Sunday, May 31, 2009

Better add Alt-A to your vocabulary list

Alt-A is another classification of mortgages that's going to be a problem sooner rather than later. Alt-A loans were marketed as slightly riskier loans than prime borrowers, but safer than subprime loans. The irony is that subprime loans went to borrowers with bad credit histories, but decent colateral and an ability to pay.

Alt-A, the supposedly "safer" loans, went to borrowers with good credit scores, but limited collateral and suspect abilities to repay.

So, subprime crushed the banking industry and guess what's coming...

Alt-A Loans: a second wave of foreclosures ahead

"Like the subprime loans that began imploding in 2006, these Alt-A loans offered seductively low introductory payments that enabled many borrowers to buy or refinance homes that were pricier than they could otherwise afford.
Now, those borrowers increasingly are discovering the true cost of their loans. When the introductory period ends, monthly payments can jump 50 percent or more on the typical Alt-A loan, far higher than many borrowers can afford.

“They were sold to the consumer as affordable but the payments on the backside are large,” said Hans Bruhner, managing partner of First Priority Financial, a Forestville mortgage company. “It was a recipe for disaster that everyone should have seen coming.” (AHEM, some of us did see it coming....)

Today, there are 18,000 Alt-A mortgages in Sonoma County. They account for about 18 percent of the county’s 102,000 home mortgages — triple the U.S. average, according to First American CoreLogic, a real estate research company.

It is a far larger share of the county’s real estate holdings than subprime loans, which accounted for about 10 percent of local mortgages at their peak five years ago."

So consider that bit of news - 18% of Sonoma County loans are Alt-A and subject to rising payments as the economy falters, while just 10% of their loans were sub-prime.

To quote Calculated Risk....

"Alt-A was and has always been about maximizing consumption. If subprime was supposed to be about taking a bad-credit borrower and working him back into a good-credit borrower, Alt-A was about taking a good-credit borrower and loading him up with enough debt to make him eventually subprime."

I found this story interesting - Black Swan Fund Makes Big Bet on Inflation.

Anyone that was up 100% in their hedge fund last year (while global markets were crashing) is worth listening to and these guys have a pretty serious following right now. Their bet is that the fight to reflate the global economy will lead to sharply higher inflation in the coming years. I'm not in that camp, probably as much out of fear for what that really means for all of us if this is true, but it's worth noting that many smart people have recently begun playing the inflation trade (selling US Dollars, Treasuries, buying gold, oil, and other commodities).

Finally, I'd also note that the hottest hedge funds rarely stay hot. It's not an implication of this fund's ability, it's merely an observation that most hedge funds have a day or two in the sun before another strategy suddenly becomes the hot new thing.

I've alluded to my expectations for the economy, commodities and stock market but I thought it might make sense to put some actual numbers down on the web so that I have a point of reference to review at this time next year.

1) The economy: It's really struggling. For all of the talk of green shoots, stimulus, etc. the reality on the ground is that business has taken another leg down in the second quarter. Unemployment is probably north of 9% and looks like it's screaming toward double digits. The auto sector is going to weigh heavily on many regional economies. I don't really see any light at the end of the tunnel on the economy.

2) The market: This is where there is a disconnect. The markets continue to rally in the face of bad news and I think there is a better than even chance that we climb the wall of worry higher for some time. Falling treasury prices will help the stock market (and hurt the taxpayer, but that's another story:)) and investors are getting antsy. Many that have sat on the sidelines through the rally and there is a fear of looking like an underperformer.

Ultimately, the economy - lost jobs, falling revenues, more foreclosures, more bank failures, more commercial real estate busts, etc - will take the stock market back down and it's possible that we revisit our 2009 lows (and possibly break beneath them). The timing of when this happens 2009 or 2010 is difficult to say, but this is my current thinking.

3) Oil, etc -- Oil is the commodity that you interact with the most unless you're buying copper tubing to redo a house. Oil is starting to feel pretty comfortable in the mid-sixties and it has three big things working in it's favor - the US summer driving season is coming up, the US dollar may struggle, traders are moving back into oil. Since, we don't live in one of those tax friendly states, we're already paying $2.65/gallon and I expect we'll see $3.00 before Labor Day. Ultimately, demand for oil is low (unless China drains a couple of lakes to fill them with oil) so I think we'll see prices retreat - assuming there are no major hurricanes - before making another move up in 2012.

Disclaimer - this is little more than a collection of educated guesses - much like the weather forecaster that predicts 10mph NW winds that turns into a 44mph gale that sinks my dock for the 3rd time this year Grrrr!!! - many of my guestimates will prove wrong. Perhaps wildly wrong. Only time will tell.



Scott A. said...

Thank you for writing this. I'm like you (except without the education, experience or smarts) in that it seems crazy to me for people to be talking about a 'recovery' when the underlying motion of the economy is so seriously negative.

I especially like the 'we're all day traders now' meme.

The Artful Blogger said...

There is always a reason to be optimistic, but I think that the many reports of a rebound are dramatically overstating the case. In most data we are seeing a slowdown in the rate of decline, but nothing resembling growth. I think that could change in certain regions as stimulus money flows (however, much of the stimulus seems to be spent on maintaining jobs rather than creating jobs), but I'm still of the opinion that 2009 will prove to merely be a bump in our 20 year cycle.

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