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The Next Leg Down in the Credit CrunchBy Greg McCoach | Monday, September 8th, 2008 I wanted to take some time to explain the worsening situation related to the U.S. sub prime mortgage crisis and falling real estate prices here in America... and also to detail why the prime mortgage crisis is now taking shape. I feel that it is important for all of us to understand this information because the unfolding debacle has affected—and continues to affect—our investments, including the junior mining stock market. The Genesis of the U.S. Sub Prime Mortgage Crisis
The whole crisis got its start years ago. The Asset-Backed Securities (ABS's) and Collateralized Debt Obligations (CDO) businesses were enormously profitable for Wall Street firms. To produce these products, Wall Street needed a lot of loan product. And mortgages were a quick, easy, big source.
The extreme demand for this loan product was the key driver of the decline in lending standards that began to take place in 2003 and initiated great fraud in the system.
The problem with the above scenario was that lenders cared little about who they lent to because they assumed perpetually rising home prices! But as home prices began to go south, loss severity began to take its toll and ripple through the system.
Watching the statistical data and reports lately, it is clear to me that we are still in the earliest stages of the bursting housing and credit bubbles!
If you are thinking that the worst is over or are starting to buy into the mainstream media hoax that all is well... THINK AGAIN!
The sub prime crisis here in the U.S. is just about to get a whole lot worse!
Home prices are in an unprecedented, accelerating freefall. In March, home prices fell an average of 14.4% year-on-year in 20 major metropolitan areas. Americans have lost an average 12.0% in the value of their homes in the past six months alone, and 22.6% at an annualized rate!
In the six months since March, housing prices in the United States fell at an annualized rate of more than 30% in San Diego, Miami, Las Vegas, Phoenix, Los Angeles, and San Francisco. And delinquencies and foreclosures are soaring!
The new data that's coming out keeps getting worse with each quarter by a wide margin. Advertisement
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But Forget the Sub Prime Mortgage Crisis... Watch Out For the Prime Mortgage Crisis
At J.P. Morgan Chase (NYSE: JPM), 3.5% of the bank's prime mortgages, (not subprime) were 30 days or more delinquent in the first quarter. These prime mortgage delinquencies are up 40% since December and more than 200% year-on-year.
Nearly 3,000,000 homeowners were behind on their mortgages at the end of 2007, and 1 to 2 million are at risk of foreclosure in 2008.
The data for 2009 is looking even worse... much worse. 8.8 million homeowners were underwater on their mortgages (balances equal to or greater than the value of their homes) at the end of March 2008.
70% of mortgage loans created after 2005 are underwater in this manner.
In Las Vegas alone, half of all homes sold in recent months had been in foreclosure.
The vacancy rate in American homes and condos rose to 2.9% in the first quarter of 2008, its highest level since the government began tracking this statistic. Even more alarming is the fact more than 10% of all homes built this decade (April 2000 to present) are vacant today!
Sales of existing homes are falling, which is leading to a surge in inventories while the proportion of Americans planning to buy a house is at a 33-year low.
These are not good signs for the American homeowner. And they're even worse for the banks holding vacant properties, which becomes a nightmare because of vandalism, theft of appliances, maintenance issues, pipes freezing, etc, etc.
So what about the future? The Prime Morgage Crisis: ARM Resets and The Future of Prime Lending Well, up until this point we have only seen the affects of the defaulting subprime and Alt-A loans, which have been responsible for the mortgage crisis and credit crunch. But this only represents the tip of the iceberg.
The next leg down is going to be driven by defaulting prime loans, primarily option ARMs, home equity lines of credit, and second mortgages.
For those not familiar with an option ARM, it's an adjustable-rate mortgage loan that provides the borrower with the option each month to make a fully-amortizing, interest only, or minimum payment. The minimum payment, however, is typically insufficient to cover the interest accrued in the prior month and any unpaid interest is deferred and added to the principle balance of the loan. Roughly $440 billion of adjustable rate mortgages are about to reset. Loans with teaser rates were never supposed to reset.
Based on history, both lenders and borrowers assumed that home prices would keep rising and easy credit would keep flowing, allowing borrowers to refinance before they reset. But now the mortgage market has frozen up and very few borrowers can refinance, which is leading to a greater surge in defaults, even before the interest rate resets!
Option ARM resets don't surge until 2010-2011!
As you can imagine, these kinds of loans are going to be in major trouble.
Borrowers who make the minimum payment on a regular basis can see their loan balances grow and their monthly payment more than double when they begin making payments of principle and full interest. This typically happens after five years, but can occur earlier if the amount owed reaches a predetermined level, usually 110% to 125% of the original loan balance.
Many of these option ARMs are in the housing bubble states of California, Nevada, Florida, Arizona, and Hawaii. My sense is that many of these option ARM borrowers are actually in a worse position than subprime borrowers.
This upcoming nightmare is looming in our not to distant future. It is the next tsunami to hit the housing market. This will hit the much higher priced homes as this was the product of choice used by higher income households to buy that dream home.
The worst loans are those with two-year teaser rates. They are defaulting at unprecedented rates, especially once the interest rates reset.
When you consider that it takes an average of 15 months from the date of the first missed payment by a homeowner to a liquidation (generally a sale via auction) the data clearly shows we are about to be hit with a much larger wave of this activity.
There are sobering implications for expected defaults, foreclosures and auctions towards the end of 2008, and into 2009, which promise to drive home prices down dramatically. How low they go is anybody's guess, but based on what I am seeing, we are not even close to a bottom at this point.
In many areas that were overbuilt it will probably get to the ridiculous level where you can buy a beautiful new home for pennies on the dollar from today's prices. So if you're in the market, the buy opportunity of a lifetime is coming in the next year to year and half.
Based on what we now know about the mortgage market, it looks like things could get so bad that a large scale federal government intervention is likely. This is on top of the Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) situation which congress is already wrestling with.
The tsunami gets worse when you consider that the financial firms on Wall Street and elsewhere have leveraged themselves in a massive way with derivatives to these mortgages, which many including myself have been talking about for the past several years.
The derivative time bomb that is rippling through Wall Street is absolutely frightening. We are about to see the next list of affected companies which could include the likes of Lehman Brothers (NYSE: LEH), Merrill Lynch (NYSE: MER), Bank of America (NYSE: BAC), and many more.
What we have witnessed thus far is only the warm-up for what is to come. The upcoming combination of defaulting, on the part of individuals, banks, and financial houses is as ominous as it gets. And if you think the Federal Reserve and U.S. officials are going to wave their magic wand and make all this better without any consequences, you are in for a big, nasty, surprise. The Affect on Junior Mining Shares Unfortunately, all of this is going to affect our investments. Our junior mining shares have been hit with massive selling pressures due to liquidity issues on the part of big players in our market. Other markets are being affected as well.
In my opinion, the Dow Jones is going to get clobbered, eventually making one share of the Dow equal to one ounce of gold. This ratio of one on one has happened twice throughout history and looks like it will repeat again in the coming years.
Right now we are at a ratio of 13.8 ounces of gold to buy one share of the Dow. Where the two shall meet is anyone's guess but gold will have to be much higher and the Dow will have to be much lower when that happens.
In the end, those who have little or no debt, who own gold and silver, and have positions in the quality junior mining shares should fare very well. The move to the upside in our market will gain momentum as a growing number of investors worldwide seek protection of their assets from the ongoing destruction of wealth cascading through the system.
Hang in there, our day is coming for the precious metals and junior mining shares. Greg McCoach |
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