Mish,
lets think this thru for a minute ......
In the event of a housing collapse, what happens to interest rates?
Let us define a housing collapse as 10% or more, or do you have a higher percentage in mind?
I would like to use two types of loans to illustrate my point.
Piggyback loans that were collateralized by little or no equity to start with are now basically unsecured lines of credits with NO RECOURSE. Any default would result in 100% charge offs.
Senior liens, the 80 of 80-10-10 or 80-20, transform into 100-0. They are now at the mercy of the financial well being of the borrower. All losses will be borne by the lender from that point on, dollar for dollar.
The FNM monthly summary is a good tool for our analysis.
fanniemae.com
If you look at the table on the top right corner of page 2, "Delinquency Rates", you will see the breakdown between "Non-Credit Enhancement", which are the 80% LTVs or lower, and the "Credit Enhancement", which are loans above 80% LTV with mortgage insurance.
If real estate value is to drop 10%, would anyone venture a guess on what the delinquency rate would be for each of the categories?
Under these circumstances, what is likely to happen?
The MBS market could collapse. When the risk premium is recalulated to reflect the true cost of the bubble, I don't think anyone has enough data to quantify this premium right now. The feds are totally out of the picture, as they have no power to alter the market forces here.
Ironically, the treasuries may be stable, or even go higher (with lower yield) because it will become the safe haven once again.
The Feds may try to take short term rates down but it would be of no use. Regardless of how low short term rates are, it will only affect short term ARMs. Many borrowers, especially the ones who really need it, are not going to be able to refi to this lower rate because they now have negative equity. To refi, they may have to take money out of pocket to pay off the existing loan. This is called the cash-in refi. <gggg>
Underwriting standards will return to a more prudent level and likely overshoot on the conservative side.
As defaults go up, banks would be forced to set aside higher reserve requirements, cutting into profits as well as liquidity.
This is a pretty scary picture but we have not come close to the real scary part yet - the derivatives. With the risk carved out in such complexity, is it possible that a real estate collapse would trigger LTCM II? What if a real estate collapse would trigger a combined LTCM II and a RTC II? Would that be like Russ' trainwreck and the cargo on the train is the missing WMD from Iraq?
(How's this for a cheery Saturday morning post?) |
