Salvador Dali was a Spanish surrealist known as much for his handlebar mustache and flamboyant personality as for his beautifully crafted representations of an alternative reality. His most famous painting, The Persistence of Memory, featured richly-hued images of melting clocks, while others offered up such visual delights as floating elephants and subjects made out of rhinocerous horns. Over time, a variation of the artist's name, Daliesque, has often been used to describe situations and settings that are no doubt real, but which nonetheless seem to belong in the realm of the humorously absurd. Below are several recent reports emanating from the financial world that seem to fit that description to a tee.
"Does Your House take Plastic?" (via The Wall Street Journal MarketBeat Blog):
We don’t really know how else to say this, so we’ll just take a straight-ahead approach: This looks like a really bad idea.
We’re talking about American Express’s plan to allow cardmembers to pay monthly mortgage bills on their American Express card. The company’s lending arm, American Home Mortgage, will be the first lender to offer the program for those with “eligible prime loans,” which at least means those with subprime credit won’t be ringing up the mortgage payment with the plastic.
This comes at a time when U.S. consumers have more debt outstanding than ever before. Homeowners’ financial obligations ratio (the percentage of income marked for mortgage, auto lease payments and consumer debt) has never been higher, at 18.2% as of the fourth quarter, according to the Federal Reserve.
The arrangement seems to be limited — it involves opening a new mortgage or refinance your mortgage with American Home Mortgage Corp. and the loan has to be a prime loan. Then you have to pay $395 to enroll in the program. The tax ramifications are as follows: mortgage interest payments are still tax deductible if you itemize, but the finance charges on the credit card won’t be.
The other issue is this: will American Home’s fees and rates be consistently competitive enough to result in enough business for Amex? Payments aren’t going to be allowed if the mortgage is through another bank.
For some consumers, such an arrangement would make sense if it’s handled properly – earning rewards on the mortgage payment, which is immediately paid off instead of getting dinged by finance charges. But the recent history of credit-card transactions (and the recent passage of bankruptcy legislation that makes getting out from under debt more onerous) suggests that, for some, this won’t work out well.
Parts of this post were written by WSJ.com Terri Cullen (the good parts).
"When it Comes to Houses, More Are Living Large" (via the Associated Press):
McMansions are sprouting in the suburbs of Washington and Atlanta, in southern Connecticut and out West in Utah as an appetite for bigger homes just keeps on growing.
One in five American houses had at least four bedrooms in 2005. That's up from one in six in 1990, despite shrinking families and increasing costs for construction and energy.
Houses with five or more bedrooms were the fastest-growing type in that time, adding to the nation's consumption of resources and reputation for excess.
"In this country, bigger is better," said Gopal Ahluwalia, vice president of economic research at the National Association of Home Builders. "This is true for houses and this is true for automobiles."
Utah leads the nation with nearly 40 percent of homes having at least four bedrooms, according to a report Tuesday by the Census Bureau. Demand is high in part because Utah has more people per household (3.07) than any other state.
Evan and Valerie Astle are having a 5,700 square-foot house built in a new subdivision near Ogden because they want more space for their three teenagers. They have been renting a storage unit while living in their old, 2,100-square foot home.
That won't be a problem in the new house, which has four big bedrooms, 3 1/2 bathrooms and a three-car garage.
"Our kids have more stuff. They need more living space," said Valerie Astle, a grade-school teacher. "Our (old) house was fine when they were small, but we've just outgrown it."
Among states with the biggest percentage of large homes, Utah was followed by Maryland, Virginia, Colorado and Minnesota. Arkansas had the smallest share, at 12.6 percent.
In much of the country, the growth in big houses is fueled by suburban homebuyers seeking luxury, rather than big families needing space, Ahluwalia said.
"They are buying for lifestyle," he said.
Nationally, the average household size has shrunk slightly since 1990, to about 2.6 people. Meanwhile, the average new house grew by nearly 400 square feet, to 2,434 square feet.
"You cannot sell a new home today with 1 1/2 bathrooms," Ahluwalia said. "Even if only two people are in house, they still want 2 1/2 to three bathrooms."
Dale Mattison, a real estate broker in the Washington area, said smaller families are getting creative with all those extra rooms. One option: his and her offices.
Some bedrooms are converted into dens, but many big houses already have those, Mattison said. They also have media rooms, which used to be called TV rooms back when there were fewer electronic devices to choose from.
Homes in the United States are much bigger than they are in other countries, according to figures compiled by the United Nations.
American homes, on average, are nearly twice as large as those in many European countries, including Britain, France and Germany. Only Luxembourg comes close among European nations, with average homes about three-quarters the size of those in the United States.
U.S. homes are also becoming more expensive. The median home value jumped more than 40 percent form 1990 to 2005, to about $167,500.
Most big homes in the U.S. are going up in the suburbs, contributing to sprawl and congestion, said Vicky Markham, director of the Center for Environment and Population.
The Washington metro area fits the national trend. About a third of all homes in the region, which includes suburbs in Virginia and Maryland, have at least four bedrooms. In the city of Washington, only 12 percent of the homes are that big.
All those big suburban houses require more land, more materials to build and more energy to heat and cool, Markham said
"Excess is a matter of how each person views their own life," Markham said. But, she added, "Each person today is taking up more resources, more land, more energy than generations before."
"Speed of Subprime Bust Surprises Lenders" (via CNNMoney.com):
The subprime mortgage meltdown has been a shock to industry insiders, but now they say it's hitting harder and faster than expected - even to those who predicted the crisis in the first place.
That was the message Monday from a panel of leading industry executives on the state of the mortgage lending industry at the Mortgage Bankers Association's National Secondary Market Conference & Expo in New York.
Michael Marriott, a panelist and managing director for Credit Suisse, said, "Last October, I predicted the subprime market would collapse and many issuers would go out of business. But the violence and speed of the market sell-off surprised people."
David Lowman, a panelist and chief executive of JPMorgan Chase & Co.'s global mortgage business, said, "35 percent of what once could be done, can no longer be done," referring to mortgage loan products that have effectively been taken off the shelves.
And speaking separately from his Atlanta office, Duane LeGate, president of House Buyer Network, a specialist in short sales and foreclosure prevention, said one of the real estate agents he works with had six deals blow up within four days because, "The loan originator told him, 'We're not offering [these products] anymore.'"
According to LeGate, this kind of thing just started to happen in the past month or so.
Allen Hardester, director of business development for mortgage broker Guaranteed Rate, said many once-common subprime loans products are now almost impossible to find.
"Anything that smacks of no-income and no-documentation is history," he said. "Anything above 85 percent to 90 percent loan-to-value, anything non-owner occupied, anything ludicrous as to value - like someone stepping up from a $1,000 a month payment to a $6,000 a month - is history."
Lenders are also scrutinizing applications much more carefully, and many don't like what they find.
Lowman said he had recently looked at a low-documention application for a UPS driver who earned a quarter of a million dollars last year - or so the application stated. Fictional claims, often involving outside income, are far from unusual.
"If you took into account every person with a lawn care service on the side, there wouldn't be a blade of grass left in the United States," he said.
Investors who buy and sell bonds backed by the mortgage payments of ordinary homeowners have seen bad loans rise and have told lenders and brokers they will no longer buy whole classes of securitized mortgages, which can quickly pull the plug on a prospective home buyer.
Lauren Pephens, managing principal of financial services advisory firm, Pephens & Co., called it the "push-down effect" at a session on loss mitigation at the MBA conference. She said that some buyers have gone to close the deal only to be told that their financing had fallen apart.
All the fudging, the lax underwriting, the push for loans that went on during the housing boom were facilitated by the rapid rise of home prices. Outsized increases in home equity in many U.S. housing markets covered a multitude of sins and encouraged lenders to extend loans to poor risk borrowers.
If an owner couldn't afford to pay the monthly mortgage bill when her hybrid adjustable rate mortgage reset at a much higher interest rate, well, that was just fine.
Her home had gone up in value from $200,000 to $300,000 in the interim, and she could tap that extra $100,000 in home equity to pay her bills. If worse came to worse, she could sell her house at a big profit and pay off the entire bill.
But when homes became unaffordable for too many buyers starting in 2006, "The people who were driving up prices couldn't drive them up further," said Hardester.
The speculators, the flippers and rehabbers fled. Houses went on the market and just sat. Inventories lengthened, home builders started pulling back and foreclosures climbed.
A drop is seen before recovery
So far the turnaround on prices has not been huge - unless you compare it with what immediately came before. In 2006 the median U.S. home price rose 13.6 percent, and in 2005 it climbed 8.8 percent, according to the National Association of Realtors. Now the industry group has forecast a drop in home prices this year.MBA's chief economist, Doug Duncan, who was at the conference, predicted his own housing-price decline of 2.7 percent for 2007. Factoring in inflation of about 2 percent, the decline in real dollars is between 4 percent and 5 percent.
Duncan had said a recovery would begin mid-year but he's revised that forecast, delaying his predicted rebound until the fourth quarter of 2007.
Despite their surprise at the speed and depth of the subprime meltdown, Marriott, Lowman and their fellow panelists expected a quicker recovery than Duncan.
The group, which also included Patti Cook, an executive vice president with Freddie Mac, and Thomas Lund, an executive vice president with Fannie Mae, cited a strong economy, low unemployment and favorable demographic growth for their optimistic stance that recovery will come soon.
The recovery will "play out quicker than in the past," according to Lowman, "because [the fall] happened faster than in the past."
"Hedge Funds 'Pose No Risk' to Financial Stability" (via Adfero):
Experts are stating that hedge funds do not pose any significant risk to the stability of wider financial markets, despite the fact that they use large amounts of money as derivatives.
According to Simon Gray of Hedgeweek fears that hedge funds could undermine other financial markets are by and large unfounded, stating that there is a level of misunderstanding surrounding hedge funds and their derivatives.
Mr Gray also highlights past occurrences of hedge funds collapsing at no detriment to other markets, even if they were worth billions.
"There've been some big hedge fund collapses over the last few years… However the world financial system carried on merrily," he explained.
"The thought is that somehow if a significant number of trades go wrong and people trading them collapse, that somehow the whole system will break down … I think the risk of derivatives is perhaps exaggerated by people who don't really understand what derivatives are used for."
Proposals under consideration by the Financial Services Authority could give private investors access to hedge funds in the UK.
"Banking Chief: Subprime Woes Relatively Few" (via The Atlanta Journal-Constitution):
The subprime mortgage market was spoiled by bad guys who tried to make a quick buck in an otherwise reputable business, John Robbins, president of the Mortgage Bankers Association, said Tuesday.
"It's not just our reputations that have been damaged. People have been hurt. ... All because of a very few unethical actors," Robbins said in a speech at the National Press Club, where he called for tougher licensing standards.
"Frankly, it's too easy to hang a shingle and call yourself an expert in mortgages," said Robbins, whose trade group represents the real estate finance industry. "We need licensing of brokers, with a threshold that will weed out those unwilling to be responsible."
But Robbins opposes any legislative attempts to outlaw subprime mortgages, which are used to help borrowers with spotty credit records or irregular income. Typically, such mortgages have provisions that keep the interest rates moving higher over time.
Because many Americans got such mortgages between 2003 and 2005, their interest rates only recently have started ratcheting higher, making mortgage payments less affordable even as home prices have flattened or fallen. This year's weak housing market is making it hard for borrowers to sell their homes or refinance, forcing growing numbers to default.
Many members of Congress have been critical of the looser lending standards that allowed subprime mortgages to proliferate.
Robbins said he is "mad as hell" about the rash of foreclosures but insisted the industry's problems have been exaggerated. He noted that only 5.1 percent of all U.S. homeowners have subprime, adjustable-rate mortgages. Among those, four out of five borrowers are still making their payments on time, he said.
That means the rate of foreclosures will be too small to trigger a recession, he said. "No seismic financial occurrence is about to overwhelm the U.S. economy," he said.
But he conceded that in certain areas, particularly Ohio, Michigan and other nearby Midwestern states, the foreclosure rate has become painfully high. That region has lost 460,000 jobs, causing its housing market to be exceptionally weak, he said.
Still, the solution should not be a nationwide ban, he said.
"We must find a way to prevent future abuse without eliminating subprime loans," Robbins said. "I want you all to remember that 3 million Americans used a subprime loan to purchase a house. It is an extremely important tool for providing homeownership opportunities."
He recounted the story of "Judy," a longtime resident of West Palm Beach, Fla., whose divorce forced her to sell her home and incur credit card debt. Traditional lenders refused to finance her attempt to get back into homeownership, but a subprime lender gave her a mortgage. After three years of prompt payments, she was able to refinance that loan, according to a trade association spokesman who said Judy is a real person whose last name can't be used.
"She rebuilt both her credit and her wealth," Robbins said.
House Financial Services Chairman Barney Frank (D-Mass.) is pushing for Congress to establish national protections for all mortgage borrowers, regardless of where they live, and establish standards to make sure borrowers can afford the mortgage payments beyond the first year.
Robbins said Congress should not rush to legislate when the market already is fixing itself, driving out those who took too many risks. For example, New Century Financial Corp. and more than 30 other subprime lenders have gone bankrupt this year.
"Many of those who most abused the system are already out of business," he said.
"Why Market Optimists Say This Bull Has Legs" (via The Wall Street Journal):
Vernon Smith, a Nobel laureate economist, is so bullish on stocks that he's put money in small drug companies -- investments he "wouldn't have touched in the late 1990s," he says. Louise Yamada, a longtime Wall Street market analyst, sees the Dow Jones Industrial Average climbing to 16000 as part of a bull market that she compares with the post-World War II boom. Fritz Meyer, who develops investment strategy for AIM Investments, a $149 billion money-management group in Houston, sees stock gains stretching as far as the eye can see.
A decade long bull market is supposed to be a once-in-a-generation rarity: There was one in the 1920s, another in the 1950s and a third in the 1990s. Historically, most bull markets have run their course in three or four years. That means, recent stock-market highs notwithstanding, the current one should be on its last legs.
But just seven years after the great bull market of the 1990s thudded to a halt, a small group of seasoned investors -- including some with no vested interest in selling stock -- believe the U.S. market is in the midst of another long period of gains.
This group of extreme optimists believes that global economic strength will keep shares rising for much longer than has been common in previous eras. Not only China and India, but also Japan, Western Europe, Latin America and other parts of Asia are feeding on one another.
Such sentiments give traditionalist investors the shivers, because they can signal that excess is percolating back into the market. Many cite Yale economist Irving Fisher, who shortly before the 1929 crash famously said, "Stock prices have reached what looks like a permanently high plateau."
"Whenever there is a market surge, people invent New Era stories to justify it," says Robert Shiller, the Yale economics professor who wrote "Irrational Exuberance," a book about the 1990s stock bubble. Prof. Shiller and other skeptics worry that the headlong profit growth and rock-bottom interest rates that have supported stocks are overdue to revert to average historical levels or worse, and that bullish investors are wrong to extrapolate them far into the future.
The dollar's sharp decline -- down 27% against the euro since early October 2002, when the current bull market began -- could also have a damping effect. If it continues to decline and erode shareholders' gains, investors could shift more heavily away from U.S. shares toward foreign stocks.
The bull cadre credits the Federal Reserve's interest-rate policy with sustaining the market advance by engineering an economic "soft landing" -- slowing growth to a manageable pace while staving off recession. When stocks began to slide in May of last year and again in February, experienced investors were surprised by the speed of their recovery, as the combination of low world-wide interest rates, tame inflation and strong profits offset the stock weakness.
This adds up to a special time in market history, says Ms. Yamada, the former head of technical research at Citigroup's brokerage arm, who now runs Louise Yamada Technical Research Advisors. Comparing the market's behavior with historical patterns -- the number of advancers and decliners, for example, or the duration and magnitude of gains -- she says that in April 2006, the market looked like it was primed to fall heavily. Instead, it bounced back before it fell as much as 10%, which she attributes to the breadth of global economic strength. "That is why I say it really is different this time," she says.
The growing market optimism helps explain the sustained rally that has driven stocks higher since last summer. The Standard & Poor's 500-stock index closed at 1524.12 yesterday, up 25% since last June and almost back to the closing record of 1527.46 of March 2000. It has surged 96% since bottoming in October 2002, having fallen 49% from its peak.
The Dow industrials, less exposed to technology stocks than the S&P 500, suffered less in the bear market and returned to record territory last October. The blue chips closed at 13539.95 yesterday, just off Friday's record of 13556.53, the 46th record close in less than eight months. But the Nasdaq Composite Index, which is dominated by technology stocks and lost the most of any major index in the bear market, would have to nearly double to return to its old record. It finished yesterday at 2588.02, a six-year closing high, but far from its March 2000 record close of 5048.62.
The current market looks different from the last big run, say those in the bull camp. It has been led by laggards of the 1990s, including energy and commodity companies. The S&P 500's approach to record territory this week has essentially been a round trip, with big stocks retracing the ground lost since the old bull market ended. Stock prices have risen less rapidly than corporate profits, meaning that the price of the overall market actually has fallen since 2000 when expressed in terms of corporate earnings, leaving the market valued just a little above its historic average.
Optimists also point out that the S&P 500 is currently trading at about 18 times its constituent companies' earnings over the past 12 months, not much above the post-war average P/E ratio of 16 and far below the high 30s, the peak during the tech-stock bubble.
Prof. Smith knows a stock bubble when he sees one, and he says he doesn't see one now.
The Persistence of Fantasy, you might say.
Hi,
It will be interesting to see how the situation in the mortgage industry will unfold in the future. The real estate industry is surely feeling the effects, and I know that it may be a while before this situation sorts itself out. I agree that subprime loans should not be banned. Instead, subprime loans should be more controlled, and all abuses should be eliminated.
Nice blog!
Posted by: Suzette West, RECS, EBA | May 25, 2007 at 03:58 AM