Jul

10

Looking at the news today, there are several stories that reek of bearish propaganda. An article on Reuters talks about a ruthless sub-prime lender who talked a woman into signing for a mortgage as her husband underwent open heart surgery. Instead of perhaps discussing the ruthless behavior of the woman trying to get a death bed comp., the story is about the ruthless behavior of the lenders who make these high risk, high return mortgages.

Only 10% of sub-prime mortgages are apparently in arrears right now, with only 5% total under threat of foreclosure. On the other hand, how many low income families have been able to improve their status in last five years because of what this product offers? Enough to bring the home ownership rate to 70% of all families (2004), and presumably this is even higher now.

Most of the sub-prime mortgages are to low income people who would not have been able to improve their life style without the brokerage houses packaging these mortgages up, enabling all the new sub prime lenders to compete with the big banks. Just like the organized protests against fast food restaurants in fancy neighborhoods, the root cause of the trouble here is in part envy that the formerly low income people can now enjoy luxuries once reserved for those wealthier than them.

Another propaganda story for the bears is the news that Home Depot and Alcoa disappointed in early earnings reports. The hope that we will have a disappointing earnings season is always highest when the pre-earnings announcements are negative (which they have to be for legal purposes). Bear in mind that these are two companies suggesting that they may not meet expectations, amidst a sea of those that have hit or beaten their targets in each of the last twelve quarters.

The last bearish propaganda story I saw today was about Bernanke's talk today, and the fear he will talk about inflation. This is a man who wrote a Principles of Economics textbook, and chaired the Princeton Economics Department — clearly he is able to tell what inflationary expectations are from the bond rate, which is currently a little below 3%.

This orgy of negative news induced me to reduce my level of reticence, which was a naturally little high coming off a week like last week.

Thomas Miller replies:

Thank you for keeping your positive perspective, based on counting, in the current negative-news atmosphere. The bears are always trying to entice us to fall into their cesspool of negativity. We are fortunate to have a guide to help keep us out of financial danger.

Your comments on sub-prime are right on point. I know a 46 year old woman who was able to become a property owner thanks to sub-prime. She struggled to raise two straight-A students by herself. She was always a renter and would probably always be one without sub-prime loans. She is now very happy and proud, and is improving her financial situation. She will be able to refinance at a lower rate as her credit score improves.

This is what America is all about: a land where hard-working people have opportunities to improve their lot. The majority of sub-prime borrowers are like my friend. They now own property and they will do what it takes to keep it. Based on man's innate desire to improve his lot in life, the vast majority of sub-prime borrowers will not default.

Roger Arnold writes:

Congress is currently going through the process of increasing the FHA loan limits to match those of Fannie and Freddie and to increase the loan amount to up to 100% of purchase price from 97%.

That would increase the FHA loan limit about 15% from $362,790 to $417,000. That process should be completed within a few months.

They may also allow refinancing into FHA loans from non-FHA loans (now FHA loans may only be used for purchase transactions). This would allow borrowers in subprime loans to move out of the private lender space and essentially to a federally co-signed mortgage. Obviously this would also allow the holders of those loans, and the associated MBSs and CDOs to offload their risks to the federal government, thereby shunting the necessity for the normal process of defaults, foreclosures, evictions, bond market disruptions, etc.

The same is being considered for the VA loans.

The FHA and VA, however, have loan processing guidelines that are very paperwork-intensive and require lenders to be individually licensed to make FHA / VA loans.

Most lenders as a result, until recently, have avoided providing FHA / VA loans. Now, most are gearing up for these changes, educating their loan officers, going through the paperwork required to provide these loans, and creating marketing systems to go after them.

Once begun, this should alleviate much of the concerns in the sub-prime space, such as liquidity and contagion.


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5 Comments so far

  1. Leebone on July 10, 2007 1:49 pm

    Do you people live in this country? and see what is happening in streets all over?
    First of all, people are getting ripped off by lenders, here in LA area especially minorities, there are massive theft, not a fraud, occuring by independing agencies against hispanic populations, locking people up for 3~5 years for double commission, straight out theft of chunks of equity during the loan process.
    Get down from the ivory tower and smell the street, will ya?
    Oh yes, and what benefits me is fair journalism, and anything that does not is Propaganda. Right? Riiiight!

  2. Cliff Tan on July 10, 2007 4:48 pm

    The Bernanke speech in plainer English:

    Whatever else others believe, Bernanke believes the short-run Phillips Curve is flatter (cf. Greg Ip’s article in the Wall Street Journal a few months back), more powder for the view that the Fed is still on hold.

    But the Fed’s gotta remain vigilant, because they really don’t know (Victor’s remarks notwithstanding):

    1) The best measure of inflation expectations (in the past, break-even TIPs inflation displayed a seasonality, tending to rise in the first half of the year);
    2) How inflation expectations translate into price setting by businesses; and,
    3) How the public learns so as to anchor inflationary expectations.

    So Bernanke put out a research call on these topics. On (3), it’s worth re-emphasizing that Prof. Bernanke believes in central bank talk; i.e., from time to time he’s going to try to improve the public’s ability to forecast what the Fed believes about inflation (actual and target). Hence the final 15 paragraphs of details on how the Board staff forecasts inflation.

    My subjective view: When Sony cuts Playstation prices $100, I’m not too worried about inflation coming back.

  3. Paul Marino on July 10, 2007 5:15 pm

    Considering I work directly for one of the bulge bracket I-Banks in their CDS Mortgage Derivative’s department I find it amusing how little knowledge the media and the Bears actually have regarding the mortgage derivative business. The majority of these trades are amongst the Dealers, which utilize, amongst other legal clauses under the ISDA Master Agreements signed between them, the concept of having “Netting” rights between each Dealer under FASB regulation. If I owe you 200mm across a portfolio of trades and you owe me 188mm, I owe you 12mm if it so happens that a “credit event,” the trigger behind the exchange of risk payments on the contract occurs. That might cover 1bn or more worth of the Notional on the trades conducted, depending on how long into the trades they are. Trades done in 2005 already have a percentage of their original notional paid down through the monthly payments of buying the insurance to begin with. The media doesn’t discount this, only original notional matters to them.
    I advise everyone to go to the ISDA and Markit websites and read the free literature on there. If the media did, this might not be such a “Paris Hilton” type story. I am happy that my firm’s stock sold off amongst the other dealers today, given what a small percentage of revenue mortgages is at almost all of the firms, and considering that I will get to buy more stock cheaper on Friday when I deposit my 401K money for my bi-monthly dollar cost averaging.
    I also agree with Vic, wholeheartedly, that this is a zero sum game and for every BSAM fund blow-up, there is a Paulson type fund which I just read is up 130% or so for the year for doing the exact opposite of the others.
    Thanks for this site and your books and everyone who contributes here, my market knowledge increases exponentially on a daily basis.

  4. john on July 10, 2007 10:51 pm

    sure, only 10% are in arrears w/ 5% under threat of foreclosure, but they were packaged/priced/sold as if those numbers would be, i dunno, 4% and 2% respectively. in a market this size, that’s a hell of a lot of money. how is that not a problem when we’re talking about?

  5. Kenneth on July 12, 2007 5:23 pm

    If you think the source of the news is negative you should see how willingly, and quickly, the Forex message boards take the baton.

    After reading these boards on Monday evening I thought I was back in Argentina and I had the urge to scamper back to my hotel before the bank acorss the street exploded!

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