November 28, 2008

When Will We Reach the Bottom?

In the recent past I've pondered the question of "where's the bottom of the stock market." Now I ponder "When will we reach the bottom?"

A lot is made of the increasing rate of mortgage foreclosures, more this month than last month, and so on. Eventually, there will be a month with fewer than the previous month, the monthly rate of foreclosures will decrease, and we will have passed the peak... of foreclosures. Lets assume that the bottom of the stock market will be around the same time (could be longer, could be a little sooner).

The rate of foreclosures is strongly influenced by the schedule of when adjustable rate mortgages (ARMs) readjust from low teaser interest rates to high rates, which are often unaffordable and lead to foreclosure. The peak in the number of subprime ARM interest rate resets per month came at about the end of 2007, tapering off to a low right about now in late 2008 (about month 22 in the graph below, where January 2007 corresponds with month 1).

However, another wave of ARM rate resets is coming and will peak about two years from now. It has been pointed out that the holders of these mortgages, which are of better quality than subprime, might be able to refinance to a fixed rate and afford the transition. True, but this is potentially offset by the fact that many of the associated property values will be worth less than when they were purchased. Statistics say some will fail so that we'll have another wave of foreclosure problems growing to a peak over the next two years.

That's the story on residential mortgages. What about commercial mortgages? According to the Associated Press,

the same events poisoning the housing market are now at work on commercial properties, and the bad news is trickling in. Malls from Michigan to Georgia are entering foreclosure. Hotels in Tucson, Ariz., and Hilton Head, S.C., also are about to default on their mortgages.

That pace is expected to quicken. The number of late payments and defaults will double, if not triple, by the end of next year, according to analysts from Fitch Ratings Ltd., which evaluates companies' credit.

"We're probably in the first inning of the commercial mortgage problem," said Scott Tross, a real estate lawyer with Herrick Feinstein in New Jersey.

And there are compounding factors.

Unlike home mortgages, businesses don't pay their loans over 30 years. Commercial mortgages are usually written for five, seven or 10 years with big payments due at the end.

There's also a chain-reaction effect. As the economy turns down, retailers who are renting space in malls will close some of their stores and stop paying rent. The mall owners will loose their ability to pay their mortgages, and more commercial foreclosures will ensue, placing greater burden on the financial sector, which will be reflected in the stock market.

So when do we reach the bottom? Here's another hint.

About $20 billion [in commercial mortgage payments] will be due next year, covering everything from office and condo complexes to hotels and malls. When those $20 billion in mortgages come due next year — 2010 and 2011 totals are projected to be even higher — many property owners won't have the money.

With both residential and commercial real estate foreclosures possibly peaking out two years from now, it doesn't look like the bottom will be here too soon. This malaise will likely be with us for a while. We seem to have caught what Japan had, for over a decade, starting in the late 1980s.

Psssst... Do Something




libhom said...

A federal law stopping or even spreading out the ARM adjustments could do wonders for the economy.

Kim said...

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