C.M.O. 7.8.2009
Credit Market Overview
July 8, 2009
A list of the ironies that have associated economic events for the last two years and the market place’s reaction to them could fill an encyclopedia no less this humble page. Not the least of which is that after the 10th wettest June since records began being kept in 1872 the “green shoots” withered vs. grew.
Or maybe it was that June 2009 was also logged as the 2nd gloomiest month at the Blue Hills Observatory outside of Boston where records have been kept since 1885. “Gloom” is calculated based on amount of sunshine, precipitation and temperature.
The real culprit for the withering shoots it seems is not the weather at all but the employment picture or, really, the unemployment picture. The number of unemployed and underemployed continue to weigh on consumption which, for the umpteenth time, is 70% of our GDP.
The chain of events that starts with a lot of people out of work always seems to link back to the housing market and more specifically the number of people walking away from their homes which results in an increased number of foreclosures, which results in lower home prices in the surrounding neighborhood, which results in lower levels of equity for the other homes in the ‘hood, which results in even more owners walking away. Lots of gloom to be sure.
There are a few other factors helping to keep the foreclosure momentum going. The first is that “the Obama foreclosure-prevention plan was ‘built around the subprime crisis model, not the unemployment model’” according to Michael van Zalingen, director of homeownership services for the nonprofit Neighborhood Housing Services of Chicago.
The plan Michael speaks of was designed to incent mortgage servicing companies and investors to reduce mortgage-related payments to 31% of monthly income. The problem comes from the fact that many borrowers don’t have sufficient income to qualify for a loan modification. At a recent gathering 45% of the 900 attendees fell into the “non-qualified” category according to Mr. van Zalingen.
Deputy Assistant Treasury Secretary Seth Wheeler has said “We recognize the unemployment is a significant complicating factor. We are studying what more we can do”.
To the extent that focusing on foreclosures vs. employment is similar to trying to cure the symptom and not the disease it is also worth taking a look at where the majority of foreclosures are emanating from.
Here too it would appear tilting at the subprime windmill was as Quixotian as the phrase suggests as it appears, based on a study from McDash Analytics, a component of Lender Processing Services, a loan-level data source covering over 30MM mortgages, that equity and not loan type is the biggest factor in determining foreclosure probability.
The simplest way to present this is to say that while only 12% of the homes in the McDash database had negative equity they comprised 47% of the foreclosures. Some other data that support the McDash claim come from the Mortgage Bankers Association: 51% of all foreclosed homes had prime loans, not subprime and the foreclosure rate for prime loans grew by 488% vs. 200% for subprime loans since the 3rd quarter of 2006.
The home builder ETF, XHB, closed last night at 10.86, very close to the 10.93 price seen on April 7th of this year and about halfway up the “green shoots” shot.
Names the CEC Strategy is short in this sector include: BDK, HD, KBH, MDC, RYL, SHW, SWK, TOL and USG. At the risk of redundancy these shorts exist because of widening CDS spreads, first and foremost, being complimented by a falling stock price. These positions were put on at various times during May and have been in place since.
To the extent that we hear over and over again that the recovery won’t begin until housing recovers it appears that since the real culprit in the house price decline is employment we now have the dreaded “second derivative” situation.
Enjoy the week.
Jim Delaney
