by Calculated Risk on 8/10/2005 10:33:00 PM

Here are two stories on mortgage lenders. The first story, from the WSJ, explores the financials of Downey Financial.

As of June 30, $12 billion, or 87 percent of Downey's ARMs are option ARMs. Its customers have racked up $72 million in additional balances on those mortgages by choosing to make minimum monthly payments. That's called negative amortization.

Right now, Downey's negative amortization is a mere 0.6 percent of its ARM portfolio. But that measure understates its significance. Its negative amortization balance is accelerating, from $51 million in the first quarter and $37 million in the fourth quarter of 2004.

These noncash earnings were 20 percent of Downey's earnings per share in the second quarter. If that trend continues, more than 40 percent of Downey's current-quarter earnings would be noncash. Analysts already expect earnings to decline to $1.79 a share in this quarter, so it would be a bigger slice of a smaller pie.

In other words, the bank's earnings are being increasingly driven by sales of a product to inherently risky customers. Downey Finance Chief Tom Prince says concerns about option ARMs are exaggerated and that his bank previously has had even more exposure to them without problems. "I'm not particularly concerned about it," he says.

This is the "good" story. It doesn't appear that the risk from option ARMs puts Downey at risk, but it does show the speculation using leverage in the California housing market. As the story points out:

At Downey, disclosure is good; it's the exposure that's bad.

The second story, Wolves in Small Print, details the predatory practices of some apparently unsavory lenders.

Garcia went with the bigger loan, one he thought was going to be for about $70,000 with about the same interest rate. But when closing day arrived, the figures had changed, he said.

"The final figures came out to around $100,000 with all the fees and closing costs, and when I read the papers a few days later, I said ‘Goll-ee,’ " Garcia said this week. "The new loan payments were about $900 a month. With my original loan I was paying insurance and taxes in the loan, but with the new loan I found out that that stuff wasn’t included. They told me it was a fixed interest rate, but I found out later it was variable. So every few years my interest rate was going to go higher. I found out I was going to be pricing myself out of my own home."

This story gets even more bizarre. Apparently Garcia only received $2800 from the proceeds of the new $100K loan, even though his previous loan balance was just over $60K.

Garcia never got the $7,200 in the new loan to fix his foundation; according to the court documents, he got only $2,800. He thought he was getting a fixed interest rate of 8.7 percent, but the fine print said it was a variable loan that’s now up to 12.4 percent. What is even more amazing is the bottom-line amount that Ameriquest loaned, compared to the value on his house and his equity in it. Texas law limits home equity loans to 80 percent of the appraised value of a home. For him to get a loan of $100,000, Garcia’s house would have to be worth around $140,000 — more than double what Garcia paid for the house just eight years earlier.

The second story sounds like fraud and I doubt it is widespread, although the story has some alarming numbers and other anecdotes. And it does show the naivete of some borrowers. There is also an interesting section on the "charities" that donate money to FHA buyers (really the money comes from the seller with a higher selling prices). I've written about these DAPs earlier with a chart on their growth. It appears to be getting worse:

...the increased use of "down payment assistance" programs that give mostly first-time buyers a "charitable" gift of the down payment money needed to close the loan under Federal Housing Administration loan rules.

Here is how it worked on a recent loan deal, coincidentally, just down the street from Felipe Garcia’s house in Edgecliff Village. According to documents sent to the buyer and obtained by the Weekly, the asking price on the home was $85,000. But the proposed buyer had bad credit, and the lender wanted a hefty down payment. So the Genesis Foundation, based in Indiana, was brought in to "give" the buyer the $7,200 down payment in return for a $595 fee that was rolled into the loan. In return, the company selling the house gave Genesis a tax-deductible "gift" of equal value and paid Genesis a $750 transaction fee.

It’s illegal for a home seller to give down payment money to a buyer, under federal lending rules. But in this case, the down payment technically came from a charity. In reality, it was just a way to move the money from one pocket to another. The new purchase price for the house was $93,000. So, in the end, the FHA (which requires at least a 3 percent down payment) was backing a higher loan with no real down payment. And instead of an $85,000 loan, the buyer now had a $93,000 loan.

The DAP story is worrisome. And the first story on options ARMs is concerning since that appears to be a systemic problem.

by Calculated Risk on 8/10/2005 11:10:00 AM

According to Briefing.com the market expects the trade deficit in June to be $57.2 Billion. The deficit for May was $55.3 Billion. My guess for June is $57.7 Billion.

PROJECTIONS:
I. Petroleum Prediction. I made an earlier prediction but I'm not happy with the BLS estimates. I'm going to lower the projection slightly to reflect the DOE estimates.

Forecast: Total NSA ERRP Imports: $19.46 Billion

Total SA ERPP FORECAST:
Imports SA: $19.3 Billion (seasonal factor estimated at 0.9925 for June)
Exports SA: $2.3 Billion
Balance ERPP: $17.0 Billion

Including petroleum exports and adjusting for seasonal effects, the SA oil balance for June is projected at $17.0 Billion. This compares to $15.8 Billion for May - an increase of $1.2 Billion.

II: For China, I project (see bottom) a NSA deficit of $16.3 Billion for June compared to $15.75 Billion in May. SA this is $16.3 Billion vs. $16.3 Billion for May (no change).

III. Japan. I haven't figured out how to estimate trade with Japan yet, but I suspect we will see a larger deficit in June than May for two reasons:

A) inbound port traffic at Los Angeles was up 7% over May and outbound traffic was down 9%. It appears that Long Beach trade fluctuates more with China and Los Angeles with Japan and other Asian countries. Based on these numbers I expect the deficit with Japan to grow by about $1 Billion in June.

B) Bloomberg: Japan's June Exports Rise 3.6%, More Than Expected

IV. OVERALL: I haven't developed a method for predicting the deficit for other countries, but based on Oil and China I think the deficit in June will be slightly higher than May's deficit of $55.3 Billion. Oil will be about $1.2 Billion more in June (than May), SA China will be approximately the same and Japan/Asia will add another $1 Billion.

My Guess (not enough work to call it a projection / estimate): $57.7 Billion Deficit.

NOTE: I expect July to be worse than June.

CHINA: The following is the estimate for trade with China based on this methodology.

CHINA TRADE BALANCE: Table numbers in Billions $

NOT SEASONALLY ADJUSTED

MONTH	NSA Balance	NSA Exports	NSA Imports
February	-$13.9	$3.08	$16.95
March	-$12.9	$3.3	$16.21
April	-$14.7	$3.4	$18.12
May	-$15.75	$3.3	$19.05
June	-$16.3(est)	$3.2(est)	$19.5(est)

SEASONALLY ADJUSTED (all estimates)

MONTH	SA Balance	SA Exports	SA Imports
February	-$18.1	$3.08	$21.19
March	-$15.1	$3.3	$18.42
April	-$15.5	$3.4	$18.88
May	-$16.3	$3.3	$19.6
May	-$16.3	$3.2	$19.5

by Calculated Risk on 8/10/2005 09:53:00 AM

Reuters reports:

Applications for U.S. home mortgages fell last week, its third consecutive drop, as refinancing activity waned and interest rates reached four-month highs, industry group figures showed on Wednesday.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity fell 0.9 percent to 745.0 in the week ended Aug. 5, adding to the previous week's 0.3 percent loss. The four-week moving average is down 1.5 percent to 763.1 from 774.9.

What is puzzling is the high percentage of borrowers still using ARMs:

After falling during the previous week, demand for adjustable-rate mortgages (ARMs) rose in the week ended Aug 5, the MBS said.

The ARM share of activity stood at 29.7 percent of total applications last week, up from 28.5 percent the previous week.

Of course I was puzzled last month too:

Given the spread between the various mortgage products, I'm surprised anyone is using an ARM. The breakeven point for a 30 year fixed rate mortgage vs. a 1 year ARM is less than 3 years. For those using a 5/1 year ARM (fixed for 5 years), the rate is the same as a 15 year fixed!

Since 28% of all application are for ARMs, this probably means:
1) Buyers think interest rates will decline in the future, or
2) Buyers are planning on moving within 3 years, or
3) Buyers can only qualify with a reduced payment.

None of these reasons seem compelling. I think this is more evidence of speculation / excessive leverage.

by Calculated Risk on 8/09/2005 03:58:00 PM

The National Association of Realtors (NAR) President Al Mansell made some interesting comments today:

"It's a great time to sell, but it may be a better time to buy about a year from now when the market should come closer to balance,”

I'm sure he meant that there are still below normal inventories and that he expects the housing market to be more balanced between supply and demand next year. But it sure sounded like a "Sell now, buy later" recommendation. Also from NAR chief economist David Lereah:

“The housing market is probably close to a peak right now in terms of sales activity, but there is tremendous momentum. Sales are expected to coast at historically high levels into next year, but they will trend slightly downward."

Falling sales and rising inventories followed by declining prices is what I expect.

by Calculated Risk on 8/09/2005 03:01:00 AM

UPDATE: PJ had a similar post a few days ago and excerpts from a NY Times article - check it out!

On the Discovery Channel: Flip That House.

House flipping — buying and renovating a house to sell for profit — is currently the hottest trend spreading through the real estate industry. A "flip" occurs when an individual purchases a home, remodels the home in a short period of time (anywhere from 3 weeks to 4 months) and then re-sells the home for a profit.

Flip That House is a new series for Discovery Home that dives into this very craze. Each episode is a fun, fast half hour that will document the entire flipping process of one house.

And on A&E: Flip This House. On Sat Aug 13th:

Richard and Kevin's friendship is put to the test when Kevin asks to be involved in the investment side of the business. Setting his sights on a beautiful but unfinished waterfront house on Foley Beach, Kevin convinces Richard it's a good house to flip. At $1.2 million it's a big gamble but Richard, unsure at first, agrees to go 50/50 on the house with Kevin. Things get out of hand as costly decisions are made that Kevin and Richard don't necessarily agree on and threaten a slim profit margin. A lifelong friendship strains at the seams until Dawn takes matters into her hands and uses a little southern style coaxing to get the two friends back together. Tune in to learn the incredible value of waterfront property, true friendship, and find out whether Richard is pushed out of his helicopter or does he jump?

And some people thought that flippin' was a fad.

by Calculated Risk on 8/08/2005 07:31:00 PM

Barry Ritholtz, chief market strategist for Maxim Group and author of the excellent blog "The Big Picture" announced today:

"We expect a recession in the 2006-07 time frame."

In an excellent summary post, Mr. Ritholtz argues that the slowing housing market will lead the economy into recession.

Two major themes we have been discussing for quite some time appear to be coming together:

A) Real Estate, though not a bubble, is an extended asset class overdue to retrace;
B) RE has been the dominant sector in the US economy since the recession ended.
...
Given the significance of this sector and the relative modest strength of the rest of the economy, we suspect the Fed will fail in their attempt to engineer a soft landing.

We expect a recession in the 2006-07 time frame.

Note that Mr. Ritholtz doesn't think the housing market is a "bubble", but an "extended asset class". I think he just defines a bubble differently than me, but the result is the same. Its still too early for me to call a recession.

by Calculated Risk on 8/08/2005 06:53:00 PM

From a story on CBS MarketWatch by Rex Nutting (always informative): U.S. house prices soar 16.5% in Q2

U.S. housing prices reaccelerated in the second quarter, mortgage giant Fannie Mae said Monday.

This is really no surprise; housing was clearly very strong in Q2. If there is a slowdown it has started in the last month with rising inventories. Apparently Fannie Mae chief economist David Berson believes housing is still strong:

Recent data on home sales, mortgage applications and homebuilder attitudes "show no slowdown in the housing market," said Fannie Mae chief economist David Berson.

Berson is a straight shooter, and he is certainly correct on existing and new home sales and homebuilder attitudes. I think there has been some weakness in mortgage applications. But all of this data (except mortgage applications) is backwards looking.

I'm looking forward to the Q2 data from OFHEO:

OFHEO will release its comprehensive housing price index for the second quarter on Sept. 1, including data from both Fannie and Freddie Mac. The data are based on comparing purchase prices for the same home over time.

Hat tip to Fred C. Dobbs in the comments!

by Calculated Risk on 8/08/2005 01:12:00 PM

My guess is this will be the theme for the month of August: Housing inventory spikes in 'burbs.

Inventory of single-family houses is piling up in Greater Boston in a sure sign the residential real estate market is slowing.

Buyers are taking advantage of the increased inventory, waiting longer before they make their offers and hitting more open houses. Sellers, meanwhile, many of whom are trying to cash out near the height of the market, are growing increasingly frustrated as their houses sit on the market for weeks and months.

First, there is a seasonal component to inventories - they usually rise in August. So its important to do a YoY comparison.

The number of listings of single-family houses in 17 towns in Greater Boston was up 25 percent or more last week compared with one year ago. And those houses are taking longer to sell. In four towns, listings increased 50 percent or more.

Second, some see this simply as a return to normal market conditions:

The slowdown is not a bubble bursting, and in many cases is merely a return to more traditional market conditions, after months of record-breaking sales volume and prices.

Others are less sanguine:

The "huge amount of inventory" is bringing prices down in Milton and Quincy, said Betsy Trethewey of Re/Max Landmark in Milton. Sellers are not acknowledging the changing dynamic, though, she said.

Price reductions from $20,000 to $60,000 are not unusual, she said. Sellers are frustrated, and some are angry, she said. "They've been very spoiled for the past few years. They're not accepting the truth of what is actually happening," Trethewey said.

Sellers traditionally are slower to realize when the market is changing, usually because their information is more dated than buyers'.

Or maybe the housing story will be the spreading of the bubble. There are bubble concerns in Fort Collins, Colorado housing and Sioux Fall, South Dakota farm land.

Fort Collins might have a housing market not only as overheated as Denver but also nearly as overpriced as San Francisco, Atlanta and San Diego.

A shift in the types of mortgages being used in Fort Collins may indicate the city is facing a steep housing market with buyers struggling to find a way to afford homes, according to recent statistics.

Of Fort Collins' April purchase loans, 42 percent were interest-only mortgages, in addition to 33 percent of refinances, according to LoanPerformance, a San Francisco real estate information service.

Or maybe the story will be rising foreclosures:

"Foreclosure inventory is up nearly 10 percent compared to July 2004 -- an uncharacteristic upward trend throughout the summer months," said Brad Geisen, president and CEO, Foreclosure.com. "More significantly, we are seeing an increase in foreclosures in a majority of states. These blanket increases may indicate that factors such as weakening sustainable home ownership and the volatility of the housing market are beginning to add to the geographic economic factors that contribute to foreclosures."

I think the August story will be rising inventories, followed later by fewer transaction. The foreclosure story is probably for next year.

by Calculated Risk on 8/07/2005 10:15:00 PM

Dr. Paul Krugman writes in Monday's NY Times:

This is the way the bubble ends: not with a pop, but with a hiss.

Over on Angry Bear I added a chart showing the slow, steady price declines associated with previous housing busts. Krugman also addresses bubble "denial" in his commentary. Krugman writes:

Of course, some people still deny that there's a housing bubble. Let me explain how we know that they're wrong.

One piece of evidence is the sense of frenzy about real estate, which irresistibly brings to mind the stock frenzy of 1999. Even some of the players are the same. The authors of the 1999 best seller "Dow 36,000" are now among the most vocal proponents of the view that there is no housing bubble.

His commentary is short, and for those looking for proof of a bubble, Krugman doesn't come close. But as I wrote in the comments to the previous post:

I now understand there is no way to convince everyone there is a bubble. I suppose that is a third "bubble" characteristic:
1) Fundamentals out of line.
2) Excessive Speculation.
and 3) Denial!

Krugman thinks the bubble may have already started deflating. If inventories rise as much as I expect, I will agree.

by Calculated Risk on 8/07/2005 02:54:00 AM

As a follow up to the LA Times article that discussed the slowing San Diego housing market: I spoke with one of the top RE agents in San Diego yesterday and she told me the market has taken a "nosedive". (Her words referring to time on market, not prices). She told me specifically about two of her listings that have been on the market for 45 days that would have sold in a week or two earlier this year.

Also the LA Times article included this comment on the previous bust (1991-1997):

San Diego home prices were virtually flat for six years.

"Virtually flat" is being generous.

Click on graph for larger image.

According to the OFHEO house price index, housing in San Diego experienced a steady decline for six years following the peak in 1991. In nominal terms, house prices dropped 10% in San Diego and didn't achieve their previous highs until Q4 1999 - eight years after the previous peak.

In real terms (adjusted for CPI less shelter), house prices declined 24%, also over a six year period and didn't recovery their value until Q2 2001 - eleven years after the peak.

Finally, this housing bubble appears far worse than the '91 bubble. Earlier I posted a Price-Rent ratio for the US on Angry Bear:"Housing: Speculation and the Price-Rent Ratio". And the same calculation for San Diego.

UPDATE: See link for San Diego Price to Rent ratio.

Based on the price-rent ratio and many other measures, the current housing bubble dwarfs the '91 housing bubble. Therefore it might be reasonable to expect that the bust will also be worse and last longer.