Jan 11 2010

The Option ARM Day of Reckoning for California is Here: 60-Month Window Opens for $134 Billion in Recasts. Why Option ARMs will hit Mid to Upper Priced Homes.

The day of option ARM reckoning is now here.  The 60-month window on many of these loans is now over and we are going to enter the first major waves of recasts.  In the next two years $134 billion in option ARMs will hit their first recast.  This might seem like a tiny amount given the massive mortgage universe but nearly 60 percent of option ARMs (of those active) are in the state of California.  An aspect that is being missed with the option ARM situation is many of these loans are situated in higher priced areas.  Many of these areas have buffered a lot of the price decline that has plagued California.  Yet that will change if early data is any indicator of where we are heading.

First, we should look at data on loan distress:

distress data

Option ARM distress levels are extremely high.  Nearly 50 percent of all option ARMs are now 30 days late.  Some of the big originators of option ARMs have changed loans into other products like interest only loans but data on this change has yet to be released.  Now California in 2009 experienced a jump in sales but many of these sales occurred in lower priced areas.  The higher priced markets stalled.  So these loans, if the distress data is any indicator, will add additional inventory in markets where prices have held better (smaller sample size).  Distress properties sell for less so this will depress prices in markets where prices have been resistant to the correction.  Part of this is the makeup of the market in which they sit.  Home owners in higher priced regions are likely to have higher buffers of capital to withstand changes in the economy.  For example someone in a subprime loan with just enough income doesn’t have the option to wait a downturn out.  Someone with money reserves can wait to see how the market will do and pull their home off the market.  This has occurred many times in California.

Yet with bank owned option ARMs, banks will sell these for what the market will take.  And in many cases, many of these loans will be significantly underwater because those that took out option ARMs elected to go with the absolute minimum payment:

option arm

So you have two things occurring here.  First, the price of the home is going down because of the California housing bubble popping.  Next, you have the actual mortgage balance increase because of negative amortization.  That is, your minimum payment doesn’t even cover the full payment so it is tacked on to the overall mortgage total.  So this has put the vast majority of option ARM holders in California underwater.  In fact, it would almost be a surprise to see someone with an option ARM in California that has equity in their home.

Yet this will depress prices because of the lack of sales in the higher priced markets.  These homes will sell for lower prices and thus hurt appraisals for those trying to sell (many of those who are holding off on selling).  At any given time you have people looking to buy and sell.  It is all a matter of price.  Right now, homes priced at the lower end are moving.  Those at the higher end, not so much.  But an increase in inventory in these areas will spur sales but hurt overall price points for many current owners.  Many are hoping for sky high bubble prices but clearly the market has changed.

Take an area like Sausalito in Marin County.  The last month of sales data shows 10 homes selling.  The median price is currently $574,000.  A few option ARM sales will start cutting into this price point.  Expect this to happen in the next few years.  This is just because most of the option ARMs are here in California:

california option arms

This is largely the next phase of the housing bubble burst in California.  The interesting thing is that while specific cities will start seeing their median price fall, the overall median price for the state may rise.  After all, the median price for the state is around $275,000 so any home that sells for more than that will pull prices higher.

If we are to look at the new option ARM map this is how it looks:

option arm chart

The lack of attention given to this nationally has more to do with the regional structure of the problem.  75 percent of these loans are concentrated in four states.  While subprime and prime issues were nationwide and still are issues, this is going to be a targeted problem with California in the crosshairs.  These loans don’t qualify for HAMP so it is really up to banks to fix this mess (or take homes back).  Wells Fargo converted many of these loans to interest only but the success data is yet to be seen.  Why anyone would continue paying on a home that is massively underwater is really a personal question, not an economic one.  The day of impact for option ARMs is now here.

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Jan 6 2010

U.S. Dollar and the 1971 Shock: How Going off the Gold Standard is now Coming Back to Harm the U.S. Dollar. The 40 Years Spending Spree.

The U.S. dollar has been on a wild rollercoaster ride for decades.  Most Americans rarely concern themselves with currency markets or larger macro economic trends.  Yet this is such an important financial area to understand since Americans are paid in U.S. dollars.  It is fascinating to understand why the U.S. went off the gold standard to begin with in 1971.  As you might suspect, we were spending more than we could afford and the Vietnam War was costing more and more money so countries like Switzerland and then West Germany were worried about being paid and converted dollars to gold as was possible then.  Inflation was rampant.  Clearly this was unsustainable yet today we have taken the game to another level.  The banking sector with no restraints was then able to print and expand as much as it needed.

The critical problems we face today stem from decades of horrible economic policy.  Let us first look at the U.S. dollar over this time period:

us dollar

It is fascinating that after we went off the gold standard, the U.S. dollar remained rather steady for the decade.  In the early 1980s the dollar strengthened but this really had nothing to do with how we were managing our budget.  This was an era when the idea of deficit spending was somehow seen as a new miracle of finance.  The corporatacracy was finally unhinged to print and spend whatever it wanted.  And many Americans didn’t argue because they now were able to go into massive debt at the expense of the world.  This system is now failing.

If we look at our Federal surplus or deficit over the years it is rather clear when this mentality took hold:

deficit

This chart is downright astonishing.  Those years of spending have now come to catch up with a tanking U.S. dollar.  Now if we couple the charts you can see how this notion exploded quickly and re-coupled:

deficit and dollar

This spend more than you earn idea worked for the first decade with no problem.  But then the entire system started re-coupling.  Americans had the illusion that things were getting better and their quality of life was improving but this was all due to massive consumer debt spending:

household debt

U.S. households took on so much debt that they reached a peak of $14 trillion.  This is made up of all things including mortgages, credit cards, student, and auto loans.  Yet that game is quickly reversing as we are seeing with the bursting housing bubble.  But were Americans really better off?  Not exactly.  Because now our employment base is being destroyed and the artifacts of wealth are being taken back by the corporatacracy since you don’t own the item until the debt is paid off.  People that thought they owned their home no longer have possession with a few missed debt payments.  Even if we look at the graph above, if our annual GDP is roughly $14 trillion American households have this much in debt!  This was clearly unsustainable.

The U.S. dollar has taken a massive beating.  The Federal Reserve is eating up toxic mortgages and trying to keep the credit bubble going.  The world by their reaction to our dollar is clearly not buying this game anymore.  The Federal Reserve cares not about the typical American.  They would be satisfied if every American was out in the street so long as their elite group of cronies was able to maximize their banking profits.  What real innovation has come from the financial sector?

Now some might be saying so what if the U.S. dollar is declining.  For most Americans however I would imagine that they would like to keep their buying power as strong as possible.  Other countries are getting stronger (China now overtook Japan as the 2nd largest economy) and are growing their middle class.  You think we’ll keep buying cheap products forever?  This is unlikely especially when other economies start creating their own internal demand.

We can thank the banking system for ripping off the country and leaving a bucket of pain with 10 percent unemployment and massive amounts of debt.  Yet somehow they are the industry that gets bailed out.

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Jan 4 2010

The 5 Percent Solution: How 5 Percent of the Workforce Generated 40 Percent of U.S. Business Profits and all of it was a Ponzi Scheme.

From 1948 to the early 1980s the financial industry in the U.S. generated from 5 to 15 percent of all U.S. business profits.  In the early 1980s this started to creep higher and higher.  It reached a triumphant climax generating over 40 percent of all U.S. profits at the height of our financial bubble.  The only problem of course is the financial sector generated the largest Ponzi scheme known to humankind.  The 2000s should go down as the decade of the Ponzi economy.  It is almost fitting that the poster child of this excess ended up being Bernard Madoff who ironically was chairman of the board for NASDAQ at one point in his career.

If we only look at the actual financial employment data we can easily see how the last decade created a culture of Ponzi employment.  While the smoke was blowing jobs were being erased off the paper of the U.S. economy.  In the U.S. we currently have 132 million people in non-farm employment.  Of this, roughly 7.7 million work in what is dubbed the “FIRE” sector (finance, insurance, and real estate).  But when we look at the profits from this industry the bubble becomes more prominent:

finance sector profits

It would be one thing if the financial sector actually produced a product.  They tried and tried to convince the public that “financial engineering” was the wave of the future.  After all, the public was able to go into massive debt to purchase homes and cars only to have them yanked away once the bubble imploded.  No need for that MBA when all that was needed was a simple signature to control hundreds of thousands of dollars.  Yet it was only on borrowed time.  Not only where the artifacts of wealth taken away from many Americans, their jobs were also disappearing.  Let us look at a few sectors:

information services jobs

The last decade was horrible for those that work in information services.  We have 20 percent less people working in this sector even though our population has added 27 million people.  Sure the tech bubble burst but the financial sector tried to convince the public that it was perfectly fine in letting good paying jobs slowly float away overseas.  After all, the financial sector was more than willing to take you on.  Apparently the core driving force of our GDP for the decade was selling homes to one another and allowing banks poetic license to create fancy Ponzi instruments to eventually implode the global economy.  Their sophistication in blinding the public got to the point where they didn’t even need to produce a product to be the top money grossing industry.  It was a casino economy.

As tough as the decade was for information service jobs, the manufacturing sector felt even more pain:

manufacturing jobs

We now have 35% less manufacturing jobs even though our population has added 27 million people.  The FIRE propaganda was that we would all be fine by simply off shoring every good producing industry in the country.  Everyone would put on a suit and sell homes to one another or bang away on a Bloomberg Terminal.  This was the new economy.  But of course anyone with an ounce of common sense realizes that a sustainable economy is both balanced in the jobs it provides to its citizens.  The FIRE economy cannibalized profits even though only 5 percent of the population works in this field.  How did this sector do for the decade?

usfire jobs

The FIRE economy still is net positive for the decade even though it is largely responsible for the credit and housing implosion that has devastated our economy.  The fact that there is no contraction in the sector over the decade should tell you something.  Did it fall from the peak?  Of course but it got to ridiculous levels.  It is the one sector where jobs are up for the decade.

This is a question we really need to examine.  Wall Street and D.C. have attempted to convince the public that bailing out the banks was the important thing to do.  But for who?  The cost has been incredibly deep and the majority of the population has seen no benefit.  But like the Wizard of Oz they tried to scare the public into handing over money with no questions asked or things would not go well.  Yet the public never wanted these bailouts.  Remember the early legislation for TARP?  The public was outraged and called up their local representatives and it was voted down.  The stock market imploded because the Ponzi game was up.  Yet it was passed anyway and not because the public wanted it.  Many politicians are simply puppets for the FIRE sector.

Most Americans probably think that these companies have their best interest at heart.  They don’t.  They are multinational.  They follow the money and it doesn’t have to be only in dollars.  Too bad for many since they are paid in dollars.  The folks at the helm of the FIRE sector have offshore accounts and move money freely across international banks.  They have no allegiance to anyone.  They are happy with slave wage labor in China so long as they have the laws of the U.S. protecting them and the wallets of American taxpayers bailing them out.

Do people still believe that the bailouts were to help the average citizen?  Just look at the above trends in employment.  It is rather clear how the decade played out.  And keep in mind things were “good” up until 2007!  The stock market peaked, housing peaked, and all was supposedly good.  But it was one giant bubble.  Yet somehow the FIRE sector has managed to keep its power and its profits incredibly high with taxpayer subsidies.  What is even more amazing is the corporatocracy has somehow managed to avoid any serious reform.

Noam Chomsky says it best:

“People cannot be told that the advanced economy relies heavily on their risk-taking, while eventual profit is privatized, and ‘eventual’ can be a long time.”

Something needs to radically change in this upcoming decade.

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