Parsing the Subprime Bullshit

As a matter of proper usage, I doubt that one can parse bullshit. Bullshit, by nature, comes in big blobs of varying degrees of firmness, depending on the diet of the bull of origin, while parsing is an analytic activity. The inherent unsuitability of bullshit as raw material for logical or syntactical scrutiny is probably why it is such a commonly used mode of discourse.

Nevertheless, Michael Panzner in a post today, “Dali’s World of Finance,” served up a series of articles that embodied “humorous absurdity.” The two on subprimes, while they weren’t featured sequentially, were revealing when read in combination.

Let’s start with, “Banking Chief: Subprime Woes Relatively Few,” from the Atlanta Journal-Constitution:

The subprime mortgage market was spoiled by bad guys who tried to make a quick buck in an otherwise reputable business, John Robbins, president of the Mortgage Bankers Association, said Tuesday.

“It’s not just our reputations that have been damaged. People have been hurt. … All because of a very few unethical actors,” Robbins said in a speech at the National Press Club, where he called for tougher licensing standards.

“Frankly, it’s too easy to hang a shingle and call yourself an expert in mortgages,” said Robbins, whose trade group represents the real estate finance industry. “We need licensing of brokers, with a threshold that will weed out those unwilling to be responsible.”

But Robbins opposes any legislative attempts to outlaw subprime mortgages, which are used to help borrowers with spotty credit records or irregular income. Typically, such mortgages have provisions that keep the interest rates moving higher over time….

Robbins said he is “mad as hell” about the rash of foreclosures but insisted the industry’s problems have been exaggerated. He noted that only 5.1 percent of all U.S. homeowners have subprime, adjustable-rate mortgages. Among those, four out of five borrowers are still making their payments on time, he said.

That means the rate of foreclosures will be too small to trigger a recession, he said. “No seismic financial occurrence is about to overwhelm the U.S. economy,” he said….

Still, the solution should not be a nationwide ban, he said.

“We must find a way to prevent future abuse without eliminating subprime loans,” Robbins said. “I want you all to remember that 3 million Americans used a subprime loan to purchase a house. It is an extremely important tool for providing homeownership opportunities.”

A few quick comments: tougher licensing merely elevates training requirements and would raise average compensation by restricting entry. It will have no impact on ethics. New York State has very tough entry requirements to become a mere residential broker, yet the industry continues to have a high rate of complaints. Similarly, the executives at Enron were highly educated, and securities fraudsters (the kind that run boiler room operations) obtained licenses.

The fact that Robbins is “mad as hell” is a bad sign. Generally speaking, anger is directed outward. He isn’t blaming himself or his industry. Even if he secretly believes his cohort is blameless, a little contrition would go over much better.

And the argument that the subprime mess isn’t affecting the economy is utter garbage. Yes, it (alone) is not going to cause a recession, but my Hedge Fund Operator/Former Fed Economist colleague, who is pretty optimistic and gives credence to the less dire estimates of subprime fallout, reckons that it will take 1% off GDP for one year. That isn’t chump change.

And saying that 80% of the subprimes are current, as if that were good, is ludicrous. A 20% default rate, particularly in a low unemployment economy, is horrific.

Now to the counterpoint, “Speed of Subprime Bust Surprises Lenders,” from CNNMoney.com:

The subprime mortgage meltdown has been a shock to industry insiders, but now they say it’s hitting harder and faster than expected – even to those who predicted the crisis in the first place.

That was the message Monday from a panel of leading industry executives on the state of the mortgage lending industry at the Mortgage Bankers Association’s National Secondary Market Conference & Expo in New York.

Michael Marriott, a panelist and managing director for Credit Suisse, said, “Last October, I predicted the subprime market would collapse and many issuers would go out of business. But the violence and speed of the market sell-off surprised people.”

David Lowman, a panelist and chief executive of JPMorgan Chase & Co.’s global mortgage business, said, “35 percent of what once could be done, can no longer be done,” referring to mortgage loan products that have effectively been taken off the shelves.

And speaking separately from his Atlanta office, Duane LeGate, president of House Buyer Network, a specialist in short sales and foreclosure prevention, said one of the real estate agents he works with had six deals blow up within four days because, “The loan originator told him, ‘We’re not offering [these products] anymore.'”

According to LeGate, this kind of thing just started to happen in the past month or so.

Allen Hardester, director of business development for mortgage broker Guaranteed Rate, said many once-common subprime loans products are now almost impossible to find.

“Anything that smacks of no-income and no-documentation is history,” he said. “Anything above 85 percent to 90 percent loan-to-value, anything non-owner occupied, anything ludicrous as to value – like someone stepping up from a $1,000 a month payment to a $6,000 a month – is history.”

Lenders are also scrutinizing applications much more carefully, and many don’t like what they find.

Lowman said he had recently looked at a low-documention application for a UPS driver who earned a quarter of a million dollars last year – or so the application stated. Fictional claims, often involving outside income, are far from unusual.

“If you took into account every person with a lawn care service on the side, there wouldn’t be a blade of grass left in the United States,” he said.

Investors who buy and sell bonds backed by the mortgage payments of ordinary homeowners have seen bad loans rise and have told lenders and brokers they will no longer buy whole classes of securitized mortgages, which can quickly pull the plug on a prospective home buyer.

Lauren Pephens, managing principal of financial services advisory firm, Pephens & Co., called it the “push-down effect” at a session on loss mitigation at the MBA conference. She said that some buyers have gone to close the deal only to be told that their financing had fallen apart.

All the fudging, the lax underwriting, the push for loans that went on during the housing boom were facilitated by the rapid rise of home prices. Outsized increases in home equity in many U.S. housing markets covered a multitude of sins and encouraged lenders to extend loans to poor risk borrowers.

If an owner couldn’t afford to pay the monthly mortgage bill when her hybrid adjustable rate mortgage reset at a much higher interest rate, well, that was just fine.

Her home had gone up in value from $200,000 to $300,000 in the interim, and she could tap that extra $100,000 in home equity to pay her bills. If worse came to worse, she could sell her house at a big profit and pay off the entire bill.

But when homes became unaffordable for too many buyers starting in 2006, “The people who were driving up prices couldn’t drive them up further,” said Hardester.

The speculators, the flippers and rehabbers fled. Houses went on the market and just sat. Inventories lengthened, home builders started pulling back and foreclosures climbed.

A drop is seen before recovery
So far the turnaround on prices has not been huge – unless you compare it with what immediately came before. In 2006 the median U.S. home price rose 13.6 percent, and in 2005 it climbed 8.8 percent, according to the National Association of Realtors. Now the industry group has forecast a drop in home prices this year.

MBA’s chief economist, Doug Duncan, who was at the conference, predicted his own housing-price decline of 2.7 percent for 2007. Factoring in inflation of about 2 percent, the decline in real dollars is between 4 percent and 5 percent.

Duncan had said a recovery would begin mid-year but he’s revised that forecast, delaying his predicted rebound until the fourth quarter of 2007.

Despite their surprise at the speed and depth of the subprime meltdown, Marriott, Lowman and their fellow panelists expected a quicker recovery than Duncan.

The group, which also included Patti Cook, an executive vice president with Freddie Mac, and Thomas Lund, an executive vice president with Fannie Mae, cited a strong economy, low unemployment and favorable demographic growth for their optimistic stance that recovery will come soon.

The recovery will “play out quicker than in the past,” according to Lowman, “because [the fall] happened faster than in the past.”

Let’s look at the comments in this article that contradict what Robbins said in the preceding story. First, a lot of people saw the subprime problem coming. Second, the impact has been significant. 35% of the products being taken off the market corresponds in some crude order-of-magnitude way to the shrinkage in activity. This wasn’t just a few bad apples. This was wide-spread, out of control lending orchestrated by middlemen who had no reason to care about the long term. And you could look at the products and tell they were bad news.

Why, for example, would you ever let someone put less than 10% down? If the buyer needs to use a broker to sell the property, that’s 5-6% in fees, say 1% in legal, at least 1% to dress the place up for sale. So you are talking zero equity after transaction costs if someone had to sell. The only way that makes sense is if the buyer intends to put equity in via improvements, and the bank is being accommodating by letting him do one financing, rather than having him refinance once he has fixed up his fixer-upper.

The reason that this is general is a dopey idea is that there is no job security in the US, and that for most people, health insurance is tied to employment. Even Americans who look prosperous via having well paid jobs face the risk of sudden downward mobility, via either job loss or medical adversity. Yet in an era of stagnant incomes, weak and getting weaker labor rights, and escalating health costs, lenders were offering terms that made sense only if the borrowers faced no risks. They deserved to get their heads handed to them.

And while you have to give the MBA’s economist a wee bit of credit for predicting a meaningful price decline this year (in contrast to the National Realtors Association, which is forecasting a price drop of less than 1%). But he undoes his good karma by calling for a “hockey stick” recovery. That’s such a staple of business plans that no one gives them any credence. And, excepting Superballs, since when does a bigger splat produce a bigger rebound?