by Anonymous on 7/13/2007 10:18:00 AM

Hey! It's Friday the 13th! Anybody want to buy a subprime mortgage company?

No? How about some hodge-podge funds?

No? How about some nice European corporate debt? We hear it deteriorates only "gradually."

Oh well. There's always treasuries . . .

Or stocks:

Consider the latest reading of the Hulbert Stock Newsletter Sentiment Index (HSNSI), which reflects the average recommended stock market exposure among a subset of short-term market timing newsletters tracked by the Hulbert Financial Digest. As of Thursday night, the HSNSI stood at 40.6%.

In contrast, at the stock market's late-February high, when the Dow was below 12,800, the HSNSI stood at 62.4%.

This is an amazing contrast. The stock market, in fits and starts, has managed to tack on more than a thousand points while simultaneously pushing the average market timer away from the bullish camp.

Normally, of course, advisers become more bullish and exuberant as the stock market rises. The fact that just the reverse happened over the last three months is quite unusual - and bullish.

To appreciate why, it can be helpful to imagine a bull market as a bucking bronco in a rodeo, trying its darndest to throw everyone off its back on the way to the other side of the ring. By doing exactly what it's supposed to do, this bull market is revealing itself to be very healthy indeed.

Okie dokie.

by Anonymous on 7/13/2007 08:34:00 AM

From the Census Bureau, "Advance Monthly Sales for Retail Trade and Food Services":

The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for June, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $373.9 billion, a decrease of 0.9 percent (±0.7%) from the previous month, but 3.8 percent (±0.7%) above June 2006. Total sales for the April through June 2007 period were up 3.9 percent (±0.5%) from the same period a year ago. The April to May 2007 percent change was revised from +1.4 percent (± 0.7%) to +1.5 percent (± 0.3%).

Retail trade sales were down 1.0 percent (±0.7%) from May 2007, but were 3.5 percent (±0.8%) above last year. Nonstore retailers were up 9.5 percent (±4.5%) from June 2006 and sales of health and personal care stores were up 7.0 percent (±1.7%) from last year.

You don't get the pretty updated chart you usually get because CR is spending a long weekend getting high climbing mountains and he doesn't let me mess with his charts. Last month's chart is here.

by Anonymous on 7/13/2007 07:41:00 AM

Yes, I mean utter worthlessness. I have seen one or two unhelpful Fed Letters in my time, but this one, "Comparing the Prime and Subprime Mortgage Markets," brings a remarkably shallow grasp of the subject to bear on a perfectly vacuous thesis in order to produce three and a half pages of tripe. If this is the sort of advice the Fed Banks are taking from "economists," then no bloody wonder we're in trouble.

Here's how it starts:

We show that the subprime mortgage market is facing substantial problems, as measured by delinquency rates, while the prime mortgage market is experiencing more typical delinquency rates, i.e., at historical averages (see figure 1). Within the subprime mortgage market, we observe a substantial increase in delinquency rates, mostly for adjustable-rate mortgages (ARMs). Since the subprime ARM market is less than 7.5% of the overall mortgage market and a vast majority of subprime loans are performing well, we believe that the subprime mortgage problems are not likely to spill over to the rest of the mortgage market or the broader economy.

That's it. In three and a half pages, the authors demonstrate that subprime ARMs are the segment performing at worse than "historical" rates of delinquency, and that they are indeed 7.5% of the outstanding mortgage book. What we never get is a statement of what it might mean for "subprime problems" to "spill over to the rest of the mortgage market or the broader economy." What, exactly, does that mean? Is the implication that the "subprime problem" could "spill over" if it were only a bigger piece of the mortgage pie? What, exactly, would be the mechanism of this "spill over"? If you guessed that it might have something to do with declining MEW and downward spirals of home values due to subprime foreclosure waves, you might have a point, but neither of these issues is raised in the Fed Letter. Apparently, on Chicago Fed's planet, things just "spill over" when the bucket gets full enough of delinquencies.

The whole thing is littered with irritating mischaracterizations of both mortgage lending practices and recent so-called "bailout" initiatives, the latter of which involves throwing around some numbers ($20 billion from Freddie Mac, a billion from Citi and BoA) without offering any analysis of how far that goes to sort out the $1.5 trillion in subprime loans on the books. You get this level of analysis on Bloomberg (and you get it more timely).

Dear Chicago Fed: we're all really tired of rehashing sound-bites. How about you using the institutional smarts you have to answer some interesting questions for a change? Such as: how did we get so many subprime borrowers in the first place? Do states like Michigan and Indiana have high rates of delinquency and default because of employment woes, or high rates subprime originations because of employment woes? Is it possible that the "historically" low rate of prime mortgage default exists because subprime has been available to accept the "spill over"? What happens when the lender of last resort goes away?

Look, there are two reasons why the default rate on prime loans is as low as it is. The first, obviously, is that decent credit standards in the first place limit the number of loans that experience delinquency. The second is that, historically, there has been somewhere for those loans that do experience delinquency to go: either a voluntary sale of the home that covers the loan amount or a refinance into a subprime loan. The existing home market and the subprime refi market are the "spill overs" of the prime mortgage market. To discuss the question of "prime contaigon" without reference to existing home sales or refinance opportunities (by price and by credit standard tightening perspectives) is, indeed, utterly worthless.

by Anonymous on 7/12/2007 07:19:00 PM

I thought you might be interested in this little tidbit from Moody's. According to Moody's, the average serious delinquency rate for 2006-vintage subprime securities at 10 months of seasoning is 9.2%. But some originators are more average than others:

S&P also released information on actions taken on the 612 securities it put on "watch negative" on July 10:

Regarding the July 10, 2007, CreditWatch actions affecting 612 classes of RMBS backed by first-lien subprime mortgage collateral, 498 classes were downgraded, 26 classes remain on CreditWatch, and the ratings on 74 classes were affirmed and removed from CreditWatch. Additionally, the ratings on nine other classes were affirmed and removed from CreditWatch because they involve Alternative A mortgage collateral and were not intended to be included in July 10, 2007, action. These nine classes are from the following deals: GSAA Home Equity Loan Trust 2006-5, Lehman XS Trust 2006-7, and Luminent Mortgage Trust 2005-1, and will be addressed when Standard & Poor's reviews transactions backed by Alternative A mortgage collateral.

The ratings on 26 classes remain on CreditWatch because the issuer has appealed the decision based on the presence of mortgage insurance in those transactions. We are currently reviewing this appeal. In addition, the ratings on five other classes remain on CreditWatch because they are backed by closed-end second-lien mortgage collateral and will be addressed when Standard & Poor's reviews transactions backed by closed-end second-lien mortgage collateral.

Regarding the 70 classes placed on CreditWatch before July 10, 2007, 64 were downgraded and six remain on CreditWatch. Three classes remain on CreditWatch because the issuer is appealing the decision based on the presence of mortgage insurance and we are reviewing this appeal. Three classes remain on CreditWatch because they were placed on CreditWatch before July 10, 2007, and involve either closed-end second-lien or Alternative A mortgage collateral. They will be addressed when Standard & Poor's reviews transactions backed by closed-end second-lien and Alternative A mortgage collateral.

Ooops. We didn't notice the mortgage insurance coverage? We can't tell the difference between subprime and Alt-A? Some second liens snuck in when we weren't looking? It has not been a stellar week for S&P.

Of the 612 classes placed on CreditWatch on July 10, 2007, the 498 downgraded classes total approximately $5.69 billion in rated securities, which represents 1.01% of the $565.3 billion in U.S. RMBS first-lien subprime mortgage collateral rated by Standard & Poor's between the fourth quarter of 2005 and the fourth quarter of 2006. The 64 downgraded classes that were placed on CreditWatch before July 10, 2007, total approximately $700.9 million, which represents 0.12% in RMBS first-lien subprime mortgage collateral rated between the fourth quarter of 2005 and the fourth quarter of 2006. The combined impact of these 562 downgrades total approximately $6.39 billion in rated securities, or 1.13% of all RMBS first-lien subprime mortgage
collateral rated by Standard & Poor's between the fourth quarter of 2005 and the fourth quarter of 2006. The ratings associated with the downgraded classes, as a percentage of the total $6.39 billion in downgraded securities, are as follows:

Rating Percent
-- AA 0.07%
-- AA- 0.22%
-- A+ 1.66%
-- A 4.61%
-- A- 6.79%
-- BBB+ 14.01%
-- BBB 17.96%
-- BBB- 24.49%
-- BB+ 16.58%
-- BB 11.24%
-- BB- 1.06%
-- B 1.31%

And finally, Fitch is getting into the game:

Fitch Ratings-New York-12 July 2007: Following its monthly surveillance review, Fitch Ratings identified 170 U.S. subprime transactions among its $428 billion rated universe of subprime transactions as 'Under Analysis', indicating that Fitch will be issuing a rating action over the next several weeks. The total amount of bonds rated in the BBB category and below, which are the ones most likely to face rating actions, is $7.1 billion, representing 1.7% of Fitch's rated subprime portfolio.

by Anonymous on 7/12/2007 10:22:00 AM

Remember the big deal S&P announcement from Tuesday, announcing negative ratings watch on 612 classes of subprime securities? This is what S&P said on July 10:

The affected classes total approximately $12.078 billion in rated securities, which represents 2.13% of the $565.3 billion in U.S. RMBS rated by Standard & Poor's between the fourth quarter of 2005 and the fourth quarter of 2006.

This is what the revised version, dated July 11, says:

The affected classes total approximately $7.35 billion in rated securities, which represents 1.3% of the $565.3 billion in U.S. subprime RMBS rated by Standard & Poor's between the fourth quarter of 2005 and the fourth quarter of 2006.

No explanation is given for the difference between $12.01 billion and $7.35 billion. I'd certainly like to hear S&P verify that $7.35 billion is the original balance of these securities. If it's the current balance, then I'd like to know what the current balance is of the $565.3 billion it is being compared to. Perhaps an enterprising Real Reporter (you know who you are) will delve into this question.

by Calculated Risk on 7/12/2007 09:05:00 AM

The Census Bureau reported today for May 2007:

"in a goods and services deficit of $60.0 billion, compared with $58.7 billion in April"

Click on graph for larger image.

The red line is the trade deficit excluding petroleum products. (Blue is the total deficit, and black is the petroleum deficit).

The increase in the trade deficit was primarily due to oil imports, and mostly because of price increases.

Looking at the trade balance, excluding petroleum products, it appears the deficit peaked at about the same time as Mortgage Equity Withdrawal in the U.S. This is an interesting correlation (but not does imply causation). I had more on MEW vs. the trade deficit last month.

by Calculated Risk on 7/12/2007 08:55:00 AM

From Bloomberg: U.S. Foreclosures Jump 87 Percent as Lending Practices Tighten

There were 164,644 loan default notices, scheduled auctions and bank repossessions in June, led by filings in California, Florida, Ohio and Michigan that together accounted for half the total, according to RealtyTrac, a seller of foreclosure data.

The June foreclosure figure was 7 percent lower than that in May, when filings reached a 30-month high ...
...
An estimated 58 percent of properties in the foreclosure process are linked to borrowers with subprime loans, and RealtyTrac expects U.S. foreclosures to reach 1.8 million by year's end ...

by Calculated Risk on 7/11/2007 10:04:00 PM

On Bloomberg Video: (hat tip Miguela)


Click image for video.

Ohio Attorney General Marc Dann talks with Bloomberg's Brian Sullivan from Columbus about the Ohio's investigation of credit-rating agencies and mortgage brokers, the state's anti-predatory lending statute, and the relationship between credit-rating agencies and investment banks. (Source: Bloomberg)

Note: If clicking the picture doesn't work, try here.

by Calculated Risk on 7/11/2007 08:59:00 PM

Note: I changed the post title. Orginally I quoted the WSJ blurb that Moody's had cut the ratings, but that appears to be premature. The WSJ blurb:

"Moody's cut its rating on some $5 billion in CDOs, a sign of the subprime market's impact on other investments."

Orginal post: From the WSJ: CDOs Are Hit With Fallout From Laxity With Subprimes

Turmoil in the subprime-mortgage market fanned out yesterday, hitting a group of investments that are exposed to this struggling class of home loans.

Moody's Investors Service said yesterday it may cut its credit ratings on slices of 91 collateralized-debt obligations, or about $5 billion of securities. It is a small percentage of the overall CDO market, but still an important development, because it is a signal that subprime fallout is rippling through financial markets to an important class of investments.

In another sign of these ripple effects, Fitch Ratings released a report yesterday raising cautionary flags about the commercial real-estate market. It projected rising defaults in this sector after years of increasingly lax lending standards, which could hit bonds backed by commercial real-estate loans.

UPDATE: Financial Times: Investors’ flight from risk picks up pace

Investors in European and US credit markets accelerated their flight from risk on Wednesday as the turmoil from the US mortgage markets continued to spill over into other asset classes.

The change in sentiment, which triggered sharp moves in credit derivatives markets, suggested that recent problems in the subprime mortgage sector could be spreading to other corners of the financial world.
...
JPMorgan observed that swings in derivatives prices were so extreme they implied “scenarios in which the core of the global liquidity system suffers a serious assault”. But it stressed “the meltdown in the credit indices seem completely at odds” with trends in the real economy, implying it should be reversed.

by Calculated Risk on 7/11/2007 05:47:00 PM

Many of us have been trying to understand why BLS reported residential construction employment has only fallen 4% from the peak (March 2006), even though housing completions have fallen close to 30%.

Click on graph for larger image.

This graph shows starts, completions and residential construction employment. (starts are shifted 6 months into the future). Completions and residential construction employment were highly correlated, and Completions used to lag Starts by about 6 months.

Both of these relationships have broken down somewhat (although completions have fallen to the level of starts). The time between start and completion has increased recently. But the puzzle is why residential construction employment hasn't fallen further.

The main explanations have been:
1) The BLS has not counted illegal immigrants working in construction.
2) The BLS Birth/Death model has missed the turning point in employment, and therefore the BLS has overstated the current number of residential construction employees.
3) Some construction employees have moved from residential to commercial work, but they are still being reported as residential construction employees to the BLS.
4) Some companies are "hoarding" workers for the expected recovery.
5) Many workers are still employed, but they are working far fewer hours.

Yesterday, Greg Ip at the WSJ reviewed an analysis from Deutsche Bank economists suggesting that the illegal immigrant explanation accounts for most of the misssing job losses.

In a new report, economists at Deutsche Bank estimate construction employment should have fallen about 900,000 since early 2006 when in fact it’s only down 150,000. They conclude 500,000 of the unexplained gap is attributable to layoffs of illegal Hispanic workers.

The economists addressed most of the other explanations listed above:

Deutsche Bank dispute many competing explanations for the disconnect between home building and construction employment. Errors in the Bureau of Labor Statistics’ “birth/death” model, which estimates job creation and destruction at new firms, can only account for 20,000 construction jobs, they say. It’s unlikely many workers now classified as employed in residential construction have moved to commercial work because the type of work is so different, they say. Third, the notion that because of lags, the layoffs have yet to come, is “starting to wear thin ... We are now 1.5 years into the slowdown .... We find ourselves increasingly skeptical with the notion that construction companies have not yet recognized the severity of the situation.”

Although uncounted illegal immigrant workers might account for some of the puzzle, this analysis is not very satisfying.

I'm not sure why the Deutsche Bank economists think errors in the birth/death model can only account for 20,000 construction jobs. We know from the Business Employment Dynamics Summary that 77,000 construction jobs (NSA) were lost in Q3 2006, and yet the BLS reported a gain of 5,000 construction job (NSA) for the quarter. That is a difference of 82,000 jobs (1) (NSA) and we don't know the errors for Q4 2006, and Q1 2007 yet.

This brings us to a second potential flaw in their analysis. The economists wrote:

the notion that because of lags, the layoffs have yet to come, is “starting to wear thin ... We are now 1.5 years into the slowdown ..."

Actually employment tracks completions, not starts - and completions only fell off the cliff starting at the beginning of 2007. It is very possible that many workers are still employed - for now - but are working reduced hours. This would be combination of explanations 4 and 5 above.

And if the BLS missed by 82,000 workers (NSA) in Q3 2006 before completions started falling off a cliff, perhaps they missed by many more in Q1 and Q2 2007 when completions were dropping rapidly.

And finally, I believe there is some merit to the argument that workers have moved from residential to commercial work, and are still being reported as residential workers to the BLS. Commercial construction spending has increased 25% from January 2006 to May 2007, but the number of workers in non-residential construction has only increased 4% over the same time period. This raises the opposite question: why hasn't the boom in commercial construction created more jobs?

I think the answer will be combination of these explanations.

(1) Note: In a previous post, I used SA instead of NSA numbers and overestimated the BLS error.