patrick.net

Very true. The default risks of the MBS have been replaced with the default risks of the sellers, i.e. the GSEs, which have implicit “guarantee” of the US government. Following this logic, MBS has only as much default risk as the treasury.

Yes, I'll agree with the "implicit guarantee"...... in other words, the investors assume they are safe.

http://www.federalreserve.gov/boarddocs/testimony/2004/20040224/default.htm

[snip]
The GSEs' special advantage arises because, despite the explicit statement on the prospectus to GSE debentures that they are not backed by the full faith and credit of the U.S. government, most investors have apparently concluded that during a crisis the federal government will prevent the GSEs from defaulting on their debt. An implicit guarantee is thus created not by the Congress but by the willingness of investors to accept a lower rate of interest on GSE debt than they would otherwise require in the absence of federal sponsorship.

Yes, I’ll agree with the “implicit guarantee”…… in other words, the investors assume they are safe.

The government does seem to be sending out messages to reinforce this assumption though. (e.g. regulation)

Just one thought... many believe that if housing prices fall 60% regionally we will plunge into a depression and most will end up in soup lines. I doubt this logic.

I do not recall miso soup lines in Japan a while ago.

The government does seem to be sending out messages to reinforce this assumption though. (e.g. regulation)

I do remember AG saying in one of his speeches that the FED will not be responsible for the GSE's irresponsibility in his own convoluted language.

I never saw any shantytowns when I lived there in the early years of the housing decline, but obviously things have gone downhill since then.

I am planning to go to Kyoto/Osaka in two weeks. Perhaps I will look at open houses. ;) (I have not been there for over 20 years, so I cannot possibly compare)

I’m not saying that we’ll all end up in soup lines, but I saw an interview with Donald Trump, and even he acknowleged that the effects of a RE crash could be catastrophic.

I am sure that the crash will be catastrophic, but I do not envision martial law yet. ;)

In a declining market, you might be able to pick up that reno for free.

Very true. In a strong buyer's market, such reno is nothing more than an attraction. Pergraniteel for free!

"...but this is why rehabbers look like such geniuses in this market"

Yes, this concept may be beaten to death, but thanks for the confirmation.
Many people have overspent on their homes, believing they'll see this money someday.
Maybe, or maybe not.

Pergraniteel for free!

And bowls of soup at open house!

In reality, securitizers/lenders live and die on pricing the default risk correctly.

Very true.

However, individuals within the securitizers/lenders may not align their best interests with those of their firms. Throwing in the Greenspan Put, the game is interesting again.

Risk pricing can be very interesting in the presence of intense competition of moral hazards.

Risk pricing can be very interesting in the presence of intense competition and moral hazards.

Anyone considering shorting Home Depot stock? (Not my game, just curious)

Possibly. The stock does not seem to have responded to the possible implications of the housing bubble bust yet.

(Not investment advice)

That is why it makes no sense to say that “the lenders know a lot of them will default, but they don’t have to worry”. In reality, securitizers/lenders live and die on pricing the default risk correctly.

From the same link:
http://www.federalreserve.gov/boarddocs/testimony/2004/20040224/default.htm

[snip]
Securitization by Fannie and Freddie allows mortgage originators to separate themselves from almost all aspects of risk associated with mortgage lending: Once the originator sells the loan into the secondary market, he or she may play no further role in the contract. This development was particularly important before the emergence of truly nationwide banking institutions because it provided a dramatically improved method for diversifying mortgage credit risk. Fannie and Freddie demonstrated that, by facilitating the diversification of mortgage portfolios and insisting on the application of sound loan underwriting standards, the credit risk associated with holding conforming mortgages could be reduced to very low levels and could be distributed across a wide variety and large number of investors.

notice above:

the credit risk associated with holding conforming mortgages could be reduced to very low levels and could be distributed across a wide variety and large number of investors.

The stock does not seem to have responded to the possible implications of the housing bubble bust yet.

Perhaps not, but I found a few home improvement stocks did well around the same time as the builder stocks were at an all-time high:

http://tinyurl.com/ex5ka

Wasn't July/August a peak for housing sales?

This brings up an interesting point–how much cost of improvement can be passed along in the sales price?

In a declining market, you might be able to pick up that reno for free.

This is a very interesting question, so I did a little research. The NAR/Realtor Magazine does an annual nationwide survey on this (Cost vs. Value Report), although their archive only covers the period of skyrocketing home values (2000-2004), so this may not be a good benchmark for the future:

realtor.org/rmomag.nsf/pages/costvaluedec04

Here's another good link that also covers what rennovations DON'T add much value in addition to what does:

loan.yahoo.com/m/living5.html

I don’t know what you intend to say through your quotation of the Fed statement.

H.Z.

Securitization by Fannie and Freddie allows mortgage originators to separate themselves from almost all aspects of risk associated with mortgage lending: Once the originator sells the loan into the secondary market, he or she may play no further role in the contract.

I'm not a rocket scientist, but does this statement not mean that the lender (aka mortgage originator) is not responsible for the loan once they sell it? Because if this is what it means that is why I say the lender does not have to worry.....and because of this, they have loosened their standards so it is much easier to get a loan. If this is wrong, then please explain to me what they mean.

I don’t know if anyone has posted this yet, but San Diego’s own Napoleon Bonaparte Mike Aguirre (DA) is now requiring environmental review for condo conversions. This may reduce the large supply of conversion projects in the future, although I don’t think it will be enough to patch the popping bubble.

Is he an environment fundamentalist?

"I've got mine, so screw you."

Another interesting snip from the previous link.

Indeed, in the United States, more than $2 trillion of securitized assets currently exists with no government guarantee, either explicit or implicit.

MBS holders get less yield than holding mortgages directly, in return for not being exposed to default risk (at least not for the first loss).

Exactly. One major feature is the credit enhancement.

Pricing default risk is essential for the profit (and the survival) of the GSEs and other securitizers.

Risk has a "fair" price 99.9% of the time...

H.Z.

Thank you, I do understand what you are saying and that may be true, but aside from the GSE, the lender/bank that originates the mortgage will no longer be liable for the loan once it is sold. Fannie gives the lender/bank a computer program that determines whether the borrower meets fannies (ridiculously lenient) requirements so the lender/bank can sell to fannie.......once they do, it is out of their hands. There was an article that describes this in detail and I could find if you would like. Just like with any other investment that has a potential profit, there is a risk involved and if someone is willing to buy it, they will buy the risk also.

Yes, But they’re all part of the problem.

....also don't forget about the greedy sellers that put pressure on the realtor by expecting them to get more than its worth or they'll use another realtor.

Dr. Strangelove said...

What really hit me and I thought was most interesting in my research is a quote from a warden of one of the more sizeable and violent prisons…”quantify? who needs to quantify that which is readily observed?”

I think many RE bears (myself included) are like the warden…we know through observation, rational awareness and research that the bubble simply IS. I sensed its existance quite early on, just looking at the hyperbole, ridiculous rise in prices (DOT.com anyone?) and of course–the unreal euphoric faces of those buying into this thing (at the wrong time).

Doctor...while I'd like to agree with you, and while you'll probably be proven right, this kind of thing doesn't leave room for the inevitable surprises that fill life and markets.

In Cupertino, reduced from 1,000,000 to 799,000

They still have a long way to go I'm sure.

Holy smokes, I wish I lived nearby and could learn some stuff from you.

I thought I could learn some stuff from you...

In Cupertino, reduced from 1,000,000 to 799,000

And that $1M was probably what they could've got a market top, from what I've heard about sales in the vicinity. Track that one over time and see where it goes.

Very good R Patrick....now you can work on Billys song "movin out".

Who needs a house in suburbia........Is that all you get for your money?

It may drop around 90% in your area Jack...only because you live there..........Kidding Jack...just kidding :lol: :lol: :lol:

Not quite true, many prime neighborhoods like Los Altos, Los Altos Hills, Saratoga, Monte Sereno (the prime part of Los Gatos), were all down >15% in 2001 and continued the trend well into 2003. If not for the loose credit, they would have continued their descent.

I am targeting a 40% reduction from the current price, if they don't go down that much, I stay put in my home. If they do, upgrade time.

_singing_

Who needs a house out in marin....Is that all you get for the money?

Sorry Jack.....it's the beers talkin' now. :lol:

I am targeting a 40% reduction from the current price, if they don’t go down that much, I stay put in my home. If they do, upgrade time.

What if your house drops 40%?

I predict a 99% drop in anything not built on sand.

Liquefaction is Prime

I hear Troll Brothers is throwing in a McMansion dog house for fido.....woof! :lol:

My house will drop less than the top prime areas in absolute value, because it is worth less to begin with. Also, my house a lot more potential buyers who can afford it when it drops 40% compared to say, Los Altos Hills. Therefore, for the owneroccupiers who want to upgrade to a better neighborhood or a larger home, they always hope for a big drop in the market, because the difference in price will be smaller.

Also, when the market tanks, and when I upgrade, I don't have to be locked in to a higher realty tax valuation, which was the major reason stopping me from upgrading in the last few years.

Therefore, for the owneroccupiers who want to upgrade to a better neighborhood or a larger home, they always hope for a big drop in the market, because the difference in price will be smaller.

Sure...if they have the supporting equity.

Therefore, for the owneroccupiers who want to upgrade to a better neighborhood or a larger home, they always hope for a big drop in the market, because the difference in price will be smaller.

If only the drop will be uniform...

Many subprime areas are highly infested with newly abundant liquidity...

The key is the supporting equity or savings put aside for trading up. Actually even the subprime areas can only drop so much in terms of aboslute value. Let's say you live in a 400K home, and have another 400K set aside for trading up to a 800K home. Your house can only drop to the max 400K, while in the same dire strait, the 800K home can drop easily over 400K.

As long as one has enough money set aside, it is almost always beneficial for the person trading up. I live in Los Gatos, I am sure when Los Gatos drops 40%, my target neighborhood will drop similarly, if not more in %, but definitely more in absolute value.

Actually, it is such a weird “market moment” right now that I COULD see just about ANY scenario become reality!

Jack, I'm with you on that...after slogging through market data, economist's analyses, and stories here, all I can say is we're in strange times--and whatever happens, we'll be there together (more or less).

Peter P:

You mention Home Depot… are you thinking of shorting?

I doubt that Home Depot will fall. Home improvement tends to be countercyclical to homebuilding and housing markets. It is true that Home Depot is also a bit of a mix with builder supply, but is mostly home improvement. When people can not trade up they are more likely to spend on modest upgrades to their current place. When things are tight they are more likely to do it themselves. That is precisely the sweet spot for Home Depot. Further, Bob Nardelli is a really smart guy. I would be reluctant to bet against him. I doubt that you will benefit from shorting HD.

Remember our Fannie Mae discussion… FNM had just collapsed to about $41 when we discussed that. You were considering shorting FNM. I said don’t do it. FNM immediately bounced and then rose to the high 40s and has since stabilized around $46. Any short would have been a real losing bet. I hope you didn’t do it.

Peter P:

The weak point for Home Depot is their decline in customer service quality. I am assuming that they will improve this. This issue has been festering somewhat, and is not news. If they fix it the prospects improve. This weak spot is therefore a potential source of upside.

Under the Armageddon scenario there will be very few unaffected investments. But such doomsday scenarios are farfetched.

RIC, Doubling in five years is not the norm nor the average. There are many places that have appreciated by less. The national average is still largely affordable. Over time some locations become premium priced. It is not realistic to expect the average person to be able to buy in the premium-priced areas.