TheStreet.com's Jim Cramer explains why "purchased HELOC" is the next phrase to fear.
Purchased HELOC.
Get that term into your head. Home equity loans that were purchased from other originators are the scourge of the system. Any piece of paper backed by these second liens that were issued by pure mortgage originators is just a goner.
This is the paper that was generated by Fremont General (NYSE: FMT) (Cramer's Take) and NovaStar (NYSE: NFI) (Cramer's Take) and New Century Financial and American Home Mortgage and so many of the other bankrupt and walking-dead companies. It was mostly no-documentation loans paper and served as another way to tap money that was meant to be paid back when you flipped a home. It was predicated on the continued increase in value of your home.
And now it is being defaulted on massively. It simply doesn't pay to pay it, even if you lose your house eventually. The moment that house drops 10% in value -- and that has been happening all around the country but particularly in Florida -- you get only the most braindead people paying it back. (I said this in front of a Washington Mutual (NYSE: WM) (Cramer's Take) executive this September and he was livid, but look where that stock was vs. where it is now.)
Purchased HELOC, home equity loans bought, is the most dangerous kind of business, one that Wells Fargo (NYSE: WFC) (Cramer's Take), which prides itself on rigorous lending, should never have participated in,. This is also the paper that E*Trade (NASDAQ: ETFC) (Cramer's Take) has in abundance. In fact purchased HELOC is what I think will make it so E*Trade has an awfully hard time surviving. It appears that CIT (NYSE: CIT) (Cramer's Take) has a lot of home equity loans on the balance sheet, too, if you want to look at another potential disaster. Of course, Washington Mutual and Countrywide (NYSE: CFC) (Cramer's Take) didn't need to purchase. They have it in spades. Citigroup (NYSE: C) (Cramer's Take) has it because American Home originated a lot for them. Bank of America (NYSE: BAC) (Cramer's Take) has tons of home equity loans too.
Soon we will begin to figure out that second lien mortgages originated between 2005 and 2007 by bankrupt and near-bankrupt originators that we all know about must be cordoned off and marked down to zero. That this hasn't happened yet, that we haven't even been able to isolate California and Florida loans because of the convoluted and incomprehensible way that the makers of CDOs tried to diversify the mortgages in particular bonds has made it extremely difficult to sort out, cordon and purge. The sooner it is done, the sooner we will wake up to new daily charges.
Anyone who has purchased HELOC or too much California or Florida HELOC will not make it because the Fed will not cut in time and housing will not rebound in time to make it so it is economical for the borrowers to pay it back.
Any insurer who insured a bond with home equity loans backing it will also not make it.
There simply isn't enough capital in the system to absorb these losses.
Jim Cramer is a director and co-founder of TheStreet.com. He contributes daily market commentary for TheStreet.com's sites and serves as an adviser to the company's CEO. At the time of publication, Cramer was long Citigroup.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider Fremont General, NovaStar to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
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Reader Comments (Page 1 of 1)
11-28-2007 @ 9:31AM
Roger said...
Jim,
You hit the nail squarely on the head.
It's BIG PICTURE time, and those who fail to see it will be long all wrong as the tide runs out.
Roger
11-28-2007 @ 11:23AM
Alec said...
Owning a home in America; what should this mean to Americans ? It once meant something and I still believe that it is the American dream. I cant believe that a society could lose sight of this. I also can’t believe that homes are now bargaining chips for markets to play with our dreams.
11-28-2007 @ 11:46AM
Sam said...
Thankfully even most "braindead" people in America desire to pay back their obligations such as borrowed money. Only those who can't possibly pay it back are in the category you imply is widespread. In America it is still a good idea to pay your debts. But the sooner we can stop unscrupulous lenders from loaning money based on vaporous valuations of homes, the better for all of us. This is where we need some additional government regulation because segments of the market are only motivated by greed--without responsibility.
11-28-2007 @ 12:05PM
sandra said...
Jim, You are right again. My question is this, when will the banking industry get that sub primes, 125% equity loans etc just don't work???? Has everyone in banking forgotten the savings and loan debacle of just a few years ago?
When will the banks stop encouraging people to think of their homes as a bamk account, to be refinanced over and over again to tap equity that only exists on paper? It is time to regulate lending practices unilaterally.
11-28-2007 @ 1:05PM
Ryan said...
For what it's worth, CIT has some 5% of the remaining $10B hfi assets in HELOC and second lien loans, representing a maximum loss of around $500m if they were written down to 0. Hardly a disaster compared to CFC's 38.6% of second lien loans among their $80B hfi portfolio. Is that even the same ballpark?
11-28-2007 @ 2:12PM
Carol said...
It was silly for banks to make these loans. But it was silly for homeowners to take that money. If its too good to be true, it probably is. Today you have to do your own research-- whether its your bank, your home, your doctor, your broker. We're in this too deep and there will have to be some help to straighten this out-- but we all should take from this some lessons learned.
11-28-2007 @ 4:30PM
Andy said...
I think that this is just the tip of it. The article is only talking about the bad HE loans but doesn't get much into the secondary effects on presently solvent regular home loans. What will happen when the rest of the people with home loans have to sell? At best, they will make very little off the equity which will cause them to buy a cheaper house. Others whose houses are going to be valued less than what their loans are for will fair worse. This will result in a further increase in surplus homes further depressing prices. Looks like a lot of trouble.
1-18-2008 @ 3:33PM
J Scriv said...
Can someone please tell me what happens to the underlying asset when a loan in a HELOC fund is defaulted on? A specific loan was made on a specific piece of property - which presumably the HELOC fund now owns. Now what happens? Is the home auctioned off at a minimum price? Who holds the mortgage on that? Does the fund get the proceeds from the sale, or does it 'hold' the mortgage (through some kind of associated lender)? Does the HELOC ever work with property management companies and take over the properties as rentals, to sell as the market improves? Even if a mortgage in the original product does default, there is some offsetting value there. Can anyone enlighten me on this?