by Anonymous on 8/08/2007 08:04:00 AM

Boy howdy, things had really calmed down there for a while on the purple prose front. It's been a few days since I've seen anything like this:

The credit default swaps market is an immature market, prone to irrational swings as a sudden spike in uncertainty can breed fear among traders. Such fears have spread like wildfire as evidence mounts that credit defaults in the so-called subprime lending market are spilling over into consumers with stronger credit histories, calling into question the reliability of credit ratings on which investors have relied.

Who among us cannot relate to the image of the CDS as the hormonally turbo-charged adolescent, moodily breeding--

Uh, no. Let's not go there. Stick to fears spreading like wildfire as defaults spill over like water--

No. No. We'll go with uncertainty spiking as evidence mounts.

by Calculated Risk on 8/08/2007 12:14:00 AM

Mathew Padilla at the O.C. Register reports on comments from Impac Mortgage CEO Joseph Tomkinson:

Tomkinson said regulators need to let the GSEs buy loans greater than the $417,000 conforming loan limit today. The market needs liquidity and the limit doesn’t reflect current home prices, he said. He’d like to see it raised to somewhere in the range of $500,000 to $550,000.

Perhaps the conforming limit "doesn't reflect current home prices" because the prices are too high, and are based on the excessive speculation of the last few years. Here are the historical conforming loan limits including the higher limits for certain high cost areas.

And from the WSJ: Big Fans for Fannie, Freddie

Sen. Christopher Dodd (D., Conn.), chairman of the Senate Banking Committee, yesterday called on the companies' regulator to consider raising the caps placed last year on the amount of mortgages and related securities Fannie and Freddie can hold, as a way of ensuring that plenty of money is available to fund mortgage loans.

Sen. Charles Schumer (D., N.Y.) also called for higher caps. Both Fannie and Freddie are pushing for the same move. A spokeswoman for their regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo, said the agency will respond to the senators shortly.

Are Fannie and Freddie really "pushing for the same move"? I don't think so (see Freddie's Syron's comments)

And this suggestion does not make economic sense. House prices in many areas are currently unrealistic when compared to incomes, and the sooner prices return to more normal levels, the better for the economy.

As Tanta noted in Conforming Loan Limits: The Subprime Excuse

"... it's also a question of mission or mandate for Fannie, Freddie, and FHA: these government-sponsored enterprises and agencies have always been mandated to provide liquidity to the low-to-moderate (moderate meaning "average") housing market, not its high end."

Back to the WSJ:

Joshua Rosner, an analyst at the New York research boutique Graham Fisher & Co., describes as "mass delusion" the idea that they can save the day for investors exposed to billions of dollars of ill-advised home loans now heading toward foreclosure. For one thing, he says, Ofheo has required Fannie and Freddie to follow stricter standards, recently imposed by banking regulators, in assessing borrowers' ability to repay. So they can't buy up loads of reckless loans to speculators or people failing to pay bills.

Richard Syron, chief executive of Freddie, agrees that there are limits to what his company can do. "Neither we nor anyone else can buy at par loans that probably shouldn't have been made in the first place," he says.

I think Syron is correct, these are loans that "shouldn't have been made in the first place" - and there is no reason to bail out the investors who bought those loans - or the lenders who made them.

It might be reasonable to have different limits for different areas, based on the median income for each area. As an example, a low to moderate income in California is much higher than a low to moderate income in Mississippi, and the loan limit should probably reflect the median income in each local Metropolitan Statistical Area (MSA). This might be something worth discussing over the next few years as house prices decline, but I suspect that will mean lowering the limit in Missisippi, not increasing the limit in California.

by Calculated Risk on 8/07/2007 08:45:00 PM

From Mathew Padilla: S&P puts 207 classes of Alt-A loans on negative watch

Standard & Poor’s Ratings Services today placed its ratings on 207 classes of securities backed by first-lien Alt-A mortgages, or loans to people with mid-range credit profiles, on “CreditWatch with negative implications.”
...
The agency cited a rising level of loan delinquencies and said it expects losses to “exceed historical precedent and may exceed our original expectations.”

by Calculated Risk on 8/07/2007 06:00:00 PM

This is an attempt to forecast how much further housing starts will decline.

Over the first half of 2007, housing starts averaged a 1.46 million unit annual pace. (data from Census Bureau: Housing Starts)

Over the same period, New Home sales have averaged a 0.87 million annual pace. (data: New Home sales)

This brings up a key point: New Home sales come from a subset of housing starts. Housing starts also include owner built units, rental apartments, and other units that would still not be included, if sold, in the New Home sales report. So when we try to forecast the decline in housing starts, based mostly on the dynamics of the new home market, we are assuming that starts for the other units will remain steady.

Click on graph for larger image.

This graph shows total starts, starts of single unit structures, and new home sales since 1970.

During some periods (early and late-70s, mid'80s) there was a surge of apartments being built (think baby boomers leaving the nest in the '70s). But in all periods, you can't compare starts (either total or one unit structures) directly to new home sales.

Definition: New Home sales

Another key point: the new home sales estimate reported by the Census Bureau includes only new single-family residential structures that include both the structure and the land. The Census Bureau defines single-family homes as either fully detached structures or certain attached homes with an unbroken ground-to-roof separating wall. This definition includes some condominiums (side by side units), but does not include condominium units with another unit above or below.

Although large multi-story condominium projects account for a small percentage of housing starts in the U.S., it is important to note that sales and inventory for these units are not included in the New Home sales report, but that the starts are included in the housing starts report. Based on anecdotal evidence, there is a large number of these units currently for sale - and it is probably reasonable to assume that starts will decline significantly for these large condominium projects.

For data junkies, the Census Bureau provides a quarterly report that breaks down the data by many of the above definitions: Quarterly Housing Starts by Purpose of Construction and Design Type

One more point: the National Association of Realtors (NAR) reports total units sold for existing homes, including all condominiums and co-ops. These different definitions can be confusing.

Inventory

This brings us to the inventory data reported by the Census Bureau. This inventory is for new single-family residential structures as defined above and therefore does not include some condominiums and co-ops. Also cancellations aren't included in the data and this can skew the inventory numbers during periods of significant changes in cancellations. See: How does the Census Bureau handle cancelled sales contracts in the published estimates of New Home Sales?

The Census Bureau breaks down the inventory as Completed, Under Construction, and Not Started. The following chart shows the inventory levels, and months of supply, excluding the "Not Started" category.


The median months of supply for hard inventory (competed or under construction) is just under 5 months since 1974. To reduce the inventory to the median (assuming sales stay steady) would mean an inventory decline of around 100K units. Some estimates suggest there might be another 100K+ completed units due to cancellations, so let's call it 200K units of excess inventory.

If the builders worked off the 200K excess units over 2 years, then starts would need to fall to 1.36 million units per year.

Other Excess Inventory

In addition to all the assumptions above, there are two additional problems with the above estimate: 1) sales will likely fall further due to tighter lending standards, and 2) there is substantial excess inventory that is coming back on the market from desperate sellers and foreclosures.

We can use the Residential Vacancies and Homeownership report from the Census Bureau to estimate the excess inventory.

Click on graph for larger image.

The first graph shows the vacancy rate of homeowner units for sale since 1956. From the Census Bureau: "The homeowner vacancy rate is the proportion of the homeowner inventory that is vacant for sale." A normal rate for recent years appears to be about 1.7%. The small decline in Q2 leaves the homeowner vacancy rate almost 1% above normal, or about 750 thousand excess homes.

Rental units are competing products for new homes too. The rental vacancy rate has been trending down for almost 3 years (with some noise). This was due to a decline in the total number of rental units in 2004, and more recently due to more households choosing renting over owning.

It's hard to define a "normal" rental vacancy rate based on the historical series, but we can probably expect the rate to trend back towards 8%. This would suggest there are about 600 thousand excess rental units in the U.S. that need to be absorbed.

This approach would suggest there are between 750K (homeowner units only) and 1.35 million excess housing units in the U.S. Perhaps the excess rental units will keep pressure on other areas of Starts, and we should just focus on the excess homeowner units. To work off 750K units over two years - assuming sales stay steady (unlikely) - housing starts would have to fall to about 1.1 million units per year. This housing is "permanent site" and isn't transportable, so some regions may have a shortage of units and other areas may have more excess inventory - so as a reminder, this is just a rough estimate for the aggregate national market.

There are several significant assumptions in this approach, but my expectation is that starts will fall to around the 1.1 million units per year level; a substantial decline from the current level.

UPDATE: BusinessWeek has some more on the excess inventory: Another Reason For Those Empty Houses (hat tip James)

by Anonymous on 8/07/2007 02:55:00 PM

I'm not sure if this would be better before or after lunch. I would suggest putting down your drink.

From CNN Money, "A last chance to get rich in real estate?":

At a recent seminar at a Hilton in Phoenix, Fix 'n Flip - a daylong course in the art of the fixer-upper - was standing room only. So was Creative Financing, in which students learned how to tap their retirement savings and their home equity for money to invest. Between classes, throngs of students flocked to the lobby to booths featuring affiliates of Nouveau Riche. Save Our Scores (or SOS, as it is called) helps high-risk borrowers boost low credit scores so that they can borrow more money at lower rates. (Fees range from $600 to $1,200.) Investor Concierge, the real estate brokerage firm owned by Piccolo and his associates, helps students buy houses and condos, arranges financing, then provides management services for their far-flung properties. (The firm's slogan: "Click a mouse, buy a house.") Meanwhile, the Nouveau Riche University Store did a brisk business in polo shirts, plus jackets with the college logo, a stylized eagle.

Read the rest at your own risk. (Thanks, HCC!)

by Calculated Risk on 8/07/2007 02:10:00 PM

Fed Statement:

Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.

emphasis added

by Calculated Risk on 8/07/2007 10:45:00 AM

From Greg Ip and Jon E. Hilsenrath at the WSJ: How Credit Got So Easy
And Why It's Tightening. This article tries to explain how we got here. The authors discuss why the Fed set rates so low in 2001 and quotes Greenspan today:

"We tried in 2004 to move long-term rates higher in order to get mortgage interest rates up and take some of the fizz out of the housing market. But we failed."

The authors then discuss the changes in the mortgage business:

"All of us felt the suction from Wall Street. One day you would get an email saying, 'We will buy no-doc loans at 95% loan-to-value,' and an old-timer like me had never seen one," says Mr. Barnes [co-owner of a small Colorado mortgage bank]. "It wasn't long before the no-doc emails said 100%."
...
At first, delinquencies were surprisingly low. As a result, the credit ratings for bonds backed by the mortgages assumed a modest default rate. Standards for getting a mortgage fell. ...

The delinquency rate was a mirage: It was low mainly because home prices were rising so much that borrowers who fell behind could easily refinance. When home prices stopped rising in 2006, and fell in some regions, that game ended.

And they also touch on the easy credit for LBOs.

... lenders began to ease borrowing requirements. They agreed, for instance, to "covenant-lite debt," which dropped once-standard performance requirements, and "PIK-toggle" notes, which allowed borrowers to toggle interest payments on and off like a faucet.

Bankers began marketing debt deals for companies that, unlike Yellow Pages, didn't have comfortable cash flow. There was Chrysler, burning cash rather than producing it. And there was First Data Corp., whose post-takeover cash flow would barely cover interest payments and capital spending, according to Standard & Poor's LCD, a unit of S&P which tracks the high-yield market.

Last month, investors began to balk. Now many banks find themselves having committed to lend about $200 billion that they had intended to turn over to investors, but can't.

These are just a few short excerpts from a very good summary article.

by Anonymous on 8/07/2007 09:27:00 AM

I was going to post something on this yesterday, but it blew my mind so badly that I had to take refuge in Star Trek reruns until my faith in technology was restored. Sorry about the delay and everything.

Fitch sent out a press release describing the modifications it is making to the software it uses to rate mortgage-backed securities. I was, personally, a little shocked to discover that Fitch just now got around to working with state-level adjustments for RE market volatility. They are still working on incorporating MSA (Metropolitan Statistical Area) level factors. In other words, their analysis of loss frequency and severity due to rapid changes in a local real estate market just went from a blunt instrument to a somewhat less blunt instrument; the "pinpoint laser" thing is in the works.

But these two items are another order of magnitude entirely:

3) New Documentation Category: ResiLogic initially provided three categories for documentation, reflecting the categorization of loans in the model development sample. However, after evaluating lender programs and the recent performance of subprime and Alt-A mortgages, Fitch's analysts felt that greater differentiation was called for. This has resulted in the introduction of a new 'Low' documentation category, which indicates default risk which is greater than the existing 'Reduced' category but less than the existing 'None' category. Fitch will publish a research report the week of Aug. 6, 2007 describing the mapping between lenders documentation programs and the new categories.

4) Change in DTI Ratio: Back-end DTI ratio data is generally more available than front-end data in the data files provided by mortgage issuers. Therefore Fitch has modified ResiLogic to utilize back-end DTI. However, Fitch continues to be concerned by the prevalence of missing DTI data. Fitch will use a default assumption for missing subprime DTI of 50%.

OK, so we'll have to wait for the new report to find out how bad the doc type problem is, but I'm going to guess that Fitch has been lumping things like an AUS-approved loan with a single paystub and a verbal verification of employment in the same bucket with a "stated income" program for a W-2 borrower in which there is no documentation of income whatsoever. That would tend to improve the performance history of true "stated income" loans.

I'm hoping I'm wrong about that, but the following item gives me zero confidence in the matter. Long-time readers of this site are pretty familiar with "DTI," which people like me use to refer to the borrower's total monthly obligations, including but not limited to the mortgage payment, divided by the borrower's gross monthly income. The reason most of you all have never heard of "HTI" is that it's so damned obsolete in most quarters that not even your Tanta cares about it.

Many moons ago, lenders used two ratios to qualify borrowers for mortgages: the so-called "front ratio" or HTI, which included just the mortgage payment, and the "back ratio" or DTI, which included total debt. After a number of years, industry consensus became that HTI really isn't very strongly predictive of default as a separate measure, and so nearly every lender dispensed with a benchmark for HTI. Lately we've obviously gone a little nuts with the DTIs we will allow, but the point is that every credit model out there--except, apparently, Fitch's--used DTI as the sole measure in the model, or at most the primary determinant of capacity evaluation with HTI being considerably less weighted in the analysis.

Fitch is saying one of two things, and I'm still not sure which: either they really did use HTI instead of DTI in their models, which means that the weighted average DTI information they've been publishing is junk, or they've really been using DTI all along but didn't realize it, because they didn't understand the difference. I'm inclined to the latter view only because I believe that DTI is the only data they're getting from issuers. I do not know how anyone could look at DTIs of 50% and assume that other debt had to be added to that to get the borrower's total picture and still rate these deals with a straight face.

Of course Fitch is saying that this factor is of only modest impact. Well, duh. My own view of the matter has always been that DTI is a critical measure of loan quality, but not if you don't verify the "I" part. If you let borrowers and originators just back into a "stated income" that produces the right ratio, it doesn't exactly matter what that number is, and it's better to ignore it entirely in your evaluation of credit than to use it, because you end up giving "credit" to loans that have low but entirely bogus DTIs. I don't exactly have huge confidence in Fitch's handling of this problem now that I know that they've also had some trouble identifying doc types with any precision.

This is not a little bitty deal, a quibbling over geeky details of underwriting archana. This is big bad-ass deal. Fitch just came out and admitted that "ResiLogic" is working with corrupt or missing data, that Fitch's analysts don't know how to "crack" a mortgage tape (that is, how to map an originator-specific data field into a standard one that can compare across deals), and that there is no reason for any of us to believe them when they say that certain loan characteristics are more or less predictive of default. Some of you may have suspected this before today. But I'll admit that I didn't think they were making mistakes at this elementary a level. It's hard to get the rocket science right. Defining the DTI field? Lord love a duck.

In other news, Fitch is having a conference call today at 11:00 ET to discuss this matter. I may attempt to listen in, although I'm telling you now I'm not sure I can stand any more of this.

by Anonymous on 8/07/2007 07:44:00 AM

Bank of America is with me.

Bloomberg:

Aug. 7 (Bloomberg) -- A California Bible school sued its bankers on July 31 for fraud in connection with swaps, and you have to wonder how many other municipalities can say what the school said in its lawsuit.

We did everything they told us to.

They negotiated all the terms on our behalf.

They assured us they were representing our best interests.

We relied on them to get everything right.

We didn't know what we were doing.

Sounds like a bunch of subprime deadbeats to me.*

*Warning: You are consuming irony. This early in the day, too.

by Calculated Risk on 8/06/2007 09:17:00 PM

From the WSJ: Mortgage Fears Drive Up Rates On Jumbo Loans

Turmoil in the U.S. home-mortgage market is starting to pinch even buyers of high-end homes with good credit records ...
...
Lenders ... now are jacking up rates on jumbo mortgages for prime borrowers. These mortgages exceed the $417,000 limit for loans eligible for purchase and guarantee by Fannie and Freddie. They account for about 16% of the total mortgage market, according to Inside Mortgage Finance, a trade publication, and are especially prevalent in California, New Jersey, New York City, Washington, D.C., and other locales with high home costs.

Lenders were charging an average 7.34% for prime 30-year fixed-rate jumbo loans yesterday, according to a survey by financial publisher HSH Associates. That is up from an average of about 7.1% last week and 6.5% in mid-May.