by Calculated Risk on 6/13/2007 10:56:00 AM

From Reuters: Fed mulling ban on some mortgage lending

The Federal Reserve Board is weighing whether it should ban some mortgage lending practices that fueled the recent housing market boom, Fed governor Randall Kroszner told a panel of lawmakers Wednesday.

"We will also seriously consider whether there are mortgage lending practices that should be prohibited," Kroszner said in prepared remarks at a U.S. House of Representatives Financial Services Committee discussion on consumer protection.

Kroszner said the Fed was specifically eyeing 'stated-income' loan applications and prepayment penalties, as well as considering whether lenders should require monthly payments of annual fees like taxes.

by Calculated Risk on 6/13/2007 12:57:00 AM

From Professor Hamilton: Reconciling the BED, CES, and birth/death employment data

A great analysis, with some important corrections.

by Calculated Risk on 6/12/2007 04:24:00 PM

Bloomberg reports: Treasury Yields Rise to Highest in Five Years on Growth Concern

Yields on benchmark 10-year Treasuries rose to the highest in five years ... The yield on the benchmark 10-year note rose to 5.25 percent, an increase of 9 basis points, or 0.09 percentage point, at 3:24 p.m. in New York ...

The following graph covers a longer time period (since April 1971) as compared to the graph presented this morning (since January 1999).

Click on graph for larger image.

Here is a scatter graph showing the 30 year fixed rate mortgage (Freddie Mac average monthly rate) vs. the monthly average Ten Year treasury yield for every month since April 1971.

The Green line shows the approximate current 10 year yield. This shows rates are still low compared to the last 35 years. Mortgage rates in the '50s and '60s were on the low end of the scale, but Freddie Mac doesn't provide any data for those periods.

It now appears the 30 year fixed rate will move up to 6.75% to 7% this week. As an aside, I'm always amused when the article tries to explain why rates are moving.

by Calculated Risk on 6/12/2007 02:46:00 PM

From Bloomberg: U.S. Mortgage Foreclosure Filings Rise 90% in May (hat tip Brian)

U.S. foreclosure filings surged 90 percent in May from a year earlier as more homeowners fell behind on their monthly mortgage payments, RealtyTrac Inc. said.

There were 176,137 notices of default, scheduled auctions and bank repossessions last month, led by California, Florida and Ohio, the Irvine ...

"Such strong activity in the midst of the typical spring buying season could foreshadow even higher foreclosure levels later in the year," [James Saccacio, chief executive officer of RealtyTrac] said in the report. That will add "to the downward pressure on home prices in many areas."

by Anonymous on 6/12/2007 11:00:00 AM

I thought we might look at some details in this piece in the New York Times by our dependable Vikas Bajaj, "Effort to Advise on Risky Loans Runs Into Snag." As usual, Bajaj pulls together enough information to allow us to get past the spin, without actually crossing the line into editorializing. But hey! I'm a blogger. About editorializing I have no scruples.

I strongly encourage you to read the whole thing. A few choice bits:

Now, the state is retooling the program to include all of Cook County, which encompasses Chicago and many of its suburbs. Under the proposal, first-time home buyers and borrowers who are refinancing would be referred to counseling only if they selected certain loans like adjustable-rate mortgages that reset in five years or less, or loans that initially require only interest payments. A state agency is drafting the rules, which must be approved by a committee of lawmakers.

Even as that process plays out, the Illinois General Assembly is considering legislation that would enshrine the new counseling rules in law. In addition, the bill would require mortgage brokers to act in their clients’ best interest and bar state-regulated lenders from making loans without verifying borrowers’ income with tax returns, paycheck stubs or other documents.

Interesting, is it not? Illinois is taking the position that certain kinds of mortgage transactions are so risky--so, shall we say, likely to be "non-economic" for the borrower--that the fact that the borrower elected to apply for such a loan is a presumption that counseling is appropriate. Someone needs to alert the hedge funds.

Furthermore, Illinois is connecting the dots between the fiduciary duty of the broker and the terms of the loan. The implication is that a stated income loan is simply not sufficiently in any borrower's best interest such that it is presumptively a failure of fiduciary duty to originate one. I haven't seen the text of the Illinois statute and I'm prepared to be as disappointed as I usually am once this stuff gets out of committee, but let me say good on Illinois for having advanced the ball this far. I'm rather hoping ISDA is taking notes.

And while we're on the subject of brokers earning their fees by providing services to borrowers:

A report compiled by an advocacy group, Housing Action Illinois, shows that the majority of borrowers who were about take on adjustable-rate mortgages believed that they had fixed-rate loans. More than two-thirds of the borrowers were spending more than 60 percent of their take-home pay on housing expenses. And 75 percent of the borrowers were refinancing existing debts; the rest were buying a home.

If I'm reading this correctly, these folks have already talked to a mortgage broker and they're still this confused. Do I believe this data? With all my heart and all my soul and all the decades I've spent trying to explain how ARMs work to people with bachelor's degrees in financial fields. Of course an advocacy group might have an interest in portraying these borrowers as more ignorant than they are. Did anyone else see this little survey that Lending Tree published recently?

81% of on-line consumers who are paying a mortgage or are planning on buying a home in the next 12 months say they understand how an ARM works. (See q31.)
−Young Singles are the least likely to understand how an ARM works.

On-line consumers are not as informed about their ARM as they first indicated. When asked what they know about their ARM, the majority did not know the interest rate cap, the adjustment schedule, the index their ARM was tied to, or the interest rate ceiling. (See q46.)

Most on-line consumers (91%) with an ARM are aware that their rate will adjust. (See q41.)

In what was quite possibly a sample of savvier-than-usual borrowers, you could still find 9% who are not aware that their ARM will adjust. You can also get a bunch of people to say "yes" to the question "Do you understand ARMs?" But if you ask them any trick questions involving, you know, how ARMs work, the majority has no idea. The usual justification of collecting an origination fee from a borrower involves at least some implicit claim that part of the effort of originating a loan is explaining it to the borrower.

Back to the Times:

The president of the Illinois Association of Mortgage Brokers, Bill McNamee, said the nonprofit agencies’ analysis could not be trusted because they have an incentive to play up problems — they receive $300 for each counseling session, which is paid for by brokers and lenders. “They are going to want to justify their existence so they can continue to collect their fees,” he said.

Delicious. Irony, with a touch of vermouth. My favorite cocktail.

But don't think those brokers are just anti-education:

John West, a mortgage broker, said the government should emphasize first-time home buyer classes and a more rigorous financial education curriculum in public schools. “People want government to safeguard them,” Mr. West said. “But I don’t want to be turning my head and seeing the government saying, ‘We think you should make another decision.’ ”

You know, one of these days, someone is going to explain to Mr. West the connection between public schools and the government. It won't be me, though; I can see a losing battle coming.

Not that the local regulator comes off sounding that much brighter:

Dean Martinez, secretary of the state’s Department of Financial and Professional Regulation, says that the uproar is missing the point and suggests that the term “counseling” may be the problem. He views the sessions as akin to state driving tests. They are there to make sure borrowers fully comprehend what they are doing, not to watch over their every action.

“Mario Andretti has to take a driver’s license test,” Mr. Martinez said, “even though he is one of the best drivers in the world. No one disputes that.”

Well, forgive me for having thought that the point of a driver's license test was to make sure you know how to drive, not to make sure you understand why the hell anyone would want to drive in the first place. What a terrible analogy. The issue is not that Mario Andretti has to have a driver's license; the issue is that not even Mario is allowed to drive an Indy 500 race car on the suburban streets at 150 mph, whether he is considered "capable" or not.

Mr. Martinez is letting himself fall into the trap here. The state of Illinois appears to be on the verge of declaring certain loan types to be so dangerous that anyone offering to get one is going to have to prove to the party who is going to have to pay the eventual bar tab--and that'll be the states, the counties, and the townships, not the NAMB--that it is "informed consent." And the very fact that we don't seem to be able to find many people who can pass the quiz at the end of class ought to be telling us that there's something markedly wrong with these loan products. Any good teacher will tell you that it isn't always the students' fault or the teachers' fault; sometimes it's the material.

Possibly you do not understand your mortgage loan because you keep trying to tell yourself that it benefits you somewhere. Free yourself of that a priori problem, and the pieces might fall into place for you.

by Calculated Risk on 6/12/2007 09:40:00 AM

Click on graph for larger image.

Here is scatter graph showing the 30 year fixed rate mortgage (Freddie Mac average monthly rate) vs. the monthly average Ten Year treasury yield for every month since January 1999.

The parallel lines show the 30 year rate 150 bps and 200 bps above the Ten Year yield. Although there are other factors in determining the 30 year rate, the Ten Year yield (and adding 150 to 200 bps) gives a pretty quick approximation.

Currently (this morning) the Ten Year yield is at 5.2% implying a 30 year rate of 6.7%+.

by Calculated Risk on 6/12/2007 09:27:00 AM

From the WSJ: For Troubled Firms, A Flood of Big Loans

In a world awash in investable funds, even many of the most troubled companies are finding lenders willing to offer them big money. This rescue financing, as it's sometimes called, can give companies time to clean up their balance sheets and avoid a trip to bankruptcy court. U.S. filings for bankruptcy reorganization ... are at a 10-year low. Also at historic lows are U.S. corporations' debt defaults.
..
It ... can be risky to have so much debt sloshing around the economy's shakier regions. When rescue lending fails, the extra debt can make a bust just more spectacular. Among lenders that risk taking it on the chin are some hedge funds, which have largely replaced banks as lenders in this kind of finance.

See the story for some nice graphs of the rapid increase in speculative grade loans.

by Calculated Risk on 6/11/2007 06:09:00 PM

Dryfly can stop holding his breathe!

David Malpass, chief economist at Bear Stearns, kindly responded to my email today (see this post for background: Bear Stearns and RI as Percent of GDP). I don't have permission to post his email, but basically he says the chart is as intended - the chart uses chained 2000 dollars for both Residential Investment (RI) and GDP, and then presents the ratio of RI (chained 2000 dollars) as a percent of GDP (chained 2000 dollars).

UPDATE: Professor Tim Duy provides a Fed paper that explains the error in using real ratios from chained series, and recommends the approach I used. See: A Guide to the Use of Chain Aggregated NIPA Data, Section 4.

Click on graph for larger image.

This graph shows Residential Investment as a percent of GDP (red), and using a ratio of chained dollars (dashed purple, Bear Stearns).

At the least, the chart in the Bear Stearns research note (not shown), is mislabeled. Note that Bear Stearns shows RI as a percent of GDP for Q1 2007 as 4.5%, but in reality it is 5.07%. Here are the numbers from the BEA:

Q1 GDP: $13,613.0 Billion
Q1 RI: $690.5 Billion
RI as % of GDP: 5.07%

I frequently use real quantities (adjusted for inflation), but one of the exceptions is when I normalize by some other factor. In this case, I normalized RI with GDP.

David Malpass argues "Our graph is relevant in thinking about the number of
people employed in the sector, the useage of commodities, etc.". I don't share his view. I think normalizing by GDP (red line) provides a better view of how much of GDP is dedicated to housing.

And finally, I'd like to note that RI is not the same as housing prices (see What is "Residential Investment"?). Most of RI is value put in place for new construction, home improvement spending, and commissions. Only brokers commissions are directly tied to housing prices (although there is usually more RI when prices go up significantly). So when we talk about RI, we are mostly talking about construction materials and labor costs.

by Anonymous on 6/11/2007 05:44:00 PM

As I have written extensively, and to no apparent purpose, on this subject, I feel obligated to note the following letter to the editor of the Financial Times, published today:

Sir, Your articles "Hedge funds hit at subprime aid for homeowners" and "Fears over helping hand for mortgage defaulters" (June 1) mischaracterised our efforts to prevent market manipulation as somehow against loan modification. To be absolutely clear, we have no objection to loan modification; however, we are vehemently opposed to market manipulation.

Paulson & Co and other major financial institutions are concerned about credit protection sellers providing non-economically motivated credit support to mortgage-backed securities (MBS) trusts for the sole purpose of artificially influencing the value of the credit protection sold. This can be done, for example, by purchasing defaulted mortgages worth less than par from the trusts that hold them at par value. Because the credit default swaps (CDS) market is so much larger than the amount of the underlying MBS securities, a credit protection seller can spend a small amount on such credit support and achieve huge gains on related derivatives positions.

Our concerns about manipulation arose when we heard about plans by certain market participants to sell credit protection and simultaneously to provide credit support to the underlying MBS trusts. Although these transactions are market-manipulative and therefore prohibited under securities laws, our firm proposed that the International Swaps and Derivatives Association amend the language of its CDS documentation expressly to prohibit such transactions. ISDA's staff asked us to help them gather views from interested market participants, including credit protection buyers, in order to hold a meaningful discussion of the issue. The language we proposed in no way references or restricts loan modification.

The manipulative transactions we are seeking to prevent have nothing whatsoever to do with loan modification or helping subprime borrowers. Your articles suggest that our firm, as the organiser of a "group of more than 25 hedge funds", opposes loan modification. To the contrary, we support loan modification as the fastest way to resolve troubled loans in a way that helps keep borrowers in their homes. What we oppose is deliberate market manipulation.

Michael Waldorf,

Paulson & Co

So we can all stand down. It's just one of those things that is clearly "prohibited under securities laws," but apparently not prohibited under ISDA deal documents.

(Hat tip, jck)

by Calculated Risk on 6/11/2007 12:06:00 PM

From MarketWatch: Pulse on housing

It's still too early to tell exactly when this housing slump is going to end, with house prices just beginning to soften, mortgages at risk of defaulting beginning to hit reset dates and lending standards that are starting to tighten, according to researchers at the Harvard University's Joint Center for Housing Studies.

One thing's for sure: Before the sun shines again on the housing industry, a good amount of excess inventory will have to be sold, according to the center's "State of the Nation's Housing" report, released Monday.

This is a stunning statistic:

"In just one year the number of households spending more than half their income on housing increased a startling 1.2 million to 17 million in 2005," Rachel Drew, research analyst for Harvard's Joint Center of Housing Studies, said in a news release.

I believe this isn't correct:

"If you were an economist, you would think that prices would have fallen precipitously," [Nicolas P. Retsinas, director of the center] said.

I believe most economists recognize housing suffers from "sticky prices" and they wouldn't have expected a precipitous decline in prices, rather they would expect real prices to decline over several years.

Here is the report: The State of the Nation's Housing 2007

And the Joint Center for Housing Studies home page.