by Calculated Risk on 6/22/2005 05:54:00 PM

In the comments to an earlier post, malabar asked if "something like the PIK (payment in kind) bonds used during the 80s LBO days" were being used in the housing market. I suggested that Option ARMs might be similar in that one of the options is a minimum monthly payment that allows for negative amortization.

And reading our minds, The Housing Bubble featured a post today on option ARMs:

S&P Warns On Option ARMs

The alarms about option ARM loans couldn't be any louder. "Recently, option ARMs have become increasingly prevalent in the market. After extensive research, Standard & Poor's has determined that additional credit enhancement is required to account for the increased risk of default resulting from the payment shock inherent in these loans."

"The ratings company said the tightening applies to loans that are bundled into mortgage-backed securities for sale to investors as well as option adjustable-rate mortgage loans, or option ARMs, The Wall Street Journal said."

"Some economists fear that option ARMs and other loans that reduce initial payments are fueling house-price inflation by enabling people to bid more for homes than they could if they were taking out conventional loans, said the Journal."

"Option ARMs and similar loans are among 'the only things left that are keeping home prices rising,' Stuart Feldstein, of (a) financial-services market-research firm."

This link reveals the problem may be bigger than previously reported. "According to UBS AG, option ARMs now account for 40 percent of prime-rated mortgages packaged into securities, compared to just 1 percent in 2003."

The widespread use of Option ARMs is clear evidence of excessive leverage in the housing market.

Thanks to malabar. Hat tip to Ben Jones.

by Calculated Risk on 6/22/2005 03:15:00 PM

Bloomberg reports that Chevron is expanding their Pascagoula, Miss. refinery to boost gasoline output:

The expansion will raise daily gasoline output by 11,900 barrels, or 500,000 gallons, to about 131,000 barrels, [Steve Renfroe, Chevron Spokesperson] said. The $150 million project is expected to begin in July and be finished in late 2006.

I don't doubt that additional refining capacity will be needed. But the following sentence in the article perpetuates the myth that the lack of refining capacity is contributing to the high price of oil:

The shortage of refining capacity worldwide has contributed to the 57 percent rise in oil prices in the past year.

This is similar to a recent comment by Saudi oil minister Ali al-Naimi:

"There is no shortage of oil. It's there. What is driving the price is the inability to make the oil into products."

The BBC article continues:

Some analysts say there are insufficient oil refineries, both in the US, where no new refineries have been built since 1976, and worldwide.

This shortage could help keep oil prices high.

Here is a simple diagram of a bottleneck:

Raw Material --->> bottleneck --->> Finished Good

What happens with a bottleneck? If the process is running at full capacity, there is a fixed supply of finished goods, so the price of the Finished Good will rise rapidly with any increase in demand.

But what happens to the price of the raw material? Since the process is running at full capacity (a bottleneck), the demand is fixed, and any additional supply of raw material will cause the price of the raw material to drop!

For the Oil industry: Crude oil is the raw material, the potential bottleneck is the refining process and the finished good is gasoline (also other products, but I'll use gasoline in this example). If refining is at or near full capacity, any additional demand for gasoline would increase the price of the finished good (gasoline) but would not change the demand for crude oil (demand is fixed by the refining bottleneck).

Since demand for crude would be fixed with a bottleneck, any additional supply of crude would depress the price of the raw material (crude oil). Therefore the lack of refining capacity could only depress the price of crude and would not contribute to the rise in the price of crude - the opposite of what is being reported. Adding more refining capacity would increase the demand for crude oil and could lead to higher crude oil prices, unless additional supply of crude is brought online.

Perhaps the Saudi oil minister has ulterior motives for blaming refining for the high price of crude oil, but that doesn't mean the financial press should perpetuate the myth.

UPDATE: In the comments, darffot suggests that he interprets al-Naimi's comments as: The lack of refining capacity for sour crude is pushing up the price of sweet crude. Here is darffot's comment:

i would like to offer an alternative interpretation, which is the way i have always taken al-Naimi's comments on this issue: the incremental production adds coming out of SA and elsewhere is primarily high-sulfur "sour" oil. this is oil which most refineries cannot process, especially thanks to recent enactment of emissions legislation in various parts of the world. just as American electricity producers created a glut of NG-based power plants in keeping with the clean air theme, refinery capacity additions have been skewed toward light sweet oil, which is easier to process with lower pollutants. and, just like the NG-turbine additions, these geniuses did not stop to think beforehand whether the supply would be there when the capacity came on.
the result today is that there is high competition for light sweet crude (the widely followed WTI) while the excess sour production goes begging for buyers. this can be clearly seen in the historically large spreads between sweet and sour crude products, and is also very apparent in the chart of Valero (VLO), the US based refiner most heavily focused on sour crude. just listen to a VLO conference call and you will learn how they are printing money thanks to the record spreads between sweet and sour. this, i believe, is what al-Naimi is alluding to when he says there is not enough refining capacity--there's not enough sour refining capacity to keep in alignment with the composition of crude coming online at the margin. meanwhile, there is high competition for the sweet crude.

UPDATE 2: According to a recent Forbes article, the spread between light and sour has increased from $2.50/ bbl to almost $9/bbl over the last 2 years. This is darffot's point and he is clearly correct about more demand for light sweet crude.

However, this still means there has been a substantial price increase for sour crude (from around $27 to almost $50 today spot prices). Perhaps a few dollars of the WTI prices are related to refinery mix (but that isn't what the financial press claimed), but blaming the doubling of oil prices on lack of sour crude refining capacity is also incorrect.

by Calculated Risk on 6/21/2005 02:41:00 AM

The UCLA Anderson Forecast will be released today. According to a preview in the LA Times:

... the UCLA forecasters once again predict that a housing slowdown could push California into recession, while causing a noticeable slowing in U.S. economic growth.

UPDATE: Another preview article: Home bubble could weaken

the residential real estate market could soften in the latter half of this year, slowing the state and national economies.

Still, Edward Leamer, an author of the quarterly outlook from the university's Anderson School of Business, stopped well short of forecasting a recession this year. "The probability remains essentially zero ... before April 2006."

Leamer said the first indication of a turn for the economy will be fewer home sales with properties sitting longer on the market. Then builders will retreat and pull fewer permits, and jobs that depend on home sales will be lost. While a price softening and not a collapse is expected, this series of events will trickle down through the overall economy.

He noted a drop in spending on homes played a major role in nine of the past 10 economic downturns since World War II.

While the outlook for the economy over the next 12 months is positive, predicting after that gets dicey, but real estate will play a large role in what happens.

"The bad news is that we have real problems in the housing sector that will cause the economy a good deal of stress soon enough," Leamer said in his report, referring to home prices that have reached unsustainable levels in some markets.

ORIGINAL POST:

Others are expressing similar concerns:

On Monday, Merrill Lynch added to the bubble concerns, releasing a report that said U.S. economic growth could slow by a full percentage point next year if home prices were to stagnate in the biggest cities.

Merrill Lynch senior economists found that six California markets — San Diego, Inland Empire, Los Angeles, San Francisco, San Jose and Sacramento — were "well in bubble territory" with above-normal ratios of home prices to household incomes.

Federal Deposit Insurance Corp. data, provided to The Times on Monday, further underscored such concerns that declines in the nation's biggest housing markets could throttle the entire U.S. economy.

And on California:

... to the UCLA economists, the sizzling housing market has masked a number of weaknesses in California's economy, including job growth that is not as good as it looks. Employment and personal incomes in California have gained only modestly in the last year, UCLA's Thornberg said. Yet, many Californians "feel" wealthier because they perceive their homes to be worth a lot more.

They could say the same thing about much of the US: the housing boom has masked otherwise weak job growth. Look for more comments later today.

by Calculated Risk on 6/20/2005 02:49:00 PM

The Port of Los Angeles released their May statistics today. Inbound (loaded containers) was 313 thousand compared to 329 thousand in April - a decline of 5%.

Outbound volume was 105 thousand loaded containers vs. 107 thousand for April. This is similar to the 1% decline for the Port of Long Beach.

Port of Long Beach statistics correlate better with imports from China, but I can't overlook the weak imports for the Port of LA.

by Calculated Risk on 6/20/2005 12:05:00 AM

My most recent post is up on Angry Bear - Housing: Bubble Talk.

UPDATE: I added this to my AB post: The WSJ (Greg Ip) has a front page article this morning: Booming Local Housing Markets Weigh Heavily on Overall Sector (pay): A few quotes:

New federal housing data show that the nation's most overheated local housing markets now make up such a large share of the total U.S. market that a sharp fall in their values could stall or slow national economic growth.
...
"It's a widespread boom and has macro implications," says Richard Brown, chief economist of the FDIC. "A slowdown would not only hurt these markets, but the U.S. as a whole."
...
Unlike stocks, the housing market "would be more likely flat with 10% to 20% declines in some regions, or down slightly nationally with some regions looking ugly," says Ethan Harris, chief U.S. economist at Lehman Brothers. Even local housing crashes take years to unfold, he says.

Also see WSJ: Fannie Sees Higher Odds of Regional Busts

ORIGINAL POST:

A couple of interesting facts about the San Diego market: First, here is an interactive graph showing the number of condos in the downtown San Diego market by week. There has been a surge in listings downtown.

And the last few paragraphs in this article indicate the job market is slowing down for housing related jobs in San Diego.

Phil Blair, a co-owner of the San Diego offices of Manpower, said construction firms are gearing up for continued growth. In a survey asking local companies about their hiring activity over the next three months, construction firms were the most optimistic that they would be adding new staff.

Blair said that financial and real estate firms were among the least optimistic, with some firms planning to lay off employees.

"Usually construction and real estate go together, but not this time around," he said. "I don't know if that means that there's some sort of a lag between one industry and the other or if the real estate people are beginning to worry that a bubble has burst."

He added that with real estate purchasing and mortgage applications slowing, there is less demand for work in those industries.

Construction firms are hiring, but real estate and financing firms are cutting back. Is the bubble ending?

by Calculated Risk on 6/19/2005 03:37:00 AM

The London Sunday Times asks: Is the global housing bubble set to burst?

As glittering spires continue to rise around the world and buyers still dream of escape to idylls in the sun, the questions grow more pressing. What has driven the boom? Has globalisation changed the law of gravity? Can the vertiginous ascent continue? Or is the biggest pop ever heard about to deflate the global property bubble and take the world economy down with it?

The Times does not completely answer the question. They do argue that stagnation is more likely than a crash. But price stagnation might lead to recession, and a recession might cause lower house prices leading to a deeper recession - a vicious cycle.

Perhaps their real opinion can be gleaned from their choice of companion pieces: Booms Past.

TULIP MANIA 1634

In Holland the craze for collecting tulips peaked in 1636 when investors paid more than 5,000 florins — about £25,000 at today’s prices — for a single bulb. But when buyers dried up, prices plummeted.

SOUTH SEA BUBBLE 1711

The vogue for public companies in the early 1800s produced the South Sea Company, which was granted a monopoly over trade to North America. But the bubble burst in September 1720 when banks could not collect loans on inflated stock.

1929

In the 1920s technological change saw the Dow Jones rise sevenfold, prompting investors to stake their life savings on the stock market. Interest rates rose, Wall Street panicked and by November 1929 two-thirds the Dow’s value had gone.

LAWSON BOOM

House prices in Britain soared in the late 1980s, buoyed by low interest rates and tax cuts. When interest rates doubled in 18 months house prices crashed, dropping by 30%-40% in some areas.

DOTCOM BUBBLE

In the 1990s internet stocks boomed. But after peaking in spring 2000 they lost two-thirds of their value in three years. Many firms vanished.

For a great summary of previous bubbles, I recommend "Extraordinary Popular Delusions And The Madness Of Crowds", By Charles MacKay, 1841.

by Calculated Risk on 6/17/2005 09:04:00 PM

Financial Times: EU crisis as Britain rejects deal on budget

Excerpt:

The European Union was plunged into political crisis on Friday night after Britain led the way in blocking a proposed deal on the new seven-year budget.

Tony Blair, the UK prime minister, was one of a minority of leaders who refused to accept a compromise package, as the Brussels summit collapsed in acrimony shortly before midnight. The failure of the talks means the transfer of billions of euros of aid to former communist countries in eastern Europe, due to start on January 1 2007, may be delayed.

The political ramifications of the breakdown, coming after French and Dutch voters rejected the EU constitution, could be severe.

This is another serious setback for the EU and is not good for America. A European Union in disarray and possibly entering recession will likely exacerbate the global imbalances and probably lead to larger US trade and current account deficits.

See Dr. Serser's 6.4% of GDP current account deficit in q1

General Glut's 6.4% AND GROWING

See Dr. Altig's The EU Divide and more.

by Calculated Risk on 6/16/2005 06:04:00 PM

Last month I started building a simple model to help forecast the monthly trade deficit. A review of the partial forecast showed some promise.

So here we go for May starting with oil. Using the same model (described here) the ERPP trade numbers for May are forecast to be:

IMPORTS: Energy Related Petroleum Products.
Barrels Crude: 337.9 million barrels.
Barrels Other ERPP: 85.0 million barrels.
DOE Price per barrel (Crude): $43.90
DOE Price per barrel (Other): $50.48

Preliminary - Total NSA ERRP Imports: $19.1 Billion

NOTE: The BLS reports petroleum import prices fell 6.5% in May from April. The above model used DOE prices. After reviewing the prior prices and comparing the DOE and BLS approaches, the DOE has been slightly more accurate. However, I think it might be even better to try to split the difference. The BLS approach would predict P(crude) = $41.85. DOE P(crude) = $43.90. So the modified forecast for Imports NSA is:

BLS/DOE Price per barrel (Crude): $42.88
BLS/DOE Price per barrel (Other): $49.31
Forecast: Total NSA ERRP Imports: $18.7 Billion

Total ERPP FORECAST:
Imports SA: $17.4 Billion (seasonal factor estimated at 0.93 for May)
Exports SA: $1.9 Billion
Balance ERPP: $15.5 Billion

by Calculated Risk on 6/16/2005 02:57:00 AM

UPDATE: I've been notified that "Housing Links" will not be continued. He recommends these two sites:

Patrick's Housing Links

RGEMonitor Housing Market Bubble?


I've been directed to a new housing resource: Housing Links. This site is a running compendium of stories, commentary and analysis on all aspects of the housing market. Here are some recent examples:

UPDATE2: In the comments, Stephane Grenier directs us to his interesting article "Is There Really a Real Estate Bubble?". He references me!

UPDATE: Two new stories in The Economist about the perils of the housing boom / pending bust: In come the waves (Great Graphs) and After the fall.

The Trillion-Dollar Bet - The NY Times looks at the widespread use of Adjustable Rate Mortgages:

This year, only about $80 billion, or 1 percent, of mortgage debt will switch to an adjustable rate based largely on prevailing interest rates, according to an analysis by Deutsche Bank in New York. Next year, some $300 billion of mortgage debt will be similarly adjusted.

But in 2007, the portion will soar, with $1 trillion of the nation's mortgage debt - or about 12 percent of it - switching to adjustable payments, according to the analysis.

The Mortgage Trap - BusinessWeek "Lenders are cranking out an ever-growing array of financing schemes and lowering standards to keep the housing boom going":

All those innovative mortgage products are a sure sign that lenders are doing everything they can to keep the housing boom going and to capitalize on yet another round of falling interest rates that no one expected. There are plenty of other signs of frenzy as well. Home appraisers complain that mortgage originators are demanding the optimistic appraisals needed to close on loans. "They started warning me to 'be a team player' and to 'hit the number' they needed to seal the deal," says Robert Burnitt, an appraiser in Midlothian, Tex.

And some positive stories:

Purchase Activity at Record High; Refinance Volume Jumps In Latest Application Survey - The Mortgage Bankers Association reports their "seasonally-adjusted Purchase Index increased by 10.4 percent to 529.3, a record high":

"This week there was a combination of record-setting purchase activity as well as a substantial pickup in refinance applications, with the refinance index at its highest level since April 2004," said Michael Fratantoni, senior director of single-family research and economics.

Builder Confidence Hits New High For 2005 - According to a survey by the National Association of Home Builders and Wells Fargo, "single-family home builders are more confident this June than they’ve been all year".

The most optimistic builders are in the West, where an HMI reading of 88 far outpaces that of builders in all other regions. Moreover, the 88 reading reflected a solid four-point gain from last month. Southern builders were also a bit more confident this time around, posting a one-point gain in their regional confidence gauge to 76 in June. Builders in the Northeast maintained a healthy, 70-point reading on the confidence scale, while builders in the Midwest registered a two-point confidence boost, to 52.

Check it out. Enjoy!

by Calculated Risk on 6/15/2005 06:35:00 PM

In a well coordinated attack, the Empire today unleashed a barrage of statistics and comments from in-house economists to poke holes in the silly notion of a "housing bubble". First up was Carl Steidtmann, chief economist of Deloitte Research:

"There has been much discussion recently about a housing bubble, but the truth is that home price appreciation has slowed considerably in the past three months. The time to talk about a bubble was last December," says Carl Steidtmann, chief economist of Deloitte Research and author of the monthly index.

"Consumer spending growth in the summer months will be largely dependent on the direction of home prices and job growth," continued Steidtmann. "As job growth continues to accelerate, we should see a corresponding pickup in real wage growth."

By this logic you should have worried about the Nasdaq bubble in the late '90s, but in March of 2000 everything was fine. Not the best investment strategy. And "job growth continues to accelerate"? The 3 month moving average of payroll growth (Seasonally adjusted from the BLS) shows job growth is at best flat after peaking in the Spring of 2004.

But that was just the beginning. The ubiquitous David Lereah responded to Fed Chairman Greenspan's recent remarks:

"Yes, there is froth in the markets, but froth can be healthy," said David Lereah, chief economist for the National Association of Realtors. "It's not a bad word."

Froth for a foamy latte or cappuccino might be good; froth in the housing market, especially when you are a new home buyer, is decidedly not good.

Economists representing members of the Washington, D.C.-based Homeownership Alliance, which includes a coalition of about 15 housing-related organizations, fired another salvo: See Housing boom won't let up.

Frank E. Nothaft, chief economist for mortgage industry giant Freddie Mac said "there are signs of 'suds' around the country" (good in your beer) but he is not worried:

"I think we'll see some gradual moderation in house-price valuation over the next couple of years," with about a one-in-three chance of a region in the country seeing stagnant or declining home values over the next couple of years, linked to regional economic weakness.

Paul Merski, chief economist for the Independent Community Bankers of America added:

"Bankers are being very diligent now about their lending practices," and the FDIC is "closely monitoring bankers' lending practices right now due to the long run in the housing boom."

"(The notion) of exotic products out there that are extremely dangerous is well overblown."

Since bankers are being very "diligent", I wonder why the Office of the Comptroller of the Currency, the FED, the FDIC and other agencies took the highly unusual step of issuing new credit risk management guidance for home equity lending in May.

Merski also addressed the issue of home-price "froth." He said, "Economists have a saying that unsustainable trends will not be sustained," and that may hold true for some markets that have rapid, double-digit price appreciation. He forecast a "reasonable cooling off in certain markets in the prices but certainly no crashes in these markets because of the strong demand." Even so, the overall housing market should be strong for the rest of the year and going into 2006, he added.

No crashes. What a relief!

And finally, David W. Berson, chief economist for Fannie Mae added:

"There are no signs of any slowing in the housing market at all. You need a pretty good decline for the second half of the year not to set a record this year."

Those final comments are true; the housing market is still HOT.

For some reason I'm having the same reaction to all of these industry economists' comments as I do when the oil industry scientists assure me that global warming is not a problem. Maybe I need some suds!