| 20 November 2009
A recurring theme of mine has been that the housing, mortgage and credit crisis isn’t over. While panic losses are for the moment receding, the actual losses are growing and will now likely accelerate. Or, to go back to the argument I have been making for over three years now, this is not a liquidity crisis, or a panic (though these crises have raised their ugly head as well) but a solvency crisis.
The solvency crisis is not a subprime crisis, the weakest hands just folded first. It is the rest of the housing market and the debt associated with it that will see the largest losses. These defaults not only haven’t happened yet, they haven’t been marked down for the most part either. John Hussman looks at the issue from a number of different angles (my emphasis)
I've noted that we are facing a predictable second wave of defaults, based on a mountain of scheduled resets for Alt-A and Option-ARM mortgages, which began in recent weeks and will continue through 2010 and 2011. One of the counter-arguments against such concerns is the assertion that “the majority of these mortgages have already been modified.” Unfortunately, this assertion is not true. Certainly not for distressed mortgages, and not for pre-reset mortgages either (where there is absolutely no economic incentive to modify the mortgage before the reset date).
Moreover, the 2.7 million delinquent mortgages counted above were those that were already distressed early in the third quarter of this year. Many of these modifications are simply term extensions that reset the clock. A recent Fed study pointed out that only about 3% of delinquent mortgages have received modifications that would reduce their monthly payments in the first year. As noted a few weeks ago, “coupling state-by-state delinquency rates and foreclosure starts (as reported by the Mortgage Bankers Association) with other data, the Center for Responsible Lending [which correctly predicted, but slightly underestimated the size of the first wave of defaults] projects that for most states, foreclosure totals will more than triple over the coming 4 years, for a total of 8.1 million foreclosures.”
So, are the banks behaving in a way that fits that thesis?
Bloomberg reported last week that “Citigroup and J.P. Morgan Chase & Co. are hoarding cash as if another crisis were on the way.”
Notably, a week after CIT and Advanta filed for bankruptcy, Citigroup has sent letters raising the finance charge on some of its credit cards to 23.99% annually - even for creditworthy customers who pay their balances in full on a monthly basis. This is a bit of deja vu, given that Advanta did virtually the same thing in August of 2008, raising rates to 25% on its cards. This is not the type of development that encourages debt-financed economic activity (which has historically been the primary driver of early economic expansions).
Hmmm… Maybe that is anecdotal. Banks must be lending again because we keep hearing the crisis is over. Or not:
What we are looking at here is evidence that since June, not last October, not the first quarter, bank loans and leases have declined at the steepest rate of the post war era. Meanwhile , as the assertion by Bloomberg suggests, banks are hoarding cash in ever greater amounts. Any guess about why? Mine is that they believe they will need it to have any hope of staying solvent:
Source: Fullermoney
Where are the banks getting that cash? From the Federal Reserve in exchange for longer-term debt instruments, mostly mortgage-backed securities insured by…..you guessed it… Fannie and Freddie! These loans are deteriorating at a rapid rate meaning the taxpayers face further exposure from these dysfunctional behemoths. It unfortunately gets even worse for them as huge off balance sheet losses already in the pipeline have been going unreported, and that is about to change as new reporting standards are about to go into effect:
Under these accounting standards, the company will record the underlying mortgage loans in these single-family PC trusts and some of its Structured Transactions on its balance sheet. These mortgage loans have an outstanding unpaid principal balance of approximately $1.8 trillion as of September 30, 2009… While Freddie Mac continues to evaluate the impacts of adoption, the company expects that the adoption could have a significant negative impact on its net worth.”
I would think it would.
Of course, commercial real estate, home equity, credit cards and other category defaults are gaining steam as well.
No, I don’t believe the credit crisis is over at all.
So, what does that mean for investors? I would suggest that it means sustained economic growth and the associated earnings has a serious headwind.