The next couple of posts are a bit dated, but they reference events going on in the real estate mortgage market that I am sure I will point to later.
Adapted from a speech given August, 2007
There has been a lot of discussion in the press lately regarding the mortgage industry and the increase in foreclosures. I am here today with a good news/bad news type of report. The good news is that the actual stats are not nearly as bad as the press would have you believe. The bad news is that it is going to get much worse. The sub-prime issue is only what we currently see; the real problem, Option Arms, lurks just below the surface – and it is the size of Countrywide and Washington Mutual plus many more. The US Mortgage ship Titanic be warned: “Iceberg dead ahead!”
Here is the concept in a nutshell: Virtually all lenders use accrual based accounting (as do virtually all corporations of any business type). Standard practice in this type of accounting is to book accounts receivable even though you have not actually received the cash. This is, as I said, standard practice. But what do you think might happen when this accounting standard is practiced by a lender such as Countrywide or Washington Mutual; lenders with a tremendous amount of option arms on their books? These lenders are booking the expected income (which is to say the interest income) from all of their loans. Yet with option arms there is a percentage of customers (in some cases I suspect a very large percentage) that are paying only the minimum payment. “OK”, says the lender, “we are not receiving the income right now, but we will eventually”. Which is fine until you look at the mortgage reset tables and recognize the vast number of loans that will be going into foreclosure in the near future. To the degree that these loans are option arms the lenders will have to go back and remove the interest income they booked but did not receive and will now never receive. This often results in a process on Wall Street called “restating your earnings”. If you are curious how Wall Street views companies that restate their earnings, ask the people over at New Century Mortgage… oh, that’s right; you can’t. They had to declare bankruptcy about 48 hours after they restated theirs.
Filed under: LENDERS, POLITICAL & ECONOMIC FOLLY , Countrywide, option arms
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[...] or just ignorance is anyone’s guess) and never given the light of day by these firms themselves: the accounting debacle tied to neg-ams. Want to know who is going down next or where “surprise” losses will most likely come into [...]
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