by Calculated Risk on 7/09/2007 11:17:00 PM

From the Financial Times: Junk-rated loans hit new lows

The price of junk-rated loans in the US and European markets has tumbled in the past couple of weeks as investors begin to turn away from the asset class, according to new data from S&P LCD, the market information service.

US leveraged loan prices have fallen to their lowest level in more than four years, while in the derivatives markets a sell-off has pushed the prices of both US and European loan risk to less than the face value of the loans themselves.

The fall in prices is significant for banks and private equity firms preparing to launch new debt deals after recent buy-outs because it implies a rise in loan yields, which means higher borrowing costs.

by Calculated Risk on 7/09/2007 10:53:00 PM

The details of Freddie Mac chief economist Frank Nothaft's housing forecast are now available.

Nothaft is predicting combined new and existing home sales will fall to 6.28 million this year (2007), but Nothaft is only counting "new and existing detached single-family homes". (emphasis added).

So adjusting for total sales, Nothaft's estimate is around 7.05 million for 2007; this is significantly above my estimate of 5.6 to 5.8 million existing home sales (including attached homes) and 0.85 new home sales.

As an aside, the Bloomberg story used 6.2 million for 2001:

Sales of new and previously owned homes probably will total 6.28 million, according to the world's second-largest mortgage buyer. That would be the lowest since 6.20 million in 2001.

The 6.2 million number is total sales, including attached homes, and is not comparable to Nothaft's forecast. This is an error in the Bloomberg story.

Finally, it is pretty clear that Freddie Mac's forecast is already wrong. Sales would have to pickup to reach their forecast, and that seems very unlikely.

by Calculated Risk on 7/09/2007 01:13:00 PM

From Bloomberg: U.S. Housing Sales to Tumble to Six-Year Low on Rates, Defaults (hat tip Yal)

Sales of new and previously owned homes probably will total 6.28 million, according to the world's second-largest mortgage buyer. That would be the lowest since 6.20 million in 2001.

I'd like to see the details. I've been forecasting 5.6 to 5.8 million existing home sales and close to 0.85 million (or so) new home sales. It sounds like Freddie Mac chief economist Frank Nothaft is in the same range - or actually even lower - now.

Here is the link for Freddie Mac's forecasts. (July 9th isn't available yet).

by Calculated Risk on 7/09/2007 10:48:00 AM

"The contagion and contamination I'm most concerned about is what effect this will have on the consumer."
William Rhodes, senior vice chairman at Citigroup Inc. in New York.

From Bloomberg: U.S. Rebound May Be Bumpier Than Fed Expects as Credit Tightens

The biggest worry is that falling home prices and rising interest rates will undermine consumer spending, the bedrock of the economy.

Consumers are showing some signs of stress. They fell behind on loan payments in the first quarter at the highest rate since 2001, the American Bankers Association reported.

Retailers feel the fall-out. The International Council of Shopping Centers and UBS Securities last week cut their forecast for June sales growth at retailers to 1.5 to 2 percent, from 2 percent.

``It's soft,'' says Michael Niemira, chief economist at the council. ``More retailers are feeling that something has changed after years of pretty healthy demand.''

by Calculated Risk on 7/09/2007 01:35:00 AM

From the NY Times: Increasing Rate of Foreclosures Upsets Atlanta

Despite a vibrant local economy, Atlanta homeowners are falling behind on mortgage payments and losing their homes at one of the highest rates in the nation, offering a troubling glimpse of what experts fear may be in store for other parts of the country.
...
A big reason the fallout is occurring faster here is a Georgia law that permits lenders to foreclose on properties more quickly than in other states. The problems include not just people losing their homes, but also sharp declines in property values, particularly in lower-income and working-class neighborhoods.

For example, a three-bedroom house near Turner Field, where the Atlanta Braves baseball team plays, fetched a high bid late last month of $134,000 at an auction by the bank that took possession of it. Almost three years ago, the new home was bought for $330,000.

This is probably just the beginning of increasing foreclosure activity in Atlanta and the entire country.

by Calculated Risk on 7/09/2007 12:07:00 AM

The "unexpected" sharp slowdown in Q2 Personal Consumption Expenditures (PCE) will likely restart the discussion of the impact of the housing slump - and less Mortgage Equity Withdrawal (MEW) - on PCE.

Some variation of the following graph will probably be part of the discussion.

Click on graph for larger image.

This graph shows MEW(1) as a percent of Disposable Personal Income vs. the Year-over-year change in Real PCE. An example of the use of this graph is presented as Exhibit 5 in this paper from Wells Fargo: Housing Bust Without A Consumption Bust???. The author writes:

Exhibit 5 shows virtually no relationship between real consumption growth and MEW. As MEW exploded between 1998 and 2003, consumption growth declined from over 5 percent to about 2 percent. As MEW has collapsed since 2005 from about 10 percent to about 3 percent, consumption growth has remained remarkably healthy at about 3.5 percent. Despite the widespread belief that MEW is a primary driver of consumer spending and the fear that any decline in MEW would certainly cause a collapse in consumption, this exhibit suggest consumer spending has been and continues to be little impacted by MEW.

First, although the author is correct that there is no clear correlation between MEW and the change in real PCE during the period presented, perhaps he has it backwards; maybe the reason PCE was in the normal historical range for the last few years was because of MEW.

Of course the graph is flawed too. The author uses the YoY change for PCE (introducing a lag in PCE) and compares it to the current quarterly value for MEW (even though studies have shown MEW is spent over a number of quarters following extraction). This error in graphing led the author to this conclusion:

As MEW has collapsed since 2005 from about 10 percent to about 3 percent, consumption growth has remained remarkably healthy at about 3.5 percent.

If declining MEW was going to have an impact on PCE, we wouldn't expect it to happen until several quarters after MEW declined. And since the YoY real PCE presentation introduces a mathematical lag, we would expect the graph to show a decline in PCE significantly after MEW declines - so the author's conclusion regarding "remarkably healthy" PCE while MEW is "collapsing" is, at best, premature.

Another perspective comes from Dallas Federal Reserve senior economist John V. Duca (written last November): Making Sense of the U.S. Housing Slowdown

The limited U.S. econometric evidence indicates that the strong pace of MEW may have boosted annual consumption growth by 1 to 3 percentage points in the first half of the present decade.[8] This implies that a slowing of home-price appreciation into the low single digits might shave 1 to 2 percentage points off consumption growth and 0.75 to 1.5 percentage points from GDP growth for a few years.

While these estimates provide an idea of housing’s potential economic impact, considerable uncertainty exists about how much a slowdown in MEW might restrain consumption growth. Key issues include how much home-price appreciation might slow, how much the deceleration would affect MEW and how much a slowdown in MEW would restrain consumer spending.

Dr. Duca presents this graph (as chart 4). Duca suggests that the recent increase in PCE as a percent of GDP might have been driven by MEW - and declining MEW might "shave 1% to 2%" off consumption growth for "a few years".

Duca's paper also includes references to much of the recent research on the impact of MEW.

Now we just have to wait for the "unexpected" decline in Q2 PCE!

(1) MEW calculations courtesy of James Kennedy, and are based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

by Anonymous on 7/08/2007 09:14:00 AM

Frequently Imagined Questions:

What is an UberNerd post?

It’s a long post discussing everything you never wanted to know about random mortgage-related topics that are extremely important I felt like writing about at the time. UberNerd posts appear on this blog periodically on no known schedule.

What’s an UberNerd?

For those of you new to what passes for insider humor around this blog, an “UberNerd” is someone who is compelled to understand how things work in grim detail, even if the things in question are tedious in the extreme, like mortgage insurance policies. Not everyone who visits the blog is an UberNerd, or aspires to UberNerdity, but on the other hand those who display UberNerditude in the comment threads are treated with a respect bordering on lunacy. That’s just the way we are. Fortunately, we are not so intellectually intense that we cannot be distracted on a regular basis by rock videos and some damned fine figure skating.

What’s a Compleat UberNerd?

Someone who has read all these posts already and quotes them at tailgate parties. You can recognize them because their adolescent children walk ten paces ahead of them at the mall, in hopes that people will think they’re someone else’s parents.

Why are you reposting all these links?

Because I have been asked to over 100 times in the last six months or so and I just now got around to it. UberNerds may have a superficial resemblance to highly-organized people who carry day-planners, but at heart we are poets. And you know what poets are like.

Why can’t you just put a side-bar link to The Compleat UberNerd for us?

Because CR, being smarter than your average blogger, won’t give me access to the side-bars or any other part of the template. I get to play in the center column where I can’t hurt anything. You may therefore pester him and see how poetic his heart is.

What would constitute an “on-topic” comment to this post?

Beats me. Perhaps you could reminisce about what you were drinking the first time you read all the way through a great long post on mortgage insurance without being paid to do it. We also welcome testimonials from people who have tried some of this stuff out on the neighbors. Recipes are always welcome, too. It is traditional for the first comment in the thread to complain about the length of these posts.

The UberNerd Collection:

Mortgage Servicing

Negative Amortization

FICOs and AUS

Private Mortgage Insurance I

Private Mortgage Insurance II

Foreclosure and REO

MBS I

MBS II

MBS III

Delinquency and Default

Reverse Mortgages

Leverage, Ratings, and Forced Unwind

Mortgage Origination Channels

by Anonymous on 7/07/2007 01:38:00 PM

More proof that Australians are smarter than us Americans: here's an article from the Sydney Morning Herald on CDOs that is not stupid. I found the discussion of credit spreads a bit foggy, it is true, but since the issue is either absent or entirely mangled in every other mainstream media piece I've seen on the subject, I can accept foggy. In any case, I recommend the whole thing if you're new to the leveraging issue.

Ibbetson says there are three parties who need to shoulder blame for the current imbroglio, and all are equally culpable: Bear Stearns for leveraging the fund so highly, banks for lending the money to enable the leverage, and investors for buying into an investment that they really should have known could be exceptionally risky.

I guess they haven't figured out down in Oz that it's all the rating agencies' fault. John Mauldin has some ideas on that in this week's newsletter:

When a corporation gets a rating there are audits, not to mention regulators that are there overlooking the data upon which the ratings are based. But no one was looking at the data used to create the ratings on RMBSs and CDOs, to make sure there was some type of reasonable similarity or standard of the securities being rated and the databases used to do the risk analysis.

Subprime loans made in 1999 or 2002 were significantly unlike those made in 2004-2006. At the end of 2006, many subprime loans were defaulting in only one or two months from the date of the loan. No-documentation "liar's" loans were common. Adjustable Rate Mortgage (ARM) loans, made where the applicant could clearly not make the payments when the interest rate reset, were common. Thus, the past performance the ratings were based on was significantly different than for the crop of then-current loans, and was substantially misleading. We are talking an apples and cumquats type of difference here.

So, the rating process was not the same as the ratings that were used in the corporate world. But the problem is that the ratings used the same designations. Instead of creating a whole new type of rating standard (say, using numbers like "CDO rank 1-10"), they used the same designations that bond investors were used to.

I think it is disingenuous for a rating agency to explain the difference in paragraphs 457-503 in 7-point type and dense legalese in their disclosure document. Investors had (and should have) a certain level of expectation when the designation "AAA" is used. GE and Exxon types of expectations.

I am not expecting infallibility here. Let's make it clear that the rating agencies have made mistakes in the past and will make them in the future. You do your best, and in general I think they do an excellent job given the pressures and the vagaries of the business. (I certainly have made a few mistakes here and there in my career that I would not make today. And I will make more in the future. We live and learn.)

The problem is in allowing the confusion of rating a CDO as you would a GE or Exxon. I think Dann has a point when he says the rating agencies aided and abetted the investment banks. And that point gets even bigger when we are talking about CDOs.

When you pool BBB tranches into a CDO and now turn 80% plus into AAA at the touch of an algorithm, based on faulty assumptions, someone somewhere should have raised an eyebrow.

This is not going to end up pretty. You can bet that 20-20 hindsight is going to kick in here as the regulators and various attorneys general get involved. The rating agencies may be able to justifiably say that they were doing exactly what they said they were doing in the disclosure documents. But then someone at the investment banks (especially those that owned subprime mortgage brokers and should have been able to see the deteriorating quality of the loans) should maybe have thought that the default rates would change and therefore should have used different assumptions.

But then, that would have killed what was a very profitable business. And everyone was doing it, so to unilaterally disarm when every other investment bank and agency was doing the same thing evidently did not cross the mind. Last year there were $500 billion in CDOs sold, and half of it subprime. In June, there was only $3 billion. And you can bet there was no subprime in them.

As an aside, the rating agencies are starting to downgrade the CDOs. Of the pool of securities created from 2006 subprime mortgages, Moody's has downgraded 19% of the issues they've rated and put 30% on a watch list. That will grow.

And let's look at the investment banks. Creating and selling CDOs was a particularly juicy business. I have heard, but not verified, that sales commissions were running 5%. You can bet the banks were making at least as much. Put together a $250 million CDO and sell it to institutions, pension funds, insurance companies, and hedge funds, put some of the equity portion into your own portfolio, and you could generate substantial profits and commissions. Rinse. Lather. Repeat.

by Anonymous on 7/07/2007 10:53:00 AM

Sorry, friends, but no rock blogging today. For those of you who missed the news, Beverly Sills died on July 2, 2007.

Like many, many people, I first encountered the joy of opera watching Sills on TV. More than anyone else, she was responsible for demystifying operatic culture and inviting a mass audience into a world of beauty without a hint of condescension or pedantry. Her humor and gallantry have been and will remain as legendary as her beautiful voice.

Goodbye, Bubbles.

by Calculated Risk on 7/07/2007 12:46:00 AM

From the San Jose Mercury News: Once rare in valley, lender-owned homes on the rise

REOs, once rare in Silicon Valley, may soon contribute to lower home prices in some neighborhoods.
...
In May, $2.8 billion worth of California real estate went up for sale in foreclosure auctions, according to ForeclosureRadar.com, a Discovery Bay company that sells foreclosure information to subscribers. Of that amount, about $2.6 billion worth failed to find buyers, and so became bank-owned. The figures represent the total value of the outstanding loans that went up for auction.

Those figures are way up from early this year. In January, for example, $1.49 billion worth of property was auctioned statewide, and $1.32 billion went back to banks. January is typically a busy month because trustees usually refrain from foreclosing during the December holidays.
...
An estimated 8 percent of homes for sale - or about 450 houses and condos - in Santa Clara County as of June 30 were "distressed" in some way - either being sold in a "short sale," or in foreclosure or as REOs ...