When Realtors Become Waiters
If you were to ask most Wall Street analysts about the condition of the nation’s housing market, they would probably say that it is “bottoming out” or “stabilizing.” But if you were to pose the identical question to most CEOs of major homebuilding companies, they would probably say, “We have not yet seen tangible evidence of a market recovery,” just like Lennar’s CEO, Stuart Miller said on a recent conference call.
We’d like to believe Wall Street’s upbeat outlook – really, we would – but we find the first-hand accounts from the homebuilders themselves to be much more persuasive. Furthermore, the rapidly imploding subprime mortgage industry persuades us that homebuilding CEOs will not be heralding a recovery any time soon.
“Subprime” refers to borrowers with relatively poor credit – i.e., borrowers who cannot qualify for a traditional “prime” or “conforming” mortgage. Not so long ago, subprime borrowers represented a small sliver of the overall mortgage market. But during the recently ended housing boom, these borrowers came to represent a whopping 23% of the total share of new loans. [The nearby chart previously appeared in the December 22, 2006 edition of the Rude Awakening: “The Housing Crash of 2008”]
What’s bad for subprime borrowers, therefore, is bad for the entire housing market. And what’s beginning to happen to subprime borrowers – and their lenders – is quite bad indeed. These borrowers are defaulting in large numbers, while their lenders are going bankrupt in large numbers.
During previous housing booms, a buyer who could not qualify for a conventional loan could not buy a house, plain and simple. But during the boom that just ended, a relaxed, new set of lending standards emerged. Borrowers who could not qualify for a traditional loan could still obtain a non-traditional loan – i.e., a sub-prime loan.
“Thanks to relaxed lending standards in recent years,” the Dallas Morning News relates, “borrowers with bad credit – such as a bankruptcy or a delinquent loan on their record – found it relatively easy to get home mortgages.”
Unfortunately, the mortgages they got usually contained toxic features like “adjustable” interest rates that, inconveniently, would adjust higher whenever short-term interest rates moved higher – in the process raising mortgage payments to unaffordable levels. Since rates have been moving higher, therefore, at the very same time that home prices have been moving lower, many subprime borrowers are finding themselves with no way out…except to default.
Nationwide, foreclosure filings jumped 51 percent last year. In California, the epicenter of the housing bubble-cum-bust, default notices jumped 145% in the last three months of 2006. It was the largest number of default notices in any three-month period since 1998.
Therefore, as James Grant explains in a recent issue of Grant’s Interest Rate Observer, “It’s a fact of macro as well as micro significance that roughly 25% of the U.S. home-buying population can be classified as ‘subprime.'”
It is significant, says Grant, because this large contingent of marginal buyers played a major role in the powering the housing boom. If, as it now appears, these marginal buyers are disappearing, the housing market will miss them dearly.
“It was the marginal lender who financed the marginal borrower,” says Grant. “And it was the marginal borrower who stepped up to pay the extra dollar for the incremental house. Such was the way off the boom. Now, the marginal, or subprime, lender is withdrawing and so, too, is the marginal borrower.”
The marginal buyer is not withdrawing, as much as he is collapsing under the weight of unbearable mortgage payments.
“We project that one out of five (actually 19%) subprime mortgages originated during the past two years will end in foreclosure,” a December report from the Center for Responsible Lending (CRL) predicts. “This rate is nearly double the projected rate of subprime loans made in 2002, and it exceeds the worst foreclosure experience in the modern mortgage market, which occurred during the ‘Oil Patch’ disaster off the 1980s.”
Meanwhile, subprime lenders are disappearing rapidly.
In early December, Ownit Mortgage Solutions Inc., a California-based lender, went out of business. “It’s a lousy market right now,” one of the company’s loan officers complained, “and it’s heading down, not up.” Ownit was the nation’s 11th largest subprime lender. Since early December, several more subprime lenders have ceased operations.
The Mortgage Lender Implode-O-Meter is reporting “Twelve lenders have now gone caput since December 2006″. This number has been increasing at a rate of 1-2 a week since December. In early January, for example, subprime lender, Secured Funding, announced, “Based upon market conditions and limited product availability, we are ceasing wholesale operations. We have stopped accepting new applications.”
One week later, Bay Capital announced that it would be shutting its doors. One week after that, FundingAmerican announced, “Due to current market conditions in the mortgage industry, Funding America has decided to discontinue accepting any new business.”
Some subprime lenders continue to operate, of course. But the surviving lenders are issuing fewer mortgages than they used to issue.
“It’s tightening up a lot,” says Eddie Carmona, a mortgage broker who deals with subprime borrowers. “Almost every single subprime lender has done dramatic changes. It’s all recent.”
The new and improved subprime lending environment requires borrowers to have higher credit scores, make larger down payments, and possess larger reserves of savings.
But even though the lenders have closed their proverbial barn doors, the subprime horses are still running wild. And many of these wild horses will straggle back to the stable as delinquents. “[S]erious delinquencies have increased almost 50% year-over-year,” Fitch Ratings points out.
In short, the increasingly dire conditions of the mortgage industry suggest that a genuine recovery remains a delusional hope. The willingness to lend and the willingness to borrow are both in retreat. This is how cascades start. As long as the marginal borrower continues to struggle, and the marginal lender refuses to help him out, the housing market is unlikely to flourish.
Over the near-term, therefore, do not be surprised to hear an occasional California diner call out, “Hey waiter! Could we please see a menu…and a copy of your newest listings?”