by Calculated Risk on 8/18/2008 09:44:00 AM

From the Financial Times: US banks scramble to refinance maturing debt (hat tip AT)

Battered US financial groups will have to refinance billions of dollars in maturing debt over the coming months, a move likely to push banks’ funding costs higher ...

Mohamed El-Erian, co-chief executive of Pimco, the asset management group, said: “If banks keep borrowing at these levels, you will get a repricing of credit for the whole economy.”
...
Adding together 10 of the biggest bank borrowers, Dealogic said that maturing bonds total $27bn in August, $52bn in September, $23bn in October, $20bn in November and $86bn in December. The extent of the scramble for funds became clear last week when banks tapped central lending facilities ... US commercial banks borrowed a record daily average of $17.7bn from the Fed last week.

Higher borrowing costs for banks probably means higher lending costs for customers, negatively impacting the economy.

by Calculated Risk on 8/12/2008 10:30:00 AM

This was released yesterday, but this chart is worth posting.

Click on table for larger image in new window.

The Home ATM is drying up. And now lending standards are being tightened for credit cards and other consumer loans.

From the Fed:

About 65 percent of domestic banks—up notably from about 30 percent in the April survey—indicated that they had tightened their lending standards on credit card loans over the past three months, and about the same fraction of respondents—up from roughly 45 percent in the April survey—reported having tightened standards on consumer loans other than credit card loans. In addition, considerable fractions of respondents reported having increased minimum required credit scores on both types of consumer loans and reduced the extent to which such loans were granted to customers who did not meet their bank’s credit-scoring thresholds. Finally, large net fractions of banks noted that they had lowered credit limits on credit card accounts over the past three months, and increased interest rate spreads on consumer loans other than credit card loans. On balance, about 35 percent of domestic banks—up from roughly 25 percent in the April survey—expressed a diminished willingness to make consumer installment loans relative to three months earlier. Regarding loan demand, about 30 percent of respondents, on net, indicated that they had experienced weaker demand for consumer loans of all types over the past three months, up from about 20 percent in the April survey.

by Calculated Risk on 8/10/2008 09:38:00 PM

From the WSJ: Banks in Euro Zone Tighten Lending Again

Banks in the euro zone continued to tighten lending standards during the second quarter amid a deteriorating economic outlook, and criteria could become even tighter, according to the European Central Bank's July Bank Lending Survey.
...
"The ongoing tightening of bank credit standards and the further weakening in demand for bank loans strengthens our belief that the euro-zone credit cycle is turning sharply lower," said Martin van Vliet, an economist at ING Bank.

The Fed's July Senior Loan Officer survey should be released soon - and will probably show banks tightened lending standards in the U.S. too.

The Credit Crunch continues. And the 2nd half recovery - projected by many economists - has been cancelled. From Kelly Evans at the WSJ: Economists Expect 2008's Second Half to Be Worse Than First. Here is a video of the WSJ's Evans summarizing the article:

by Calculated Risk on 8/09/2008 05:55:00 PM

In February the Auction Rate Securities (ARS) market froze. Auction-rate securities are a borrow short, lend long (or invest long) strategy used by cities and student-loan organizations to lower their borrowing costs.

It has been alleged that many banks marketed ARS to investors as "safe as money markets". Since the markets froze, many investors have been unable to withdraw their funds. Now the banks, to avoid legal action, are having to buyout those investors.

From the WSJ: UBS to Pay $19 Billion As Auction Mess Hits Wall Street

On Friday, facing allegations of wrongdoing over its sales of so-called auction-rate securities, UBS AG agreed to buy back from investors nearly $19 billion of the investments as part of a settlement with federal and a group of state regulators. It will start buying from individuals and charities in October and from institutional clients in mid-2010.

UBS was the third major firm this week to vow to buy back the securities, which allegedly were improperly sold as higher-rate equivalents for super-safe money-market funds.

UBS, Merrill Lynch & Co. and Citigroup Inc. have committed to taking back a total of more than $36 billion of the instruments. Other financial firms are expected to follow suit.
...
Wall Street sold more than $330 billion of these securities to more than 100,000 individuals and other investors.

This isn't a loss for the banks - although there may be some losses in the future - because the Auction Rate Securities are still paying interest. However this does tie up the banks' capital and contributes to the credit crunch.

by Tanta on 8/07/2008 08:51:00 AM

The Wall Street Journal continues our run of bad news about the 2007 mortgage vintage:

An analysis prepared for The Wall Street Journal by the Federal Deposit Insurance Corp. shows that 0.91% of prime mortgages from 2007 were seriously delinquent after 12 months, meaning they were in foreclosure or at least 90 days past due. The equivalent figure for 2006 prime mortgages was just 0.33% after 12 months. The data reflect delinquencies as of April 30. . . .

Data on other classes of mortgages suggest the same trend. Freddie Mac reported Wednesday that 1.38% of the 2007-vintage loans it purchased were seriously delinquent after 18 months compared with 0.38% of 2006 loans at the same point in their life. Freddie Mac generally purchases loans made to creditworthy borrowers.

Last month, J.P. Morgan Chase & Co. said it expects losses on prime mortgages that weren't securitized and remain on its books to triple from current levels. The increase in bad loans is driven mostly by jumbo mortgages originated in the second half of 2007, a company spokesman said. . . .

Economists and industry officials say several factors may account for the dismal performance of the class of 2007. Home prices were falling sharply in much of the country by 2007, meaning many borrowers who took out loans in that year for nearly the full price of the home now owe more than the home is worth. These borrowers are particularly vulnerable to a weakening economy, and have difficulty selling or refinancing if they lose their job.

Questionable business practices may have played a role, too. Some of the 2007 loans "were knowingly originated as really bad loans," says Chris Mayer, a professor of real estate at Columbia University's business school. Mortgage originators who profited handsomely from the housing boom "realized the game was completely over" and pushed mortgages out the door, says Mr. Mayer.

As credit began to tighten last year, some mortgage brokers and borrowers tried to circumvent tougher restrictions by inflating borrowers' credit scores and appraisal values, says Jay Brinkmann, vice president of research and economics for the Mortgage Bankers Association.

No doubt all of these factors are in play, even though I'm not yet convinced that they were that much more in evidence in 2007 than in 2006.

It seems to me that one thing that would help us understand this marked difference in performance between these two vintages is an analysis of the "cure" rate and method of cure of the 2006 vintage delinquent loans, as well as some analysis of the actual loan life (number of months to payment in full) of the higher-risk 2006 loans. I think we need this before we conclude that either the 2007 vintage contained worse loans than 2006 or that house price depreciation itself is an unproblematic "cause" of the elevated early delinquencies in 2007.

What I am saying is that when you compare two vintages like this, you want to know whether the loans in the earlier vintage experienced a lower serious delinquency rate because fewer of those loans were "bad," or because more of those loans had an "exit" short of foreclosure when they went bad. Another way to say this is that we are not simply asking about what origination practices or loan characteristics were at the time of origination of these loans; we are looking at what mortgage market (and RE market) conditions are at the time of first delinquency of these loans.

I am personally not ready to believe, without more data, that inflated FICOs, inflated appraisals, fraudulent income claims, etc. were more prevalent in the 2007 vintage than in 2006. I think it's possible that the marked difference in the early serious delinquency rate is more a function of the choices that a delinquent borrower had in mid-2007 compared to mid-2008. Assuming for the sake of argument that these two vintages were of either comparable quality at origination--or that the 2006 vintage was even worse at origination than 2007--you can still get a higher serious delinquency rate at 18 months for the 2007 vintage just because at 18 months out, 2006 borrowers could still refinance, get a HELOC, or sell their homes when they were still current or only mildly delinquent. No doubt some of those 2006 borrowers refinanced--in 2007, meaning that they just got "revintaged." But the 2007 vintage is hitting its 18-month history right now, when they cannot "escape" into the 2008 vintage or sell or get a HELOC to make first-lien mortgage payments with.

That's just a way of saying that credit tightening will in the nature of things--along with home price drops--increase the serious delinquency rate of a book of mortgages compared to earlier books even if the original credit quality is similar across books. The classic metaphor is "musical chairs."

One thing that was in the Freddie Mac investor slides we didn't look at yesterday was some data on "roll rates" from 2007-2008. I sure wish we had comparable charts from 2006 for comparison purposes. The "roll rate" is the percentage of loans that were in a given status last month and a given status this month. For instance, the "30 to 60" roll rate tells you what percentage of loans that were 30 days delinquent last month became 60 days delinquent this month. You need to bear in mind that a couple of things could have happened to the loans that didn't "roll to 60": they could have become current (the borrower caught up on the missing payment), or stayed at 30 days (the borrower made the next month's payment but never caught up on the missing payment). When you begin to get into the roll rate of serious delinquences, especially 90 to FC, you can also have loans that didn't roll to the next status because of a workout (modification, forbearance, repayment plan).

These roll rates are based on Freddie's total portfolio, not just the 2007 vintage. What they show is that roll rates from 30 to 60 and 60 to 90 increased from January 2007 to June of 2008 for any loan in Freddie's total portfolio in that delinquency category. The 90 to FC roll rate also increased, but seems to have hit a plateau in 2008. I suspect that is because of Freddie's major efforts in the workout department.

But very few if any 30-day or 60-day loans get workouts. Loans that "cure" from a 30-day or 60-day delinquency are almost exclusively a matter of the borrower making up missed payments from his or her own funds, whatever the source of those funds. One possible explanation of the rising roll rates here is that those funds in at least some cases were coming from HELOCs or credit cards until those got maxed out or frozen. Again, that doesn't necessarily mean that the loans that rolled to serious delinquency were "worse" at origination than the loans that cured; it may simply mean that the most recently-originated loans had fewer opportunities to avoid serious delinquency.

Roll rate analysis like this has a major drawback: it doesn't tell you about prepayments. Roll rates are calculated on how many loans you still have on your books today that were in a certain status last month. It is possible to have a rising roll rate but a more stable delinquency rate: the loans you still have on the books get worse (roll to a more serious delinquency at a higher rate), but if at the same time a lot of loans that were mildly delinquent last month paid off this month, your total percentage of seriously delinquent loans can be unchanged or rise at a much slower rate than your roll rate.

We do know that 2006 vintage loans prepaid at a faster rate than 2007 vintage loans. One way of looking at the matter is that you simply have to expect delinquency levels to be higher for 2007 than for 2006 simply due to loan life: the fewer high-risk-at-origination loans in the vintage that refinance (or sell the home) in the first 18 months, the higher the serious delinquency rate will be just because these loans got old enough to go bad.

We have to think about that because we have to understand that the process of credit tightening inevitably forces delinquency rates up. This is the thing that a lot of our politicians just don't get: you cannot "return to sane lending standards" and still prevent the "insane" loans from earlier vintages from ending up in foreclosure. You have to consider the possibility that at least some of the nasty performance of the 2007 vintage is a function of lenders having originated fewer high-risk loans in 2007 than in 2006, not more. It's just that the bad loans they didn't originate in 2007 were things like HELOCs that 2007 borrowers might have used to stave off serious first-lien delinquencies in the first 18 months of their loan lives. Obviously any first-lien loan that basically requires the availability of high-CLTV HELOCs in order to perform for a year and half is not a "good" loan. I'm just not sure that more of that kind of loan was originated in 2007 than 2006. I think it's possible that more of them are getting "flushed out" earlier because of credit tightening in 2008 is putting a stop to their ability to limp along as earlier vintages did.

by Calculated Risk on 8/04/2008 10:30:00 PM

From the WSJ: Credit-Card Bonds Fight A Tougher Debt Market

Investors are growing wary of bonds backed by credit-card payments, jamming up another debt market ... Rising defaults on credit-card payments, coupled with a bleaker economic outlook, are spooking investors ... with risk premiums on ... deals widening by as much as 0.10 to 0.25 percentage point in the past month.

Banks had already started tightening lending standards (see figure 4 panel 1 of May Fed Loan Officer Survey) on credit cards during the first half of 2008, but this probably means higher rates and even tighter lending standards.

The July survey of loan officers will be released soon (usually a few days after the Fed meeting). It will be interesting to see if more banks are tightening standards on credit cards.

by Calculated Risk on 7/22/2008 11:49:00 AM

Can you say "credit crunch"? From Wachovia:

On page 26 we talk about some other aspects with regard to $20 billion reduction of loans and securities. We are focused on the reinvestment of securities and lean toward very little reinvestment of maturing securities. We will also have enhanced discipline with regard to commercial lending to be sure we are focused on our very most important strategic relationships. New return targets [have been established] for renewals and new commitments to insure we are using our capital in the most judicious fashion. Active programs to further enhance the mix of our consumer loan portfolios by reducing mortgage concentration through tightening standards, discontinuing negative am option loan originations, eliminating the general bank wholesale channel and eliminating the focus on pick a pay mortgage retention..we have additional measures of enhanced pricing in the auto portfolio and continuing to review noncore assets.

Also see the Pick-a-Pay analysis on page 15. Wachovia is now projecting house prices will bottom in mid-2010.

Reader Brian suggested the post title. thanks!

by Tanta on 7/11/2008 08:44:00 AM

The whole essay is worth reading, if only as a refreshing change from the overheated rhetoric of the last few days. Note that Pearlstein will be having an online chat today at 11:00 Eastern to discuss Fannie and Freddie.

A financial crisis like this one calls for policymakers and regulators who can keep a cool head and remain flexible and practical rather than insisting on strict adherence to economic orthodoxies. Not every instance of regulatory forbearance need be viewed as a step down a slippery slope toward Japanlike stagnation. Nor is it particularly constructive to characterize every instance of government involvement in the private sector -- whether it be refinancing a troubled home mortgage, opening the Fed lending window to cash-strapped investment banks or orchestrating a private-sector rescue of a failing hedge fund -- as a massive government bailout.

As for Fannie and Freddie, nobody would be particularly happy if it became necessary for the Treasury to inject some fresh capital into the mortgage giants, in exchange, say, for newly issued preferred stock that could be sold back at a profit when the mortgage market recovers. But even the editorialists at the Wall Street Journal acknowledged yesterday that this wee bit of socialism might be the most effective and least costly way to keep the mortgage market functioning and prevent a meltdown in global credit markets.

A financial crisis is not a morality play. What matters most isn't the precedents that are set, the amount of taxpayer money that's implicated or whether people are made to suffer fully for their financial misjudgments. In the end, what matters most is that we get through it as quickly as possible with an economy and a financial system intact.

If this blog's comment threads are any kind of representation of a slice of reality--I am often agnostic on that question, but still--there are more than a few people who are more interested in getting a front-row ticket to a morality play than working through a financial crisis with the least (further) damage to the banking system. Lord knows that a lot of bad policy can be floated along under the guise of "pragmatism," but I for one would rather try debating with a pragmatist than a purist or a moralist.

by Calculated Risk on 7/07/2008 09:32:00 AM

From the WaPo: Small firms struggle to pay credit card debt

As credit standards loosened at the beginning of the decade, banks expanded their small-business credit card offerings. ... The result was a boom: Small businesses will charge 2 1/2 times more this year than when they ran up about $140 billion in 2002, according to estimates from TowerGroup, a financial service research and advisory firm.

But as the economy slowed, so did payments. Major small-business credit card issuers reported a sharp increase in late payments and bad debt over the last year.
...
Now credit card issuers are becoming more careful.

"The mantra before was bigger is better in the card business; now [issuers] are becoming much more risk-averse," said Brian Riley, research director for bank cards at TowerGroup. "Standards are getting tightened in line with the economy."

Just another sector were lending standards were too loose and are now being tightened. When a small business goes under - assuming the business was separated from the borrower's personal finances - the loss to the credit card lender is probably 100%.

by Calculated Risk on 6/27/2008 08:57:00 AM

From CNBC: Merrill Likely to Write Down $3 Billion-$5 Billion

Reuters is reporting: Merrill may take $5.4 bln in Q2 writeoffs: Lehman

Merrill Lynch will likely incur $5.4 billion of write-downs in the second quarter, mainly from its exposure to monolines, said an analyst at Lehman Brothers ...

Here comes another round of visits to the confessional!

by Calculated Risk on 6/26/2008 06:02:00 PM

From Bill Fleckenstein's Daily Rap today: It's About to Blow! (Here is Fleck's Site for the Daily Rap):

Note: excerpted with permission.

[About midday] I received a phone call from the Lord of the Dark Matter, who began the conversation: "It's about to blow!" He then repeated himself.

He went on to say that behind the scenes, many parts of the credit/mortgage market were "offered only." He said it had nothing to do with month-end or quarter-end. Instead, he believed it had to do with the enormous amount of inventory that would be looking for a home in the next quarter. He believed that the equity market was "miles behind what was occurring in the mortgage-backed/credit markets." Though he noted that he'd said it before, he repeated: "It's never been this bad."

And I heard confirmation from a bond shop today that "liquidity is getting worse and worse". Here we go again?

by Calculated Risk on 6/26/2008 02:53:00 PM

From MarketWatch: Oil prices tops $140

TED spread rising sharply. Is this the 4th wave of the credit crisis?

by Calculated Risk on 6/25/2008 11:46:00 PM

The TED spread is starting to rise again and is back above 1.0 for the first time since the beginning of May. Here is the TED Spread from Bloomberg. The spread is still far below the previous three waves, but well above the normal level (below 0.5).

And from the WSJ: European Bank-Lending Anxiety Returns

Tensions in Europe's short-term lending markets are on the rise again, repeating a pattern that central bankers had hoped to end by pumping in hundreds of billions of dollars in recent months.

The pressure partly reflects an end-of-quarter effect, as banks hoard cash to make sure their finances look healthy when they report second-quarter results.

But it also demonstrates that fears of further write-downs and possible failures aren't going away.

And from the Fed Commercial Paper report, the A2/P2 less AA spread has risen to 82 bps. Note: This is the spread between high and low quality 30 day nonfinancial commercial paper.



Perhaps it's a little premature to worry about a 4th wave, but these are worrisome signs.

by Tanta on 5/28/2008 08:18:00 AM

As a general rule I do not recommend reading "Realty Times" at 6:00 a.m., but I'm blaming twist.

It's not that people don't want homes, it's that they can't buy them under the stricter lending standards. . . .

Lenders are turning the clock back to 1975, requiring larger downpayments and higher credit scores to qualify for low interest rates. That's only prudent, but what they're also doing is tightening appraisals on properties that are being sold or refinanced.

In 1975, it was not unknown--it was in fact only made illegal that year by the Equal Credit Opportunity Act--to inquire about a married woman's future childbearing plans, her use of contraception, and her religion before deciding whether to "count" any income she might produce for purposes of qualifying for a loan. (If she said "Catholic," forget it.) If you think we are experiencing 1975 mortgage loan underwriting, you were born yesterday.

So why is it "prudent" to require larger downpayments and higher credit scores, but another thing entirely to tighten up on appraisals? And how is this nefarious appraisal tightening preventing people from buying homes?

*****************

There must be an anecdote, and we actually get a twofer:

Dallas Realtor Mary O'Keefe was hit with the new lending realities in a double whammy just this week.

"I had a closing that was delayed because the lender wanted a second appraisal," says Mary O'Keefe, a Dallas broker. "I told my clients absolutely no way would they pay for a second appraisal."

That deal finally closed, but O'Keefe lost another. A client wanted to take out some equity on her townhome, buy another property to live in, and save the townhome for mailbox money. The client had an 800-plus credit score, was approved by a lender, but went to her personal banker for the HELOC. She had an appraisal from the year before for $467,000 giving her about $155,000 in equity.

Because banks want to use appraisals no less than six months old, the personal banker called for a drive-by appraisal, which came in at $400,000, more than $20,000 below the lowest priced home in the community, and $75,000 below a home that sold a year ago three doors down.

So the purchase transaction actually did close, although it was--gasp!--"delayed," but this poor lady who wanted to cash out the "equity" in a townhome she was not going to occupy was stymied by some evil bank who--get this--wouldn't use a year-old appraisal. Turn on the disco ball and haul out your lava lamps! It's the seventies!

I confess to being somewhat alarmed, by the way, about a Realtor who tells a buyer that "no way" are they going to pay for a second appraisal. You would not, in the current environment, even consider paying another $350-$400 to assure yourself that you are not overpaying for your property by thousands of dollars?

The real problem here is that Realty Times wants to continue to perpetrate the view that establishing reliable appraised values is not in a homebuyer's best interest as well as a lender's. For some reason this reminded me of a story we posted just a year ago, in which the Wall Street Journal waxed outraged about some poor rich doctor who was having trouble getting his loan approved to buy a property for $1.05 million when the lender had gotten a broker price opinion stating that it was only worth $750,000. I did a bit of looking in the county real estate records, and it appears that our man did indeed buy the home on April 17, 2007 for $1.05 million. On April 27, 2007, the county assessed the property for tax purposes at $793,400. Per the WSJ he borrowed $885,000. I wonder if he still feels ripped off by the lender who told him he was overpaying for that home.

OK, I'm game. How?

by Calculated Risk on 5/20/2008 10:08:00 AM

From Bloomberg: Credit Crisis Will Extend Into 2009, Oppenheimer Says

The U.S. credit crisis will extend into and even beyond 2009 as banks will write off more than $170 billion of additional reserves by the end of next year, according to Oppenheimer & Co. estimates.

``The real harrowing days of the credit crisis are still in front of us and will prove more widespread in effect than anything yet seen,'' analysts led by Meredith Whitney wrote in a research note today. ``Just as strained liquidity pushed so many small and mid-sized specialty finance companies to beyond the brink, we believe it will do the same with the U.S. consumer.''

From the report titled: Far From Over: We Believe The Credit Crisis Will Extend Well Into 2009

"... in our opinion the "next shoe to drop," is what became an over-reliance on the securitization market for consumer liquidity. Herein, we draw a direct correlation between a shutdown in securitization volumes and accelerating losses on bank balance sheets. As we see no near or medium term come back in securitization volumes, we believe losses will only accelerate further and far worse than even the most draconian estimates."

And the opposite view: TED Spread at Nine-Month Low, Signals Credit Easing

Lending confidence at banks rose to the highest level in more than nine months, according to a key indicator, signaling the global credit crunch may be easing.

The so-called TED spread, the difference between what the U.S. government and banks pay to borrow in dollars for three months, dropped below 78 basis points for the first time since August.
...
``The worst of the fears about the liquidity crisis appear to be alleviating,'' said Peter Jolly, head of markets research in Sydney at NabCapital, the investment-banking arm of National Australia Bank Ltd. ``Liquidity is becoming more available ever since the bold moves by the Fed.''

by Calculated Risk on 5/15/2008 06:30:00 PM

From Bloomberg: Fed's Direct Loans to Banks Climb to Record Level

The Federal Reserve's direct loans of cash to commercial banks climbed to the highest level on record in the past week, a sign of continued stress in financial markets that threatens to curtail credit for households and companies.

Funds provided through the so-called discount window for banks rose by $2.8 billion to a daily average of $14.4 billion in the week to May 14, the central bank said today in Washington. Separately, the Fed's loans to Wall Street bond dealers rose by $75 million to $16.6 billion.

The increase indicates financial firms' emergency needs for cash haven't receded.

by Calculated Risk on 5/07/2008 06:59:00 PM

The Fed's Senior Loan Officer Opinion Survey is qualitative, not quantitative, and there has been some discussion on the predictive ability of the survey.

Luckily there was a paper written in 2000 that examined 'the value of the Senior Loan Officer Opinion Survey in predicting both lending and output'. See: Listening to Loan Officers: The Impact of Commercial Credit Standards on Lending and Output by New York Fed researchers Cara S. Lown, Donald P. Morgan, and Sonali Rohatgi.

From their conclusion:

Off and on since 1967, the Federal Reserve has surveyed loan officers at a small sample of large banks about their commercial credit standards. The idea behind the survey is that the availability of bank credit depends not just on interest rates, but on credit standards as well. Notwithstanding the small and changing sample, the checkered pattern of questions, and the sometimes curious responses of lenders, the reports are informative. The changes in standards that they report help to predict both commercial bank lending and GDP, even after controlling for past economic conditions and interest rates. Standards matter even in the 1990s, when capital markets were supposed to have eclipsed the role of banks in the economy. Changes in standards also help to predict narrower measures of business activity, where commercial credit availability from banks seems most crucial. The connection between bank standards and inventories is especially promising, because inventory investment is notoriously unpredictable and heavily bank dependent.

A shock to credit standards and its aftermath very much resemble a “credit crunch.” Loan officers tighten standards very sharply for a few quarters, but ease up only gradually: two to three years pass before standards are back to their initial level. Commercial loans at banks plummet immediately after the tightening in standards and continue to fall until lenders ease up. Output falls as well, and the federal funds rate, which we identify with the stance of monetary policy, is lowered. All in all, listening to loan officers tells us quite a lot.
emphasis added

Click on graph for larger image.

The authors provide these graphs that show the response of GDP, and in the amount of commercial and industrial loans, following a credit tightening shock. The impact on GDP is mostly within the first year, and peaks about 3 quarters after the shock.

The impact on lending lasts for a few years, and peaks about 2 years after the shock.

In the most recent tightening cycle (see graph here), there have been two tightening shocks: the first started in late 2006, and the 2nd was at the end of 2007. If the current cycle follows the normal pattern, the impact from the significant tightening at the end of 2007 should hit GDP later this year, and impact commercial loans for the next 2 to 3 years.

by Tanta on 5/07/2008 04:42:00 PM

Just yesterday Fannie Mae mentioned in its Q1 2008 Earnings Release that, as part of its "Keys to Recovery" initiatives, it would offer "a new refinancing option for up-to-date but 'underwater' borrowers with loans owned by Fannie Mae that will allow for refinancing up to 120 percent of a property's current value." That, so far, is all the information I have directly from Fannie Mae on this subject.

Unfortunately it got Dean Baker worked up. I respect Dr. Baker a great deal--he was calling the housing bubble long before it was cool--but I think he's got the wrong end of this:

This is a difficult move to justify from the standpoint of either taxpayers or homeowners.

The basic point is that homeowners will start out in these mortgages hugely underwater. Fannie’s policy means that it is prepared to lend $360,000 on a home that is appraised at $300,000. This gap implies that the homeowner can effectively put $60,000 in their pocket by turning the house back to the bank the day after the loan is issued. If the price drops another 10 percent in a year (prices are currently falling at an annual rate of more than 20 percent in the Case-Shiller 20 City Index), then this homeowner will be $90,000 underwater next May. If a seller would face 6 percent transactions costs, then in this example, walking away would provide a $106,000 premium compared with the option of a short sale.

This gap provides an enormous incentive for homeowners to default on their mortgage. Many homeowners will undoubtedly choose this option rather than make excessive mortgage payments on a house that is worth far less than the mortgage. A high default rate will of course lead to large losses for Fannie Mae and increase the likelihood that it will need a taxpayer bailout.

Fannie’s policy does have the effect of aiding banks that made bad mortgages. The new mortgages will allow these mortgages to be paid off. If matters were left to the market, the banks would almost certainly suffer large losses.

Baker is assuming that Fannie Mae will allow cash-out refinances in this program; although the mention in the earnings release doesn't specify that, I certainly assumed when I read it that we were talking about no-cash out refinances. (Fannie Mae's term for those, by the way, is "limited cash out" refinances. By this they mean that the loan balance can increase, but only to pay closing costs or pay off subordinate liens. That is what the rest of world means by "no cash out"--no cash disbursed to the borrower or to pay off non-mortgage debts.)

Fannie does make it clear that we are talking about Fannie Mae-owned loans. That is significant for two reasons. First, if the loans are upside down, it's already Fannie Mae's problem. To use Baker's example, if the borrower already owes $360,000 on a $300,000 home, the situation isn't made worse by refinancing it into a new loan with a lower payment. For Fannie to purchase a refinance of loans it already owns--presumably at a lower rate or payment, which improves the borrower's position and thus the strength of the loan--is not to take on risk you didn't already have. Second, of course, this isn't bailing out banks or anyone else.

That is why I assumed--and will confirm as soon as I find the Announcement from Fannie Mae--that these are no-cash-out refis. It would, indeed, worsen the risk of an existing underwater loan to let the borrower take more cash out.

Finally, it is specifically limited to performing loans. These are borrowers who are not, generally, eligible for a "workout" because they're not delinquent. But if they have hybrid ARMs coming up on a reset, or fixed rates that are higher than current market rates, this gives them the opportunity to get into a lower rate and payment while other costs--gas, anyone?--are taking more out of their pocketbooks. It isn't clear to me why this would increase any incentive to default, or increase Fannie Mae's losses if the borrowers did subsequently default. The loans are already underwater; even putting them 5% more underwater by rolling in closing costs seems to me, under the circumstances, to be less frightening than letting performing underwater ARMs get to a reset that will be hard for the borrower to bear. Not every borrower who is upside down will default, but every borrower with an unaffordable payment will in the current environment.

So there's a whole lot wrong with a whole lot of pressure to make the GSEs bail out the problems of the mortgage and housing markets, but so far this one sounds to me like Fannie Mae "bailing out" Fannie Mae, and, well, they ought to do that if it makes sense. Fannie Mae certainly does need to get a press release out clarifying the cash-out issue right away, before more nothingburgers get supersized.

by Calculated Risk on 5/05/2008 04:31:00 PM

From the WSJ: Casino Operator Tropicana To File for Bankruptcy Protection

Struggling casino operator Tropicana Entertainment LLC is expected to file for bankruptcy protection as soon as today ... It would be the largest corporate bankruptcy of the year, and the latest blow to Las Vegas, which has seen gambling revenues decline and major building projects canceled or delayed in the last few months.
...
"Gaming operators overall are facing headwinds from the broader economy. And unlike some past recessions, casinos are not proving to be recession proof this time around," [Peggy Holloway, Moody's vice president and senior credit officer] said.

by Calculated Risk on 5/05/2008 04:24:00 PM

The TED Spread from Bloomberg:

The TED spread has declined to 1.17%. Still high, but falling.

Note: the TED spread is the difference between the three month T-bill and the LIBOR interest rate. Usually the TED spread is less than 0.5%. The higher the spread, the greater the perceived credit risks (compared to "risk free" treasuries).