Housing Doom is pleased to present the third installment of our unauthorized annotated transcript of the American Enterprise Institute’s March 17, 2009 seminar "The Deflating Bubble, Part V: Forecast and Policy Recommendations for the Next Six Months." [1] This is the presentation by Tom Zimmerman [scroll down]. The event site has several resources, including both an audio and a video recording of the 2 hour proceedings. There is a brief summary, but as yet no official transcript.
Zimmerman’s presentation makes use of a slide deck.[2]
Highlights
back to AEI Subprime V transcript links
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Tom Zimmerman [24:26]: Hi, Good afternoon. [slide 0 -- refer to note [2] ] I’ll sort of pick up where Desmond left off … more on the housing market. But before I do that just real quickly in terms of a policy prescription …
As we sat here for the past 2 years every 6 months talking about this problem, none of us got it right 2 years ago. We thought … were all pretty bearish, but we had no concept of how bad it would be. My own personal experience in some of the securitized markets, whether it’s residential mortgage-backed securities [RMBS] or now commercial mortgaged-backed securities [CMBS], we always get it wrong. [25:00] And it’s always much, much, much worse than we anticipated.
And my concern right now is we take a look at what the Administation is trying to accomplish in all these different fronts. It does concern me that they’re not focusing enough on this issue — the credit crisis, the banking crisis. So my policy prescription is they really should focus … well as Jack Welch said the other day [3] "Focus, focus, focus, focus, focus … ." Because this is a big problem, and we don’t know how big it is.
So it’s not like you have it contained yet, it’s not like you have it solved yet … we haven’t even started to solve it. And we don’t know how big it is, that’s the problem. No one around here was even close 2 years ago, or even a year ago — as what was going to happen. So I would say that the Administation really should set priorities and go for what’s really serious, which they don’t really seem to be doing.
… no that wasn’t it, was it … there we go …
So I’ll just do a quick rundown on some of the … some more data on the housing market, just to add to what Desmond’s talked about already. But just a couple of things …
These are existing home sales and new home sales [slide 1] — and one of the interesting things I thought a year or so ago was that existing some sales were more important, because they’re about 80 percent of the market existing — 20 percent’s new. But this thing flattened out for about a year and a half. And things were like … "Oh, this is a bottom of this thing." And what happened was in the 4th quarter of last year, after that big break in the stock market, consumers really threw in the towel, and you can see what happened. All of a sudden, what had been a level for a year and a half in existing home sales started to crater. And what’s behind this — kind of interesting: Here’s a regional breakdown. [slide 2] Look at this West Coast here. This is California, Phoenix, Las Vegas … they actually were rising for a year and a half in here. Existing homes sales were actually coming up because they’d hit a bottom finally. After you knock prices down 50 percent you get some reaction.
We did, but what happened was again at this … this is sort of like the 4th quarter of last year, all of a sudden that started to go sideways, other markets started to crater. So there really was a change in consumer attitude which is bad enough, but starting in the 4th quarter and continuing through the 1st quarter of this year things have gotten increasingly ugly.
Inventory is down a little bit, but it’s still at a very high level. [slide 3] Here’s this Case/Shiller data in another dimension. [slide 4] This Case/Shiller data shows you what happens on the national basis on this black, this hard line right here, this line … what it is is the monthly change annualized. So it sort of tells you month-by-month what’s going on.
Well, our last conference, we were around here somewhere. And I was saying well, we’re in a slow down in this deterioration in the housing market.
This is back in here. Well, now we’ve got this situation where … it has re-accelerated, if you will on a month-to-month basis.
Some of this is seasonal. There is a seasonal pattern in this housing market, but that’s not all. I think a lot of this has to do with this late 4th quarter and beginning of this year — a really negative, negative attitude which is being exacerbated, it’s not getting better, let’s put it that way.
And here, which is an interesting chart which shows, again with the Case/Shiller data, here’s the national data on the far left [slide 5] — national in the sense of the 20 MSA areas that they measure on a monthly basis. And the blue line is total decline year to date, which like the 27 percent we talked about before. The other two lines are just the month … the decline in the month of December, of this past December. The white line is December ’07.
So we’re going down a little faster than we did a year ago. What’s interesting is this is all the bad states. We all know about this. This is Phoenix, Las [Vegas] … this is all the bad states, we all know about this. What’s interesting … take a look over here. These were the areas that were holding up pretty well before …
[crosstalk]
… so now we’ve got — Seattle, Atlanta, …, Minneapolis. These cities, these regions that held up pretty well, now as the recession starts to take hold, these places are really starting to see the impact to the recession.
So before it was more bad subprime underwriting, et cetera et cetera — now you’re getting the impact of this recession, and it’s not pretty on the housing market.
Another way to look at it, though — the positive if you will: this data is a little old, it’s like to the 3rd quarter of last year. [slide 6] It’s not as good as this looks, but what’s interesting is even though this market’s declined dramatically across the board here, there were only 6 States here where this thing is negative for the past 5 years. So if you go back 5 years in most of these States, you’re still above water; i.e. you’re not below water.
So … and that’s sort of back to this point: some of these States that have held up pretty well, it’s now their turn to get hit. So I think there’s a long ways to go in certain areas of the country — not in California, not in Miami, but in a lot of other parts of the — New York for instance, yes — I think we have a long ways to go in this housing market, in the correction.
This is an affordability chart. [slide 7] Desmond showed a better one. This is quarterly data, it’s here the monthly data that Desmond showed us up here somewhere. [30:00] Affordability’s much better in a lot of areas of the country, but if you need to have 20 percent down and a FICO score of 850 you’re not likely to get a loan. So it’s still a credit crisis as far as the housing market is concerned.
These 4 charts [slide 8] show the delinquency trends in the non-Agency market — subprime, Alt-A, option-ARM, JUMBO. You’re probably all familiar with these data — or these names by now — for the non-Agency market. What’s interesting … subprime, the cause of all — not cause but — the what, the [audience prompt] triggering event thank-you — has leveled off. Subprime is going to get better pretty soon.
Chris Whalen: As you predicted last time …
Tom Zimmerman: As you talked about … right. So it’s leveling off. But, over here Alt-A …
Chris Whalen: … right …
Tom Zimmerman: … is still accelerating, option-ARMs are accelerating faster, Jumbos is going up. So you add this all together [slide 9] and put them in our models and try to forecast what is going on … this is in terms of units, millions of units … and these are — it’s a little complicated, but — these are loans that right now are either in foreclosure or REO by the servicers, or they are 90+ or 60+ in a percentage …
Alex Pollock: Just say for the audience what REO is, Tom …
Tom Zimmerman: … oh, Real Estate Owned, sorry. These are the houses which have already been through the foreclosure process. The bank now owns that property.
So that volume of that … of all those delinquent and foreclosed loans … is … here we are right now … . well we think it’s going to peak out here this summer, maybe in the fall sometime like this. And this is subprime, this is Agency — Freddie / Fannie kind of stuff — here’s the Alt-A stuff. And even though option-ARM is pretty explosive, it’s still — in terms of units it’s pretty small compared to the other guys. So you end up with this crisis, this continuous pressure in terms of the … build-up … in terms of delinquent loans is going to continue right through the end of this year.
What happens though is those loans that are in this pipeline, this delinctive pipeline, takes them 6 months, 9 months or a year to get through to the end where they come … on the market. So the real pressure in terms of the number of homes that end up in the marketplace and the pressure on the housing market is not going to come here, it’s going to come 6 months or a year later in here somewhere. So we’re talking about the middle or the 2nd or 3rd quarter of next year.
So back to that price chart we saw forecasting the price chart for the Case/Shiller futures price index, everybody’s kind of pointing to the same thing — this maximum pressure, the worst this thing’s going to … it’s not over with. But at least people are starting … trying to find a point where it might bottom out.
So in the best of all conditions we’re guessing some time in the middle of next year, just in terms of the inventory and the process of delinquent and foreclosed loans.
Now what impact has this had on the valuation of these troubled assets on the bank balance sheets? [slide 10] Well, this break in the market took place after all that bad, bad cycle we went through when we thought the world was ending last fall, right? This is October … this is all the crisis situation … and it’s reflected in the valuation of these securities that we’re talking about — these troubled assets. They got hammered dramatically in the 4th quarter.
They felt a lot better. I’m sorry, this is ABX. This is the one index of asset prices which is readily available to the marketplace. There’s a lot of other parts of the market that are being priced, but the one index which is readily available is this ABX pricing.
Well, it rebounded a little bit and held pretty well, and now unfortunately after the first of the year, whatever happened, we’ve seen a pretty dramatic sell-off since then.
So it was a bit of confidence, it was building into the market place, a bit of complacency if you will. And since then, these markets have sold off pretty sharply.
Now if you move from that ABX pricing to — this is the CMBX, the commercial real estate — and unfortunately, I didn’t have time to convert this. [slide 11] This is red data, yield data, and not the prices, so it’s just the inverse of the last chart. So going up is bad. And as you can see … and this is the break that took place in the October problem, but now look what happened here.
The commercial real estate market has really been clobbered the first part of this year. And part of that is a realization that "oh my God, this commercial real estate market might not quite turn out to be a subprime-like, but not as good as we thought it was going to be 6 months ago."
So this is part of my theme, is that as different sectors of the market sort of hit this recession you start to get the data … people’s expectations start to go south. And that’s clearly the case in commercial real estate.
What’s next to come? …
Alex Pollock: Hey Tom … could you just go back to that chart so we could …
Tom Zimmerman: … yeah sure …
Alex Pollock: … let me just ask a question here … If we take the middle cases, which are the Single A and Double A
Tom Zimmerman: … yeah OK … single A and double A, right …
Alex Pollock: … what that says is that that’s a 25 percent spread, right? Being demanded by the market. [35:00]
Tom Zimmerman: … right …
Alex Pollock: … so we’ll roll over your real estate loan so to speak at something like 28 percent …
Tom Zimmerman: … some crazy number …
Alex Pollock: … yeah at some crazy number …
Tom Zimmerman: … right …
Chris Whalen: … this, by the way is what’s killing real estate development firms, because they can’t roll … the terms to roll are basically liquidation terms, so they liquidate instead …
Alex Pollock: OK, so we’re giving you an extra minute to make up for that interruption [laughter] …
Tom Zimmerman: … great.
Chris Whalen: … there’re not going to want to hear what I’m …
Tom Zimmerman: It just keeps getting worse ….
[laughter]
This is going down … But in any event, you know, there are other markets we all know are going to get hit pretty hard too as this recession unfolds. [slide 12] We don’t know … And the problem is we don’t know the depth of it. The credit cards are starting to get hit, autos HELOCs, etc.
A quick anecdote: we had a gal from the treasury market join our ABS research group last year, and she knew nothing about … her specialty was not consumer assets. So she came out with an article, went past any editor and it got out, and she suggested that credit card losses could hit 10 percent. Well we all went crazy because that was off the charts at that point in time. It was a really stupid thing for her to say. But now I wrote 2 weeks ago saying, "Mary Beth, good call!" [laughter -- possibly this analyst [4] ]
So this is the story, what’s … and this is what scares me about not focusing what’s going on. Because this does not get better, because each time you turn around, what you thought was your worst case scenario turns out to be the average scenario. That’s the problem.
And this thing is spreading, but now here’s the homeowner’s plan [slide 13] … How much time do I have, by the way? … 4 minutes, good, OK, we can handle the homeower’s plan in 4 minutes.
This is the Administration’s current plan. And what’s interesting is here are the previous plans … both by the Administration and by the private sector, with FHA Secure, et cetera et cetera, Hope for Homeowners, they all … none of them worked. So now we’re into the Affordability and Stability plan here.
Well, the approach is to use this carrot and stick approach. We’re going to use a carrot in this plan, and we’re going to subsidize the homeowers, the servicers, and to a minor extent investors, and what we’re going to do is we’ll say if you don’t, servicers, if you don’t modify these loans, lower the loan rate, give the homeower at break — guess what? We’re going to turn you over to the bankruptcy judge and he’s going to cram this thing down.
Well this thing’s happened to stall in the Senate. We thought this was going to roll right through. So this piece may not happen. There’s a little controversy about some breaking contracts, etc., sort of things going on, so now … but this one’s going to go ahead. This piece of it’s going to go ahead, definitely.
Now what does it do? [slide 14] It gives the servicer, the person who’s servicing your loan, $1,000 up front, $1,000 per year, that’s $4,000 over a 3 year period. What does he ordinarily make servicing these loans? About $1,000 a year. This is one hell of a … this is really a bonus to the servicer. This is good stuff, man. He’s going to modify every loan he can get his hands on. This is great.
How about the home owner. He’s going to take his DTI, which might be 45 or 40 percent down to 31 percent by reducing his loan rate. Going to drop it dramatically — I don’t know, this is only an example … $500, whatever — And also he gets some principal relief at the end of 5 years if he’s a good guy. It gets reduced.
And then, if the housing market goes up later on that’s fine, he gets all that upside if it happens. So he’s getting a benefit right now, an upside.
The investor, well he gets screwed, if you will. He’s going to end up getting … taking the brunt of most of these reductions. Although they do reduce his … the loan amount at the end of this process.
Problems with this proposal? [slide 15] Well the homeowner’s loan actually is an option-ARM. Now we all know that those things are the worst things in the world, but that’s essentially what they’re doing. They’re taking that loan rate way down for 5 years, and then it goes back up to a normal interest rate, right? So good luck 5 years from now. You want to roll the problem down the hill, so … forwards … pushing it forward, right?
Very strong incentives — oops, I’m sorry — very strong incentives for the servicer to do this, maybe even against the contract law, even against what the pooling servicing agreements might say. So look for lawsuits from the investors on this one. DTI at 31 percent for everybody? Well, if you managed to …
Alex Pollock: Could you say what DTI is, please …
Tom Zimmerman: … oh, Debt to Income, sorry, Debt to Income …
If you managed to really lie a lot on your first loan, and really are overburdened and cannot handle this, and you get your loan crammed down to your DTI — the interest rate down to the point where it’s only 31 percent, you’ve won.
The guy who only cheated a little bit lost.
So the more you outrageously were overleveraging yourself, the better you’ll be in this program.
It also rewards you if you’re delinquent. If you’re doing it by a couple of loans, a couple of dates, a couple of months, that’s great. So there is an encourage … this program encourages [40:00] you to be late on your payment, and finally, you’re going to punish the investors who … people would like to get back into the market at some point, well what you’re going to do is you’re going to discourage any investor from ever getting back into the securitized markets. Which is just in the opposite of what the … we should be trying to do.
How did the market respond to this? [slide 16] Well here’s the housing plans announced on the 18th of February. And here’s what’s happened since then. So that’s, that’s the market’s vote on how the plan might work for the investor. This is not from a servicer or from a homeowner point of view, it’s from an investor point of view.
And for the last minute — and I’m sorry I don’t have more time — this is the New New Deal, right? [slide 17] So we had the New New Thing during the Dot Com, well this is the New New Deal, right?
So, very quickly, TALF was going to be the resurrection of the securitized markets? The only problem is that … a lot of issuers that we thought were going to take advantage of this TALF program — these are people who securitized credit cards and auto loans and things like that, the problem is that through this program they’re going out into the marketplace and fund their assets at LIBOR plus 150 200 [basis points] whatever, but back here’s another program that’s still ongoing. The FDIC has a temporary liquidity guarantee program where they can go out and raise money in the capital markets with FDIC guarantee money, so why would anybody worry about TALF when the can get it cheaper up here.
So sometimes when you plan these things you’ve got to worry about unintended consequences. And that’s what’s happening here.
And finally with TARP and CAP, this whole process of how you save the banks, I’d just like to make 2 real quick points in the last 30 seconds. [laughter]
These assets are very tricky and very complicated and very convoluted and it’s not easy to deal with this stuff. They really should get the troubled assets isolated from the rest of the bank. One way or the other they can’t do this Citi BofA thing where it’s still all convoluted with the rest of the bank. It’s not going to work.
I don’t know whether you take those assets and put them in a separate fund, what you do with them. But you do not leave them inside these institutions to be dealt with. They have to be … a Good Bank / Bad Bank of some sort. I’m not sure how you fund it exactly, what you do with it, but the last thing you want to do is keep these managers — the people who created this … and their … people who work for them — to be in charge of both the Good and Bad Bank. You’ve got to separate them.
… and I’m done. [slides 18-20 not used]
Alex Pollock: Thank-you Tom. Chris. [42:40]
Notes and References
[1]: "The Deflating Bubble, Part V: Forecast and Policy Recommendations for the Next Six Months", AEI Event Homepage, March 17, 2009.
[2]: "The Deflating Bubble, Part V: Forecast and Policy Recommendations for the Next Six Months" (PDF Slide Deck), by Tom Zimmerman, AEI, March 17, 2009.
[3]: "MSNBC: Morning Joe 3/9/09 – Jack Welch says Obama Focus on one thing", posted by radiovice, YouTube, March 10, 2009.
[4]: "US SWAPS – Spreads mixed ahead of inflation data", Reuters, March 14, 2007.
"People are positioning more for PPI and CPI later in the week. We’re positioning for a steepening of the (Treasury yield) curve and that might be driving some of that. When the yield curve steepens, the swap curve also steepens," said Mary Beth Fisher, a strategist at UBS in Stamford, Connecticut.
"If they are trying to put on a 2-10 swap steepener, then they pay in 10s and they receive in 2s, which would tend to widen long-term spreads and narrow shorter-term spreads. We have seen a little bit of that trade today."
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