from Floyd Norris' blog:
August 19, 2008, 2:02 pm
Who Could Have Known?How bad are the new housing start numbers? Horrid.
Here’s one statistic: The government calculates that construction began on 59,000 single family homes in July. The last time that few homes were started in a July was, well, we don’t know. It was before 1959, when the government started counting housing starts. The old low was 61,400 starts in July 1982, when recession and high interest rates had ravaged the housing market.
It is not hot news that the housing market is in trouble. But there are insights available as to how we got into this mess in a CreditSights.com report released this week on Wachovia, the bank that made perhaps the worst acquisition of the decade when it bought Golden West, a lender that specialized in “pick-a-pay mortgages,” also known as option adjustable-rate mortgages.
David Hendler and Baylor A. Lancaster interviewed the departing chief financial officer and chief risk officer, who were reflective on the lessons they had learned. Here are some excerpts:
“Wachovia noted that some portion of the population which is attracted to the option ARM product seemed to ‘know something that the underwriters didn’t.’ . . . So it seems that borrowers who choose a mortgage with the option of lower minimum payments may in fact be indicating to the lender that there is more likelihood that they will not have the resources to cover the fully amortizing payment.”
“Wachovia noted that Golden West had a ‘life of customer’ approach, meaning that the company liked to re-fi loans with customers as they needed it. . . In these cases, that borrower had essentially gotten back out all of his initial downpayment, or more, over time. . . Wachovia is seeing that the borrowers have less inclination to keep making payments when they have negative equity since they have essentially none of their ‘own’ investment left in the house.”
In other words, Wachovia has discovered that people who take out loans that let them make smaller initial monthly payments often do so because they cannot afford other loans. Given that option ARM loans cost more in the long run, that should not be a huge surprise. And homeowners who have no money invested in a home are more likely to walk away when it loses value. Who could have foreseen that?
By making such loans, Wachovia and other lenders assured that a lot of homes were built and “sold” to “buyers” who could not afford to keep them, or who concluded it was not in their interests to do so once prices fell. That extra demand enabled a seasonal business to stop being seasonal. For five consecutive years, through 2005, there were more single family homes started in July than had been started the year before. That had never happened before.
Since then, there have been three consecutive declines. and there were 63 percent fewer starts this July than in the same month in 2005. We’ve never seen a three-year fall like that.
Until there are enough real buyers for all those homes that are being left by the people walking away from mortgages, this housing downturn is likely to continue.
http://norris.blogs.nytimes.com/2008/08/19/who-could-have-known/
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