Debtor's Prison

Greetings fellow prisoners,

Last week, the Mortgage Banker’s Association published its quarterly National Delinquency Survey, which covers 45 million homes. This report is the broadest available data on home mortgage delinquencies and foreclosures. What last week’s report showed was stunning. The reason why this matters is because US mortgage debt has always been at the epicenter of the GCC. Real losses on the underlying loans, as well as mark-to-market losses on securities backed by those loans have wrecked havoc on the financial system and caused much of the GCC. These losses continue to mount and they are a big part of the huge debt overhang that needs to correct before anything gets better. Originally, the troubles started in Residential Mortgage Backed Securities (RMBS) and indices that tracked the prices of those instruments, few people remember that this first broke out in January 2007. As the GCC progressed, those plummeting prices spread to other securities and created huge mark-to-market losses. Some people have argued tirelessly that mark-to-market losses overestimated what the real losses would end up being. As time passes, this proposition looks less and less likely. As the foreclosures rise, and the associated real losses increase banks and other investors all over the world will continue taking losses.

In Q1, a record 1.4% of homes entered into the foreclosure process, a new record, up from 1.1% in Q4 08. The total delinquency rate across ALL mortgages is at a whopping 9.2%! Take that into consideration for one second: nearly one out of every 10 mortgages is behind on the payment. To put this number into perspective, here is a chart of the total delinquency rate for the past 30 years. Truly astounding.

Initially, subprime, option ARM and Alt-A loans were the focus of the problem. However, in the last year, foreclosure rates on prime fixed-rate loans have doubled and they now represent the largest share of new foreclosures. This is troubling for a variety of reasons. For starters, it is a clear indication of the under-water problem where people find themselves owing more on the mortgage than the house is worth. This problem will only accentuate because, in case you forgot, house prices are still declining. All the silly talk about green shoots in the housing market are related to second-derivative optimism, where investors hang on the hope that things aren’t getting worse as fast as before. The fact of the matter is that they do keep getting worse. More and more people will fall under-water, greatly increasing the incentive to walk away on their mortgage and their house. Another reason why the infection of prime lending is worrying is because it might lead to losses on Agency MBS, which incorporates a lot of the prime fixed-rate market. Surely, this would spell a heap of trouble for the USD seeing as it is now backed by $1.25tr (at least) of that debt.

The chief economist of the MBA said that “until the country's employment situation improves, it's not likely that the level of mortgage defaults will begin to fall.” This is a very important statement. As we have discussed several times, unemployment is rising and showing signs of acceleration. Even Uncle Benny, a bastion of conservatism when it comes to GCC prognostication, has said that unemployment will not hit its peak until mid-2010. There is still a long way to go from here in terms of foreclosure growth. Also, don’t forget that the option ARM problem has not gone away, since the most problematic vintage was for mortgages originated in 2007. These complex mortgages have a floating interest rate that resets after two years, making 2009 the expected peak year in “bad” mortgages, those people that wouldn’t afford the home in a declining price situation. This statistical “peak” does not even take into account the “underwater” problem, which will make things a lot worse. Are you starting to get the picture?

As we saw in the US commercial banking sector, banks still hold close to $3.8tr of real state debt, about $2tr of which is residential. These are the loans that they still have on balance sheet and have surely not marked down nearly enough. This does not include their off-balance sheet assets and securities stored away as SIVs and the like. The loss on the loans themselves will definitely bring down many banks in the next two years, especially some smaller ones. As for the losses on the securities, the IMF’s latest estimate is that credit losses (in large part due to housing) will mount to $4tr when all is said and done. Of this, only about $1.5tr has been reported. Those optimists that have always claimed the mark-to-market market pricing has overestimated losses often forget the incredible amount of LAG there has been in loss reporting and loss realizing. We apologize for beating a dead horse, but we really want to stress the fact that losses stemming from the US home mortgage market keep growing at a fast rate and have much more to go.

More generally, we want to end by commenting more generally how concerned we are for the home mortgage market in terms of the USD. Over the past year, nations everywhere have been selling Agency debt and Agency MBS like nothing else. There is good reason for this; they realized the risk of holding debt in a rapidly deteriorating market that was so bloated and rotten to require years of cleansing. The only buyer of MBS now is Uncle Benny. When he made the decision to purchase $1.25tr of MBS he effectively tied the fate of the USD to the performance of the mortgage market. This was a very risky move that we think will end very badly for Uncle Benny and all of us. Perhaps it is fitting justice: the gargantuan debt overhang/imbalance that clogged the world’s financial arteries is now being absorbed into another hugely imbalanced security, the USD.

Finally, as a short administrative note, we'd like to thank our readers for another month of strong traffic growth.  We have updated our DP Demographics section, which now shows we have visitors from over 55 countries and growing!  Your referrals through other sites, forums or non-internet sources are much appreciated.  

May your capital be safe and your investments prosperous,

MAAA