We’ve only just begun
on September 19th, 2008 at 9:53 am
I’ve had a couple of very enjoyable chats this week with Red Symons, on the ABC Breakfast Show in Melbourne, and some friends have been trying to get me to throw some old Skyhooks song lines into the conversation–such as “Horror Movie” and the like (for any non-Australian and/or non-”Living in the Seventies” readers, Red was a guitarist–and played drums on the one occasion I saw them live, at Sydney University’s Union Building in the early ’70s–and lyricist; here is a link for the lyrics).
Though they’re definitely apt, the piece of 70′s music that most came to mind when I spotted this new feature on the US Federal Reserve’s website this morning was from The Carpenters (which in contrast to The Skyhooks, was not one of my favourite bands): “We’ve only just begun“.
It’s an interactive map of the subprime and alt-A mortgage catastrophe in the United States. The numbers, which are also available for download as Excel spreadsheets, are simply staggering.
The scariest part of the data relates to what are known as ARMs (“Adjustable Rate Mortgages”)–fixed rate mortgages that began with a “teaser” low rate, and then reset after a number of years to a higher rate (the standard US mortgage is a fixed rater, unlike Australia where variable rate mortgages are the norm).
Of the almost 3 million subprime loans (the precise number is 2,919,604, representing 2.5% of America’s 115,904,641 housing units), almost 2/3rds are ARMs (the national average is 62.9%), and just over 30% of them will reset to the higher rate in the next 12 months (with another 10% to follow over the next two years).
That’s why this crisis has “only just begun”. There are two sides to this catastrophe, and whatever is done about it, one side or the other is bankrupt.
IF the ARMs go ahead, then the number of American households that will go bankrupt is at the minimum 1 million–because there’s no way these borrowers can pay the higher rate. At the simplest scale, this is because the rates will rise from an already high average rate of 8.8% to a usurious 14.8%. But on top of this, the effective rate for the loans throughout has been the higher rate–and the gap between this and the initial teaser rate was capitalised onto the debt.
So a borrower who took out a loan in 2006 of $183,900 (the average subprime loan size–note by the way how small this is compared to median Australian housing loans), and whose loan resets to the higher rate next year, will go from paying 8.8% on 183,900 to paying 14.8% on $219,200–a doubling of annual interest payment commitments, from $16,180 to $32,440.
This for a cohort of borrowers who are already massively behind on their payments–though not as massive as it will get (currently 10% are behind 30-60 days, 5% 60-90 days, 10% 90 days plus, and 11% are in foreclosure). There’s no way they can manage this: they are, as the Americans put it, “toast”.
But what if they are freed from this obviously onerous burden by legislative fiat? Then the people and institutions who bought the residential mortgage-backed securities (RMBSs) that these mortgages finance are “toast”: the bonds will be next to worthless.
And it won’t end there. After the subprimes come the “Alt-A” mortgages–ones not high enough grade to qualify as prime, but above subprime in past credit history. There are roughly 2 1/4 million of them, with much higher debt levels (average of US$321,000), lower average interest rates (6.6%), currently lower default rates (5.6%–half as many in foreclosure as the subprimes), and lower levels of arrears (just over 10% behind, versus 25% of the subprimes).
But just over half of them also have ARMs, and about half of them are scheduled to reset to a 3% higher rate in 2010 or later. By then, economic conditions will have deteriorated so much that their own finances will be “subprime” at the time, and the snowball will continue rolling down the Highway to Hell.
So We’ve Only Just Begun. And it is a Horror Movie, though not “right there on your TV”–if you’re American, you’re living in it.
And if you’re not American, then it’s still almost guaranteed that some of your investments will suffer–whether indirectly if you own shares or property, or directly if you or an agency that affects you purchased the RMBSs that funded the subprime scam. You may well wish that you were still “Living in the Seventies“.
David
““Also buying may have less loop gain than short selling”
Are you including credit expansion in the above opinion?”
No, but this and some others factors would need to be considered in a complete analysis.
Phil and David
On the question of equilibrium. From a completely engineering point of view any exponential growth is not sustainable, so economic growth is a terminal condition that is unstable. I think that for economics an exception for this could be derived from its qualitative nature.
If however the parameter can go positive and negative like the Current Account no explanation is possible. Therefore continuous CADs or CASs are definite harbingers of disaster. I started to worry about 1986. To my Engineering mind (and my son’s) the bubble started to grow in 1973 third quarter.
Phil and Brightspark,
Check out this chart of average relative pay and interesting it begins around the time of fiat money.
http://www.nytimes.com/2008/09/24/business/24pay.html?em
What I fear is the dynamics that have created these disparities will continue.
An obvious disequilibrium is credit expansion and a denial of that reality has obvious advantage to those who make use of it. I hope such initiatives of advanced physics, engineering, and hardcore mathematics and so on and a purist passion wins out in main stream economics. What my concern is is that the disequilibrium dynamic of credit expansion is not complicated of itself and if it will just become more shrouded in complex new models . I thought it was the mathematicians and physicists who have been employed creating these wonderful derivative instruments we have now.
OK, in the spirit of “Only Cowgirls Get The Blues”, it’s time to get the champagne glasses out. BrightSpark’s post was number 100 for this blog entry–a new milestone in this little discussion forum, which is now regularly attracting over 1500 readers a day.
I apologise to all and sundry that I don’t have time to take full part in the discussions, but I keep as much of an eye as I can on the contributions, and I certainly enjoy them.
All the best, Steve
Dr Keen, I have just seen on Dow Jones newsire that Mr Swan has instructed the AOFM to issue bonds in order to buy up RMBS.I find this very disturbing the market has finaly realised the debt bubble is unsustainable and rather than let whatever credit is available be allocated to more useful purpose he will ensure the housing market experiences a final terrifying blow off before the crash. Is he insane? Whatever previous govts hav done in terms of negative gearing restricting land supply etc. This is the most reckless. Is he going to provide banks with wholesale funding also when the are shut out of the U.S market in 09. How long could they keep it up with the big 4 borrowing $30B each offshore to maintain this Ponzio scheme? I would think a couple of years at best before the wheels fell off. I fear for the future.
Stephen
Stephen, this is escatly what I was referring to.
Govenments have a vested interest in keeping this mess afloat.
It’s probably passed the point where they do anything else as were all pretty much on the hook now.
Big Game Hunter,
Hyperinflation maybe the other risk and not as rare as one would think.
Hyperinflation Around the Globe: http://www.dollardaze.org/blog/?post_id=00107&cat_id=17
The dogs have been barking louder and louder for several years. Our form of capitalism relies on continuous expansion to survive. One has only to look behind the Oz immigration policy to see the motor driving the policy.
Those in charge of the US Federal Reserve and Treasury have known all along the full consequences that would result from their loose credit policy. They have for years progressively lowered interest rates and encouraged massive lending and borrowing not only in the housing market but in every sphere of available commerce, knowing that much of this credit would never be repayed.
If those making the policy didn’t know the likely consequences, they had only to look at the national and international papers and read what others had to tell them.
The questions must be asked what were/are the policy makers trying to achieve, and who were/are the real policy makers behind the scenes, and what are their motives?
Were the policies designed to allow those cashed up to reap the coming harvest as the fruit falls off the trees and/or are the policies designed to achieve the ultimate destruction of the existing world financial and monetary system?
Based on what we have witnessed, even the $700 billion bail-out proposed by the architects of the failed system will only postpone the final demise.
May be this result is inevitable.
Hi all.
I have been reading Steve’s blog and reviewing his alarming data presentations for some time, I’m no economics guru, but common sense (well that’s what it seemed like to me) told me that the economic behaviour we have been watching for perhaps the last 6-7 years was unsustainable. I was so concerned that I shifted my super to an SMF and put it in cash. Seeing potential problems, I also opted not to upgrade my lifestyle and buy a bigger house with associated debt.
Anyway, I have what is probably a very basic question which I haven’t been able to get my head around. But then none of my freinds can explain either.
From the information in this blog, I still don’t get why 3 million Sub Prime and 2.25 million Alt–A mortgages, can bring the market down, even if they were all 100% in foreclosure. As it stands 11% of Sub Prime and 5.6% of Alt-A are in foreclosure and some percentages are in default. (I understand these numbers will rise dramatically as the ARM’s kick in and the economy falters) There are nearly 116 million dwellings in the US(according to Federal bank data in one of the links, without knowing what percentage of these have mortgages.) How can such a ‘relatively’ small number of foreclosures trigger such big problems.
It would seem like the house of cards scenario, but I still don’t quite get why. My sense of it is that the Sub-prime issue is a symptom and that the overall private debt in the US is the actual problem.(and probable problem here in Aust in the not to distant future)
Perhaps somebody can clarify for me.
thanks in advance
Steve
Adelaide