Altruistica

"Altruistica": Seeking a return to full financial disclosure and regulatory oversight. A financial market analysis blog for "entertainment purposes" only by an experienced CFA seeking new hedge fund engagements for investment writing and analysis. The author has experience investing internationally, running a hedge fund, making angel investments, and helping launch five startup companies. Investors should do their own due diligence.

15 January 2007

Fleckenstein Highlights Home Loan "House of Cards"


Long time market bear, Bill Fleckenstein, says that the mortgage finance bubble is now unwinding. "Fleck" warned early but correctly about the tech bubble in 1998 and 1999, and was also right about the rollover of U.S. real estate starting summer 2005. He quotes a source saying it's fraud, not to mention a complete abandonment of home lending standards, that is the trigger:
Bird's-eye view of a bitter housing brew
This week brings an update on the deterioration, via comments from two very knowledgeable friends. One of them, a former top executive at a subprime lender (whose chronicling of the unwind has been amazingly accurate and timely), told me that serious issues are developing, and that large companies like New Century Financial (NEW, news, msgs), Accredited Home Lenders (LEND, news, msgs) and NovaStar Financial (NFI, news, msgs) will, in his words, "hit the wall" very soon. He writes:

"We had a loan that was FPD (first-payment default) on a home in So Cal. It is a very nice high-end town that had a section of new homes built . . . in the low end of town. Normal homes sold for $1 million in value. In this new seven-home development, (homes) sold for $1.3 million to $1.5 million each. The homes you had to drive through to get to this place were worth $400,000 to $500,000. The market topped out, and now most of the seven homes are vacant -- worth no more than $900,000. Thus, all the lenders are sitting on losses of $400,000 to $600,000. This is just one of many that are happening daily. "The commentary I am getting from field and legit brokers is that fraud is an out-of-control locomotive. Stated-income loans are now finished for all the unemployed people around. We will quickly see cash-out loans curtailed. This vicious cycle has yet to play out. We are in the second inning of the unwinding.


Not surprisingly, financial instruments tied to over-leveraged borrowers are beginning to "blow out". The little followed ABX index tracking mortgage derivatives is signalling that the collapse is now underway:
In the beginning, there was financial darkness
I am not as sure as he is that it will take "years" to play out. The damage will last for years, but the crackup that precedes the big damage will happen this year, I think. Meanwhile, the other friend, a broker who deals in the financial dark matter universe, noted that the risky BBB-minus tranche of the June 2002 ABX.HE (a synthetic version of assets backed by U.S. home loans) just traded at a new low -- down more than eight points from early September. (For a review and the key definitions, please see my September column "Voodoo debt and the coming recession.") Its credit-default swap has now blown out to 477 basis points. Although the BBB-minus tranche is just a fraction of the $1 trillion subprime market, it seems impossible to me that a train wreck there will not have ramifications. Here is how this friend described where he thinks we are -- and what comes next:
"The subprime trade continues to evolve. Stage one was the turn in the housing market in July 2005. Ironically, stage two occurred in September 2006, a month after home builder stocks bottomed, when spreads on subprime home-equity loan securitizations started to widen. I think we are now into stage three, where some of the bigger listed subprime lenders start to get hit. That might bring the ongoing problems in subprime to a wider audience. Stage four is when a top-three-listed subprime lender goes broke, leaving various Wall St. firms saddled with bad loans. Stage five is when the market really gets it, and eurodollars (at least for a time) start to rally hard as the market fears some kind of financial turmoil. We're not there yet, as we are just now entering stage three, but do not take your eye off subprime for a second."


Russ Winter has generously documented in the Wall Street Examiner the sub-prime disaster that the Fed should be doing something about now; rather than just pumping liquidity into the bubble.
What the Riskloves haven’t quite looked at or even remotely addressed are late 2004 and 2005 vintage loans with a toxic demeanor. As mentioned the 2006 subprime market is large, and conditions in that vintage are worsening quickly. The next chart shows the amounts involved in the last three years with this genre. Subprime made up 25% of the total mortgage market in 2005 and 2006, and about 20% in 2004. Indeed 93% of all subprimes in 2005 were purchase originations (see second chart). That’s $665 billion worth, pretty much the whole blue block in the chart, and ditto for 2006. Poo poo it if you must, but there were about $1.9 trillion subprimes originated in 2004-2006. Add in a trillion in second mortgage HELOCs and lord knows how many midprime and/or Alt A pay options, and you have ground zero for a credit bust of biblical proportions.

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