Settle down, Chicken Littles!

Lately we've been warned about a possible "financial collapse" related to the housing market that will mean another "Depression" and a steady decline in the U.S. standard of living (not to mention torturous declines in housing prices nationwide).

Or maybe not.

Writing in his blog, Dr. George Friedman (Founder and CEO of Stratfor, a consulting firm providing intelligence on global economic, political and security issues) argues that today's interlinked global economy will likely prevent any Depression-style meltdown in the U.S. economy.

While this is a lot to copy over, his points are made so well that I think they must be shared as much as possible, although I highly recommend reading the entire blog entry.

Given the broad belief that the subprime crisis is only the beginning of a general financial crisis, and that the economy will go into recession, we would have expected major market declines by now. Markets discount in anticipation of events, not after events have happened. Historically, market declines occur about six months before recessions begin. So far, however, the perceived liquidity crisis has not been reflected in higher long-term interest rates, and the perceived recession has not been reflected in a significant decline in the global equity markets.

When we add in surging oil and commodity prices, we would have expected all hell o break loose in these markets. Certainly, the consequences of high commodity prices during the 1970s helped drive up interest rates as money was transferred to Third World countries that were selling commodities. As a result, the cost of money for modernizing aging industrial plants in the United States surged into double digits, while equity markets were unable to serve capital needs and remained flat.

So what is going on?

Part of the answer might well be this: For the past five years or so, China has been throwing around huge amounts of cash. The Chinese made big, big money selling overseas — more than even the growing Chinese economy could metabolize. That led to massive dollar reserves in China and the need for the Chinese to invest outside their own financial markets. Given that the United States is China’s primary consumer and the only economy large and stable enough to absorb its reserves, the Chinese — state and nonstate entities alike — regard the U.S. markets as safe-havens for their investments. That is one of the things that have kept interest rates relatively low and the equity markets moving. This process of Asian money flowing into U.S. markets goes back to the early 1980s.

Another part of the answer might lie in the self-stabilizing feature of oil prices, the rise of which should be devastating to U.S. markets at first glance. The size of the price surge and the stability of demand have created dollar reserves in oil-exporting countries far in excess of anything that can be absorbed locally. The United Arab Emirates, for example, has made so much money, particularly in 2007, that it has to invest in overseas markets.

In some sense, it doesn’t matter where the money goes. Money, like oil, is fungible, which means that if all the petrodollars went into Europe then other money would flow into the United States as European interest rates fell and European stocks rose. But there are always short-term factors to consider. The Persian Gulf oil producers and the Chinese have one thing in common — they are linked to the dollar. As the dollar declines, assets in other countries become more expensive, particularly if you regard the dollar’s fall as ultimately reversible. Dollars invested in dollar-denominated vehicles make sense. Therefore, we are seeing two massive inflows of dollars to the United States — one from China and one from the energy industry. China’s dollar reserves are derived from sales to the United States, so it is stuck in the dollar zone. Plus, the Chinese have pegged the yuan to the dollar. The energy industry, also part of the dollar zone, needs to find a home for its money — and the largest, most liquid dollar-denominated market in the world is the United States.

In other words, the combination of the rise of China and higher oil prices may actually help soften the blow from the mortgage meltdown by stabilizing both the dollar and the economy. Very interesting...

Analyzing the Fed Bailout

I think the Federal Reserve should have to obey the same motto taught in medical school: Primum non nocere, or "First do no harm." While this saying is not technically included in the Hippocratic Oath, perhaps the Fed could launch its own "Hypocratic Oath," in which its moves should not be seen as nakedly political maneuvers.

I say this because some analysts believe that the Fed's latest move to shore up global liquidity may actually prolong the mess that has to be cleaned up by allowing the market to mop up its excess inventory. Senior Fortune magazine writer Peter Eavis explains:

The potentially dangerous aspect of the TAF is that it will allow banks with problems to borrow their way out of trouble, rather than by taking measures like issuing large amounts of stock to bolster their balance sheets. Struggling banks are struggling chiefly because they were mismanaged and wrote too many risky loans when credit was cheap. The TAF potentially gives mismanaged banks even more cheap credit, which will delay a much-needed restructuring of the banking sector. Nervousness about banks could then deepen, leading to even fewer loans being made. One of the big lessons of the credit crunch is that overly cheap credit causes massive harm to the economy in the long run. The TAF suggests that the Fed still hasn't learned that.

I remember back in 2005 when I was trying to explain -- at least to those who would listen -- that a housing price bubble was simply a symptom of a worldwide credit bubble. In other words, there was too much money sloshing around looking for the best return -- in this case, subprime, Alt-A and other adjustable mortgages. Around the same time, I noted that Congress had made it much more difficult for individuals to file for Chapter 7 bankruptcy, potentially leaving many on the hook for homes even though they long ago parted with the keys, and minimum payments on credit cards doubled from 2% to 4%.

I guess I'm just surprised at all the surprised looks out there...

HousingTracker Stats for California

I think the HousingTracker website is useful because it regularly updates asking prices and inventory for various metro areas. So for 12/10/07, here's how the various metro areas of California look:

Los Angeles (median prices stabilizing, inventory declining last 3 months):

Trend	12/10/2007	1 month	3 month	6 month	12 month
Median Price	$498,900	-0.2%	-4.1%	-7.6%	-9.3%
Inventory	44,715	-3.8%	-3.7%	+9.7%	+27.5%

Of course that probably just means buyers are taking their homes off the market and waiting for a better day; this time of year is almost always very slow for real estate sales (last year was an exception).

Orange County (prices still falling, inventory falling last 6 months):

Trend	12/10/2007	1 month	3 month	6 month	12 month
Median Price	$575,000	-2.5%	-5.7%	-10.9%	-11.5%
Inventory	17,825	-5.3%	-8.4%	-4.7%	+20.6%

Same story as L.A.; buyers waiting (at least for now) for a better day to sell.

Riverside (prices still falling, inventory falling last 3 months):

Trend	12/10/2007	1 month	3 month	6 month	12 month
Median Price	$355,900	-3.6%	-7.6%	-11.9%	-15.3%
Inventory	52,474	-2.8%	-7.3%	+3.9%	+26.8%

This is really the market to watch next year: inventory up by 27% over the last year, median asking prices down by 15%; the recent inventory declines are likely due to buyers pulling their listings off the market.

San Diego (prices still falling, inventory falling last 3 months):

Trend	12/10/2007	1 month	3 month	6 month	12 month
Median Price	$456,900	-2.4%	-6.6%	-8.6%	-13.0%
Inventory	20,403	-3.9%	-7.2%	+1.2%	+14.1%

Still a very challenging market, although San Diego may improve before other areas of California because it was the first to join the boom.

San Francisco:

Trend	12/10/2007	1 month	3 month	6 month	12 month
Median Price	$549,950	-3.5%	-6.8%	-8.3%	-12.0%
Inventory	16,864	-8.6%	-9.8%	+3.0%	+36.0%

San Jose:

Trend	12/10/2007	1 month	3 month	6 month	12 month
Median Price	$624,889	-2.3%	-5.3%	-8.1%	-10.5%
Inventory	7,369	-5.4%	-7.5%	+10.0%	+55.0%

Sacramento:

Trend	12/10/2007	1 month	3 month	6 month	12 month
Median Price	$338,500	-3.0%	-8.6%	-14.9%	-17.4%
Inventory	16,569	-5.5%	-10.5%	-3.6%	+16.6%

And, just for fun, let's see how Las Vegas and Phoenix are doing:

Las Vegas:

Trend	12/10/2007	1 month	3 month	6 month	12 month
Median Price	$289,900	-2.7%	-5.6%	-9.4%	-11.9%
Inventory	29,115	-2.1%	+1.5%	+5.6%	+27.4%

Phoenix:

Trend	12/10/2007	1 month	3 month	6 month	12 month
Median Price	$279,000	-0.4%	-3.8%	-8.5%	-11.4%
Inventory	49,445	-1.2%	+1.7%	+7.2%	+26.4%

Potential widespread fraud behind the mortgage meltdown?

From Sunday's San Francisco Chronicle is an opinion piece by a local attorney who claims that none of the remedies set forth by either the Bush Admin. or those running for President will amount to much. That's because:

The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value - right now almost 10 times their market worth.

The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process...

The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC...

We are on the cusp of a mammoth financial crisis, and the Federal Reserve and the U.S. Treasury are trying to limit the liability of their banking friends under the guise of trying to help borrowers. At stake is nothing short of the continued existence of the U.S. banking system.

Oh, my.

Now I have to admit that this is a very well-written article and lays out some important points. There are some folks (such as Bruce Norris, speaking at tomorrow's sold-out Real Estate Research Council lunch at Cal Poly Pomona) who think that 2008 will be even worse than currently predicted (and for the low, low price of $4,000 he'll teach you how to benefit!). But I like Bruce -- he's a straight shooter and has been proven right before on some prior predictions and usually makes a good case for his ideas.

Subprime loans only the first to default?

As also noted in the L.A. Land blog, it seems that defaults in the subprime mortgage sector are only the first wave of others to follow. According to a mortgage insider named Mark Hanson who regularly emails Herb Greenberg, a blogger on mortgages for MarketWatch:

The Government and the market are trying to boil this down to a ’sub-prime’ thing, especially with all constant talk of ‘resets’. But sub-prime loans were only a small piece of the mortgage mess. And sub-prime loans are not the only ones with resets. What we are experiencing should be called ‘The Mortgage Meltdown’ because many different exotic loan types are imploding currently belonging to what lenders considered ‘qualified’ or ‘prime’ borrowers. This will continue to worsen over the next few of years. When ‘prime’ loans begin to explode to a degree large enough to catch national attention, the ratings agencies will jump on board and we will have ‘Round 2′. It is not that far away...

Sub-prime aren’t the only kind of loans imploding. Second mortgages, hybrid intermediate-term ARMS, and the soon-to-be infamous Pay Option ARM are also feeling substantial pressure. The latter three loan types mostly were considered ‘prime’ so they are being overlooked, but will haunt the financial markets for years to come. Versions of these loans were made available to sub-prime borrowers of course, but the vast majority were considered ‘prime’ or Alt-A. The caveat is that the differentiation between Prime and ALT-A got smaller and smaller over the years until finally in late 2005/2006 there was virtually no difference in program type or rate...

To get housing moving again in Northern California, either all the exotic programs must come back, everyone must get a 100% raise or home prices have to fall 50%. None, except the last sound remotely possible.

Personally, I always thought a good rule of thumb was to (a) multiply your income by 3 and then (b) multiply that total by .8 to figure out what you could comfortably afford in a home purchase. Sure, that could mean a condo or a townhome or a single-family home in a borderline area instead of a detached home in a nice neighborhood, but why not befriend people with the yards and just bring a nice bottle of wine?

Subprime Mortgage Crisis vs. the S&L Meltdown

I remember the dark days of the S&L crisis well; in fact, before becoming a real estate market analyst my first job out of college was working for the long-defunct Imperial Savings & Loan in the Treasury Department. I was put in charge of ensuring that the value of the company's $1.3 billion in mortgage-backed bonds, other CDOs (including car loans) and commercial paper would remain high enough to avoid defaulting on various collateralized loan covenants (including the lease on the company's HQ in San Diego). "Marking to market" (i.e., obtaining the current value of the securities) was a mess even back in those days, especially since we were coming up on the market bust of 1987. It was really due to the opacity of the securities industry that I decided to enter the "tangible" world of real estate -- just in time for the boom and bust cycle of the late 1980s and early 1990s!

Today's Wall Street Journal has an excellent story comparing the current mortgage & liquidity crisis with the infamous S&L meltdown of the late 1980s as well as the stock bust of 2000-2002. With separate interviews with George Soros, Paul Volcker (Fed Chair before Greenspan), William Seidman (former FDIC chief) and Robert Shiller (Yale professor and co-architect of the Case-Shiller index), the sheer complexity of financial instruments backed by mortgages makes it difficult to predict the eventual outcome, although so far it hasn't risen to the level of losses experienced during the stock bust of 2000-2002 (see table above).

In some ways, the S&L bailout was simpler because the players were known, but this case is much different. While the shifting of risks from banks to securities markets has helped fuel global growth of mortgages and other types of lending, it's not yet been tested for what former Fed Chair Volcker calls a "major-league crisis." Explains the article:

Mortgages today are dispersed among banks as well as more than 11,000 investment pools, each of which may have hundreds, if not thousands, of investors. Many of those pools have been further repackaged into specialized funds known as structured investment vehicles and collateralized debt obligations, or SIVs and CDOs -- each of which have their own investors. That makes determining who owns the securities, what they are worth and the nature of the underlying collateral a tricky process.

David Barse of Third Avenue Management LLC, a New York investment firm specializing in distressed companies, is steering clear of CDOs for now. He says he would need to hire new experts just to figure how much they are worth. "We don't have the analytical systems to break them down," he says.

Indeed, coming up with a value for a CDO entails analyzing more than 100 separate securities, each of which contains several thousand individual loans -- a feat that, if done on any scale, can require millions of dollars in computing power alone.

This is also why the three band-aid approaches provided by the government -- including (a) the two recent rate cuts and the one expected tomorrow, (b) the now-apparently imperiled "super fund" created by banks to create a ready market for mortgage-backed securities, and (c) freezing interest rates on *some* subprime loans (can you say "political?") -- may not be of much use in the short term.

Many analysts think that the U.S. government intervening in private markets sets a bad precedent and may constrict future mortgage liquidity, although columnist Lou Barnes makes a case for protecting unsophisticated borrowers from modern-day loans sharks.

I'd expect this entire situation -- and its solutions -- to slowly play out throughout 2008 and into the first part of 2009.

Construction Loans Souring Next?

A story set to run in Saturday's New York Times tells us that we're moving towards Stage 2 of this housing downturn: construction loans in peril.

Says the article:

Figures compiled by the Federal Deposit Insurance Corporation and released last week show that both midsize and small banks had construction loans outstanding that were greater than their total capital. A decade ago, such loans were equal to only a third of capital for those banks.

For most of this decade, that was a good strategy. Construction loans proved to be very profitable, particularly for smaller banks as competition from larger banks and securities markets eroded their position in areas like mortgage lending and credit card issuance.

Now, however, more than 3 percent of all construction loans are classified as being nonperforming, or have borrowers that are behind on their payments. That is the highest proportion in a decade.

In the real estate market research game, this is fairly typical: first sales slow, and we don't have a lot to do because builders start to put plans for new projects on hold and it's mostly about working on mixed-use, infill or non-residential projects or helping residential builders get a sense of incentives, price reductions, and what works in today's market to move product. This is a good time for us to take a vacation and catch up on long-delayed visits to the doctor and dentist (I even got an orthodontist!).

Stage 2 is more about focusing on existing projects that are not performing well at the behest of investors, partners and lenders, but this is an important stage because it helps us set the new pricing models that will absorb inventory. Stage 2 is also when some land sellers who've been sitting on the sidelines (and watching the recent Lennar land sales) may have trouble holding on, depending of course when they bought their land, how much they paid and the extent of their resources to stay in the game.

I'd expect Stage 2 to start gaining momentum after the holidays, because given the slow torture of how Stage 1 has played out over the past 15-18 months, many would like to see the market take care of itself sooner rather than later.

How ironic would it be if the supply side of building homes (i.e., construction lending) took care of itself by letting the market make its own corrections vis-a-vis oversupply and soured loans while the demand side (i.e., mortgages) is delayed so politicians get *some* voters to believe that their fixes will actually help?

Now that we've got THE PLAN, who will help the sub-primers?

Uh-oh. Looks like after all of the back-and-forth before President Bush announced his plan (and who benefits is not clear) to help *certain* sub-prime borrowers stay in their homes, there may not be enough counselors to help them out. Apparently most of these non-profit counseling centers don't really pay very well, so those potential experts who really know the mortgage business wouldn't be interested in the gig (although after reading reports of former loan brokers working in retail shops, who knows?).

Beware the angry renters -- they vote too!

Ah, politics. Just when Bush, Clinton, Edwards, etc. think they've got a solution (meaning votes) to the sub-prime mortgage mess, now the renters want a voice, too! It seems that many have been waiting for home prices to deflate so they can jump in, but are now concerned that the Bush deal (which will actually only help a small fraction of over-their-head buyers) will make that impossible.

To them I say, "be patient, don't worry; this is an election-year ploy that will only postpone the pain!" (not to mention dramatically dry up the demand for future mortgage securities), but I can understand their anger that it always seems like it's the flakes in life who are bailed out (like the alcoholic sister-in-law or the child who can't seem to keep a steady job).

According to an article in the Wall Street Journal, "Milton Ezrati, market strategist with money-management firm Lord Abbett & Co., says the plan could undermine the market for mortgage-backed securities. Investors may say, 'if you can interrupt my cash flow today, you can do it tomorrow,' says Mr. Ezrati."

Meanwhile, those who bought homes under the old rules (meaning 5-20% down payments and providing complete documentation to loan underwriters) and those who've been waiting to responsibly buy a home -- and whom I'm sure will also vote in large numbers (part of that responsibility ethic) are just beginning to shout. It's also been topic #1 on local talk radio. But will they be heard?

How to get a great headline? Predict housing prices falling by 30%!

I have to hand it to the PR folks over at Moody's Economy.com, because Mark Zandi has become a true king of the press quote. Now they're predicting a 12% decline in overall prices from peak to trough by early 2009 (over 15% when concessions/incentives are factored in), with even larger declines in places like Stockton (over 30%).

Want to read the report yourself? You can buy it for the low, low price of $3,995!

Generally, such press releases include some more detail on specific areas, but not this time (I'm hoping it magically appears somewhere in the Internet once it's released, or that they provide some summary tables so we can compare different metro areas).

It also doesn't discuss their methodologies; I don't think we should have to pay $4k for a report just to see whether or not their calculations make sense. And frankly, I wish reporters would delve a little deeper in these methodologies before running a headline that's only going to further fuel the politically motivated 'solutions' to this issue.

I'm hoping for some objective analysis by someone who doesn't work at Moody's once the report has been released.

Why it's always important to read the fine print.

There are few things more boring to read than mortgage documents (although the plain toast-dry textbook in my first microeconomics class would be a contender -- why do they always use 'widgets' as examples?), but they really do spell out the specifics. I remember when I refinanced a loan and a nice lady came to my home accompanied by a Notary Public; we all sat down and I read through EVERY SINGLE PAGE over the course of an hour because signing a mortgage is, quite literally, signing part of your life away.

Now it seems that even more credit-worthy borrowers -- who either didn't read the fine print or do their homework on the options available to them -- were blindly paraded into sub-prime loan products without their knowledge. According to the Wall Street Journal article:

An analysis for The Wall Street Journal of more than $2.5 trillion in subprime loans made since 2000 shows that as the number of subprime loans mushroomed, an increasing proportion of them went to people with credit scores high enough to often qualify for conventional loans with far better terms.

In 2005, the peak year of the subprime boom, the study says that borrowers with such credit scores got more than half -- 55% -- of all subprime mortgages that were ultimately packaged into securities for sale to investors, as most subprime loans are. The study by First American LoanPerformance, a San Francisco research firm, says the proportion rose even higher by the end of 2006, to 61%. The figure was just 41% in 2000, according to the study. Even a significant number of borrowers with top-notch credit signed up for expensive subprime loans, the firm's analysis found.

So what does that mean now? Volleyball tournaments by former loan agents and brokers at minimum-security prisons throughout the country? Maybe!

The analysis also raises pointed questions about the practices of major mortgage lenders. Many borrowers whose credit scores might have qualified them for more conventional loans say they were pushed into risky subprime loans. They say lenders or brokers aggressively marketed the loans, offering easier and faster approvals -- and playing down or hiding the onerous price paid over the long haul in higher interest rates or stricter repayment terms.

I remember when I first heard about the option ARM when I was buying a property, and I thought it was very interesting. But then I sat down and did a spreadsheet in Excel and calculated that if I were to pay the normal P&I amount for the option ARM that it was only $50 less than what I'd pay on a 30-year fixed note (which at the time had briefly dipped back down to just over 5.6%).

Although I know Excel is a fairly common software, I remember thinking at the time that what I was doing -- my homework to double-check what the broker was telling me -- was probably pretty rare. When she kept pushing me towards the ARM, I told her that I was going with the fixed note, and that if she mentioned the ARM again I'd go elsewhere. I also went through the settlement statement and wrote in what I'd be willing to pay for various items (i.e., not $50 for a FedEx) while repeating, "No junk fees!" I'll bet I was her favorite client ever.

But the fact that higher-income households may be holding sub-prime mortgages may also be good news:

Credit-worthy borrowers holding subprime loans may turn out to serve as a sort of shock absorber for the current mortgage crisis. They may be more likely than traditional subprime borrowers to withstand the double whammy of declining home prices and adjustable-rate mortgages soon due to reset at higher interest rates. The data perhaps explain why, so far, nearly 80% of the borrowers with subprime loans have continued to keep their loan payments current, according to some analysts. That could indicate the crisis won't continue to deepen as much as some fear.

Yes, it's true that brokers got a higher commission for an option ARM than a traditional fixed-rate note -- that's also why they couldn't keep quiet about it!

So thank you, Microsoft Excel, for helping me make an informed decision, because I knew that it was folly to count on objectivity from someone who saw me mostly as just another commission.

Just how politically motivated is the mortgage-rate freeze idea?

With 'Super Duper Tuesday' just about two months away, it's not surprising to see the likes of California's Governor or the Bush Administration weigh in on SubprimeForeclosureGate, but now it's apparently issue #1 at the Hillary Rodman Clinton campaign. In a somewhat threat-laden letter to Secretary Henry Paulson, the Democratic front-runner spells out her demands to put an immediate end to sub-prime foreclosures. Should he not heed these demands (what is she, on a star ship?), then he can expect her to do the following:

I will consider legislation that enables lenders to convert unworkable mortgages into stable, affordable loans without the permission of investors. Protection from lawsuits will remove the obstacle that keeps lenders, servicers and others from turning mortgages that were designed to fail into mortgages families can afford. Right now, servicers who process monthly loan payments and interface with homeowners have flexibility to modify loans. However, they are reluctant to fully exercise this discretion in part because they fear investor lawsuits. Investors who own the securities into which the mortgages have been packaged may assert that they are harmed when servicers help at-risk borrowers. Protection from lawsuits could enable the servicers to help homeowners avoid foreclosures, help investors avoid the losses they would otherwise suffer, and help the economy.

In other words, the first presumption is that all of these loans were made by unscrupulous lenders to victimized homebuyers, with the proceeds split into pieces (or 'tranches' in fancy Wall Street parlance, which means 'slice' in French) to be sold to investors who were apparently also in on the game. I can see the campaign literature now: "Too bad investors -- you have no say in this idea, and you'll take what we give you -- and you'll like it!"

At first mortgage investors hated Paulson's plan, which was to freeze rates for a shorter period of time, but they're now warming up to it because the Democratic alternative is so much more Manichean.

The second presumption is that the 'teaser' rates were set so low that refusing it would be akin to a five-year-old refusing free (and unsupervised) Halloween candy, but it's not that simple, either. According to the a recent AP story, "FDIC officials note that many subprime borrowers received starter rates that were not especially low at the time: typically around 7 percent to 9 percent, when rates as low as 5 percent were common for borrowers with strong credit."

In other words, many of these folks simply bought more home than they could afford and would have greatly benefited from (a) cleaning up their credit to qualify for a better loan; and (b) saving up a down payment to quality for a fixed-rate, 30-year loan. But when the news headlines are blaring huge price increases, it's easy to see that many thought, "If I don't buy now with WHATEVER MEANS POSSIBLE then I may lose the opportunity forever." That's exactly what happened in the last boom-and-bust cycle of the late 1980s-early 1990s.

But who, exactly, would benefit under Paulson's plan? Those already in foreclosure? Nope. Like the "Soup Nazi" made famous in numerous Seinfeld episodes, there will be not be soup (aka mortgage rate assistance) for everyone! According to this Money Magazine article, "Paulson divided subprime borrowers into four groups. The plan would be most geared toward those who can afford the mortgage now but won't be able to after the adjustment. The other three groups are largely left out: Borrowers who can afford an adjustment; those who are already behind on their payments; and those who can refinance into a fixed-rate loan."

And what about the investors and flippers who thought that praying would save them? Looks like they'll have to go soup-less too: "It has also been reported that homes that were bought as investments - as opposed to for the purpose of living in - would be excluded. More than 50% of the increase in delinquent mortgages are actually investor-related, said Wachovia senior economist Mark Vitner. 'It's hard to conceive how many people are actually going to meet this criteria. There's nothing at all in there that addresses investors,' said Vitner, who added he doesn't support an investor bailout."

Ok, so for those who do qualify, how do we decide who can and can't afford their mortgage? Why your friendly, customer-centric mortgage servicer, of course! According to a CNNMoney.com article:

There are two basic ways to determine affordability. The company that services your loan may use one or both in combination.

The first is debt-to-income ratio. So, for instance, a monthly mortgage payment (including interest and taxes) may be deemed affordable if it does not exceed 36 percent of the borrower's gross monthly income and if total debt payments do not exceed 45 percent of income.

Some lenders making loan adjustments, however, will allow total debt to run as high as 55 percent of income, Shea said.

The second method is documenting an affordability budget. To see how much a borrower can afford to pay for housing, a servicer will compare a borrower's net income to his expenses plus required debts, said Bruce Marks, founder and CEO of the Neighborhood Assistance Corporation of America (NACA).

But servicers differ in what they consider to be "reasonable" to spend on necessities such as food or on non-recurring expenses such as an unexpected car repair. They also differ on what they consider to be "required" debt. So some servicers may consider a second mortgage, a car loan or a credit card balance as debt you need to pay off, thereby reducing the amount you have left to pay your primary mortgage, but others may not.

Servicers may use a cost-of-living index to determine if the amount a homeowner spends on food, transportation and other necessities is deemed "reasonable" but they don't all use the same index, and not all indexes are adjusted for family size or geography.

Clear as mud? Great!

I've never been a big fan of mortgage servicers, which is why I opt out of loans with impounds for taxes and insurance. Each year, there was a hefty surprise: either I got to write a large check right around the holidays, or I got a nice refund check. While the refund check was nice, how hard is it to calculate annual taxes and insurance? Rocket science is it not.

While it's important to address this issue, making it a political contest of "who's doing more for the victimized homeowners?" right before a Presidential election could mean a plan that sounds great but ultimately does little to fix the very simple issue of people buying more home than they could afford and the smiling list of enablers who made it happen.

What's REALLY up with the Lennar deal with Morgan Stanley?

One reason new housing remains relatively expensive even with price cuts and incentives is the high cost of land, and most landowners have refused to sell their holdings off at deep discounts -- at least until now. While industry veterans such as Jeff Gault (now CEO of LandCap Partners) and Steve Cameron (Foremost Communities) have launched land development companies to take these assets off of builders' balance sheets, this Lennar deal with Morgan Stanley has effectively discounted the land holdings by 60%. What will that do to the valuations of other land holdings being held by owners who've refused to discount?

According to analyst Carl Weichart at Wachovia, "The deal generates immediate cash for Miami-based Lennar and is a continuation of the company's strategy of seeking to become a 'near assetless homebuilder,' Wachovia Capital Markets analyst Carl Reichardt wrote in a Monday report. 'Such business models tend to post higher returns on capital, inventory turns and free cash flow relative to peers,' the report said. In the near term, however, the bold strategy comes in 'a far second to market conditions in housing that continue to wither,' such as low margins, bloated inventories and falling prices.

Over at JP Morgan, "research analyst Michael Rehaut wrote that the $775 million loss on the deal as a 'net negative' for Lennar and the homebuilding industry because it points to more impairment charges on assets such as land into 2008. 'We believe the loss on the sale is a major negative, as it shows charges are far from over,' Rehaut wrote."

And, according to the blog authored by CNBC Realty Check host Diana Olick, one unnamed analyst simply called the news "terrifying," but is it? From today's Wall Street Journal article, it seems that the best way for banks and investors to get a non-performing asset like land to pay off is to partner with an expert -- meaning the builder -- to develop the land and either sell it off to other builders or build it out themselves.

What happens to real estate development if oil production has peaked?

One of the reasons that oil has been pushing up towards the $100 level is because production (at least of the better-quality crude) has had trouble keeping up with supply. While the Internet abounds with articles and websites predicting a post-oil economic apocalypse, it's when a mainstream source like Time magazine takes on the subject that a potential tipping point of public awareness has passed. A longer story in The New York Times from 2005 explores the issue in even better detail, whereas an interview with Chevron CEO David O'Reilly in the 12/10/07 edition of Fortune magazine has him concluding that both high oil prices and our energy dependence on it are here to stay for some time (perhaps decades). And what about renewables? Not as fast as some would hope (video interview).

People often confuse the current oil prise rise with the gas shortage of the 1970s, which then was due to a politically motivated and human-created embargo. Even if there's still plenty of the black gold to be had today, supply constraints due to political turmoil, technology, money to invest, too few qualified engineers and declines in current oil fields has even some oil company CEOs predicting that production will never eclipse the 100-million-barrels-per-day level even though demand will rise to 110 million barrels by 2030. With China, India and other upwardly mobile countries now competing with the U.S. for the limited supply (which may plateau for a long time instead of peak), gasoline prices may eventually rival those in other Western European countries, which currently approach and exceed $6 per U.S. gallon.

What would that do to our country's love of suburban development and the long commutes often required to maintain that lifestyle? Clearly, access to mass transit will be a key decider in new home purchases -- probably as much as school districts are today with families who have children. Infill and mixed-use development -- now becoming increasingly popular, especially in traditionally car-dependent areas of California -- will become even more mainstream for some of the larger builders, some of whom will be obliged to throw out out their "repeat as often as necessary" business models in favor of unique projects (and floor plans) that are specific to each site. Transit-oriented developments, currently seen more as a novelty than a required convenience for many buyers and renters, will also rise in importance.

In each case, feasibility studies will take on a micro-market focus and builders will need to make the case that new homes, with all of their benefits, are worth more than a nearby resale; simply reviewing countywide stats and hoping that the demand is there will simply no longer suffice.

Fixing the Mortgage DEBACLE

Earlier this year, when I was writing press releases on California's new home market for the CBIA while at Hanley Wood Market Intelligence, I was asked by the CBIA to soften the phrase "mortgage debacle" to something more neutral (such as "mortgage situation") that wouldn't alienate their builder members, who were already sensitive to the constant media reports of a rapidly slowing market. Since I understood the trade group's position and the wording itself wasn't that important to me I acquiesced, but I remember thinking that avoiding the truth would simply postpone the day of reckoning when the building industry risked seizing up due to lack of new credit, that some new solutions would be required and so planning far in advance of it was prudent.

Fast-forward six months later and with the lack of credit clearly having an enormous impact, the federal government's plan to freeze certain subprime loans at their teaser rates could certainly prevent foreclosures (and thereby help prop up property values, potentially helping the new home market), but it also has its critics, namely investors who hold these mortgages (and were soon hoping for greater returns) and analysts who claim that this is merely a political salvo that will postpone the inevitable foreclosure for homebuyers who simply bought more homes than they could afford.

Writing in the Financial Times, former Treasury Secretary Lawrence Summers opines that since the threat to the global economy is becoming worse, more concrete measures need to be taken now, including (1) fiscal stimuli (spending and tax cuts) that will necessarily postpone paying down the national debt; (2) maintaining the flow of credit through "super conduits" in which banks pool together to take on troubled investment vehicle assets to contain the damage; and (3) that the U.S. government, whether through the FHA, FNMA, FreddieMac or all three, keeps the credit spigot on to QUALIFIED BORROWERS while also blessing a template that would set up a comprehensive structure to modify large groups of sub-prime loan terms at risk of default instead of at the glacial pace of one at a time.

Inman News columnist Lou Barnes seconds this idea, arguing that waiting longer would simply continue to erode banks' capital requirements, making them technically insolvent (hence the recent investments in Countrywide, E-Trade and Citibank). While it does seem morally repugnant to bail out the pathologically greedy, Barnes makes a very good point:

Since it is beyond the power of the Fed to deal with capital and counterparty risks, we can't just sit here watching more capital evaporate as more and more assets cross the event horizon to black hole. Everybody wants bad actors punished, and nobody wants a bailout -- not taxpayers, and not the moral hazard police.

Get over it. Get on with it: firewall bad assets, give big banks and dealers get-out-of-jail capital cards, and restore the supply of new credit before this gets ugly.

And yet builders may need to take even faster action if they hope to continue selling homes (and generating cash). In his most recent newsletter, John Burns (yes, I'm a subscriber too!), suggests that builders not only continue to make mortgages, but actually plan to hold them in order to make the sale:

If you have information about your pricing, submarkets and buyer profiles that leads you to believe that there is very little chance that the homes you are selling will fall 20% in value, you might consider forming a venture to make piggyback loans or whole loans. While this is clearly not a preferred choice, it might be the only choice next year that allows you to continue selling homes at a reasonable sales pace.

If this idea seems absolutely absurd to you, ask some of the industry veterans how they survived the 1981-82 downturn. Most of them made the loans on the homes they sold. Today's environment is much different and the loan would be much riskier, but the key to survival is selling homes and recovering as much of the cash you have already invested as you can.

Very interesting idea. So how do you predict if new homes will not fall below 20% in value? I'd suggest micro-market studies, in which the analysis carefully considers the immediate neighborhood, locational advantages (access to freeways and mass transit, future development) and comprehensively argues why this particular project might be more immune from future price declines than elsewhere (a topic I'll be taking on later today for Builder/Developer magazine).

Because just because one WANTS their full piece of pie doesn't mean they'll get it!