Date: December 18, 2008 CNBC Interview with Whitney Tilson, T2 Partners Managing Partner
Carl Quintanilla: Our next guest warned that the subprime crisis was only the beginning. That was a year ago. Is a second meltdown now on the horizon? Joining us this morning, on set hedge fund manager Whitney Tilson, of T2 Partners, Managing Partner and manager of Tilson mutual funds.
We saw you on 60 Minutes over the weekend, and it’s good to talk to you live. We’ve been talking about the second wave for a long time. But here it is, we’re close to the turn of the year, and you still think next year will be about Prime loans, helocs, things we haven’t had to deal with yet?
Whitney Tilson: Right, I sort of hate say everything that I’ve predicted the multiple times that I’ve been with you over the past year have come to pass. The subprime bubble has been just as bad as we thought. The wave of resets, though, is coming to an end. So, these were mostly two year resets. So the peak of the bubble in writing these bad mortgages was ’05 and ’06, two years later, ’07/’08 was when they all defaulted, upon the resets. The problem is, subprime was only 13.6% of mortgage volume at the very peak of the bubble. And the crazy behavior, and crazy lending, extended far beyond subprime; up into Alt-A, a little bit better than subprime, and then, even into prime loans, these things called option arms especially. Those tended to have three and mostly five year reset, which means those resets are still coming up in the next three years. And it’s even larger volume than the subprime.
Carl Quintanilla: So, as an aftershock, this will be, ten years from now, we’ll be talking about the wave to come, or the wave that just passed. Which is the stronger element?
Whitney Tilson: They’re roughly equally sized. And, unfortunately, the default data that we are seeing looking at pools of bubble-era mortgages… I just looked at an Alt-A pool written, one of the last one’s to get out, in July of ’07, this is only a year and a half ago, Lehman put a billion dollar pool out, and already, seventeen months in, 43%, of these Alt-A loans, these are supposed to be better than subprime, 43% have defaulted. So, uh, so we’re going to see, we’re seeing, the same trend lines and trajectories of defaults and delinquencies on Alt-A and Option Arms as we’re seeing on Subprime at the same stage.
Rebecca Quick: Whitney, everything the Fed’s doing, the Treasury’s doing, has been bringing mortgage rates down. There’s all this talk of additional measures that will help some of these people out. Will that stem this crush before it makes shore?
Whitney Tilson: Yes. Um. It will to some extent. The problem is, for example, this Alt-A pool was written at 96% loan to value, it was 25% in California where home prices are down, in these areas, 30 to 40%. So people are so far underwater that a 100 bip drop in the mortgage rate might help some people at the margin. So, Credit Suisse has predicted six million foreclosures at current trend line over the next four years. I think if you drop interest rates a hundred bips, which I hope the government does, I think that will help a lot. My guess would be is that it might help about a third of those people refinance into fixed rate mortgage. But there’s not a lot you can do when someone is almost 50% underwater.
Carl Quintanilla: Wilbur, you know all about all this stuff. Do you take any issue with any of it?
Wilbur Ross: Well, I think that default rates are going up. And the toxic thing about the Option Arms is they kept building up the size of the mortgage. Instead of paying the interest, the accrued it. So what that means, is you have house value going down, the face amount of the mortgage going up. That’s a real collision. And people who are underwater don’t pay mortgages.
Rebecca Quick: Whitney, we want to thank you very much for coming in. We hope to see you again soon. Appreciate it.
End of interview
We saw you on 60 Minutes over the weekend, and it’s good to talk to you live. We’ve been talking about the second wave for a long time. But here it is, we’re close to the turn of the year, and you still think next year will be about Prime loans, helocs, things we haven’t had to deal with yet?
Whitney Tilson: Right, I sort of hate say everything that I’ve predicted the multiple times that I’ve been with you over the past year have come to pass. The subprime bubble has been just as bad as we thought. The wave of resets, though, is coming to an end. So, these were mostly two year resets. So the peak of the bubble in writing these bad mortgages was ’05 and ’06, two years later, ’07/’08 was when they all defaulted, upon the resets. The problem is, subprime was only 13.6% of mortgage volume at the very peak of the bubble. And the crazy behavior, and crazy lending, extended far beyond subprime; up into Alt-A, a little bit better than subprime, and then, even into prime loans, these things called option arms especially. Those tended to have three and mostly five year reset, which means those resets are still coming up in the next three years. And it’s even larger volume than the subprime.
Carl Quintanilla: So, as an aftershock, this will be, ten years from now, we’ll be talking about the wave to come, or the wave that just passed. Which is the stronger element?
Whitney Tilson: They’re roughly equally sized. And, unfortunately, the default data that we are seeing looking at pools of bubble-era mortgages… I just looked at an Alt-A pool written, one of the last one’s to get out, in July of ’07, this is only a year and a half ago, Lehman put a billion dollar pool out, and already, seventeen months in, 43%, of these Alt-A loans, these are supposed to be better than subprime, 43% have defaulted. So, uh, so we’re going to see, we’re seeing, the same trend lines and trajectories of defaults and delinquencies on Alt-A and Option Arms as we’re seeing on Subprime at the same stage.
Rebecca Quick: Whitney, everything the Fed’s doing, the Treasury’s doing, has been bringing mortgage rates down. There’s all this talk of additional measures that will help some of these people out. Will that stem this crush before it makes shore?
Whitney Tilson: Yes. Um. It will to some extent. The problem is, for example, this Alt-A pool was written at 96% loan to value, it was 25% in California where home prices are down, in these areas, 30 to 40%. So people are so far underwater that a 100 bip drop in the mortgage rate might help some people at the margin. So, Credit Suisse has predicted six million foreclosures at current trend line over the next four years. I think if you drop interest rates a hundred bips, which I hope the government does, I think that will help a lot. My guess would be is that it might help about a third of those people refinance into fixed rate mortgage. But there’s not a lot you can do when someone is almost 50% underwater.
Carl Quintanilla: Wilbur, you know all about all this stuff. Do you take any issue with any of it?
Wilbur Ross: Well, I think that default rates are going up. And the toxic thing about the Option Arms is they kept building up the size of the mortgage. Instead of paying the interest, the accrued it. So what that means, is you have house value going down, the face amount of the mortgage going up. That’s a real collision. And people who are underwater don’t pay mortgages.
Rebecca Quick: Whitney, we want to thank you very much for coming in. We hope to see you again soon. Appreciate it.
End of interview
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