:00] Here’s a statistic for you. For the past six months the number of subprime loans in 30, 60, 90 day delinquencies has been going down. Six months. Going down. The number in the foreclosure bucket and REO is still going up. But that pig-in-the-python, the subprime disaster, is working its way through the system, and delinquencies in subprime are coming down. They’ve been coming down for 6 or 7 months.

The back end of this thing is still going through the system. It’s going to go through and peak sometime next year. I don’t know if it’s going to peak in the middle of the year or sort of late in the year, but it will peak because this is mainly an underwriting problem, much more so than anything else. They don’t make those kinds of loans anymore, they stopped making those back in mid-’07 something like that.

So, the point I think that’s really important is the number. We’re talking like — and our analysis and what it’s based on just like for the loans that were created in ‘06 and ‘07 — we’re talking like 70 percent of those guys default. We’re not talking about 20 percent, we’re talking about 70 percent of these subprime guys are going to default.

Now if we hit a recession, which we are, this is going to push these numbers up a bit, but once you have 70 percent of the people defaulting, I don’t think the recession is going to change that a whole lot. So maybe you go to 75 or something, it’s not going to go to 90 — ah … — Mike [laughs] but I think there’s substance to this chart — that in fact the bulk of this foreclosure problem will work its way through the system and life will get better later on.

That doesn’t mean that the housing market is going to get better, because all the other stuff’s going to be in foreclosed REO properties. So maybe we’re talking about the middle of — the beginning of 2010 or something like this for the maximum worst — ?

But the point I wanted to make was that I think markets are really forward-looking and once people start to take a look and think that, oh, maybe this thing will not go on forever. Maybe there’s an end to this thing, that some people will start saying that valuations for some of these subprime securities that were trading at 50, maybe they’re worth 55 or 60, etc. etc. … So that, I think that’s the process we’re in the middle of right now.

Unemployment is going to get worse and that is bad. [slide 15] Here’s a chart which shows the relationship between unemployment and default rates in mortgages. [slide 16] And roughly — I’m not going to go through all the data — roughly the ratio is like you move unemployment up by 1 percent you could increase default rates by 20 percent.

Now that’s in a normal kind of a — normal recession. Now we’ve got this crazy thing called "subprime crisis," and it’s already, as we said — you’re not going to increase 70 or 80 percent defaults by 20 percent. So that’s not going to apply there. But in general it clearly will apply to the Freddie / Fannie portfolio and the more normal kind of mortgage loans that were created.

So yes, that’s going to have an impact going forward. And the problem of course is California, where a lot of the mortgages are located — is leading the nation again in unemployment. [slide 17] So that’s not great.

So there’s a lot of negative stuff. The worst thing though — how much time do I have? …

Alex Pollock: … 4 minutes …

Tom Zimmerman: … 4 minutes, OK … The worst thing of course that Desmond spoke about is this lack of liquidity in the market — in the financing system for homes … this … this is … there are many of these feedback loops which are devastating. [slide 18] This is the one I talk about here is the one where home prices fall, these mortgage backed securities that all the banks own get marked down, the banks need more capital, and therefore they constrain their bank lending. We all know that’s going on in spades.

In addition to that, we’ve got this situation that, where that big securitization market that no longer exists? [slide 19] — that was 40 percent of our home lending back in ‘06 … ‘05 and ‘06. 40 percent was subprime and Alt-A and Jumbo. That’s gone completely. The banks are tightening up dramatically, Freddie / Fannie’s tightened up dramatically — and of course that’s a big question mark. What are they going to do going forward?

And I was amazed to read something on the internet this morning. Where — I think it was Mudd — I think he was saying that they’re going to evaluate, what, some minimal capital return is? … before they decide what kind of lending they’re going to make? Because they are going to first decide what’s a realistic kind of … so it sounds like … you know, I thought the government might use Freddie / Fannie as a real lever to push out lending — to push out liquidity to the market. It sounds like first somebody is going to figure out what it takes to keep them reasonably solvent, then go back and figure out what kind of loans they can make. If they do that, then they’re not going to be any help going forward. If that’s the process this is not going to help the housing crisis. I swear to God I read it … [crosstalk] … I read that this morning, but I don’t know what that means. But I have not yet heard anybody in Washington say — we’re going to use Freddie / Fannie to solve the housing market. I have not heard those words.

They really contributed to what happened the last 6 months, though. They really tightened dramatically in their lending … and the FHA is growing, but they can’t handle everything, so I think that’s one of the major problems here.

So as I see it, the legislation that was passed [55:00] — the several pieces of legislation which was pretty meaningless — it’s not going to stop this tsunami coming through the-pig-in-the-python sort-of subprime lending coming through here. The FHA program is not fantastic. So I think I agree that if you want to stop this next year of really terrible pressure on the housing market you have to intervene some way. [slide 20]

If you take a look at the data I was showing earlier and say, well I’ll let it — we’ll let it go for a year or so — it’s sort of burn itself out — maybe that’s better than trying to save this thing. That may be a policy option too.

So I don’t know which way the politicians will jump. My best guess is that they will probably come down on the side of some sort of a bailout. Some sort of a — something serious. Because this is going to get a lot worse during the next 6 months, next 9 months, next year. [slide 21]

Number of foreclosures, depression of the housing market — that real physical stuff is going to be there. You can’t take that away.

And I think the other problem that the politicians don’t really get is that if you go back to this chart with that subprime chart [referring to slide 14] – and … there are a ton of people in this subprime up here — and this Alt-A market down here — that never should have been in a home. I don’t know whether it’s 3 million, or what that number is … I don’t know how you resolve that problem. These people probably should have been renters and not homeowners with all that entails. And that’s a big problem that nobody really talks about.

They’re talking about - quote - saving the housing market … but … there were some big mistakes that were made during these last 7 or 8 years and so I … nobody has a good answer, I don’t have a good answer. I don’t know which direction it goes. I just know that the pressure is downward, there probably will be some federal help of some sort, God I haven’t a clue — I know Sheila Bair has the plan coming up and the FDIC, they have a plan they’re talking about, but we can talk about that for 3 or 4 hours — What options one might take just to solve that, so … I’ll stop here.

I have some other data but we’ll save that for another day. [slides 22-33]

Alex Pollock: Thank-you, Tom. Chris? [56:56]

Notes and References

[1]: "The Deflating Mortgage and Housing Bubble, Part IV: Where Is the Bottom?", AEI Event Homepage, October 30, 2008.

[2]: "Deflating the Mortgage and Housing Bubble, Part IV: Where is the Bottom?" (PDF Slides), by Thomas Zimmerman, UBS, October 30, 2008.

0. Deflating the Mortgage and Housing Bubble, Part IV: Where is the Bottom? [title slide]
1. A Few Positive Signs
2. Have Existing Home Sales Bottomed?
3. EHS Inventory Weights on Home Prices [EHS = Existing Home Sales (NAR)]
4. Rate of Home Price Decline Has Slowed
5. Case Shiller, HPD by State (through Q2, 2008) [HPD = House Price Depreciation; 50 states & DC]
6. Housing Affordability Has Improved
7. Median Home Sales Price/Median Family Income
8. Other Indicators Very Negative
9. Timing of 60+ DQ Deterioration [60+ days; DQ = Delinquency]
10. Fannie/Freddie Serious Delinquency Rates
11. Roll Rates Show Deterioration in Non-Agency Markets
12. Subprime Loss Severities
13. Reasons Downturn Gets Worse Before It Improves
14. *** Tom’s Favorite *** Foreclosure & REO Schedule –All Sectors (# of loans) [REO = Real Estate Owned -- that is, by the lender]
15. U.S. Unemployment Rate on the Rise
16. Impact of Unemployment on Defaults [HPI = House Price Index (OFHEO / FHFA)]
17. U.S. & California Unemployment Rates
18. “Vicious”Housing / Mortgage / Credit Cycle
19. Mortgage “Credit Crunch”
20. Need for Government Intervention
21. *** last slide used in presentation *** Summing it Up
22. Historical Non-Agency Collateral Losses
23. ABX Projected Lifetime Cum Losses
24. Enhancement Levels on 2006 Subprime Deals
25. Outstanding Subprime and Alt-A MBS Securities
26. Investment Grade Residential Mortgage Securities [MTA = Moving Treasury Average]
27. Representative Alt-A Fixed Rate SSNR Bond [SSNR = Super-SeNioR class -- thanks Bloomberg!]
28. Representative Alt-A Hybrid SSNR Bond
29. Representative Option ARM SSNR Bond
30. Representative Option ARM Senior Mezz Bond [Mezz = Mezzanine financing]
31. Non-Agency Loss Forecasts
32. Estimate of Dollar Losses on Non-Agency MBS
33. Mortgage Outstanding —Top 10 States
34. Analyst Certification [legal stuff at end]

[3]: "Some Buy a New Home to Bail on the Old: Fannie Plans Rules To Avoid Practice Described as Fraud", by Nick Timiraos, Wall Street Journal, June 11, 2008.

Next month, Michelle Augustine plans to walk away from her four-bedroom house in a Sacramento, Calif., subdivision and let the property fall into foreclosure. But before doing so, she hopes to lock in the purchase of another home nearby.