by Anonymous on 6/01/2007 07:28:00 AM

We've talked a lot about the individual and community misery generated by housing busts, irresponsible lending, and waves of loan failures. We have pondered the potentially devastating effects on employment, residential investment, and consumer spending. We have surely noted the damage to shareholders of bankrupt mortgage originators and investors--true bagholders--in mortgage-backed bonds.

Evidently we have forgotten to spare a tear for those poor hedge funds, whose honest day's work of betting on failure, without having to pony up any real capital, apparently, is under threat. Yes, friends, there's a conspiracy afloat to put the interests of homeowners--the people who supply that cash-flow--and actual capital investors--the people who supply the actual loan funds--ahead of the credit default swap punters. I don't know that I've ever been so moved.

From the Financial Times, "Fears Over Helping Hand for Mortgage Defaulters":

The hedge funds are worried about modifications that mortgage administrators, or servicers, sometimes make to home loans for troubled subprime borrowers – for example, changing the interest rate, or extending the repayment term.

Some investment banks are active in the mortgage servicing business as well as being mortgage lenders, underwriters for mortgage-backed securities and derivatives traders.

The hedge funds claim that the banks’ ability to modify the terms of individual mortgage loans could go beyond helping borrowers and enable them to profit – or avoid losses – on the derivatives contracts sold to the hedge funds.

“Manipulation is a charged term, but there are concerns that the potential for manipulation is there,” said Karen Weaver, global head of securitisation research at Deutsche Bank.

This is because, in contrast to other strategies for managing troubled mortgages, these loan modifications show up in performance reports as no longer in arrears. Loans modified in this way would not trigger writedowns of bonds backed by such mortgages, and in turn, this could mean an investment bank would not have to pay out on derivatives contracts tracking those bonds.

Oh, my. Someone stands to profit from "helping borrowers." And a bunch of hedgies stand to lose some bets if those borrowers get back on their feet. Why, this is predation.

Ms Weaver at Deutsche Bank said: “The bottom line is that when a servicer modifies a loan, they have to represent that they believe they can maximise the value of the loan by doing a modification as opposed to choosing another option. There’s a fiduciary responsibility there.”

Moreover, whatever their motivation for modifying loans, dealers can only make changes if borrowers agree.

“A lot of the most problematic mortgages were taken out in late 2005 and 2006, when many borrowers took on huge loans on the belief that house prices were going up,” said Ms Weaver. “That hasn’t happened and those homes have become albatrosses, so a lot of borrowers may just walk away.”

Part of the problem is a lack of specialist knowledge on the part of some hedge funds, one dealer said. “There are participants in the derivatives market that don’t understand the servicing process and don’t understand the mortgage process. They are great macro players that made a great call on a sector that was going to underperform but they didn’t take into account that servicers have options to modify the loans.”

Ah, yes. Risk always ends up where it is most understood. And who'd have thunk that Mary Ellen in the Servicing Department could be causing all this grief for the big-money punters just by servicing a loan?

Oh, the humanity. I am driven, as I am so often, to take refuge in the consolations of great literature.

"I suggest, Headmaster, that Potter is not being entirely truthful," he said. "It might be a good idea if he were deprived of certain privileges until he is ready to tell us the whole story. I personally feel he should be taken off the Gryffindor Quidditch team until he is ready to be honest."

"Really, Severus," said Professor McGonagall sharply, "I see no reason to stop the boy playing Quidditch. This cat wasn't hit over the head with a broomstick. There is no evidence at all that Potter has done anything wrong."

Dumbledore was giving Harry a searching look. His twinkling light-blue gaze made Harry feel as though he were being X-rayed.

"Innocent until proven guilty, Severus," he said firmly.

Snape looked furious. So did Filch.

"My cat has been Petrified!" he shrieked, his eyes popping. "I want to see some punishment!"

Harry Potter and the Chamber of Secrets

by Calculated Risk on 5/31/2007 06:57:00 PM

There is no question that investment in non-residential structures is still strong. As an example, from the Orange County Register: Commercial real estate still roars

"Orange County is one of the high spots for commercial real estate," said Scott MacIntosh, a senior economist with the National Association of Realtors. "There's low vacancies and high investor interest."
...
"Commercial drivers are stronger than ever, and I have never seen so much money pouring into Orange County,"[ CB Richard Ellis' Barry Katz] said. "There's still billions of dollars chasing Orange County property."

The construction spending report today showed that private non-residential construction investment was still very strong in April. And investment in non-residential structures for Q1 was revised upwards in the GDP release today. Both reports confirmed what we already knew - CRE is booming.

However, the above article goes on to note that the Orange County office market is "facing [a] glut" later this year. That is also true nationwide, in fact vacancy rates have already started to rise, and there is significant more supply scheduled to be delivered later this year. From a personal perspective, when I drive around Orange County (where I live), I see commercial construction projects everywhere, and I also see more and more "For Lease" signs on existing buildings. An interesting combination: more supply coming while vacancies appear to be increasing.

It was just two weeks ago that I asked: Commercial Real Estate: Slump Ahead? I tried to connect the dots: rising vacancies, significant supply coming on line later this year, lower demand reported for CRE loans, many banks over exposed to CRE lending, etc.

Click on graph for larger image.

Here is an update to the second chart in the previous post, including the revision to the GDP report today. This graph shows the YoY change in Residential Investment (shifted 5 quarters into the future) and investment in Non-residential Structures. In the typical cycle, non-residential investment follows residential investment, with a lag of about 5 quarters. Residential investment has fallen significantly for four straight quarters (following two minor declines). So, if this cycle follows the typical pattern, non-residential investment will start declining later this year.

I believe that continued strong non-residential investment (both structures and equipment and software) is one of the keys to avoiding a recession this year.

by Calculated Risk on 5/31/2007 02:19:00 PM

From the FDIC Quarterly Banking Profile

• Industry Reports Year-Over-Year Earnings Decline
• Rising Loan Loss Provisions Reduce Profits at Larger Institutions
• Net Interest Margins Decline at Small Institutions, Rise at Large Banks
• Loan Growth Slows for Fourth Consecutive Quarter
• Mortgage Assets Decline for Second Quarter in a Row

Click on graph for larger image.

This is Chart 7 from the FDIC banking profile for Q1 asking a key question.

From the FDIC report it appears small institutions are struggling. But mid-sized institutions ($1 to $10 Billion) have improved their margins by taking on more risk, mostly associated with commercial real estate.

by Calculated Risk on 5/31/2007 12:16:00 PM

Some excerpts from Professor Roubini: Q1 Growth Revised Down to 0.6%: We Are Already in a Growth Recession

On housing:

In brief, [the view of four senior analysts at a 10 global financial institution]: the housing market is still weakening and - based on their May survey of traffic - housing sales traffic is close to dead; it would take developers to shut down all new construction for almost a year to get rid of the excess supply of unsold homes; thus, downward home price action may continue for the next two years; the credit crunch in the mortgage market is only at its early stages and the distress and crunch is spreading from sub-prime to Alt-A and near prime mortgages; the major mortgage lenders have not yet started to get a reality check on how bad their assets are and properly mark them to market; the ABX index (the BBB- tranche) collapsed from near parity down to 60 in the last few months and has now recovered to close a still low 67; but, given how lousy were mortgage originations in 2005 and 2006, deliquencies in subprime will further increase in the next few months and further downward pressure in the ABX indexes may be expected.

This writer has been a serious bear on housing for a long time: but after listening to these most sophisticated analysts of housing, mortgage lending and the MBS markets from a top global financial firm my concerns seemed almost not bearish enough. The main message from these analysts and the data is that the housing recession, the subprime carnage and the broader mortgage mess are getting worse, not better; and things will get worse well into 2008. There is no end in sight to the housing recession and we are only in the first innings of the mortgage credit crunch.

This fits very closely with my view: there is no end in sight to the housing slump.

And on the economy:

The latest macro data are certainly mixed with some supply side indicators showing an improvement while consumption and housing have been weakening. ... unless there is a massive recovery of net exports, capital spending by the corporate sector, inventory rebuilding, Q2 growth will remain in the growth recession range. The current soft landing consensus argues that such recovery in these components of aggregate demand may be underway. I am not convinced - for reasons I will flesh out next week.

I'm looking forward to Roubini's future posts. So far non-residential investment is holding up pretty well, although, with the typical lags, we might expect non-residential investment to start to decline about now. As far as consumption, we are still waiting to see the impact of declining MEW (and the end of the "home ATM").

by Calculated Risk on 5/31/2007 11:07:00 AM

From OFHEO: U.S. House Price Apprecation Rate Remains Slow, but Positive

The rate of home price appreciation in the U.S. remained slow but positive in the first quarter of 2007. The OFHEO House Price Index (HPI), which is based on data from sales and refinance transactions, was 0.5 percent higher in the first quarter than in the fourth quarter of 2006. This is moderately below the revised growth estimate of 1.3 percent from the third to the fourth quarter of 2006. Prices in the first quarter of 2007 were 4.3 percent higher than they were in the same quarter in 2006.

OFHEO’s purchase-only index, which is based solely on purchase price data, indicates less price appreciation for U.S. houses than the HPI does over the past year. The purchase-only index increased 3.0 percent between the first quarter of 2006 and the first quarter of 2007, compared with 4.3 percent for the HPI.

The underlying purchase-only and a seasonally-adjusted purchase-only U.S. index can be downloaded here.

Purchase-only indexes (both seasonally-adjusted and not-seasonally adjusted) are now also available for every Census Division and are downloadable here.

Purchase-only indexes are available for each state here.

by Calculated Risk on 5/31/2007 10:22:00 AM

From the Census Bureau: April 2007 Construction Spending at $1,190.0 Billion Annual Rate

The U.S. Census Bureau of the Department of Commerce announced today that construction spending during April 2007 was estimated at a seasonally adjusted annual rate of $1,190.0 billion, 0.1 percent above the revised March estimate of $1,188.9 billion. The April figure is 2.0 percent below the April 2006 estimate of $1,214.4 billion.

During the first 4 months of this year, construction spending amounted to $345.1 billion, 2.5 percent (±1.8%) below the $353.8 billion for the same period in 2006.

The decline in spending is due to the slump in residential construction. However private non-residential construction spending has remained strong:

Nonresidential construction was at a seasonally adjusted annual rate of $335.9 billion in April, 1.5 percent above the revised March estimate of $331.1 billion.

Click on graph for larger image.

This graph shows the YoY change for the three major components of construction spending: Private Residential, Private Non-Residential, and Public.

While private residential spending has declined significantly, spending for both private non-residential and public construction has remained strong.

As I noted last month, continued strength in non-residential investment is probably necessary to keep the economy out of recession. In the revision to the GDP report today, the headline number was revised down to 0.6% real growth (way below most forecasts), but the good news was non-residential investment was revised upwards: non-residential structure investment was revised up to (UPDATE: corrected numbers) 5.1% from 2.2%, and investment in software and equipment was revised up to 2.0% (from 1.9%). For those of us arguing there is a reasonable chance of a soft landing, this is good news.

Before people start thinking I've changed my views - I haven't. I still think the odds of a recession in '07 are about a coin-flip. And I still think Bernanke's downward revised view of 2.5% to 3.0% growth in '07 is too optimistic.

by Anonymous on 5/31/2007 09:52:00 AM

Our loyal commenter Yal directed my attention to this piece from CNNMoney, "Wow, I could've had a prime mortgage." I was going to get right on it, but I was a touch queasy yesterday, and the minute my mind processed the allusion to the famous V-8 commercial--I hate all forms of vegetable juice, with or without vodka--I had to reprioritize.

But it's a new day.

"I reviewed several hundred [subprime] loans recently for our wholesale division," said Allen Hardester, regional director of development for mortgage-broker, Guaranteed Rate, "and all of them, with one exception, qualified for a prime-rate loan."

Freddie Mac, a government-sponsored mortgage-loan buyer, estimated that borrowers of 15 to 35 percent of all subprime loans it bought in 2005 could have qualified for prime-rate loans.

Fannie Mae, another government-sponsored loan buyer, estimated up to 50 percent of the borrowers, whose subprimes it bought that year, had credit profiles that could have qualified them for prime rates.

There are any number of things one can say about reports such as the ones above, from highly-informed industry participants with very, very big databases and the ability to perform professional, in-depth due diligence review on a loan file. So what does CNN say?

No one to blame but yourself

"You" here means you, the hapless borrower, not me, the person who is expected to know what product you can qualify for and what the market rate might be for it.

Then there is the obligatory denial from the vested interests:

[Doug Duncan, chief economist for the Mortgage Bankers Association], however, doubted that very many prime customers do get put into subprime products.

"I have yet to see any scientific evidence that that is true," he said. "If you only see credit scores, that doesn't capture the whole story."

Jim Nabors, past president of the National Association of Mortgage Brokers, said, "[Fannie Mae and Freddie Mac] may not be seeing the whole picture. They didn't take into account a lot of things that help determine the kind of loan a borrower receives."

These factors include items such as "seasoning" of loans, which takes into account how long a buyer had a down payment on a house and the source of that money, the borrower's debt ration [sic] and the appraisal value [sic] of the property.

Nabors said that, undoubtedly, some borrowers qualified for prime did get subprimes, but the extent has probably been exaggerated. [Emphasis added]

Welcome to the wonderful world of mortgage industry logic, as mediated by the press. Duncan sees no "scientific" evidence here, even though he is being confronted with estimates that are derived from much more than a simple credit score. Nabors seems to think that Fannie and Freddie use automated underwriting systems that don't capture DTI or appraised values. The GSE systems, of course, don't simply "capture" appraised values; they have internal AVMs that subject those reported numbers to a plausibility check. Nor do they "look at" FICOs. They do "capture" FICOs in the dataset. But what they "look at" is the entire contents of at least one and usually three full credit reports (from each of the three major repositories). Plus about a thousand other data elements.

But if you're an underinformed sucker, you can read these statements by Duncan and Nabors--which are blaming you for not knowing enough--and think that the claims being made by Guaranteed Rate, Fannie, and Freddie are based solely on looking at FICO scores. If you're a reporter or editor who uses "ration" instead of "ratio" and "appraisal value" instead of "appraised value," it is possible you haven't had enough exposure to the industry and its lingo to know when smoke is being blown in your direction. And if I say you have no one to blame but yourself for printing nonsense from an industry shill, you better not start trying to explain to me why people who read CNNMoney are at fault if they don't know more about their mortgage eligibility than their lender appears to. You are a reporter. You could have called Fannie and Freddie and asked them on what basis they have made these estimates. You could have asked Mr. Hardester about the exact nature of the "file review" he performed. You could have identified Guaranteed Rate as a mortgage banker who buys loans from brokers, not as a broker itself. You could have had a V-8.

What you did, though, is give us another "he said/she said" piece of tripe.

by Calculated Risk on 5/30/2007 03:08:00 PM

From the FOMC minutes of the May 9th meeting:

The incoming data on new home sales and inventories suggested that the ongoing adjustment in the housing market would probably persist for longer than previously anticipated.
emphasis added.

Remember, these minutes are for the May 9th meeting - before the stunning increase in inventory reported on May 25th. Here is the complete paragraph:

The incoming data on new home sales and inventories suggested that the ongoing adjustment in the housing market would probably persist for longer than previously anticipated. In particular, the demand for new homes appeared to have weakened further in recent months, and the stock of unsold homes relative to sales had increased sharply. That said, participants also noted that sales of existing homes appeared to have held up somewhat better since the beginning of the year. Moreover, the turmoil in the subprime market evidently had not spread to the rest of the mortgage market; indeed, mortgage rates available to prime borrowers remained well below their levels of last summer. Nevertheless, most participants agreed that, although the level of inventories of unsold homes that homebuilders desired was uncertain, the correction of the housing sector was likely to continue to weigh heavily on economic activity through most of this year--somewhat longer than previously expected.

by Calculated Risk on 5/30/2007 10:31:00 AM

On June 14th, the Fed will hold a hearing under the Home Ownership and Equity Protection Act.

Hearing participants will discuss whether the Board should use its rulemaking authority to address concerns about certain terms and practices related to home mortgage loans, including:

• Prepayment penalties
• Escrow accounts for taxes and insurance on subprime loans
• "Stated income" or "low doc" loans
• Consideration of a borrower's ability to repay a loan

Participants will also discuss the effectiveness of state laws that have prohibited or restricted these and other terms or practices, and whether the Board should consider adopting similar regulations to curb abusive lending practices. The Board is also soliciting written comments from the public. Comments are due August 15, 2007.

Some of the questions are interesting:

• Should stated income or low doc loans be prohibited for certain loans, such as loans to subprime borrowers?
• Should stated income or low doc loans be prohibited for higher-risk loans, for example, for loans with high loan-to-value ratios?

Oh well, more hearings.

by Calculated Risk on 5/30/2007 12:10:00 AM

From the WaPo: An ATM That's Out of Money

For years ... people used their homes as glorified ATMs, pulling out money for all sorts of reasons. The trend helped support continued economic growth and recovery from the 2001 recession.

But now people are reining in their spending, raising concern that their collective decisions could nudge a sluggish U.S. economy into recession.

This has all been discussed here before, but it is now on the front business page of the WaPo. As an aside, I believe Fleck was the first writer to refer to mortgage equity withdrawal as the "housing ATM".