Major Double Whammy US Ponzi Finance Blow Up Underway

Today’s post wraps up the week with bullet points and new stories supporting several themes and theories expounded here of late. Up to this fall the problem in the housing market related primarily to supply: too many speculators, and overbuilding. Now the shift is on to the ultimate Ponzi finance killer, a credit contraction affecting demand. Conditions are rapidly and clearly tightening for various “toxic” mortgages used by marginal subprime buyers to purchase housing. This would include the ability to refi into churned mortgages (same toxicity with a new term) to avoid two and three year rate resets. This churning in the past has enabled old mortgage pools such as the 2004 vintages to avoid these subprime resets deadlines. The background on this was presented in this post and developed in a good point-counterpoint in the comment section. This Ponzi, refi-before- reset ability is now coming to a screeching halt, and the signs that follow are classic indications of it.

The latest (beyond the lender shut downs reported here) on this front are that California lawmakers on Wednesday began considering restrictions on unorthodox mortgage-lending practices that have allowed hundreds of thousands of Californians to buy homes they otherwise could not afford. At minimum this indicates that the trouble in California has struck a real chord. Legislators typically don’t react to this kind of thing until the horse is well out of the barn.

Requirements are already being tightened up for subprime borrowers across the board. A friend of mine in the mortgage biz in Oregon e mailed me yesterday saying that only one in six submissions to Novastar are being accepted. The changes include:

Higher credit scores. Previously, borrowers with a FICO credit score as low as 570 (out of 850) could qualify for a single loan financing 100 percent of their home purchase, Carmona said.

“Now, across the board, it’s jumped up to a 600 FICO score for an 80/20 loan,” Carmona said, in which a second loan has to be taken out to finance the remaining 20 percent of the home value.

More stringent savings requirements. “They want to see borrowers have at least three months of reserves in their account in case of an emergency,” Carmona said.

Anecdotal comments from folks in the industry are so much more illustrative then Ministry of Truth fabrications. This one from the comment section from yesterday lends more evidence of the change:

I work for a national appraisal and title management company as an administrative qc reviewer (Appraisals). One of our consistent clients (to be un-named) would be familiar to Russ. They order hundreds of drive by appraisals on a monthly basis (bulks). It’s obvious that the appraisals are quasi audits on prior valuations that are being repackaged.

Over the last year they have become more strict on their appraisal requirements but still strive to acquire the least expensive appraisal valuation product available. This leads me to believe that they are attempting to take a closer than normal look at the actual collateral.

We have another ‘wall st’ client that is going ‘bonkers’ over appraisals and has developed a rather complex collateral cross check program that was unheard of a year ago. It’s obvious that the tide is changing.

Suddenly the biggest barrier of all for dicey borrowers are higher rates on subprime mortgages. At last a big chunk of the ice flow has broken off as the long awaited credit spread on the BBB tranches has blown out. I wrote a primer a few weeks ago on how subprime mortgage securities are structured, and you will see that I called for this to happen. Don’t think this has major ramifications for the entire $6 trillion mortgage backed securities market?

An index that measures the health of bonds backed by subprime loans, which are made to borrowers with tarnished credit histories, flashed new warning signals. The index, which measures the spread between the London interbank offer rate and the yield on subprime mortgage bonds rated BBB-minus reached a record 640 basis points on Wednesday and was trading at 625bp yesterday. The spread has widened by about 150bp in the past week.

On the same front, comes this major item on stated income (liar loan) verification, and also a very good discussion of the pitfalls unfolding for the whole $2 trillion plus subprime genre. By the way I believe that pay option negative am mortgages given to so called Alt A, midprime, and prime credits will be the biggest time bomb of all.

On October 1, 2006, the IRS updated their capacity to respond to lenders’ requests verifying borrowers’ “stated” income. In short, what used to take months to respond to will now take two days. Inside of 48 hours, the “stated” income will be verified as false. How will these people qualify then?

Even the Fed itself is getting in on the butt covering act, although punting to the states. Gee thanks for the advice sycophants, but the states are already on the scene.

Officials of the Federal Reserve Bank of Chicago called on state agencies to clamp down on lenders that make high-risk mortgage loans to people who can’t afford them. In a conference at the bank on Wednesday, Federal Reserve examiner John Taylor said states need to put more resources into examining the lending and marketing practices of mortgage brokers before a rash of delinquencies and foreclosures do severe damage to housing markets. Mortgage brokers are regulated by states, not federal agencies. “I’m very concerned that there’s a ticking time bomb in (loan) portfolios,” Taylor said.

Without much fanfare the Chinese Yuan is appreciating,. Where is Japan’s quid pro quo? Not surprisingly Treasury Secretary Henry Paulsen seemed to give Japan a pass to help his Pig Men and speculator buddies. Others are not so sanguine.

The yuan rose 0.20 percent to 7.7585 against the dollar as of 5:30 p.m. in Shanghai, its biggest advance since Jan. 17, according to the China Foreign Exchange Trade System. The currency has advanced 6.5 percent since the dollar link of 8.30 was dropped. It may reach 7.35 by the year’s end, Nizam said.

Related to the depreciation of the USD against the Yuan is a major diversification move by the Chinese. China is forming a special fund (the State Foreign Exchange Company) to manage one fifth (US$210 billion) of its forex reserves, laying the foundations of a behemoth that will handle more money than the biggest mutual fund in the world, state media said Friday.

China’s forex reserves, which are likely to swell further as China’s trade surplus with the outside world continues, are mostly invested in US Treasury bonds. Premier Wen Jiabao told last month’s financial work conference that China should “explore new means and extend channels” for the use of its reserves.

Actually this story misses a key element, as China’s reserves are invested mostly in Treasuries AND housing agencies. The price insensitive agency purchases has been a key component of the US Ponzi finance scheme. If a chunk of those flows are removed, then a critical element of the Rube Goldberg machine will be missing. One could of course argue that this will flow into some other area of the US Risklove monster like equities, but I have my doubts. Actually right now nearly every sovereign advanced, developing and emerging nation in the world is rushing long term debt financing to the market.

Meantime, governments are flooding the market for long-dated bonds; regulators are increasingly vocal about their concerns that the derivatives market is an opaque accident waiting to happen; and even some of the people who depend on the credit market to finance their businesses are hitting the klaxons.

Sovereign borrowers are being seduced into the long end as the relative cost of selling 30-year debt rather than two-year notes has melted. Two years ago, for example, Germany would have paid about 1.8 percentage points more to extend its borrowing. The average gap between two- and 30-year German government bonds was 80 basis points in the first half of 2006, and about 60 basis points for the year as a whole. Today, the relative difference is down to about 26 basis points, or hundredths of a percentage point.

Germany, Greece, Austria, the Netherlands, France, Turkey and Italy sold almost $24 billion worth of 30-year debt in January. Japan sold 600 billion yen ($5 billion) of 30-year bonds, while France also borrowed 1.2 billion euros ($1.6 billion) for 50 years.

“We expect a huge increase in 30-year European government bond issuance, up 55 percent to 66 billion euros, as finance agencies take advantage of the flat yield curve,’‘ Luca Cazzulani and Kornelius Purps, analysts at Milan-based Unicredit, said in a research report last week. “Most of that supply should be delivered during the first half of 2007.”

There’s more to come. The U.S. plans to sell $9 billion of 30-year bonds on Feb. 8 in its quarterly refunding program. The U.K. plans to issue 2.25 billion pounds of bonds repayable in 2046 on Feb. 6. Brazil plans to add to the $1.5 billion of 30- year dollar bonds it first sold a year ago, Spain is considering a benchmark 30-year bond in the first half of this year, while Greece is mulling its first 50-year bond.

Even lower-rated borrowers found long-dated debt buyers in January. Namibia sold 40 million Namibian dollars ($5.6 million) of 17-year bonds, Colombia issued 400 billion pesos ($177 million) of inflation-linked debt repayable in 2023, while Indonesia borrowed 4.8 trillion rupiah ($528 million) for 20 years.

I’m predicting that the big price insensitive bid towards the US will wane. Such a move is also in China’s geopolitical interests as it makes them a key banker to third world resource producers. China’s influence there will get a huge boost as a result, and that’s much more important than subsidizing US mortgages with fading credit quality and in a declining currency in Yuan terms. Ironically this could distort emerging market debt to US Treasury spreads even further, although I feel all these yields are going higher because of the big supply. Regardless the US is going to be the loser by default from this exercise.

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