by Calculated Risk on 10/23/2005 12:55:00 PM

The London Times reports: Profit warnings worst since 9/11

PROFIT WARNINGS by British companies hit their highest level last month since the September 11 attacks on America four years ago
...
So far this year there have been 370 profit warnings by quoted companies, up from 261 in the first nine months of last year.

"With profit warnings averaging 92 a quarter in the past 12 months, businesses are clearly finding it difficult to forecast in the current environment," said Andrew Wollaston, an Ernst & Young partner. "Though the economy is weaker than a year ago, this continued high level of warnings is a real concern."

The increase in profit warnings is blamed on rising costs, particularly for energy, and weaker-than-expected demand.

And Reuters adds: Slowdown in housing precipitates consumer pullback; debt correction ahead?

A UK housing market slowdown and subsequent curbs in consumer spending have precipitated companies' woes, E&Y's London head of corporate restructuring, Andrew Wollaston, said.

"The last three or four years there's been a credit boom, and now people are paying off debt."

The downward cycle continues (thanks to Joshua for the Times story).

by Calculated Risk on 10/21/2005 05:47:00 PM

Foreign Policy asks Morgan Stanley Chief Economist Stephen S. Roach: What Awaits the Next Alan Greenspan?

FP: If you had to give the current U.S. economy a grade, what would it be?

SR: I’d give it a gentleman’s C. On the surface, GDP is good, inflation is low, and so is the unemployment rate. Beneath the surface, we have unprecedented imbalances in terms of low national savings. Two of the three pieces of national savings—the consumer piece and the government piece—are in the red. We have a record balance-of-payments deficit. We have record levels of household-sector indebtedness, and [a record number] of consumers living beyond their means. Superficially, it looks ok. Beneath the surface, it looks disconcerting.

Roach is too generous. The biggest problem is that the US is not seriously addressing the 'unprecedented imbalances', and there appears to be no leadership even arguing to take the first step towards more fiscal discipline. For the consumer, they have been using their homes as ATMs, and even if prices just stabilize, the ATM will dry up.

FP: What’s the likelihood of a U.S. recession?

SR: I put a 40 percent chance on a recession next year, which is high.

[Rising energy prices] are a big concern because they are hitting a consumer that has been stretched in an unprecedented fashion. The consumer savings rate right now is negative 1 percent, the lowest it’s been since 1933, which was not a terrific year. [During] the last 3 energy shocks—mid 70s, late 70s and early 90s—the same savings rate averaged 8 percent. We had a cushion that we could use to fund higher energy expenses. There is no cushion today. Consumption is going to get hit hard unless there’s immediate relief on energy product prices such as natural gas and gasoline, and home heating oil.

See the interview for more.

by Calculated Risk on 10/21/2005 03:21:00 PM

The US Department of Justice Special Prosecutor Patrick J. Fitzgerald has launched a new website today: Office of Special Counsel

"I would strongly caution ... against reading anything into it substantive, one way or the other," [Fitzgerald spokesman Randall Samborn]said. "It's really a long overdue effort to get something on the Internet to answer a lot of questions that we get . . . and to put up some of the documents that we have had ongoing and continued interest in having the public be able to access."

Source: Fitzgerald Launches Web Site

I am not aware of any economic research correlating government scandals with changes in economic activity. My guess is the economic impact of a major scandal is probably minimal. After Watergate the economy went into recession, but most major scandals, like Teapot Dome, Iran-Contra or the Monica affair had no clear economic impact.

by Calculated Risk on 10/21/2005 12:51:00 PM

CNN reports: Stricter OCC rules on exotic mortgages may help stabilize housing prices as less buyers qualify

... the increasing use of interest-only and option adjustable rate mortgages has put federal regulators on high alert. This fall, the Office of the Comptroller of the Currency, along with other financial regulators, will issue guidelines for mortgage lenders that could make lenders think twice before readily offering exotic mortgages to potential buyers.

Will the inability to gain easy access to these creative mortgage products finally help let some of the air out of the inflated housing bubble?

It's certainly a distinct possibility, said Andy Laperriere, managing director at ISI Group.

"I think it will affect a meaningful amount of loans," he said. "It'll be enough to take the marginal buyer out of the hottest markets and therefore slowdown or even stop some price appreciation."

Experts certainly see some correlation between the availability of these products and the surge in housing prices. Laperriere added that in high-priced markets such as California and Washington, interest-only and option ARMs make up about 50 percent of the mortgages used to finance homes.
...
...
...there's no denying that exotic mortgages have climbed in popularity in tandem with the rise in housing prices. According to the Federal Reserve Board's latest quarterly survey of senior loan officers from July, nearly a third of respondents said that non-traditional mortgage products make up 5 to 16 percent of their dollar volume of residential mortgages while one bank said these products make up 50 percent of its dollar volume.

And more than half of respondents noted that the share of mortgage originations accounted for by non-traditional mortgage products had been higher over the past 12 months than over the previous 12 month period.

Dean Debuck, a spokesman for the OCC, which regulates financial institutions, said the organization will issue guidance for mortgage products, adding that growth in the industry has uncovered "some things that need to be fixed." While he declined to comment on the specific guidelines, he said the OCC is focused on "safety, soundness and good risk management."

Financial analysts expect the OCC to set specific credit-worthiness standards to prevent people from over-stretching themselves into debt and make sure that these products are aimed at individuals that are capable of repaying the mortgage when interest rates climb and their monthly payments increase significantly.

by Calculated Risk on 10/20/2005 08:31:00 PM

Reuter reports: Washington home market softens as investors sell

After hitting a high in May, the number of contracts in Washington D.C. and its surrounding Virginia areas of Prince William, Loudoun, Fairfax and Arlington counties have fallen by about half, according to the Greater Capital Area Association of Realtors. Meanwhile, inventory of houses for sale has doubled and in some cases tripled, and homes are staying on the market 30 percent longer.

In Falls Church City, contracts peaked in April and inventory is double that seen in December.

Too many houses are for sale, experts said. Speculators -- who last year bought homes, not to live in, but to sell or "flip" within a year -- are trying to cash in on the price increases now. "For Sale" signs are sprouting on lawns and depressing prices throughout the market, analysts and Realtors said.

Next week, housing numbers for September will be reported, with Existing Home Sales on Tuesday, and New Homes Sales on Thursday. For New Homes I'm mostly interested in Sales (also inventory), but for Existing Homes, inventory continues to be the story.

by Calculated Risk on 10/20/2005 04:19:00 PM

Two weeks ago I looked at the short run oil and gasoline market dynamics and concluded:

"it is not unexpected to see oil prices fall - and they may fall some more. However there is a danger of much higher gasoline prices (and heating oil prices) if demand stays strong."

Since then oil and gasoline prices have fallen significantly. November crude closed at $61.03 and November unleaded futures at $1.61. Both are below the pre-Katrina levels.

The fall in the price of oil was expected. But its worth looking at the gasoline market to understand why gasoline prices have fallen.

There are four key numbers for gasoline from the Department of Energy: Stocks(S), Domestic Production(P), Imports(I) and Demand(D). We can write a simple relationship:

Change in S = P + I - D

If S is falling below the normal range, the price will rise leading to a drop in demand and probably more imports. If S is stable or rising then the price will fall.


Click on graphs for larger images.

NOTE: These graphs are intended to provide a comparison between 2005 and 2004. The Y-axis may not start at zero.

Gasoline stocks rose in the most recent week and are close to the levels of 2004.


Part of the reason for the increase in stocks is that domestic production has recovered somewhat from Hurricanes Katrina and Rita. The dip in 2004 is from Hurricane Ivan.

According to the Energy Information Administration's Daily report, a significant quantity of refining capacity is still off-line in the gulf.

"Refinery shutdowns in the Gulf of Mexico region total approximately 1.27 million bbl/d as of October 19, 2005."

This means other domestic refineries have made up a portion of the difference, probably by postponing maintenance.


Another factor in lower prices has been the quantity of imports. Imports of gasoline jumped significantly in the last month to about 1.5 million bbl/day. It is not clear how long this level of imports can be maintained.

And the last graph shows demand. Demand dropped sharply after hurricane Katrina, and is still below 2004 levels. It also appears demand is recovering as prices fall.


The Department of Energy wonders: How Much Has Oil Demand Dropped? After reviewing the data, the DOE asks:

"... what is really happening with petroleum product consumption? And, with retail prices headed toward pre-hurricane levels, at least for gasoline, are consumption and/or product supplied likely to rebound in tandem? Certainly, the latter shows signs of a rebound as this week's estimates rose well above the most recent four-week average. Although we hesitate to make too much out of one week's worth of data, product supplied is likely to continue to rebound, as Gulf Coast refinery production continues to recover. The question is, how much? Coming weeks' data may shed more light on this important issue."

If the economy weakens, I expect demand to stay below pre-Katrina levels even with lower prices. However, if the economy stays healthy, demand will most likely recover and once again put upwards pressure on oil prices. Stay tuned.

by Calculated Risk on 10/19/2005 06:58:00 PM

"The basic problem is you have huge bubbles, great big bubbles, on the coasts," David Wyss, chief economist for Standard & Poor's.

From Reuters: Economists see US housing near peak, eye slowdown

by Calculated Risk on 10/19/2005 01:15:00 PM

The Census Bureau reports(PDF):

BUILDING PERMITS:

Privately-owned housing units authorized by building permits in September were at a seasonally adjusted annual rate of 2,189,000. This is 2.4 percent (±0.8%) above the revised August rate of 2,138,000 and is 7.4 percent (±1.1%) above the September 2004 estimate of 2,039,000.

HOUSING STARTS:

Privately-owned housing starts in September were at a seasonally adjusted annual rate of 2,108,000. This is 3.4 percent (±6.3%)* above the revised August estimate of 2,038,000 and is 10.3 percent (±7.2%) above the September 2004 rate of 1,912,000.

HOUSING COMPLETIONS:

Privately-owned housing completions in September were at a seasonally adjusted annual rate of 1,979,000. This is 3.2 percent (±7.9%)* above the revised August estimate of 1,917,000 and is 10.9 percent (±8.8%) above the September 2004 rate of 1,784,000.

The Mortgage Bankers Associations (MBA) reports:

The Market Composite Index — a measure of mortgage loan application volume – was 737.5, an increase of 6.1 percent on a seasonally adjusted basis from 694.8, one week earlier. This measure includes an adjustment to offset the effects of Columbus Day on application activity. On an unadjusted basis, the Index decreased 4.4 percent compared with the previous week but was up 3.7 percent compared with the same week one year earlier.

The seasonally-adjusted Purchase Index increased by 7.3 percent to 503.9 from 469.5 the previous week whereas the Refinance Index increased by 4.5 percent to 2095.7 from 2004.9 one week earlier.

Thirty year mortgage rates rose to 6.09% from 5.98% the previous week.

A couple of comments: Permits are inexpensive and therefore a poor indicator. New and Existing Home Sales has historically been much better indicators for the housing market. In the previous housing busts, 'Starts' stayed strong right into the slow down and the excess inventory led to many builders going bankrupt. Usually 'Starts' is a trailing indicator for the housing market.

The mortgage application data from the MBA shows activity is still strong and indicates that housing hasn't fallen off a cliff - yet.

by Calculated Risk on 10/19/2005 11:47:00 AM

Federal Deposit Insurance Corp. (FDIC) Chairman Donald Powell spoke at the America's Community Bankers conference in Orlando today and cautioned on housing. Here is the press release of his comments:

Time of Transition to Follow Record-Setting Housing Boom, Powell Cautions
'Non-traditional' mortgages may elevate risks for some banks and homeowners

Residential mortgage lenders and borrowers need to be prepared for more challenging conditions ahead as U.S. housing markets enter a time of transition, said Federal Deposit Insurance Corporation (FDIC) Chairman Don Powell today in remarks at the America's Community Bankers Annual Convention in Orlando, Florida.

"The U.S. has experienced a 5-year housing boom capped by record home-price growth since 2004," said Powell. "As housing costs escalate, it is not surprising to see the rapid rise in so-called 'non-traditional' mortgages – such as 'piggyback' mortgages, low- and no-doc loans, interest-only loans, and loans with optional payment terms allowing for considerable negative amortization – all of which grew quickly in prominence over the last year.

"We know that housing booms don't last forever, and that rising interest rates will push debt service higher for borrowers relying on some of these emerging mortgage products. Credit losses are very low now, but mortgage lenders need to be prepared for higher losses. Homeowners taking on these types of mortgage product need to understand how their obligation may grow when their low introductory interest rates expire."

Powell said that the bank regulatory agencies are evaluating the importance of these and other risks to lenders. Bank regulators are looking at the lending programs of banks and will issue guidance where appropriate. Powell added that mortgage lending guidance should not prohibit innovation, but should seek to define and uphold the principles of sound banking. "We of course want to ensure that banks can continue to serve as engines of growth for our economy."

Home prices – adjusted for inflation – grew in 2004 at the fastest rate (8.1 percent after correcting for inflation) since the Office of Federal Housing Enterprise Oversight (OFHEO) began tracking the data in 1975, Powell noted. So far in 2005, home price growth has topped 2004 records.

Powell added that the housing boom is also breaking records in geographic scope: As far back as the early 1980s, the FDIC has not seen this number of metro housing markets booming simultaneously across the country, and no previous experience comes close to today's trend. (The FDIC defines a metro area boom as one in which home prices rose more than 30 percent after inflation during a three-year period.) The FDIC found the boom markets increased from 33 cities at year-end 2003 to 55 cities at year-end 2004. The FDIC estimates that these boom cities include about 40 percent of the value of all U.S. residential real estate.

by Calculated Risk on 10/19/2005 11:18:00 AM

The FEI.org provides a summary of the proposed FASB staff position:

On Oct. 13, 2005, the Financial Accounting Standards Board (FASB) released Proposed FASB Staff Position (FSP) No. SOP 94-6-a, "Nontraditional Loan Products." The proposed FSP is in response to inquiries from constituents and discussions with the SEC staff and regulators of financial institutions.

Nontraditional loan products are defined in the proposed FSP as those that "expose the originator, holder, investor, guarantor, or servicer to higher risk than traditional products…[and] include, but are not limited to" the following:

a. Loans with the contractual ability to negatively amortize
b. Loans with a high loan-to-value ratio
c. Home equity lines of credit, second mortgages, or other products that result in a high loan-to- value ratio when combined with other mortgages on the same collateral
d. Option ARMs or similar products that may expose the borrower to future increases in repayments in excess of changes that result solely from increases in the market interest rate (for example, once negative amortization results in the loan reaching a maximum principal accrual limit)
e. Loans with below market or teaser interest rates
f. Interest-only loans.

The proposed FSP states that nontraditional loan products such as those described above represent concentrations of credit risk as that term is defined in FASB Statement No. 107, "Disclosures About Fair Value of Financial Instruments," and accordingly certain disclosures under FAS 107 would be required. Additionally, certain disclosures under AICPA Statement of Position No. 94-6, "Disclosure of Certain Significant Risks and Uncertainties" (SOP 94-6) would be required.

In addition to referencing the above-named standards requiring disclosure, the proposed FSP also notes numerous other existing FASB, Securities and Exchange Commission (SEC), American Institute of Certified Public Accountants (AICPA) and bank regulatory rules requiring certain disclosures that must be considered with respect to these nontraditional loan products. Regarding the effective date of the FSP (when finalized), the proposed FSP notes, "This FSP references only existing effective literature; therefore, no effective date or transition guidance is required." As such, in considering commenting on the proposed FSP, companies may want to consider the potential implications of a lack of a delayed effective date or transition guidance.

Here is the proposed FSP from FASB.