Commercial PropertyCloudy Valuations Whack Money Companies, But Mortgage Rates Lower
Mortgages are packaged into securities and sold to investors, but the number of subprime loans in a package is unknown. What has caused investors to get spooked is not knowing whether or not securities will lose value because of the unknown quantity of high-risk mortgages that may end up in default. Mortgage securities are necessary to help provide liquidity to mortgage lenders. As their packages of loans are purchased as securities, they have new money to lend to more borrowers.
When investors got spooked about rising foreclosures, primarily due to subprime defaults, they backed off buying mortgage-backed securities, liquidity dried up and banks had to regroup by tightening credit standards to insure lower risk so investors would start buying mortgage-backed securities again.
A recent report by the Federal Reserve found that credit tightened over the summer to unprecedented levels, the worst in 17 years. Forty-one percent of banks surveyd said they were requiring more from prime borrowers, and for non-traditional loans or alt-A, 60 percent of banks raised their lending standards. Fifty five percent of banks offereing subprime loans made it harder to get financing on a home.
Jumbo loans ($417,000 or more) were harder to get, which had a devastating effect on high-cost areas like California. The California Association of Realtors reported higher inventories and lower prices in their most recent monthly survey.
The whole process had a ripple effect that hasn"t stopped yet. Fewer qualifying borrowers meant fewer homes sold which meant more losses for builders and banks, and all that impacted the gross domestic product, and so on.
The latest ripple effect is publicly-held financial companies announcing "writedowns" in which they write off the losses they incurred during the quarter. The losses were so huge, taken individually and in the aggregate, that it became obvious to all investors that no one knew how big the subprime mess really was and how many more mortgages are at risk of default.
Why would banks make high risk loans, you may ask? Because the potential for profit is huge. If the borrower pays back his note and he"s paying twice the interest rate of an A-paper borrower, the bank does well. Multiply that by thousands of borrowers and you have a windfall. While teaser rates were at 4.00 and 5.00 percent, almost anyone could qualify for a mortgage and the housing industry responded accordingly with tons of new product and higher prices. But it all came crashing down when mortgage interest went up, and sales softened. Suddenly those high-risk loans showed their true colors.
One estimate says that banks stand to lose as much as 10 to 25 percent of their profits over the next couple of years as the subprime fiasco shakes itself out.
In the upside-down world that is Wall Street, you"d think that areas of the company that can"t be valued easily would be an advantage. But fear has hit stocks hard in the last few days causing the Dow Jones Industrial Averages and other indices to lose hundreds of points in value. The big losers? Banks that loaned money to subprime borrowers and investment firms that bought mortgage-backed securities they couldn"t dump on the next greater fool.
Countrywide Financial, the nation"s biggest mortgage lender, was the first to report billions in writedowns -- $1.2 billion in losses for the third-quarter. Wall Street wasn"t pleased, even though it was the company"s first loss in 25 years and CEO Angelo Mozillo vowed that the company would return to profitability by the end of the year.
Citigroup and Merrill Lynch have both fired their CEOs over huge "writedowns" in which companies acknowledge losses and take the subsequent hit to their price shares. Citi took a $2.2 billion writedown and Merrill Lynch took $7.9 billion.
Taking a cue from Cendant"s Henry Silverman, CEO Barry Diller has encouraged the board of IAC to approve a plan to split the media conglomerate into five companies, with LendingTree as one of the new corporations.
Other publicly-held companies such as HouseValues and Homestore have reported losses as skittish Realtors shy away from spending money on advertising. Home sales have softened, inventories are over a 10-month-high and prices are dropping.
But what"s bad for providers is not necessarily bad for consumers. Mortgage interest rates are starting to come down which could cause some homebuyers to take advantage of lower prices and lower interest rates.