Collateral, the Rest of the Story

December 12, 2006

Piscataqua Research has a new report out on the consumer crunch. It is an important read.√Ǭ†The gist of it: they estimate that in 2006, consumers used new debt to provide 90% of their cash flow for investing (mostly residential property), and debt service. In other words, it’s Minsky’s definition of a Ponzi finance scheme. They go on to suggest that in 2007 new liquidity will be nigh impossible, and will lead to a large drop in both consumption and household investment. Perhaps more signs of the times, is this bomb from Best Buy this morning. Canary in coal mine Dell cuts 30% of monitor panels orders. Nucor reports a slowdown. Which pretty much leaves Pig Man Goldman Sachs and their bonus Boyz to carry (pun intended) the economy. Or have they√Ǭ†slashed, burned√Ǭ†and gamed enough already?

Significant new consumer liquidity is impossible for two reasons. Nearly three-fourths of the total, or $7.75 trillion in US mortgage financing took place in 2004-2006. I would argue that the 2004 mortgage vintage of $2.773 trillion now has collateral at levels roughly where it started, or soon will be. Any collateral appreciation that remains is dissolving, especially in light of the developments in the subprime market, which I expect to spread to the Alt A markets. I don’t see the prime market as immune at all either, especially if a contagion breaks out in the financial sphere. The 2005 vintage of $3.027 trillion is break even at best on appreciation, and really down more like 10% as a rule. And 2006 vintage mortgages of an estimated $2.5 trillion, are almost all showing depreciation.

When Christopher Cagan of First American Title conducted their collateral survey, (link to that report) it was based on September, 2005 prices, which in my view were close to the very peak. At the time (through 2Q, 2005) Cagan estimated there were $638 billion in subprime loans with 2004 and 2005 vintages. The troubling issue now is that since the Cagan report, another $750 billion subprime mortgages were made, and it is this group, that is getting into the most visible trouble.

But, forget 06 and subprime for now, let’s just look at the 2004-2005 ARMs cohorts only. Using Cagan’s own tables, we can calculate that $1.888 trillion in those years, are using ARMs. He breaks out the equity position of those debtors in Sept. 05. A 10% drop in housing prices since that survey would push $778 billion of those debtors into no and negative equity position. In fact, nearly $500 billion would have negative equity of 10% or greater. And that’s just 2004-2005! Of course some of those ARMs may have refied this year, right? Well, given the big cash out numbers seen since, this would indicate that those serial refiers (and their mortgage holders) are even more in the hole.

Don’t think the housing market is off 10% from the fall of 05? The data being reported is suspect, but I’ve found a treasure drove that I like as a measure. Of course, conditions vary in different locales, but I feel realtor sentiment is a great indicator. Most realtors are biased, and paint a happy face on what’s happening in the field. Therefore, if a realtor survey is telling you that prices and demand are weak, it is likely an understatement. In November, realtors reported that only 14 of 53 markets showed both a demand√Ǭ†and pricing ranking above 2.5 (scale of 5.0). 27, or half the markets showed at least one demand or pricing ranking below 2.0. Although there are a lot of realtors pretending to use neutral marketing spin, one can also track their often revealing commentary, so have at it. The latest rankings are at the bottom of the city comment page. The general tenor in my view: watching paint dry in sloppy markets, and desperate to drum up activity.

Since builders tend to be realistic price setters, and new houses are relative bargains to resale housing, following that market will be illustrative as well. And given the fun I had earlier with Robert Toll’s peculiar anecdotal attempt to try and call a turn, what better way to see if this is so, but to follow TOL’s quick delivery new homes site every Monday. Plus we can gauge just how things are going in the so called largely immune higher end housing market. TOL offerings increased another three to 615 on Dec. 11th from last week.

#5 subprime purveyor, CFC, offered some more snippets about conditions in their November operational report. New pay option mortgage production (which I discussed yesterday)√Ǭ†continues to drop,√Ǭ†with $3.2 billion in new originations, versus $7.9 billion in November, a year ago. This downtrend was in effect before the spread blow out witnessed this month, suggesting thar Risklove’s appetite for those ultra lax mortgages√Ǭ†has run it’s course.√Ǭ† Foreclosures are now up to 0.60%, from 0.52% in√Ǭ†September.√Ǭ†

Ali G offers some insights to consumers, in this interview on “economics” with Dr. Schultz, advisor to Presidents.

Ali G: I sold my car in Amsterdam, for 24 chicken McNuggets.

Dr. Schultz: “Don’t be high, when your buyin’ and sellin’”

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