Saturday, August 11, 2007

Renters of the World Unite: May Interest Rates Keep Rising!

As a renter, I'm starting to like what I'm seeing in the over-heated Western Los Angeles housing market! My question for Big Ben Bernanke regards China's foreign reserves. Suppose you were China's Secretary of the Treasury. If you stopped investing in U.S T-bills, what else could you do with your money? What risk adjusted rate of return could you earn in Africa or Europe? I'm not a great macro-economist but I wonder what would happen to U.S interest rates if China sold off a large number of the bonds it holds?

Are you convinced that there is an "externality" justification for the Fed to get involved and preempt a "liquidity crisis"?

Why didn't the government get involved and cap Los Angeles home prices at $1.5 million when they started to rise sharply over the last 5 years?


August 12, 2007
In a Spiraling Credit Crisis, Large Mortgages Grow Costly
By FLOYD NORRIS and ERIC DASH

When an investment banker set out to buy a $1.5 million home on Long Island last month, his mortgage broker quoted an interest rate of 8 percent. Three days later, when the buyer said he would take the loan, the mortgage banker had bad news: the new rate was 13 percent.

“I have been in the business 20 years and I have never seen” such a big swing in interest rates, said the broker, Bob Moulton, president of the Americana Mortgage Group in Manhasset, N.Y.

“There is a lot of fear in the markets,” he added. “When there is fear, people have a tendency to overreact.”

The investment banker’s problem was that he was taking out a so-called jumbo mortgage — a loan greater than the $417,000 mortgage that can be sold to the federally chartered enterprises, Freddie Mac and Fannie Mae. The market for large mortgages has suddenly dried up.

For months after problems appeared in the subprime mortgage market — loans to customers with less-than-sterling credit — government officials and others voiced confidence that the problem could be contained to such loans. But now it has spread to other kinds of mortgages, and credit markets and stock markets around the world are showing the effects.

Those with poor credit, whether companies or individuals, are finding it much harder to borrow, if they can at all. It appears that many homeowners who want to refinance their mortgages — often because their old mortgages are about to require sharply higher monthly payments — will be unable to do so.

Some economists are trimming their growth outlook for this year, fearing that businesses and consumers will curtail spending.

“In the last 60 days, we’ve seen a substantial reduction in mortgage availability,” said Robert Barbera, the chief economist of ITG, a brokerage firm. “That in turn suggests that home purchases will fall further. Rising home prices were the oil that greased the wheel of this engine of growth, and falling home prices are the sand in the gears that are causing it to grind to a halt.”

At the heart of the contagion problem is the combination of complexity and leverage. The securities that financed the rapid expansion of mortgage lending were hard to understand, and some of those who owned them had borrowed so much that even a small drop in value put pressure on them to raise cash.

“You find surprising linkages that you never would have expected,” said Richard Bookstaber, a former hedge fund manager and author of a new book, “A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation.”

“What matters is who owns what, who is under pressure to sell, and what else do they own,” he said. People with mortgage securities found they could not sell them, and so they sold other things. “If you can’t sell what you want to sell,” he said, “you sell what you can sell.”

He recalled that the crisis that brought down the Long-Term Capital Management hedge fund in 1998 started with Russia’s default on some of its debt. Long-Term Capital had not invested in Russia’s bonds, but some of those who owned such bonds, and needed to raise cash, sold instruments that Long-Term Capital also owned, and on which it had borrowed a lot of money.

It appears that in this case, securities backed by subprime mortgages were owned by people who also owned securities backed by leveraged corporate loans. With the market for mortgage paper drying up, and a need to raise cash, they sold the corporate securities and that market began to suffer.

The Wall Street investment banker who wanted a jumbo mortgage had a good credit score, and is not a subprime borrower. But private mortgage securities are now hard to sell, leading to his problem. In the end, he was able to get a mortgage with a lower interest rate, but it will adjust in five years, possibly to a much higher level.

The size of the rate increase he faced is unusual. But all jumbo lenders have raised rates. Bankrate.com reports that conventional 30-year mortgages cost about 6.23 percent now, less than they did a few weeks ago, due to a decline in Treasury bond rates. But the average jumbo rate is now 6.94 percent. The spread between the two rates rose from less than a quarter of a percentage point to more than two-thirds of a point.

Jumbo mortgages are most important in areas with high home prices, most notably on the East and West coasts. “In California, it has shut down the purchase market,” said Jeff Jaye, a mortgage broker in the Bay area. “It has shut down the refi market.”

The problems with subprime mortgages erupted as home prices began to slip in some markets, making it harder to refinance mortgages. There were reports that a surprisingly large number of loans made in 2006 were defaulting only months after the loans were made.

Many of those mortgages had been financed by securities, highly rated by credit agencies, that suddenly seemed less secure than they had. Hedge funds that owned those securities, and had borrowed against them, were asked to put up more money to secure their loans.

Two Bear Stearns hedge funds were forced to liquidate, and investors lost everything. Investors shied away from buying new mortgage securities, and several lenders went out of business, unable to finance the mortgage loans they had promised to make.

With the credit gears clogged, there has been a sudden lust for cash at many levels of the financial system. Last week banks in Europe and the United States tried to borrow so much money that central banks had to step in to keep interest rates from rising.

“What I suspect is that there is a demand for credit by institutions that don’t want to sell the securities they own, because the bids are so low, and the banks are extending credit to them,” said William L. Silber, a professor of economics and finance at New York University and the author of the book “When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America’s Monetary Supremacy.”

Fannie Mae and Freddie Mac, the government-sponsored enterprises, can still purchase mortgages and issue securities, guaranteeing that the underlying mortgages will not default. Those guarantees are still accepted by investors, and borrowers who meet their standards — meaning they can get so-called conforming mortgages — still can borrow. But those who want larger mortgages, or cannot make down payments, face a harder burden.

Homeowners with adjustable mortgages can refinance them at any time, so long as they qualify for a new loan, so some facing a payment increase may be able to wait it out and refinance later, if the market improves.

There have been sudden changes in the mortgage market before, but this one may be both more severe and more damaging than those in the past.

In past years most borrowers had 30-year mortgages with fixed rates. If such borrower kept his job, he usually could meet the monthly payments, even if the value of the home had declined so much that he could not et a new mortgage.

Now, however, many mortgages call for sharply rising monthly payments after a few years, and borrowers were given loans without regard to their ability to meet the higher payments. Lenders assumed the mortgage could be refinanced, and that rising home prices would assure repayment of the loan. It became common to offer homebuyers loans to finance the entire purchase price of a home.

In June, banking regulators ordered that adjustable-rate loans be given only to borrowers who could afford the rate at which it was likely to be reset, meaning that many borrowers would not qualify for refinancings even if their homes had not lost value. Such a rule three years ago might have prevented the crisis, Mr. Barbera said, but imposing it now may worsen the problem.

Investors made the mistake of assuming that housing prices would continue to rise, said Dwight M. Jaffee, a real estate finance professor at the University of California, Berkeley. “I can’t believe these sophisticated guys made this mistake,” he said. “But I would remind you that lots of investors bought dot-com stocks.”

He added, “When you are an investor, and everybody else is doing the same thing and making money, you often forget to ask the hard question.”

And that is how a problem that began with Wall Street excesses that provided easy credit to borrowers — and made it possible for people to pay more for homes — has now turned around and severely damaged the very housing market that it helped for so long.

3 comments :

Linda said...

The reasons for these subprime and jumbo mortgage crisis are varied and complex. Understanding and managing the ripple effect through the world-wide economy pose a critical challenge for governments, businesses, and investors. Due to innovations in securitization, the risks related to the inability of homeowners to meet mortgage payments have been distributed broadly, with a series of consequential impacts. The crisis can be attributed to a number of factors, such as the inability of homeowners to make their mortgage payments, especially if they have bad credit mortgage; poor judgment by either the borrower or the lender; inappropriate mortgage incentives, and rising adjustable mortgage rates. Further, declining home prices have made re-financing more difficult.

Anonymous said...

Having done some research into living conditions I have made the decision to move to the US! Apart from the medical care (which having just watched the film Sicko I am slightly concerned about) I have decided that there are more positives then negatives and am therefore very excited about the prospect of moving.
However I am concerned with purchasing a house, are mortgages over there the same as there are here? Do I need a large deposit and having spoke to a few people online I am concerned I wont be able to find a company to give me mortgage broker bonds.
and if I cant can I buy a house? Also I am familiar with the term surety bond so is a mortgage bond just a guarantee I will pay on time or is it more?

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