Monday, March 31, 2008

Financial Times: UBS to reveal further writedowns of up to $18bn

by Bill McBride on 3/31/2008 07:56:00 PM

Update: According to the Financial Times, the latest writedowns are expected to be released Tuesday or Wednesday (hat tip sk)

From the Financial Times: UBS set for further writedowns (hat tip crispy&cole)

UBS is poised to reveal further writedowns of up to $18bn and seek a capital increase of about SFr13bn ($13.1bn) ...

Details of the latest writedowns and capital-raising are expected to be released alongside the agenda for the bank’s annual meeting on April 23, which is to be published on Tuesday or on Wednesday.
Just a reminder that the confessional is still open, and the numbers will be huge.

Lehman to Offer $3 Billion in Convertible Preferreds

by Bill McBride on 3/31/2008 05:18:00 PM

From Bloomberg: Lehman to Sell $3 Billion of Shares to Institutional Investors (hat tip Tim)

Lehman Brothers Holdings Inc. ... is selling at least $3 billion of new shares to U.S. institutions to reassure investors it has ample access to capital.
Here are the details from the press release: Lehman Brothers to Offer 3.0 Million Shares of Convertible Preferred Stock (hat tip Dwight)
The non-cumulative dividend rate, conversion rate and other terms are yet to be determined.
TBD?

Update from Reuters: Lehman converts seen having 7-7.5 percent dividend
Lehman Brothers Holdings Inc's $3 billion of convertible preferred shares are seen having a dividend of 7 percent to 7.5 percent and a conversion premium of 30 percent to 35 percent ... The deal is expected to be sold by Tuesday before market close ...

Shanghai Market: Cliff Diving

by Bill McBride on 3/31/2008 02:07:00 PM

Remember when the Shanghai stock market declined 9% on Feb 27, 2007? That caused shock waves around the world, including a 400 points decline in the DOW index the following day. Well, that was nothing and hardly shows up on the following graph.

Shanghai stock market Click on graph for larger image.

After falling to 2772 in Feb 2007, the SSE composite index more than doubled! Now the index has fallen back to 3,472 - still well above the close after the one day sell off - but 43% below the peak.

Is this sell off in anticipation of a slowing Chinese economy? Or is this sell off just giving back some of the "irrational exuberance" of the last year?

There are some concerning signs. From the WSJ last week: Tables Turn Quickly on Chinese Developers

Just six months ago, Chinese property developers were on a shopping spree ... borrowing heavily to snap up more, and more expensive, pieces of land.

How quickly things have changed.

Three months into 2008, China's property developers are under siege. Property prices are showing signs of weakness in many of the country's key markets, and capital markets have all but seized up for these -- and other -- offerings. The Chinese government is on a high-profile campaign to clamp down on new bank loans, hoping to curb inflation, rising at its fastest clip in a decade.
Another concern for foreign manufacturers is the new labor laws in China. Over the weekend I spoke with an executive of a U.S. based company that manufactures in China. He told me the new Chinese labor laws, combined with other factors, have increased their manufacturing costs in China by 30%!

Here is an article from Crain's Manchester Business: Made in China
Manchester-based importers who source in China are about to pass on price rises of between 10 and 15 per cent. They say that currency fluctuations, Chinese wage inflation, raw material cost increases and higher freight charges mean that stable or falling prices of manufactured goods are now a thing of the past.
...
“Four of the factories that we do business with in China won't take dollars now,” said [Stuart Illingworth, managing director of Widdop, Bingham & Co, the Oldham-based giftware importer]. ...

Meanwhile, new labour laws came into force in January which have restricted Chinese workers' hours and led to an increase in labour unit costs.
I've always been skeptical of the decoupling argument, so I wouldn't be surprised to finally see a slowdown in China after the Olympics this summer. In the long run, this rebalancing of the world economy, and these new labor laws are healthy - but in the short term this might lead to more inflation in the U.S.

Note: a slowing Chinese economy might have a positive impact on the U.S. economy by leading to lower oil prices, as I speculated in Petroleum Prices and GCC Spending

Good Riddance

by Tanta on 3/31/2008 11:51:00 AM

UPDATE: I don't have time to spend the day deleting racist trolling. I have therefore closed the comments on this thread. We simply are not here to host such things.

Alphonso Jackson resigned as Secretary of HUD today. And not a moment too soon. Think Progress has the list:

A look at Jackson’s tenure of incompetence and corruption:

Loyalty Over Merits: During a speech on April 28, 2006, Jackson recounted a conversation he had with a prospective contractor who had a “heck of a proposal.” This contractor, however, told Jackson, “I don’t like President Bush.” Jackson subsequently refused to award the man the contract. A former HUD assistant secretary confirmed that Jackson told agency employees to “consider presidential supporters when you are considering the selected candidates for discretionary contracts.”

Political Retaliation: In 2006, Jackson allegedly demanded that the Philadelphia Housing Authority (PHA) “transfer a $2 million public property” at a “substantial discount” to Kenny Gamble, a developer, former soul-music songwriter, and friend of Jackson’s. When PHA director Carl Greene refused, Jackson and his aides called Philadelphia’s mayor and “followed up with ‘menacing’ threats about the property and other housing programs in at least a dozen letters and phone calls over an 11-month period.”

Contracts For Golfing Buddies: In October 2007, federal investigators looked into whether, after Hurricane Katrina, Jackson lined up an emergency “no-bid contract” at the HUD-controlled Housing Authority of New Orleans for “golfing buddy” and friend William Hairston. According to HUD, the emergency contract paid Hairston $392,000 over a year and a half; Hairston’s partner companies also received “direct contracts” with HUD. One of the companies which received a contract in New Orleans, Columbia Residential, had “significant financial ties to Jackson.” Jackson’s wife also had “ties to two companies that did business with the New Orleans authority.”

Awarding Corrupt Companies: Shirlington Limousine and Transportation Inc. is the firm that defense contractor Brent Wilkes used to “transport congressmen, CIA officials, and perhaps prostitutes to his Washington parties.” The firm’s president had a “lengthy history of illegal activity,” detailed in his 62-page rap-sheet, and his limo company “operates in what looks to be a deliberately murky way.” Despite all this, Jackson’s HUD awarded Shirlington a contract worth $519,823.

Lucrative Salaries For Cronies: Atlanta lawyer Michael Hollis, another Jackson friend, “appears to have been paid approximately $1 million for managing the troubled Virgin Islands Housing Authority,” despite having “no experience in running a public housing agency.” A “top Jackson aide” reportedly made it clear to officials within HUD that “Jackson wanted Hollis” for the job. Hollis received more than four times the salary of his predecessor.
Let's hope someone gets this taken down before the end of the day.

Thornburg Puts it on the Visa

by Tanta on 3/31/2008 11:11:00 AM

Forbes, via Atrios.

Thornburg, which is based in Santa Fe, N.M., has been beset by "margin calls," or lenders demanding their money back.

The company reached a deal under which its lenders would stop issuing margin calls if Thornburg raised $948 million.

A bond sale arranged to raise money at a 12 percent interest rate failed, and now the company is trying to sell $1.35 billion in bonds at an 18 percent interest rate.

Krugman: The Dilbert Strategy

by Bill McBride on 3/31/2008 10:24:00 AM

Paul Krugman explains the Paulson plan in the NY Times: The Dilbert Strategy

Anyone who has worked in a large organization — or, for that matter, reads the comic strip “Dilbert” — is familiar with the “org chart” strategy. To hide their lack of any actual ideas about what to do, managers sometimes make a big show of rearranging the boxes ...

You now understand the principle behind the Bush administration’s new proposal for financial reform, which will be formally announced today: it’s all about creating the appearance of responding to the current crisis, without actually doing anything substantive.
One of the key points is this plan was mostly in place to further deregulate the financial industry:
... the new plan was originally conceived of as “promoting a competitive financial services sector leading the world and supporting continued economic innovation.” That’s banker-speak for getting rid of regulations that annoy big financial operators.
Now, using the credit crisis as cover, the plan is being sold as "a fix" for the current problems.
I’ve been disappointed to see some news outlets report as fact the administration’s cover story — the claim that lack of coordination among regulatory agencies was an important factor in our current problems.

The truth is that that’s not at all what happened. The various regulators actually did quite well at acting in a coordinated fashion. Unfortunately, they coordinated in the wrong direction.

For example, there was a 2003 photo-op in which officials from multiple agencies used pruning shears and chainsaws to chop up stacks of banking regulations. The occasion symbolized the shared determination of Bush appointees to suspend adult supervision just as the financial industry was starting to run wild.

NYC Real Estate Market Slows

by Bill McBride on 3/31/2008 10:01:00 AM

From Bloomberg: New York City Real Estate Market Slows as Wall Street Cuts Jobs

New York City's residential real estate market is showing the first signs of fallout as U.S. banks and securities firms cut the most jobs in seven years.

Manhattan apartment sales fell in January and February from a year earlier and new properties came to the market at the fastest pace since at least 2000 ... Transactions slid 6.4 percent to 3,250, while the number of condominiums, co- operatives and townhouses for sale at the end of last month climbed to 6,225, 15 percent more than at the start of the year.
With sales falling, and inventory rising, price declines will follow.

Sunday, March 30, 2008

Mauldin: Where is the Bottom in Housing?

by Bill McBride on 3/30/2008 02:05:00 PM

John Mauldin writes: Where is the Bottom in Housing? (hat tips: many!)

Mauldin provides a good overview of the housing market. His analysis is based on information from John Burns Real Estate Consulting and T2 Partners. Both Burns and T2 have made their presentations public.

There is all kinds of charts and information available, but I'll comment on a couple of points. Mauldin writes:

Bottom Line? There is no Bottom in Sight

[Burns] most likely timeline is that resale stability will come back by 2011, and it will be even earlier for the homebuilders. He is projecting 6,000,000 home sales (new and existing) in 2008, but falling to only 4,000,000 in 2009. Low sales volume and high foreclosures will delay inventory reduction, which is required for there to be a stable market.

This means that home ownership will fall to 66% of the population in 2009 from the recent high of 69%. He thinks that may overcorrect to 65% in 2010. When I asked him why the overcorrection, he said it has to do with psychology. Housing will go from the greatest investment in 2006 to a bad one by 2009. The market typically overcorrects at the end of every cycle. It will take rising prices to lure the marginal homebuyer back into the market.

We discussed the recent rise in the price of the homebuilder stocks, which he attributes to short covering. Many of the homebuilders, public and private, are selling land at 16% of book value, or are trying to. He suggests that many of the privately owned homebuilders are in the worst shape.

Bottom line? We are nowhere near the bottom in the home markets.
First, on sales, I think Burns is too optimistic for 2008 and too pessimistic for 2009. Right now we are on pace for just under 5 million existing home sales in 2008, and 600 thousand new home sales (and sales will probably fall further). A forecast for 6 million total sales in 2008 is probably too high.

Similarly a forecast of 4 million total sales in 2009 is probably too pessimistic. The reason Burns is probably too pessimistic on total sales in 2009 is because prices will likely decline further than Burns is forecasting (helping sales). Burns is only forecasting a 16% nationwide price decline from peak to trough. Based on the Case-Shiller National index, house prices are already off 10.1% as of the end of 2007 - with much more declines likely in 2008.

Also according to Burns, there are "3.5 million excess homes that need to be filled by qualified buyers". This is really a confusing metric. Burns arrives at this total by adding excess vacant units to his estimate of future vacant homes due to the declining homeownership rate.

But this approach really confuses a few numbers and concepts. Burns estimate of 1.55 million "vacant homes" is about right, but this includes about 560 thousand excess vacant rental units! (see Inventory, Inventory, Inventory) So a decline in the homeownership rate cannot be added to this number directly - or there would be some double counting.

Also Burns is probably too pessimistic on the decline in the homeownership rate. Recent academic research by Matthew Chambers, Carlos Garriga, and Don E. Schlagenhauf (Sep 2007), "Accounting for Changes in the Homeownership Rate", Federal Reserve Bank of Atlanta, suggests that there were two main factors for the increase in homeownership rate between 1994 and 2004: 1) mortgage innovation, and 2) demographic factors (a larger percentage of older people own homes, and America is aging).

The authors found that mortgage innovation accounted for between 56 and 70 percent of the recent increase in homeownership rate, and that demographic factors accounted for 16 to 31 percent. Even as we unwind some of the excesses of recent years, not all innovation is going away (securitization and some smaller down payment programs will stay). And the population is still aging, so the homeownership rate will probably only decline to 67%, or maybe "over correct" to 66% - but will probably not decline to 65% or lower. (No one has a crystal ball, so maybe Burns pessimistic view will be proven correct).

And one more point on the declining homeownership rate: this is probably better viewed as a head wind for demand, not as additional supply. Using an excess inventory number of 1.6 million or so is probably more useful when discussing supply.

Even with these minor flaws, this is a good overview.

If You Don't Get It, It Might Be A Joke

by Tanta on 3/30/2008 09:29:00 AM

Taking notice of the endless silliness in the political blogosphere is no part of the mandate of this blog, and we normally try to carry on with our main mission while pretending that we can't hear most of the background noise and cannot feel that terrier gnawing on our ankles. It has never, really, been that we're stupid; it was mostly that we didn't want them to come over here and ruin a perfectly good nerd blog. Political discourse in this country has been so poisoned for so long that we were quite attracted to the possibility of pretending that it wasn't there in case it decided to go away while we weren't looking.

However, I for one did argue, quite early in this mess, that 1) housing policy is political in this country and 2) financial crises are even more so and that therefore 3) whether or not it "should" be that way is immaterial; it is so. The housing bust and the debt bubble pop have been and are going to remain political footballs for the foreseeable future. The least we can do about that is insist that everyone get the elementary concepts right.

Let me therefore do my obligatory least by pointing out that this kind of thing just has to stop:

Apparently, a lot of foreclosed tenants like to trash the house before they leave. I don't get it. It's hardly the bank's fault that you can't make your mortgage payment. I mean, I understand the rage at fate that has pushed you out of your home and left your credit record in shreds--yea, even if you had a hand in that fate yourself. But I don't get pointless destruction.
I can't do anything about anyone who can't quite "get" vandalism, as if it had never existed in the world before middle-class homeowners got in over their heads with mortgage loans. (Really. I was "not getting" the point of cutting off the handset on pay phones and stealing the directory back in the days when we had pay phones and they cost a dime. I was therefore prepared to "not get"--or to "get," as it were--foreclosure "trash-outs," at the point they began to arise (again, in this cycle), since, well, it's a reusable conceptual paradigm thingy.)

But it isn't the not-getting of the "pointless" destruction that makes it less than completely pointless for us to examine this silly little blog post. It's that first sentence with the term "foreclosed tenants" in it.

I "get" vandalism a whole lot more than I "get" a self-described "economics blogger" weilding the English language like that. Which is to say, I suspect I do "get" it. And I don't approve of the latter any more than the former.

There has, for a long time now, been a certain persistent critique of a variety of boom-lending that went something like this: when you take an interest-only no-down-payment loan to buy a house at market price--that is, at anything other than a significant discount to market price--you are in effect, if not in fact, merely "leasing" the house from the bank.

This is a "critique" because, see, "secured lending" only really works when the collateral that secures the loan belongs to the borrower, not the lender. I suppose I could write you a loan that involved my promising to hand over an asset that I already owned to myself--that'll teach me!--in the event that you fail to pay me back as agreed. I'm not sure I could pass a licensing exam with an understanding of the process like that, but you never know.

So the critique came in on the grounds that 1) this is self-defeating for lenders and that 2) it is self-defeating for borrowers. I occasionally run into newbies to the financial world who demand to know why anyone would buy one of these "PO strips" or bonds that do not pay interest. They "get it" once you explain that such bonds are purchased at a "deep discount" to their par or face value. Of course their next question was always why people were using wacky subprime and Alt-A loans to buy houses at "par," and out of the mouths of babes came wisdom.

The point being that "foreclosed tenant" is not simply a curious misunderstanding of law and fact. It is, you know, a way to "get" the "pointless" behavior, if you apply any degree of attention to a contradiction in terms. Possibly some borrowers are coming to the belated recognition that they were, de facto, not much more than tenants who were paying well above "market rent," but the market no longer allows them to "sell" the "lease" to the next sucker, and the law does not allow them to simply forfeit the security deposit and move away. To be a "foreclosed tenant" is to live in the worst of both worlds.

It is possible, you know, that about-to-be-former homeowners understand these things better than self-anointed "economic thinkers" do. They begin to grasp that they had only ever been given a short-term lease on the "American Dream," not a piece of the "ownership society" pie. More than a few of them are very, very, crabby. This, I can "get."

What I also "get" is that here you have a classic example of where the rush to start making a list of people you don't have any "sympathy" for gets you: nowhere, fast. It always disappoints me whenever a thread on one of our foreclosure or predatory lending posts immediately degenerates into a lot of people writing the same comment repeatedly: "I have no sympathy for these people."

It has, actually, been hard for me to "get" why some people think that the first question to be established in any discussion of the real world is whether their own personal sympathies are engaged or not. You'd think I'd be more familiar with the profoundly self-involved than I apparently am, coming out of the banking industry, but there you are. Some entertainment can be wrested out of the situation by responding that I don't have any sympathy for people who don't have any sympathy for other people, but it's limited entertainment because we are often dealing with heads over which such a response tends to fly at a fairly high altitude.

The trouble is I do "get" it. I get why some people need to turn it all into a matter of which contestant is more conventionally attractive, sympathies-wise. The original point of the "joke" about borrowers with these dumb loans just "renting" from the bank was about puncturing the claims of a certain class of economists, who seemed ready to believe that a finance-based "ponzi" economy could go on forever, and that it ought to. If you require to have the joke "foreclosed" in order to defend against its implications for the kool-aid you've been drinking for years about the larger economy, not just real estate, then you might want to willfully misunderstand the point of making jokes. Namely, to see it as making fun of "contemptible" people rather than unmasking the contradictions in economic silliness.

Joking around actually has a long and storied history in the old, old project of arriving at conceptual clarity about important problems, you know. Jokes are not merely "transgressive" of a kind of stuffy demeanor of academics and legislators and courts of law and so on, although they do have an invaluable function in ratcheting down the pompousness to tolerable levels. Jokes are, in fact, often funny because they fail to "resolve" or paper over real contradictions and conflicts: the joke drags it out into the light of day, and leaves it to squirm while we all laugh. We are all subprime now. Is a joke. With, as they say, more than a bit of "truth" in it.

It is of course not always easy to distinguish between a joke and a bog-standard stupidity. We touched on that the other day with the Zippy Tricks. Sometimes the joke actually arises when we find the naive or uninformed or logic-impaired coming up with an inspired phrase like "foreclosed tenants."

Sometimes people feel like they're being "laughed at." That, say, the joke's on them. It has been known for them to get very, very angry. Enough, say, to knock holes in the drywall and rip out the plumbing before following one's belongings to the curb.

Those whose only understanding of humor is to ridicule the victim--not to deflate the hot air filling the designers of this doomed system--will never quite "get" why the butts of the joke become so "pointlessly" destructive. Those humorless souls who do not see an appropriate role for humor in intellectual critique--who really just have to say that this is too serious for such lightmindedness, tut tut--will fail to grasp the overall dynamics of the situation from the other end of it. Between those who have no sympathy for others and those who have only sympathy--syrupy, patronizing, Sunday School-tract simple-minded sympathy--it's a wonder you can get a good joke going some days. Not that I've ever quit trying.

It is within the realm of possibility that some folks engaging in "trash-out refinances" are, well, making the point that the joke's on you, Mr. Bank. You might consider it a kind of performance art of the gallows-humor subgenre. I do think it's a usual expectation that people who write for outfits with the pretensions of The Atlantic are, frequently, expected to try to "get" that. We call these attempts to try to "get" such things intellectual effort. Expenditure of this kind of effort is way harder than, well, just asking yourself if you feel sorry for someone today. Or yukking it up at someone else's "expense."

Saturday, March 29, 2008

NY Times Analysis of Treasury Regulatory Plan

by Bill McBride on 3/29/2008 06:29:00 PM

Nelson Schwartz and Floyd Norris provide an analysis of the new regulatory plan from the Treasury: In Treasury Plan, a Reluctant Eye Over Wall Street

[T]he proposal would impose the first regulation of hedge funds and private equity funds, that oversight would have a light touch, enabling the government to do little beyond collecting information ...

The plan hands vast new authority to the Federal Reserve, essentially formalizing what has been an improvised process over the last three weeks.
There is much more in the analysis.

Land at 15 cents on the Dollar

by Bill McBride on 3/29/2008 04:41:00 PM

Last night I spoke with a land developer. He just purchased improved land in SoCal (update: Inland Empire) for $0.15 on the dollar from a homebuilder (builder's total cost). The deal closed Friday. The purchase price was less than half the cost of just the improvements (grading, streets, etc)!

The deal has no leverage, and the buyers are hoping to sell in 3 to 5 years to another homebuilder. They can wait much longer if necessary. The other details (like buyer and seller) are confidential.

This is an important step. The homebuilders are finally starting to liquidate surplus land at prices that are attractive to "vulture funds", and this potential inventory is also being removed from the market.

I expect to see many similar deals this year as the homebuilders, and their lenders, struggle to survive.

Friday, March 28, 2008

Treasury to Propose Changes to U.S. Regulatory Structure

by Bill McBride on 3/28/2008 09:39:00 PM

From Edmund Andrews at the NY Times: Treasury Dept. Seeks New U.S. Power to Keep Markets Stable (hat tip AllenM)

The Treasury Department will propose on Monday that Congress give the Federal Reserve broad new authority to oversee financial market stability, in effect allowing it to send SWAT teams into any corner of the industry or any institution that might pose a risk to the overall system.
Here is the Treasury’s Summary of Regulatory Proposal. Just some light reading for a friday night.

S&P cuts FGIC to Junk

by Bill McBride on 3/28/2008 08:01:00 PM

From Reuters: S&P cuts FGIC insurance unit's rating to junk status

S&P cut FGIC Corp by six notches to "B," five steps below investment-grade, from "BBB." It downgraded FGIC's insurance arm, Financial Guaranty Insurance Co, by six notches to "BB," two steps below investment grade, from "A."

The outlook is negative
This was expected (Fitch cut FGIC to junk on Wednesday), and FGIC will probably be in run-off (they've already stopped writing new business). Unlike insurers AMBAC and MBIA, FGIC was unable to raise new capital.

UBS Reducing Value of Auction Rate Securities in Individual Accounts

by Bill McBride on 3/28/2008 04:13:00 PM

From the WSJ: UBS Cutting Value Of Auction-Rate Securities In Brokerage Accounts

... UBS AG is marking down the value of the securities in its brokerage customers' accounts.

Until now, customers who were unable to sell securities in regularly scheduled auctions were told that the securities retained full value and would receive higher interest rates.

UBS ... will mark them down this afternoon and inform clients via their online statements shortly thereafter ... The markdowns will range from a few percentage points to more than 20% ...
I know investors in ARS, and their banks have been telling them they can't sell - but their principal is safe - it is just a liquidity problem. UBS is telling their customers they can't sell, and their principal is no longer safe.

Estimating PCE Growth for Q1 2008

by Bill McBride on 3/28/2008 01:47:00 PM

The BEA releases Personal Consumption Expenditures monthly (as part of the Personal Income and Outlays report) and quarterly, as part of the GDP report (also released separately quarterly).

You can use the monthly series to exactly calculate the quarterly change in PCE. The quarterly change is not calculated as the change from the last month of one quarter to the last month of the next (several people have asked me about this). Instead, you have to average all three months of a quarter, and then take the change from the average of the three months of the preceding quarter.

So, for Q1, you would average PCE for January, February, and March, then divide by the average for October, November and December. Of course you need to take this to the fourth power (for the annual rate) and subtract one.

The March data isn't released until after the advance Q1 GDP report. But we can use the change from October to January, and the change from November to February (the Two Month Estimate) to approximate PCE growth for Q1.

Personal Consumption Expenditures Click on graph for larger image.

This graph shows the two month estimate versus the actual change in real PCE. The correlation is high (0.92).

The two month estimate suggests real PCE growth in Q2 will be under 1% - but still positive.

In general the two month estimate is pretty accurate. Sometimes the growth rate for the third month of a quarter is substantially stronger or weaker than the first two months. As an example, in Q3 2005, PCE growth was strong for the first two months, but slumped in September because of hurricane Katrina. So the two month estimate was too high.

And the following quarter (Q4 2005), the two month estimate was too low. The first two months of Q4 were negatively impacted by the hurricanes, but real PCE growth was strong in December.

Looking at the data, real PCE has been essentially flat for four straight months. Based on various economic reports, I'd expect March to be even weaker. This suggests that real PCE in Q1 will still be positive, but somewhat below the two month estimate of 1%.

In Q4, real PCE increased 2.3%, but real GDP only increased 0.6%. With real PCE below 1% in Q1, I'd expect a negative real GDP report for Q1. This is very similar to how the last consumer led recession started in 1990.

KB Home on Housing: "No meaningful improvement in near term"

by Bill McBride on 3/28/2008 12:10:00 PM

Press Release: KB Home Reports First Quarter 2008 Financial Results

Our industry continues to confront a growing oversupply of new and resale homes, tight mortgage lending conditions and a highly competitive pricing environment. These conditions drove down sale prices and further compressed margins in the first quarter of 2008, prompting us to recognize additional impairment charges and abandon certain land option contracts that no longer made financial sense. Until prices stabilize and consumer confidence returns, we believe inventory levels will remain significantly out of balance with demand. We do not anticipate meaningful improvement in these conditions in the near term, as it is likely to take some time for the market to absorb the current excess housing supply and for consumer confidence to improve.”
Jeffrey Mezger, president and chief executive officer, KB Home
emphasis added
The little bit of good news was KB Home's cancellation rate improved slightly (similar to other builders):
The Company’s cancellation rate improved to 53% in the first quarter of 2008 compared to 58% in the fourth quarter of 2007. The Company’s cancellation rate was 34% in the first quarter of 2007.
Still, it's hard to be too excited about a 53% cancellation rate!

Fremont Ordered by FDIC to Find Buyer

by Bill McBride on 3/28/2008 11:48:00 AM

From Bloomberg: Fremont Ordered by FDIC to Find Buyer; Curbs Imposed

Fremont General Corp., the former subprime lender that raised doubt about its survival earlier this month, was ordered by federal regulators to raise new funds or find a buyer within 60 days.
It was just a little over a year ago that I posted a memo about lending changes at Fremont. Looking back now, that memo seems somewhat subdued, but it was very significant at the time - that memo marked the beginning of the subprime implosion and the start of tighter lending standards.

Based on the new FDIC order that memo probably also marked the beginning of the end of Fremont.

More On Chase and the Zippy Tricks

by Tanta on 3/28/2008 10:19:00 AM

Which, as Dave Barry always says, would be a great name for a band.

CR posted this shocker yesterday, a memo with a Chase logo attached (which doesn't mean much in these copy & paste days), sent via e-mail to mortgage brokers in what appears to be a "package" of "training documents," that provides tips on how to "cheat" and "trick" Zippy, Chase's AUS (automated underwriting system), into approving loans it would not normally approve. (Or, possibly, allowing loans to be documented or priced in a way they would not have been had the loan been submitted properly. It's hard to say exactly.)

I am not especially interested in the debate over whether it was "official Chase policy" (undoubtedly it was not) or whether it was a "joke" started by some wag at Chase ("this is how we oughta be training the brokers, ha ha!"). My own hunch is that it did start out as a joke, but there was at least one Account Executive at Chase who either didn't "get" the joke--which is scary--or who didn't have the sense to realize that certain forms of satire shouldn't leave the building.

But that's the thing: it works for me as a "joke," of the black humor deadpan sort, because, well, it isn't that far off "official policy." "Official policy" is simply couched in ponderous language, hedged about with earnest exhortations not to "misuse" the system that everyone ignores, and mostly "functional" in the sense that it covers certain raw acres of corporate butt, not in the sense that it really communicates clearly to a worker-bee what you're actually supposed to do when certain things--cough, cough--cross your desk.

I say this with complete confidence even though I haven't read Chase policy documents for years, and I have never read internal use only Chase policy documents. I have read hundreds of documents produced by dozens of institutional lenders, wholesalers, and aggregators describing credit policy and acceptable origination practices. I have written quite a few of them, to tell the truth. For that reason I have been in plenty of arguments over the years about those documents, since I have this thing about using language people can actually understand, explaining things clearly, and making policy documents actually useful to everyday operations rather than merely having them around in a file cabinet in case the regulators show up, and entirely ignored by everyone in-house unless and until that day arrives. So I am not speaking with actual detailed knowledge of Chase policy or the likely tone or content of Chase policy documents in particular. I am generalizing based on years and years of having to wade through that crap because no one else will.

What I really got interested in was not where, exactly, this document came from, but why, precisely, it says what it says. I mean, you can see this as a Chase Account Executive (or whoever authored it) simply baldly encouraging fraudulent misrepresentation, and that of course is what it is. But you also have to see that it does appear to require some misrepresentation to get past Zippy in some respects. That much is to Chase's credit.

Also, the way these things tend to work is that the "cheats and tricks" that people come up with--and no, this isn't the only one out there by a long shot, it's just the only one I know of so far that got to a reporter--tend to focus on routine problems. Nobody writes "cheat sheets" to deal with obscure complex things that only arise on one out of 200 loan applications. People write "cheat sheets" to deal with the problems you are most likely to have. And yes, I am using this term "cheat sheet" in its commonplace sense of a "dumbed down" policy or procedure, a set of "short cuts." The term has always been ambiguous: is a "cheat sheet" directions for breaking the rules, or just directions for following them faster and more easily? "Efficiency" and "user friendliness" have always been in danger of converging on the unethical. This is not a new problem. Perhaps our apparently willful lack of attention to this problem over the last several years is what was, in fact, different this time.

Besides the "most common problems," I have often found "cheat sheets" appearing in contexts where it's not so much that the issue at hand is "common," it's that this particular lender has a "thing" about that particular issue. If you ask a bunch of industry participants who are willing to tell you the truth, I suspect you'll find a high degree of consensus on what the "preoccupations" or "hot buttons" for any given wholesaler are. "Everybody knows," the story will go, that X is touchy about gift funds and Y is the hardest to deal with on short-form appraisals and Z isn't the place to go if you want a high-rise condo loan approved. And so on.

That kind of "eccentricity" is less common than it used to be, given nearly universal securitization of loans (which tends to "homogenize" the industry and make lenders willing to write loans they wouldn't touch for their portfolio) and competitive pressures that spawn "races to the bottom" all over the place. In the early years of the boom (until 2005 or so) I used to actually keep spreadsheets in which I tracked policy of ten major correspondent/wholesalers on a couple of dozen selected issues. I did not necessarily select the "common ones"; I was precisely interested in the more offbeat. Like condos with less than four total units in the project, or the rarer forms of temporary buydowns, or non-arm's-length transactions, or foreign national borrowers. ("Foreign national" in this context does not mean undocumented immigrant. It means someone who is not only not a U.S. citizen, but also not even a U.S. resident.) In other words, "niche" stuff that was once simply not allowed at all in the "prime" world, but which increasingly crept into "expanded criteria" programs--the precursor of what you all know as "Alt-A"--and then even into so-called "prime jumbo" or "prime non-agency."

What my little spreadsheet showed was that, over time, we went from an environment in which "go to Lender X if you have a small condo project" was the way it worked, to "just about everyone does small condo projects these days, so why shouldn't we?" It also showed that certain things were "migrating" from "expanded criteria" programs into "mainstream" programs. The race was on. Back in 2005 I was arguing strenuously that it was a race to the bottom, but that was of course a minority view.

Way too many people were convinced that we had the technology that would allow us to "race to the top." The idea was that in the Days of the Dinosaurs, doing 2-flats turned into condos or non-arm's-length deals or what have you was really very risky, but not any more, because now we have all these computer models that can much more finely-tune our risk assessments. Plus there was always the supplementary argument that hey! if someone like Chase is willing to do it, that must mean it's "respectable." That last argument wasn't always stated in such an unvarnished fashion, but that was the drift.

So this brings us back to the Zippy tricks, and the specific content of the infamous memo. If you read it from a certain angle--just for the sake of analytical clarity, not in aid of "defending" what is obviously indefensible--you can see it as some evidence that Chase's system, Zippy, has been correctly programmed to weed out a couple of serious problems:

1. Unstable income. The "trick" of putting all income in "base," instead of breaking it out (as the application form is designed to get you to do) into base salary, bonus, commissions, etc., is partly about getting the AUS to "let you by" with only a paystub to verify current income, if that. This is because it has been recognized since about the end of the last Ice Age that base salaries tend to be fairly stable, but bonuses and commissions tend to be rather volatile. This "other" income is, traditionally, used to qualify borrowers only when they can verify a history of having received it regularly, typically for a minimum of two years, and prospects for continuing to receive it, typically for at least the next three years. It is difficult to verify prospects; in most cases lenders digged so deeply into the past history of the income because that was the best clue to its likely continuation. The theory, for instance, was that an employer who regularly paid bonuses for the last several years was more likely to continue to pay them in the future than an employer who only just paid its first bonus a few weeks ago. Of course, stability of income projecting into the future was important because, well, we expected loans to repay out of income, not refinance money or sale of the home.

You can, if you like, theorize that Zippy has some "rules" built into it that involve a different set of parameters or a higher degree of scrutiny or possibly even a different "rate sheet" when the loan has substantial qualifying income other than base salary. It should. So the instructions to defeat that purpose by lumping everything into "base" is not just saving some idiot some keystrokes. And it's not a trivial thing involving some fussbudget who wants the forms filled out properly for no real reason. There's a real reason here.

2. Gift funds. We have been banging on for years now about borrowers having no "skin in the game." Lenders need to know--have always required to know--what the source of the down payment money is. It isn't just that loans with gifted down payments default more often, although they do. It's also that a lot of fraudulent "straw borrower" deals require "gift funds" to work out. Zippy was programmed to require this information for very good reasons.

3. "Inching up" income. Well, that one's pretty obvious. It is, however, the point at which I for one conclude that Zippy was probably not programmed correctly.

The fact of the matter is that an AUS should simply ignore DTI or cash reserve calculations when income or assets are or can be unverified. In fact, using DTI or months of reserves in your underwriting decision will inevitably produce worse results on a "stated/stated" loan than ignoring them will. They mislead you. I have known good, experienced, savvy human underwriters to fall into this trap, in spite of themselves: they see those "nice-looking" numbers and can't stop themselves from using them as a "compensating factor" on the loan.

There are people in the industry who think that "NINAs" are "worse than" stated income/stated asset loans, but I have never been one of them. What distinguishes them is that in a NINA, you don't even state numbers. You literally leave those boxes on the application blank. The loan is qualified with a credit report and an appraisal.

Now, I'll agree that NINAs are stupid--no problem there. But they're less stupid than "stated" deals. They don't "distract" you with made-up numbers. Actually, they often result in much better analysis of the appraisal and the credit report than you get in a "stated" deal. After all, the appraisal and the credit report are all you got in a NINA: you work 'em over. In the "stated" world people--and apparently some computers--keep getting sidetracked by those unverified numbers.

So I got the impression, for what it's worth, that Zippy is a mixed bag: it seems to have some responsible programming and some stupid programming. As I remarked in the comments to yesterday's post, the fact that it doesn't flash red lights and immediately refer the loan to the fraud-detection squad when it notices that a file keeps getting "resubmitted" with "refreshed" income and asset numbers is a huge problem. If this AUS really does allow multiple resubmissions with increasing stated income each time without setting off the red fraud flags, this is a very big deal for Chase. I'm here to suggest that Chase's regulators need to look into that. As I said, given the chance that the memo is a "joke," it's possible that the thing handles re-runs better than it sounds like it does. But Chase should have to answer this question now that the memo is on the table.

The final question for me, then, is what if anything is likely to be "unique" to Chase here. My answer is "not much." This just isn't in the same class as small condo projects or foreign nationals. We're talking Underwriting 101 stuff that brokers can, apparently, defeat by just putting a number in the wrong data-field or putting a "no" in the gift funds field or getting the system to keep "recalculating" DTI or cash reserves until you have forced it to reveal to you where its cutoffs are.

We all know why people do those things. What somebody needs to explain to me is how, after all this time, it's still so easy to do it. Where are the internal plausibility checks? Where is the "behavioral" logic that notices not just the content of the datafile but the manner in which it was submitted? Where's the basic randomly-selected pre-closing QC that snatches files out of the AUS queue and matches up the data submitted to the AUS with a quick phone call to the borrower?

Where, in other words, is the "high" tech? We've had AUS since the green-screen mainframer days of the 80s, kids. Thirty years down the road and these things are as easy to fool as Barbie's My First Laptop? After all the money these lenders have spent over the years on IT? There's something else that doesn't add up here besides a borrower's paystubs.

Technology aside, where, we also have to ask, are the "real" writers of policy and procedural and training documents? My own sense is that you find "cheat sheets" in companies that don't provide "real sheets" that are usable or comprehensible or updated or easily available on the website. We are, you know, in the "cut & paste" days. It's just no longer difficult to provide your people--or your broker clients--with the "real thing." Anyone who used to prepare policy with a Selectric and an old slow photocopier has a right, I think, to ask just what we're getting out of the "information" part of the "IT revolution." We just shouldn't have to have "cheat sheets" any longer; the "search" button takes care of the difficulties of looking things up. It matters, and it matters because asking people to look at the "real" policy instead of some dumbed-down "cheat sheet" written up by an Account Executive is not too much to ask. You think you will ever control for unethical behavior when you don't even demand moderate amounts of effort?

The whole industry has some explaining to do.

OFHEO: Fannie, Freddie May Raise $20 Billion

by Bill McBride on 3/28/2008 09:15:00 AM

From Bloomberg: Fannie, Freddie May Raise $20 Billion, Regulator Says

Fannie Mae and Freddie Mac, the U.S. government-chartered mortgage companies, may raise as much as $20 billion in capital as part of an agreement that allows them to buy more debt securities, their regulator said.
...
``There's no specific number,'' [James Lockhart, director of the Office of Federal Housing Enterprise Oversight] said. ``There was a range of numbers. The best way is to say it's significant.'' The amount raised will be ``much more'' than the $5.9 billion of capital released by reducing the cushion, Lockhart said.
...
``The two enterprises have effectively become the mortgage market at this point,'' Lockhart said. ``Effectively they have become the lender of first, last and every resort.''

Mishkin: Can Inflation Be Too Low?

by Bill McBride on 3/28/2008 01:32:00 AM

Federal Reserve Governor Frederic S. Mishkin spoke tonight: Comfort Zones, Shmumfort Zones. Mishkin tries to answer the question of why 1% to 2% inflation it better than zero inflation:

Can Inflation Be Too Low?
While the benefits of low inflation are now widely recognized, somewhat less attention has been given to the pitfalls of maintaining inflation rates very close to zero, so I will now discuss this issue in somewhat greater detail. Specifically, if the average inflation rate is too low, then the economy faces a greater risk that a given adverse shock could distort labor markets, induce debt deflation, or cause monetary policy to become constrained by the zero lower bound on nominal interest rates. These risks imply that undershooting a zero inflation objective is potentially more costly than overshooting that objective by the same amount, and that setting the inflation objective at a rate a bit above zero provides some insurance against these risks.

Downward nominal wage rigidities. Inflation at rates close to zero might create nonnegligible costs to the economy because firms may be relatively reluctant to cut nominal wages. Sticky nominal wages can prevent labor markets from reaching the optimal equilibrium. However, empirical evidence from Switzerland and Japan indicates that in an environment of deflation or very low inflation, downward nominal wage rigidities become less prevalent.

Debt deflation. Keeping the average inflation rate close to zero increases the likelihood that the economy will experience occasional episodes of deflation. Deflation can be particularly dangerous for an advanced economy, in which debt contracts often have long maturities. As described by Irving Fisher (1933), an episode of deflation can lead to "debt deflation," that is, a substantial rise in the real indebtedness of households and firms, because the nominal values of debt obligations are largely predetermined whereas the nominal values of household income and business revenue are falling together with the general price level. Indeed, the deterioration of the balance sheets of households and firms can result in financial turmoil that contributes to further deflation and greater macroeconomic instability.

The zero lower bound. With a very low average inflation rate, monetary policy is also more likely to encounter circumstances in which short-term interest rates are constrained by the so-called zero lower bound on nominal interest rates. Specifically, investors will never choose to lend money at a negative nominal interest rate because they always have the option of simply holding cash at a zero interest rate; thus, nominal interest rates cannot fall below zero.

Thursday, March 27, 2008

Freddie Mac Economist: No Housing Price Rebound Until 2010

by Bill McBride on 3/27/2008 10:57:00 PM

From Kevin Hall at McClatchy Newspapers: Home prices may not rebound till 2010 (hat tip John)

U.S. home prices are unlikely to recover until at least 2010, [Frank Nothaft, the chief economist for government-sponsored mortgage buyer Freddie Mac] said Thursday, adding that home building this year is likely to post its worst year in five decades.
Check out Nothaft's presentation: The Mortgage and Housing Market Outlook - all kinds of interesting data and charts.

New Home Sales Revisions

by Bill McBride on 3/27/2008 04:44:00 PM

After the Census Bureau releases the preliminary New Home sales estimate, they revise the estimate three times (over the next three months) as more data becomes available.

Historically the revisions can be in either direction - higher or lower - but beginning in 2005 I noticed that most of the revisions were down. All of the revisions (between preliminary and final) were down in 2006 and for most of 2007. It appeared that the Census Bureau had a systemic error in estimating preliminary sales during periods of rapidly declining sales.

New Home Sales Revisions Click on graph for larger image.

This graph shows the percent difference between the final revision and the preliminary release since the beginning of 2003.

Although we don't have the final revisions for December '07 and January '08, I've plotted the intermediate revisions - and the revisions are up slightly.

This suggests - tentatively - that the period of rapid declines in New Home sales may be over. This doesn't mean sales can't fall further - they might, or that sales will recover to 2005 levels any time soon - they won't. This is just a hint of a change in trend (I was using the same hint in '05 arguing the sales bubble might be over).

Another indication that we might be nearing a bottom in sales is that builder cancellation rates appear to be falling. As an example, Lennar reported today that their cancellation rate had declined to 26% in fiscal Q1 2008, from 33% in fiscal Q4 2007.

Earlier today, Stuart Miller, President and Chief Executive Officer of Lennar Corporation, said,

"Market conditions have remained challenged and continued to deteriorate throughout our first quarter of 2008. The housing industry continues to be impacted by an unfavorable supply and demand relationship, which restricts the volume of new home sales and, concurrently, depresses home prices in most markets across the country."
This "unfavorable supply and demand relationship" will probably continue for some time, but this may mean sales stay near this level rather than fall further. Also note, a spike down due to the recession is possible, but then I'd expect a fairly quick recovery back to the 600K level.

Fed's Lockhart: "Recovery may be delayed"

by Bill McBride on 3/27/2008 12:50:00 PM

Excerpts from Atlanta Fed President Dennis P. Lockhart: Current Economic Situation, Outlook, and Recent Actions

... the economy is in a slowdown that resembles past periods that were the leading edge of a recession.
...
Looking ahead, my forecast has been affected both by an economic slowdown that has been sharper than I had expected and the recurring spells of financial market turmoil. A few months ago our forecast at the Atlanta Fed saw growth slow in the first half of 2008, then pick up in the second half of the year. But it now appears to me that the contraction in housing and the dampening effects of financial turmoil on household and business spending could persist through the remainder of this year. The recovery in growth I had expected in the second half of this year may be delayed.
emphasis added
It appears Lockhart is still too optimistic on house prices:
I expect it will take much of the rest of the year for house prices to bottom out and financial markets to restore the necessary preconditions of stability—that is, confidence in asset values and confidence in transaction counterparties.

Zippy Cheats & Tricks

by Bill McBride on 3/27/2008 11:51:00 AM

The Oregonian is reporting this morning on a JPMorgan Chase memo titled "Zippy Cheats & Tricks". The Oregonian obtained a copy of the memo, and the memo apparently offers tips on how to get loans through Chase's in-house automated loan underwriting system:

The document recommends three "handy steps" to loan approval:

Do not break out a borrower's compensation by income, commissions, bonus and tips, as is typically done in a loan application. Instead, lump all compensation as the applicant's base income.

If your borrower is getting some or all of a down payment from someone else, don't disclose anything about it. "Remove any mention of gift funds," the document states, even though most mortgage applications specifically require borrowers to disclose such gifts.

If all else fails, the document states, simply inflate the applicant's income. "Inch it up $500 to see if you can get the findings you want," the document says. "Do the same for assets."
...
"This is not how we do things," [Chase spokesman Tom Kelly] said. "We continue to investigate" the memo, Kelly said. "That kind of document would neither be condoned or tolerated."
Added: the article very clearly states this was for stated income loans - and that Chase no longer offers these loans. In no way do I think this was Chase's policy - instead this shows how some people (possibly Chase insiders) were helping borrowers (or mortgage brokers) commit mortgage fraud.

Lennar: Housing Market Conditions "continued to deteriorate" in Q1

by Bill McBride on 3/27/2008 09:39:00 AM

From homebuilder Lennar's press release:

Stuart Miller, President and Chief Executive Officer of Lennar Corporation, said, "Market conditions have remained challenged and continued to deteriorate throughout our first quarter of 2008. The housing industry continues to be impacted by an unfavorable supply and demand relationship, which restricts the volume of new home sales and, concurrently, depresses home prices in most markets across the country."

"Home inventories have been expanding due to the high number of foreclosures, negotiated 'short sales,' and stretched homeowners looking to sell homes they can no longer afford. While sales are occurring and clearing prices are being reached, the pace of overall housing inventory growth is exceeding absorption at the current time."

"Concurrently, lower consumer confidence has quieted demand among prospective homebuyers and deterred them from a buying decision, while contraction in the lending markets has reduced the availability of credit for those prospective homebuyers that do wish to buy a home."
emphasis added

The HELOC As Disability Insurance

by Tanta on 3/27/2008 08:58:00 AM

This morning we have Vikas Bajaj in the NYT reporting on second-lien lenders refusing to go quietly:

Americans owe a staggering $1.1 trillion on home equity loans — and banks are increasingly worried they may not get some of that money back.

To get it, many lenders are taking the extraordinary step of preventing some people from selling their homes or refinancing their mortgages unless they pay off all or part of their home equity loans first. In the past, when home prices were not falling, lenders did not resort to these measures.
Um. This isn't really a very helpful way to put it, you know. In the very concept of the "lien" is the idea that the lender gets to demand payment if you sell the property that is securing the loan, and in the very concept of "refinance" lurks the idea that you pay off the existing loan with the proceeds of the new one. These concepts are not "extraordinary."

What we mean here, I take it, is short sales and short refinances (or subordinations behind a distressed first-lien refinance). If so, we really ought to say that, because "in the past, when home prices were not falling," we didn't have a lot of short sales and short refis, so the occasion for second lienholders to object to them just didn't arise much.

The reason to insist on some clarity here is that I don't think it helps much to build up certain people's sense of entitlement on the matter. Or at least their occasionally fundamental confusion about what rights you give up to a lender when you sign this mortgage thingy.

There is an example in the Times article, of a couple who attempted a short sale which was derailed because the second lienholder wouldn't play nice:
Experts say it is in everyone’s interest to settle these loans, but doing so is not always easy. Consider Randy and Dawn McLain of Phoenix. The couple decided to sell their home after falling behind on their first mortgage from Chase and a home equity line of credit from CitiFinancial last year, after Randy McLain retired because of a back injury. The couple owed $370,000 in total.

After three months, the couple found a buyer willing to pay about $300,000 for their home — a figure representing an 18 percent decline in the value of their home since January 2007, when they took out their home equity credit line. (Single-family home prices in Phoenix have fallen about 18 percent since the summer of 2006, according to the Standard & Poor’s Case-Shiller index.)

CitiFinancial, which was owed $95,500, rejected the offer because it would have paid off the first mortgage in full but would have left it with a mere $1,000, after fees and closing costs, on the credit line. The real estate agents who worked on the sale say that deal is still better than the one the lender would get if the home was foreclosed on and sold at an auction in a few months.
I'm not here to make up details not in evidence in a newspaper story, so bear that in mind. But my attention was caught by that detail about retiring due to an injury. As presented, the story seems to be that the McLains took out a HELOC in January of 2007, and at some point "last year" the borrowers fell behind in payments because of the disability. We aren't told by the Times whether the income troubles led to drawing down the HELOC, and then being unable to keep up payments, or if the HELOC had been drawn to the full $95,000 back in January of 2007, and subsequently the income troubles led to the McLains being unable to keep up the payments.

I bring this up only because the following item caught my eye yesterday (via Mish), from someone who apparently purports to be a source of personal finance advice:
As many readers know, I’m a proponent of keeping an untapped home equity line of credit (HELOC) at my disposal for major emergencies. This isn’t my emergency fund. It’s what I call my catastrophe fund.

I’ve always believed that keeping a HELOC readily available is the best insurance policy and the back-up plan for if / when the emergency fund runs empty. Think about it… being able to tap this money could buy us time in the event of job loss or illness. And time is money. . . .

The HELOC is there strictly as a backup plan. For a catastrophe. Period. End of story. But with that said, I’ve always looked at that line of credit as my money. Money I could access at any time. . . .

So it came as a surprise yesterday when we got the letter from Citibank about our $168,000 line of credit:
We have determined that home values in your area, including your home value, have significantly declined. As a result of this decline, your home’s value no longer supports the current credit limit for your home equity line of credit. Therefore, we are reducing the credit limit for your home equity line of credit, effective March 18, 2008, to $10,000. Our reduction of your credit limit is authorized by your line of credit agreement, federal law and regulatory guidelines.
Reduced to $10,000!? Hello!? Please don’t f-ck with my house in Newport Beach…

Of course, I’m calling them today to dispute it.
I left out the parts about how this writer is such a great credit risk now, and was when she qualified for the HELOC originally. I am merely struck by how unaware she is of the essential problem in her understanding of a HELOC as a kind of disability insurance: she is saying that she qualified for the line of credit as an employed, cash-flush borrower, but plans to use it only if she becomes . . . the kind of borrower who couldn't qualify for a HELOC.

Now, let me say that lenders were fully complicit in this idea; I heard more than a few sales pitches for HELOCs over the boom years based on this "do it just in case you need it" idea. But it was a self-defeating plan then and it is so clearly still one now: how do you get out of problems making your mortgage payment by increasing your mortgage debt--and not coincidentally decreasing your odds of selling your home should you need to?

More to today's point, how do you ask the HELOC lender to advance you money to pay the first lien lender with--I assume that's the idea of using the HELOC to "tide you over" in a bad patch, you're borrowing the first lien mortgage payments from the HELOC lender--knowing you aren't really (currently, at least) in any position to pay it back, and then ask the HELOC lender to let the first lien lender get all the proceeds in a short sale? Don't get me wrong: I fully understand why people hate lenders these days and think they're just getting what they "deserve." I'm just shocked at the naive assumption that they wouldn't fight back a little here.

As I said, I don't really know what the McLains' situation was, since we don't get much detail. But one can understand Citibank's near-total erasure of Ms. Newport Beach's unused HELOC as a sensible precaution on Citi's part, and not simply because home values are falling. Now is probably not a good time for HELOC lenders to be sitting on their duffs waiting for borrowers to run into financial trouble and use those HELOCs as a way to limp along to the point where the HELOC lender gets nothing in a foreclosure.

Of course Ms. Newport Beach believes that her potential use of a HELOC as "insurance" wouldn't be doomed to failure. Nobody ever believes that doubling down is doomed to failure; that's why they do it. But if in fact that's what the McLains did, it doesn't seem to have done anything for them except buy them time to negotiate a short sale that then fell through because CitiFinancial didn't like being the patsy at the table.

Wednesday, March 26, 2008

Clear Channel and Private equity firms sue Banks

by Bill McBride on 3/26/2008 07:09:00 PM

From Bloomberg: Clear Channel, Bain, Lee Sue Banks Over Buyout Plan

Clear Channel Communications Inc., Bain Capital LLC and Thomas H. Lee Partners LP sued banks financing the $19.5 billion buyout of Clear Channel to force them to honor funding commitments.
...
The banks stand to lose at least $2.7 billion because loan prices have fallen since they agreed to finance the transaction last year.
The banks have about 2.7 billion reasons to find a way out of this deal.

New Century's Improper Accounting

by Tanta on 3/26/2008 06:47:00 PM

Apparently, the accounting firms never learn. From Vikas Bajaj in the NYT:

In a sweeping accusation against one of the country’s largest accounting firms, an investigator released a report on Wednesday that said “improper and imprudent practices” by a once high-flying mortgage company were condoned and enabled by its auditors.

KPMG, one of the Big Four accounting firms, endorsed a move by New Century Financial, a failed mortgage company, to change its accounting practices in a way that allowed the lender to report a profit, rather than a loss, at the height of the housing boom, an independent report commissioned by a division of the Justice Department concluded. . . .

The 580-page report documents how New Century lowered its reserves for loans that investors were forcing it to buy back even as such repurchases were surging. Had it not changed its accounting, the company would have reported a loss rather a profit in the second half of 2006. The company first acknowledged that its accounting was wrong in February 2007 and sought bankruptcy protection less than two months later as its lenders stopped doing business with it.

The profit was important because it allowed executives to earn bonuses and convince Wall Street that it was in fine shape financially when in fact its business was coming apart, the report contended. But the report stopped short of saying that the company “engaged in earnings management or manipulation, although its accounting irregularities almost always resulted in increased earnings. . . .

“I saw e-mails from the engaged partner saying we are at the risk of being replaced,” Mr. Missal said in a telephone interview about a KPMG partner assigned to work on the audit of New Century. “They acquiesced overly to the client which in the post-Enron era seems mind-boggling.”
I have to say I have, really, no desire to read a 580-page report on this subject. But doesn't that seem like a lot of report to find one problem--under-reserving for repurchases that doesn't rise to the level of earnings management or manipulation?

(hat tip, sk)

There's Always Sick People

by Tanta on 3/26/2008 05:14:00 PM

Some of you have wondered from time to time what all the employment casualties of the credit and housing busts are going to do next.

This ought to keep you up at night:

NEW YORK (CNNMoney.com) -- When Heidi Sadowsky quit the finance sector, she abandoned a job market on the verge of collapse for one that may be air-tight: nursing.

"I was never happy in my life in finance," said Sadowsky, 39, a former liaison for institutional investors and money managers at Citibank and Invesco. "I always felt like a square peg in a round hole. I decided I had to get out of this business. I was never cut out for this."

Inspired by the compassion of nurses who cared for her terminally ill father, Sadowsky took up training last year at New York University's College of Nursing. Since she already had an undergraduate degree, she was accepted into the nursing school's accelerated 15-month bachelors program and she expects to graduate in May. . . .

Sadowsky picked the right time to switch careers. The finance sector has shed 124,000 jobs since the beginning of 2007, according to the Department of Labor, including 22,000 jobs in the first two months of this year. Major firms like Bear Stearns (BSC, Fortune 500), Merrill Lynch (MRL) and Sadowsky's old employer Citigroup (C, Fortune 500) have been hard-hit by the subprime collapse, and analysts expect up to 30,000 more job cuts in finance by the end of the year.

Meanwhile, hospitals, clinics and nursing schools are scrambling to fill vacant positions for nurses and teaching staff. The Department of Labor estimates the number of vacancies for registered nurses will expand to 800,000 in 2020, from its 2005 tally of 125,000.
I can pretty much vouch for the fact that having an undergraduate business degree and years of experience in finance qualifies you to give other people heart attacks. But is it really the kind of experience that should let you cram nursing school into 15 months?
"Tradition holds that a guy's going to be a doctor, and the female is going to be a nurse," Neville Lewis, 40, an NYU nursing student who is married to an RN.

Like Sadowsky, Lewis abandoned finance to take up nursing. Since he already had a bachelor's, he qualified for NYU's accelerated 15-month program. Lewis said he majored in political science and mass communications at Midwestern State University in Texas, and then embarked on a 15-year career in the bond and IPO sector at the investment firms Equiserve (now Computershare) and Fidelity Investments.

"I kind of fell into finance after graduation," said Lewis, who had felt the lucrative pull of the finance sector. "You make a lot of money, but do you enjoy it? I was not happy."

After getting laid off from Equiserve in 2002, Lewis took a job at Fidelity and considered going back to school to pursue tax law. But he changed his mind, quit Fidelity in 2007, and started at NYU's nursing school in January, 2008. He expects to graduate in 2009.

"I felt like I could accomplish more by working to heal people, then by helping people fight over money," he said. And as he watched his former sector collapse, Lewis realized that altruism wasn't the only motive to get into nursing.

"Seeing what's happening now, I have no regrets in leaving finance," he said. "People are always going to be sick. We live in an aging society."

OFHEO Releases Final Guidance on Conforming Loan Limits

by Bill McBride on 3/26/2008 12:45:00 PM

How many people think the new "temporary jumbo conforming loan limits" are really temporary?

Apparently the Office of Federal Housing Enterprise Oversight (OFHEO) does.

From OFHEO: OFHEO Issues Final Guidance on Conforming Loan Limit Calculations

The final Guidance addresses the handling of decreases in the house price data used to set the conforming loan limit as well as procedural matters relating to calculation of the limit that determines the size of mortgages eligible for purchase by Fannie Mae and Freddie Mac.

Based on comments received in two public comment periods, OFHEO is issuing a final Guidance that provides that the conforming loan limit would not decrease from its current level of $417,000 in 2009 and subsequent years. However, the conforming loan limit will not increase until cumulative increases in house prices exceed cumulative decreases since the $417,000 limit was first reached.
This means the conforming loan limit can never decrease, but it will not increase until prices have returned to earlier levels. Under the old guidance, the conforming loan limit was supposed to move with house prices, both up and down.

Of course, "temporary" probably means "permanent", and the limit will vary by MSA (Metropolitan Statistical Area).

More on New Home Sales

by Bill McBride on 3/26/2008 11:31:00 AM

There is actually some good news in the Census Bureau's New Home sales report this morning. But first a few more ugly graphs (see February New Home sales for earlier graphs).

New Home Sales and Recessions Click on graph for larger image.

This graph shows New Home Sales vs. recessions for the last 45 years. New Home sales were falling prior to every recession, with the exception of the business investment led recession of 2001.

It appears the U.S. economy is now in recession - possibly starting in December - as shown on graph.

This is what we call Cliff Diving!

New Home Sales Monthly Not Seasonally Adjusted
The second graph shows monthly new home sales (NSA - Not Seasonally Adjusted).

Notice the Red columns in January and February 2008. This is the lowest sales for February since the recession of '91.

As the graph indicates, the spring selling season has started - and started poorly. Toll Brothers CEO said last month:

“The selling season, which we believe starts in mid-January, has been weak ..."
And one more long term graph - this one for New Home Months of Supply.

New Home Months of Supply and Recessions
"Months of supply" is at the highest level since 1981. Note that this doesn't include cancellations, but that was true for the earlier periods too.

The all time high for Months of Supply was 11.6 months in April 1980.

Once again, the current recession is "probable" and hasn't been declared by NBER.

So what is the good news?

There are actually two pieces of good news in the report. First, inventory levels (even accounting for cancellations) are clearly falling. This is a small first step in correcting the huge overhang in new home inventory.

Note: The inventory (and sales) reported by the Census Bureau doesn't account for cancellations, and the Census Bureau doesn't include many condos (especially high rise condos).

The second piece of good news is revisions. During periods of rapidly declining sales, the Census Bureau routinely overestimates sales in the initial report - and then revises down sales over the next few months. In this report, sales were revised up slightly for November (from 630K to 631K), December (605K to 611K) and January (588K to 601K). This is actually a positive sign that New Home sales might be nearing a bottom. However, a quick rebound in sales is unlikely with the huge overhang of both new and existing homes for sale.

Analyst Meredith Whitney Projects $13.1 billion in Write-Downs for Citi

by Bill McBride on 3/26/2008 11:20:00 AM

From Bloomberg: Citigroup Estimates Cut by Oppenheimer's Whitney

Whitney predicted the bank will lose $1.15 a share in the quarter because of potential markdowns of $13.1 billion on assets including leveraged loans and collateralized debt obligations.
Hopefully there will be no death threats for Ms. Whitney this time.

February New Home Sales

by Bill McBride on 3/26/2008 10:00:00 AM

According to the Census Bureau report, New Home Sales in February were at a seasonally adjusted annual rate of 590 thousand. Sales for January were revised up to 601 thousand.

New Home Sales Click on Graph for larger image.

Sales of new one-family houses in February 2008 were at a seasonally adjusted annual rate of 590,000 ... This is 1.8 percent below the revised January rate of 601,000 and is 29.8 percent below the February 2007 estimate of 840,000.

New Home Sales Inventory

The seasonally adjusted estimate of new houses for sale at the end of February was 471,000.

Inventory numbers from the Census Bureau do not include cancellations - and cancellations are once again at record levels. Actual New Home inventories are probably much higher than reported - my estimate is about 100K higher.

Still, the 471,000 units of inventory is below the levels of the last year, and it appears that even including cancellations, inventory is now falling.

New Home Sales Months of Inventory
This represents a supply of 9.8 months at the current sales rate.

This is another weak report for New Home sales, and I'll have some analysis later today on New Home Sales.

Durable Goods Orders Decline

by Bill McBride on 3/26/2008 09:45:00 AM

From Rex Nutting at MarketWatch: Demand for durable goods falls 1.7% in Feb.

Demand for machinery and other capital goods sank in February, driving orders for durable goods down 1.7%, the Commerce Department reported Wednesday.

The unexpected decline in orders for big-ticket items marked the second straight monthly drop, an indication that domestic demand is weakening faster than exports can grow.

"This is another report that has a strong recessionary feel about it," wrote John Ryding, chief U.S. economist for Bear Stearns.
Another indicator suggesting recession.

Tuesday, March 25, 2008

FDIC to Hire More Workers, Braces for Bank Failures

by Bill McBride on 3/25/2008 11:08:00 PM

From USA Today: FDIC Plans Staff Boost for Bank Failures

The Federal Deposit Insurance Corp. wants to add 140 workers to bring staff levels to 360 workers in the division that handles bank failures, John Bovenzi, the agency's chief operating officer, said Tuesday.

"We want to make sure that we're prepared," Bovenzi said ...

Gerard Cassidy, managing director of bank equity research at RBC Capital Markets, projects 150 bank failures over the next three years, with the highest concentration coming from states such as California and Florida where an overheated real estate market is in a fast freeze.
This is a follow-up to the WSJ story last month of the FDIC bringing back 25 retirees with experience in handling bank failures.

The bank failures are coming.

WSJ: Clear Channel Deal Near Collapse

by Bill McBride on 3/25/2008 04:13:00 PM

From the WSJ: Clear Channel Communications' Privatization Deal Is Near Collapse

The $19 billion privatization of Clear Channel Communications Inc. was near collapse as the private equity firms behind the deal and the banks financing it failed to resolve their differences over the terms of the credit agreement ...
This is a deal no one wants - except Clear Channel's current owners.

Goldman Predicts $460 billion in leveraged credit losses

by Bill McBride on 3/25/2008 02:41:00 PM

From Bloomberg: Wall Street May Face $460 Billion Credit Losses, Goldman Says

Wall Street banks, brokerages and hedge funds may report $460 billion in credit losses from the collapse of the subprime mortgage market ... according to Goldman Sachs Group Inc.
A few excerpts from the report: Leveraged Losses—Still Out There (no link)
Residential mortgage losses will represent about half the damage, with another 15%-20% coming from commercial mortgages. Credit card loans, auto loans, commercial and industrial lending, and nonfinancial corporate bonds make up the remainder.
...
The losses to leveraged US financial institutions make up only a part of total credit losses, which we expect to be $1.2 trillion.
...
Thus far, our banks team has tallied approximately $120 billion in announced writeoffs from US leveraged institutions since the credit crisis began (including foreign institutions, this number rises to about $175 billion).
...
Most of the write-offs to date relate to residential mortgages, so here we may be halfway through the process, perhaps even a bit further. Elsewhere, though, we suspect significant write-offs remain in store, even after the full set of first-quarter results for financial firms becomes available.
It's hard to tell the actual losses to date, because hedge funds will probably not announce losses, and some losses are actually gains for other institutions. But it appears that the process has just started for commercial mortgages, credit card and auto loans, corporate bonds, and other lending.

Real Case-Shiller House Price Index

by Bill McBride on 3/25/2008 01:45:00 PM

Looking at the Case-Shiller house price indices in real (inflation adjusted) terms give us an idea of how much further house prices might fall.

Real Case-Shiller House Price Index Click on graph for larger image.

This graph shows the inflation adjusted Case-Shiller indices for San Diego, Chicago and the composite indices for 10 and 20 cities. (I'd add more cities, but the graph is too messy!)

Looking at this graph, I'd guess prices have fallen somewhat less than half way (in real terms) to the eventual bottom. Of course, more inflation means less prices need to fall in nominal terms.

Also look at the length of the housing bust in the early '90s. It took over six years from peak to trough in some cities. If this bust takes the same amount of time, prices will not bottom in some cities until 2012 (or there about).

OFHEO: House Prices Decline 1.1% Nationwide in January

by Bill McBride on 3/25/2008 10:14:00 AM

OFHEO is now releasing a monthly House Price Index. Note that this is a National index, but only uses data from Freddie and Fannie.

From OFHEO: New U.S. Monthly House Price Index Estimates 1.1 Percent Price Decline in January

U.S. home prices fell approximately 1.1 percent on a seasonally-adjusted basis between December 2007 and January 2008, according to OFHEO’s new monthly House Price Index. For the 12 months ending in January, U.S. prices fell 3.0 percent. Since its peak in April 2007, the monthly index is down 4.1 percent.

The monthly index is calculated using purchase prices of houses backing mortgages that have been sold to or guaranteed by Fannie Mae or Freddie Mac.
OFHEO Monthly House Price Index Click on graph for larger image.

This graph from OFHEO shows the monthly change for the Purchase Only index.

When comparing the national Case-Shiller and OFHEO indices, there are a number of differences: OFHEO covers more geographical territory, OFHEO is limited to GSE loans, OFHEO uses both appraisals and sales (Case-Shiller only uses sales), and some technical differences on adjusting for the time span between sales.

OFHEO economist Andrew Leventis’ research suggests that the main reason for the recent price difference between the Case-Shiller and OFHEO indices was that prices for low end non-GSE homes declined significantly faster than homes with GSE loans. This was probably due to the lax underwriting standards on these non-GSE subprime loans. Note that Leventis' research focused on the differences in the indices for the period from Q3 2006 through Q3 2007. I suspect the Case-Shiller index will continue to see larger price declines than OFHEO as lending standards have now been tightened significantly for other non-GSE loans (especially jumbo loans).

House Prices Plunge, "No Market Immune"

by Bill McBride on 3/25/2008 10:03:00 AM

From MarketWatch: Home prices fall a record 10.7% in past year

Home prices in 20 major U.S. metro areas have plunged a record 10.7% in the past year as prices continued to decelerate, Standard & Poor's said Tuesday.

The 20-city Case-Shiller home price index fell a record 2.4% in January, the 18th consecutive decline in prices. For 10 major cities, prices fell 2.3% in January and 11.4% for the past 12 months.

"No markets seem to be completely immune from the housing crisis,' said David Blitzer, chairman of the index committee at S&P.
The article mentions Charlotte is up year-over-year, but prices are now falling there too.

Here is the S&P/ Case-Shiller data. Note that the most recent data is for January, and this is NOT the Case-Shiller national index (these are prices for 20 of the largest cities, and a composite index of those cities).

Entitlement

by Tanta on 3/25/2008 08:42:00 AM

Yves at naked capitalism had a good post yesterday on the infamous Bear Stearns Ten Buck Rechuck, that I think needs repeating:

According to Sorkin, the $2 price for Bear was the Fed's and Treasury's idea; JP Morgan was prepared to pay more, but they nixed the idea, saying they did not like the "optics" of the deal. The implication is that the officials overstepped their bounds. That is a pretty outrageous spin when the government is putting up taxpayer money.

Had it been an option, the Fed should have nationalized Bear. It was going to declare bankruptcy Monday if there was no deal; its shareholders would have been wiped out. Why am I so confident of this view? If bondholders, as rumored, were buying shares to make sure the JPM deal went through (and thus would take losses on their stock purchases when the deal closed), that meant that they thought their bonds were worth well under 100 cents on the dollar in a bankruptcy. Shareholders are subordinate to bondholders, so equity owners would have gotten zilch.

I can think of a host of reasons, however, why the Fed did not go the nationalization route, the biggest being that it lacked clear authority (it couldn't declare Bear to be insolvent, as it could a member bank). And letting Bear fail (and having accounts frozen) was what the Fed was trying to avoid, so letting it fail and then seizing control (even assuming it could do that) was never an option. No doubt, the central bank also did not want to assume administrative control of an entity that it had never regulated (ie, its supervisors had never kicked its tires) that dealt actively in markets in which the Fed has little expertise. Even in an orderly liquidation scenario, that it a lot to take on.

Sorkin nevertheless argues that the Fed did Bear a dirty because:
.....the night that Bear signed the original bid, the Fed opened what’s known as the discount window to companies like Goldman Sachs and Lehman Brothers — oh, yes, and to Bear, too. Except that the Fed didn’t tell Bear that it planned to open the window when it was signing its deal with JPMorgan.
This verges on being revisionist history. First and most important, the discount window was opened to keep the panic about Bear from spreading to other firms, most notably Lehman. It almost certainly would not have happened then if Bear was not on the verge of imploding. Remember, a mere week and a day ago, there was pervasive fear that the wheels were about to come off the financial system, particularly if counterparties started getting leery of dealing with Lehman.

Moreover, usage of the new discount window the first week was light due to worries about stigma. If Bear had gone and used it aggressively, it may well have reinforced rather than allayed fears about the trading firm's health. If other firms continued to refuse to deal with Bear, its collapse was assured. There was a very real possibility that even if Bear had remained independent and used the window, its bankruptcy merely would have been delayed a day or two. And it would have been well nigh impossible to put together a three party takeover deal between the close of business in New York and market opening in Asia on a weekday.

But the most appalling aspect of Sorkin's account: he acts as if Bear had the right to be informed of the Fed's plans. Sorkin seems to have forgotten the golden rule: he who has the gold makes the rules. The Fed had every right to be calling the shots. They were taking the biggest risk in this transaction. The notion that a firm about to fail is entitled to be treated as a being on an equal footing with its rescuers is absurd. And the fact that Sorkin (and presumably others on Wall Street) sympathize with this view says the industry badly needs to be leashed and collared.
This, frankly, is the reason why I am so incredibly appalled by this:
Wells Fargo CEO John Stumpf said the financial crisis is presenting the bank with more acquisition opportunities.

"I would not be averse to a Fed-assisted transaction," Stumpf said in a recent interview with the San Francisco Business Times. "Fixer-uppers don't bother us."

The San Francisco banker said any deal would have to meet the company's traditional acquisition targets and benefit the bank's acquired customers.
To even mention, in public, that one "wouldn't be averse to a Fed-assisted transaction" is to hint that the acquisition targets you are looking at are in as dire straits as Bear Stearns. What is Stumpf trying to do, start a run on an insured bank? Or, well, the other option is that Stumpf doesn't believe that Bear was such a mess--that, precisely, it is "on an equal footing with its rescuers."

Either way you slice it, the very fact that he could say such a thing in public tells you how far down the wrong road we've gone. I vote for the leash and collar, pronto.