For those wanting a road map of where I am likely to post over the next few days, tonight is mortgages and real estate, tomorrow is speculation, and Friday should involve longer dated topics. For those that commented on the blog redesign, I want to say that I appreciated your comments, particularly the critical ones. In the next two months, I’ll be doing a minor redesign to fix some of the flaws that I introduced in the process. I’m not perfectly happy with the result, and it can be improved. Trivia: I co-edited the best high school yearbook in the nation back in 1979, so I do have some eye for design. It’s more of a question of the computer implementation.

Onto real estate:

1) After a bubble bursts, it’s amazing the details that come out on the ethical lapses that transpired. With Countrywide, people were steered into loans that were worse than what they might have qualified for there or elsewhere. Now, they should have shopped around; I always do that on mortgage loans. That Countrywide is still facing problems after the Bank of America infusion might not be too surprising; companies that cut corners with their customers are more likely to be aggressive in their accounting practices. After the post-bailout bounce, the convertible preferred that Countrywide got is now under the $18 strike price.

2) Can the mortgage crisis swallow a town?  Yes.  I know this personally, as some friends of mine on the Eastern Shore of Maryland are finding out right now.  They are not in one of the best areas, and demand has dropped off a cliff.  Entire neighborhoods near them are in bad shape, making everything else less salable.  They need to sell their home for medical reasons, and they can’t do it without taking a loss, which would impoverish them.

3) The internals of the housing market are now such that no one is arguing over the troubles faced.  Consider:

• Housing prices are expected to drop in the US for the next few years by some analysts, including Goldman Sachs.
• Home resales continue to fall.
• The National Association of Realtors has slashed its forecasts for home sales and construction.  (The last to admit it, kinda sad, but telling.)
• Investors in residential real estate are a disproportionate number of the defaults.
• 33% of mortgage loans did not close in August.  A more normal number is 4%.
• A record number of homes entered foreclosure in the second quarter of 2007.
• Mortgage trouble?  It’s not just a subprime issue.  The ability to finance or refinance a non-conforming loan has been greatly reduced, even for borrowers with good credit.  Higher rates reduce demand, and reduce sale prices.
• When I became a corporate bond manager, one of the rules of the firm was “no homebuilder bonds.”  The wounds of the early 90s were still memorable.  If you want to see why that was possibly a good rule, look here, because these bonds have gotten whacked recently.

4) But won’t the President and Congress bail out strapped homeowners?  Tough task.  Current proposals are just dust on the scales, and doing anything big would be a budget-buster.  I agree with Accrued Interest; a bailout is bad policy.  I suspect one will happen anyway.  Washington, DC specializes in bad policy, if it wins votes.

5)  After a bubble bursts the second order effects can be quite significant.  Consider:

• “Rising defaults on subprime home loans are boosting the inventory of unsold homes and driving sale prices lower. That’s cutting into housing-related revenues from building-permit fees, taxes on contracting and recording property transfers, and even sales taxes.”   Housing is a big source of revenue for the states; no surprise that they are suffering as prices and transaction volumes decline.
• The ranks of Realtors get thinned.  Good thing, too.  Too many thought there was easy money there.
• Title insurers get whacked by fraud claims.  (Note investable idea: wait for a little while, because the fraud claims will eventually pass.  An entry point on the title insurers will come slightly after housing inventories begin to decline.)
• Credit card defaults are probably the next significant credit issue to surface.
• In the case of American Home Mortgage, many borrowers face foreclosure because tax and insurance payments are not getting to to the local governments and insurance companies.
• What new homes are getting built are smaller, which is quite a change in the over-housed US.
• Shutting the barn door after the cow has escaped to the pasture; so much for tighter lending requirements now.  It would have been better to have had moderately tighter standards over the past five years, than to have the whipsaw.
• Then there are the higher-order financial effects, whether it is reneging on merger terms, or the effects on foreign investors from buying subprime mortgage risk inside their CDOs.  You mean they didn’t look?
• And, anytime a bubble bursts, it is a business opportunity for the lawyers.  I never thought of it this way before, but the legal profession benefits from societal volatility.

6) Now, I wonder if Merrill Lynch will have any significant hits from subprime.  I would expect it, but who can tell for sure?

7)  Was it such a good idea for the US government to promote home ownership so vigorously?  I have generally said no, and Caroline Baum questions the wisdom of the policy as well.

Finally, we keep them in a bubble to make sure that their theories on how the economy works do not get contaminated by data.  I’m partly kidding here, but the Fed is very optimistic that any spillover from residential real estate to the general economy will be light.  I think the effect will be moderate; it will definitely hurt, but not destroy the US economy.

Tickers mentioned: BAC CFC GS MER