Dust Their Brooms: Should Lehman Bros Have Been “Surprised” By Their Sudden Illiquidity? (Bear Stearns Then Fannie Mae And Freddie Mac’s Stock Price Already Plunged)

Movies like “Margin Call” and “The Big Short” make the financial crisis look like a total surprise … to them. Well, it wasn’t a surprise to GSEs Fannie Mae and Freddie Mac. Their common stock prices (green line) began plummeting in December 2007. Lehman Bros stock price didn’t start plummeting until February 2008.

aftermath2.png

Why? National home prices had peaked in 2006 and had slowly begun to retreat. But as of December 2007, the Case-Shiller national home price index had fallen 17.4% from the peak in 2016. Subprime delinquencies had risen 46.5% over the same period. U-3 unemployment started rising in a big way in 2008.

But as home prices nosedived in 2008, subprime delinquencies skyrocketed. You can see Fannie Mae’s large drop in price in November 2008 (while they didn’t purchase subprime loans in high volume, they did invest in subprime ABS and ALT-A loan deals). While ALT-A turned out to suffer big losses, they performed better than subprime after the intial subprime spike.

altasub.png

On September 6, 2008, Fannie Mae and Freddie Mac were placed into conservatorship with their regulator, FHFA and remain there ever since. Also in September, Lehman Bros declared bankruptcy … afer Fannie Mae and Freddie Mac were placed into conservatorship.

*There was other lenders that failed or had to be absorbed elsewhere, like Countrywide, and Wachovia.

wachc

But Fannie Mae, Freddie Mac and Lehman Bros demise came AFTER Bear Stearns demise in March 2008, owing to subprime deal failures. In fact, you could see trouble brewing shortly after home prices started to fall. By 2007, both Bear and Lehman were showing distress, but not Fannie Mae. Fannie Mae and Freddie Mac’s regulator, FHFA saw the warning signs with subprime and took action on September 8th (maybe prematurely since they could have continued).

bearlwhmn

Congress bailed out the banks and Fannie Mae and Freddie Mac and swept the financial dust away (aka, dust their brooms).

Just look at the above chart. Starting in 2016, risk managment at all financial firms should have been on yellow alert. By Q4 2007, it should have been upgraded to red alert. How is it possible that Lehman Bros or Bear Stearns (or Goldman Sachs) were taken by surprise as Margin Call implied.

zaquu

Oh well.

The “Sanders Polynomial” Update: Mortgage Purchase Applications And Mortgage Rates (The Raising Of Credit Standards And Demise Of Non-vanilla ARMs Since Financial Crisis)

Back in 2010, bank analyst Chris Whalen wrote this piece for Zero Hedge entitled “The Sanders Polynomial or Why “Esto se va a poner de la chingada””.

Yes, things got ugly for the residential mortgage market following the mortgage purchase application bubble that peaked around 2005. If you fit a non-linear curve to MBA Mortgage Purchase Applications, you can see a polynomial peaking in 2005.

sanderspolynomial

Here is the updated chart. Mortgage purchase applications have started to rise again since 2010, but at a much slower pace. And there is no polynomial since 2010, just a nice linear increase.

mbAPudated.png

But the mortgage market has fundamentally changed since 2005-7.  First, the volume of adjustable rate mortgages (blue line) has declined to under 10% of all mortgage applications. Second, the number of mortgage originations under 620 (also known as “subprime” is far below the levels seen in 2003-2007. Also, the number of non-vanilla ARMs (like pay-option and Limited Documentation ARMs) have reduced greatly.

mba620

So when the narrator at the end of the movie “The Big Short” said that nothing has changed,  that was fundamentally incorrect. As you can see, ARMs and subprime have essentially vanished.  Here is a chart of The Big Short period (in red) and notice that mortgage lending truly did change.

bbubblee

Also, a non-banker lender, Quicken Loans, is the second lending originator after Wells Fargo.  My how times have changed.

But are lender credit standards too high? Or are lenders and investors low riding credit?

How about a spoonful of extra credit box expansion?

But let’s not turn back the credit clock too far!!

gsdad