From Time/CNN:
The Markets’ Pain Isn’t Over Yet
By Mr. Gloom and Doom, Marc Faber
At major turning points, stock markets move in precisely the opposite direction to the one the herd expects based on the prevailing fundamentals. Bull markets begin in the depth of recessions, when investors have given up on the belief in any recovery and when doom and gloom prevail. Conversely, when the sky is cloudlessly blue and phrases like New Economy, New Paradigm and Goldilocks Scenario are in vogue, the odds of a serious bear market arriving increase significantly. Nobody rings a bell at the onset of a downturn—rather, bear markets sneak in, like a thief in the night, while the investment community is sleeping, confident that its rich market gains will grow ever richer.
To understand the recent sell-off in global equities and whether it will turn into a bear market, you first need to analyze the remarkably heady period that preceded it. Fearing deflation after the meltdown of tech and Internet stocks in 2000 and the terrorist attacks of Sept. 11, 2001, the U.S. Federal Reserve Board cut the Fed fund rate from 6.5% to 1%. The easy availability of low-cost loans triggered a dramatic rise in borrowing, which lifted the prices of all assets, including stocks, real estate, commodities, bonds, art and wine. As U.S. consumption boomed, the nation’s trade and current-account deficits exploded. But when economic growth is dependent on accelerating debt growth, the supply of money and credit has to continue accelerating in order to keep the good times rolling. This is no longer happening—not just because the Fed has tightened credit but because the market has done so. In late 2006 some cracks in the credit system were already becoming visible when several sub-prime lenders went out of business as home prices began to decline. Lending standards quickly tightened and as credit flows into housing slowed, the sector experienced some illiquidity. Consumption growth waned and the rate of growth of the U.S. current-account deficit, which is the principal driver of international liquidity, decelerated. The impact wasn’t felt right away, not least because Japanese and foreign investors continued to borrow in Yen and invest in higher-yielding, riskier assets around the world. As a result, several emerging and developed stock markets became perilously overvalued. As I warned in TIME’s Jan. 29 issue, this debt-fueled euphoria created “the greatest asset bubble ever.”
As always happens when bubbles occur, naive neophytes, overconfident speculators and overleveraged money managers all leaned together on one side of the investment boat. When the boat became totally imbalanced it was enough for only a small wave—initially, the mere rumor of regulatory changes designed to cool China’s stock fever—to sink the ship. On Feb. 27, China’s main stock index fell 8.8%. Because of the huge leverage and increased computer trading that characterize modern finance, this sell-off triggered sharp declines in other markets from Russia to Malaysia, Japan to the U.S.
Homeowners Stuck As Lenders Cinch Standards
Source: USA TODAY
Publication date: 2007-03-05
By Noelle Knox
Edward Booker is one of nearly 3 million homeowners with adjustable-rate mortgages who’ve had trouble paying their bills. And, like Booker, many of them won’t be able to refinance their loans once the interest rates start rising. At that point, they’ll have to tighten their belts, sell their homes or lose them through foreclosure.
This month, the mortgage payment on Booker’s Chicago home rose $200, to about $1,300. It’ll go up again in September. He wants to refinance, but he fell behind on payments after his wife died of cancer in 2005, so no lender wants to take the risk.
“I’m just trying to hold onto my house until I can figure out something else to do,” says Booker, 58, a former rail-car inspector who’s on disability.
Since the start of the year, more lenders have been shutting their doors to people such as Booker, just as those homeowners’ interest rates are rising. They’re slashing the “Bad credit? No problem” types of loan programs, known as subprime, that helped fuel the housing boom. And they’re raising the bar for homeowners and first-time buyers to qualify for new loans.
The trend accelerated last week after federal regulators proposed stricter guidelines for banks that make subprime ARMs (adjustable-rate mortgages). The move followed Freddie Mac’s decision to drastically raise the criteria for the subprime ARMs it would buy and to require better proof of a borrower’s finances.
The industry is reacting to the waves of subprime borrowers who’ve defaulted on their ARMs in recent months. The tighter controls should help prevent future borrowers from getting in over their heads and protect them from predatory lenders. But the sudden shift in lending rules could also threaten the homeownership gains made by families since 2000, weaken the recovery of the housing market and potentially slow the economy.
“It will be a very severe correction (in the subprime market), and I think it will last anywhere from six to 12 months, during which many of the lenders who have operated in this market will gradually get pushed out of business,” says Chris Flanagan, a managing director for JPMorgan.
Nearly two dozen subprime lenders have already closed their doors or been purchased, and a dozen more are in trouble, according to a report by Credit Suisse.
To stem their losses, lenders nationwide are notifying mortgage brokers to cancel loan programs. Many of them are:
*Reducing loans for 100% of the purchase price.
*Reducing the number of “piggyback” loans, whereby a lender makes one loan for 80% of the purchase price and a second loan for the remaining 20% of the price at a higher interest rate.
*Raising the required credit score.
*Requiring more documentation of a borrower’s income and scrutinizing the appraisal and comparable-home sales data.
“Some of these companies are yanking away six, eight (loan) products at a time, and the reps are just hanging on the phone with their mouths open, saying, ‘What are we going to sell?'” says Dave Tucker, owner of MileHighMortgage.com in Castle Rock, Colo.
That’s partly why he can’t help Anita Furakh and Bobby Pervez this time. Tucker helped them buy their first home near Denver two years ago with an ARM that covered 100% of the $195,000 purchase price. The young couple, with two children, made their payments on time until December, when Pervez traded in his car for a new one. That month, they were late on their mortgage. The timing couldn’t have been worse. They needed to refinance their mortgage before the rate started rising this month. But their home’s value hasn’t gone up, and their credit score has gone down.
“I don’t know what I’m going to do,” says Furakh, 24, who was bathing and feeding her two daughters after work. “I’m trying to work on my credit, but sometimes you can’t be that good. I’ve got two jobs. I’ve got two kids. Sometimes, I am just late.”
The industry was caught off guard by the surge in delinquencies last year. ARMs made to people with shaky credit in 2005 and 2006 are defaulting at two to three times the rate of loans from 2003 and 2004, according to First American LoanPerformance. Because the interest rates on these loans are usually fixed for the first two or three years, and then start rising, “The worst is still to come,” says Brenda White, a managing director at Deloitte & Touche.
So far, the deepening crisis seems confined to lenders who made riskier loans and hasn’t spread to the broader financial markets, which hold up to $1.5 trillion in subprime loans. Still, as many as 7% of those loans will go into foreclosure, resulting in losses as high as $70 billion, Flanagan estimates. The Center for Responsible Lending projects that 2.2 million homeowners with subprime loans will lose their homes.
Sharing the blame
Thousands of homeowners are already feeling the pain. In January, the Homeownership Preservation Foundation, a non-profit financial counseling group, received 4,500 calls to its toll-free hotline (888-995-HOPE or 888-995-4673), 150% more than last summer. The callers are in financial difficulty and often trying to stave off foreclosure. Equally alarming was that 16% of the callers from October to December didn’t know what kind of mortgage they had, according to the foundation.
Experts say there’s plenty of blame to go around. During the real estate boom, lenders began offering an array of loans to borrowers with poor credit histories. They let many borrowers finance 100% of the purchase price, often asking for little or no proof of income or assets. Last year, 43% of loans required little or no documentation of the borrower’s finances, according to First American LoanPerformance. These “stated-income” loans have earned the nickname “liar loans.”
“When these loans were introduced, they made sense, given the relatively strict requirements borrowers had to meet before qualifying,” according to an April 2006 report by the Mortgage Asset Research Institute. “However, competitive pressures have caused many lenders to loosen these requirements to a point that makes many risk managers squirm.”
The lenders typically use a network of independent brokers who sell loans from a variety of lenders for a commission. The brokers, some of them new to the industry, some of them unlicensed, were responsible for explaining the complex terms of the loan to the borrower. This led to allegations of predatory lending — pushing high-cost loans that are plainly unsuitable for a person’s financial resources and prospects.
Take Betty Jean James, 70, a retired glass inspector living on Social Security. Two years ago, she refinanced the Chicago home where she’s lived for 25 years. The rate on the loan started rising after the second payment. The payments started at $1,032 but have since climbed to $1,761. “I fell behind two months ago,” said James, who is facing foreclosure. “It just got too high.” Though James signed the loan document, which clearly states that the interest rate is adjustable, she recalls that the mortgage broker “explained to me he could refinance the house, and he did. He didn’t explain the interest rate could go up.”
Some borrowers, meantime, contracted real estate fever and took out loans they didn’t fully understand or stretched their budgets too thin. Some lied about their income on their loan applications, sometimes with a wink or a little help from their broker on a stated-income loan.
Casey Serin is a classic case. Serin, a Sacramento website designer who was profiled in USA TODAY in October, has admitted that he lied on his loan applications to buy eight houses in four states as investments. He hoped to flip them for a quick profit, but he made too many newbie mistakes. He sold three of the homes, the lenders foreclosed on two, and he’s still trying to sell the remaining three.
When the real estate market was on fire, such excesses and abuses were often overlooked. If a borrower ran into trouble and fell behind on a payment, it was easy to refinance or sell the property.
Everything changed after the market peaked in August 2005. “For sale” signs swung in front yards for months, and home prices started falling. Borrowers who fell behind on their loans sometimes owed more than their homes were worth. Or they couldn’t sell their property before the lender foreclosed and drove neighborhood prices down further.
In 23 metro areas where home prices fell 4% or more at the end of last year, at least half the subprime ARMs will reset to higher rates this year or next, according to an analysis by First American LoanPerformance for USA TODAY. (See chart.)
In Grand Rapids, Mich., for example, home prices fell 4% at the end of last year, and 56% of homeowners with subprime ARMs will see their rates reset by the end of next year. “I’ve got a handful of clients right now I want to help, but I can’t,” says Pava Leyrer, president of Heritage National Mortgage in Grandville, Mich. “They are better off selling their homes.” But that’s hard in Michigan, which has one of the highest foreclosure rates in the country.
‘One of the real tragedies’
First-time home buyers are also vulnerable. On average, first-time buyers made only a 2% down payment last year, the National Association of Realtors says.
“One of the real tragedies of this is that the folks who became first-time buyers because of this expansion of credit, many times they were first-time buyers not just themselves, but for generations of their families,” says Jim Wheaton, deputy director of Neighborhood Housing Services of Chicago, a non-profit counseling and lending service. “But if they lose that home to foreclosure, given the impact on their credit, the appreciation of home prices, and the fact that their incomes generally are not rising that quickly, they are losing their only opportunity at homeownership.”
Yet the lack of affordable housing is one of the reasons subprime ARMs became so popular. With a starting “teaser” rate, these loans let people with little money for a down payment still buy a home. Last year, 7% of buyers used a subprime ARM, according to the Mortgage Bankers Association.
It’s too soon to know how many buyers won’t qualify under the tighter criteria and how the trend will hamper this year’s expected housing recovery. “It’s a tough situation,” says Dick Syron, CEO of Freddie Mac.
Under Freddie’s new rules: If a subprime borrower wanted to buy the U.S. median-price home at $210,600 with a two-year ARM, the buyer would have to qualify not only at the starting monthly payment of $1,619, at 8.5%, but also at the maximum payment of $2,412 a month, at 13.5%.
“There’s a very delicate and difficult balance between getting as many people into houses as you can,” Syron says, “and at the same time putting people into houses they can’t keep unless home prices are appreciating or interest rates are very low.” Hanging in that balance: nearly 400,000 homeowners with subprime ARMs who, like Booker in Chicago, have already missed at least one loan payment and have a lot fewer options now.
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