The Sanders Polynomial or Why “Esto se va a poner de la chingada”

When people ask me how I have come to understand some of the mortgage mess, my reply is simply that I have good teachers.  Despite the Internet, there is no replacement for  conversation as the means for creating understanding and focus in both our personal and national life.  And conversation is more than merely blurting out electronically and unilaterally, but is a true transaction, where bits of information are passed back and forth in a symmetrical fashion, increasing the aggregate knowledge on both sides.

I am fortunate to participate in such a continuing conversation with a number of mortgage market observers, attorneys and operators, people who know the issue from the inside out legally and financially.  Most don’t want their names mentioned, but I owe them the same debt any student owes a teacher -- and the obligation to replicate the process for the next wave of students.

Last week a lot of people became acquainted with some of the nuances of loan servicing, little details that connect some of the biggest banks with trillions of dollars worth of exposure now held by Fannie Mae and Freddie Mac.  When you saw several banks spend a large part of their earnings conference calls on loan servicing, you know something is amiss. I wrote a post on Reuters about the Depression era legal evolution of the rights of note holders that will interest the ZH community:

Part of the issue facing lender/servicers such as Bank of America (BAC) is that the market for housing in the U.S. is still on a downward trajectory in terms of prices and transaction volumes.  With the GSEs, FDIC and major banks all selling into a falling market and the percentage of involuntary sales now over half of all sales nationwide, loss given default is headed towards 100% -- or more should the lender decide to retain the property for disposal.

The chart below is from my friend Anthony Sanders, Distinguished Professor of Real Estate Finance at George Mason University, and shows the MBA Purchase Index vs. the FNM 30-year MBS.   The solid line is the polynomial or curve for the MBA Index, suggesting that home purchases are in the midst of a long-term correction from a peak in about 2005-2006.

Sanders Polynomial of MBA Home Purchase Index

Source: Anthony Sanders/GMU

Draw a horizontal line from where the curve intersects the year 2000 straight across the chart and me thinks you've got the new baseline for the U.S. housing sector.  Or 2010?  And remember that housing is not seasonal.

Long-time readers of our work at Institutional Risk Analytics will recall that the peak period for housing sales volumes around 2006 is the same time frame when Washington Mutual peaked in terms of assets and began to shrink.  This is also roughly the same time when the credit card and other consumer debt portfolios in the banking industry also peaked and began to shrink.  Indeed it is “shrinkage” in the 19th Century view of the term that is the operative trend today.

The backlog of foreclosures that have not yet cleared in terms of title continues to grow, even as the industry ramps up operationally to deal with the surge.  The BAC earnings call this week provides considerable color on the timing of the peak of the operational build in terms of servicing capacity 3-4 quarters out -- at a minimum.

A good bit of what was said on the BAC call this week was contradictory and reflects confusion by BAC management.  This confusion is understandable given the dramatic situation facing BAC and the likelihood that its growing list of creditors may soon force the issue.  Part of the reason you heard BAC management spend so much time talking about loan servicing issues is the need to manage expectations of investors.

Speaking of good perception management, big high five to the folks at the Fed for timing the announcement of the litigation against BAC by the FRBNY regarding loan repurchases for the same day as the BAC earnings call.   Part of the reason for the lack of sensitivity is due to an ongoing house cleaning at the Fed Board of Governors in Washington .  Ponder this insider view:

“The staff at the BOG is in total disarray.  Numerous long-timers have left due to the stiff arm of [Governor Dan] Tarullo and his executioner - Pat Parkinson [See “I am Superman” paper for particulars on Parkinson as an advocate for the TBTF banks].  Everyone that was at the BOG and engaged during the crisis is gone.  The NY FRB is going to get bigger and badder as a result,  but then they’ve always been the Sun around which all the other banks (and the Board) revolve.  So now we have Geithner as UST Sec, ‘copter Benjamin at FRB BOG, and Dudley “who?” at the FRBNY.  Not a stellar lineup.  Thank goodness Lawrence is now gone…he can’t do more damage except pollute the minds of the kids in Cambridge.”

When people ask what to expect in the large bank,  GSE and real estate sectors in 2011, we say that the day of reckoning put off by not restructuring Countrywide, Bear, Merrill, Wachovia et al two years ago is now coming due.  The operational and financial reality of insolvency can only be put off for so long.  Or to refer to the immortal words of Joaquin “el chapo” Guzman, spoken after the mistaken 1993 killing of Cardinal Posadas at the Guadalajara airport:  “Esto se va a poner de la chingada” *

* “Things are going to get really fucked now.”  See Alma Guillermoprieto, “The Murderers of Mexico” October 28, 2010, NY Review of Books,