by Calculated Risk on 8/17/2007 11:07:00 AM

Perhaps the Fed was trying to provide liquidity to CFC.

From the LA Times: Worried about the stability of mortgage giant Countrywide Financial, depositors crowd branches.

Anxious customers jammed the phone lines and website of Countrywide Bank and crowded its branch offices to pull out their savings because of concerns about the financial problems of the mortgage lender that owns the bank.
...
At Countrywide Bank offices, in a scene rare since the U.S. savings-and-loan crisis ended in the early '90s, so many people showed up to take out some or all of their money that in some cases they had to leave their names.

by Calculated Risk on 8/17/2007 10:11:00 AM

From the Fed:

Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

And more:

To promote the restoration of orderly conditions in financial markets, the Federal Reserve Board approved temporary changes to its primary credit discount window facility. The Board approved a 50 basis point reduction in the primary credit rate to 5-3/4 percent, to narrow the spread between the primary credit rate and the Federal Open Market Committee's target federal funds rate to 50 basis points. The Board is also announcing a change to the Reserve Banks' usual practices to allow the provision of term financing for as long as 30 days, renewable by the borrower. These changes will remain in place until the Federal Reserve determines that market liquidity has improved materially. These changes are designed to provide depositories with greater assurance about the cost and availability of funding. The Federal Reserve will continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets. Existing collateral margins will be maintained. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York and San Francisco.

From the WSJ: Explaining the Discount Window

The discount window is a channel for banks and thrifts to borrow directly from the Fed rather than in the markets. ... A few years ago the Fed overhauled the discount window ... the rate was then set one percentage point above the funds rate and subject to far fewer conditions. ... discount window borrowing has remained paltry. Discount lending averaged just $11 million in the week ended Aug. 15. Although that was up from $1 million in the prior week it was puny compared to the billions of dollars the Fed has regularly injected into the financial system through open market operations.

Fed officials hope that reducing the penalty rate associated with the window and lengthening the term of loans to 30 days from one ... and gives it a tool to supplement open market operations for reliquefying markets. ... The discount window however is available to any bank or thrift, and the terms are easier than for fed funds loans. For example, banks may submit mortgage loans, including subprime loans that aren’t impaired, as collateral, and many probably will.

by Anonymous on 8/17/2007 07:45:00 AM

The question of falling yields on the low end of the curve and ARM resets comes up periodically in the comments. I offer a few UberNerdly tidbits of information about that.

First, review: an ARM adjusts to a rate equal to index plus margin. The index used and the margin, expressed as points, are spelled out in the note, as is the “reset” date. Your note will call this a “Change Date.” There are rate Change Dates and payment Change Dates. In an amortizing or interest-only loan, the payment changes on the first day of the month following the rate change. (Interest is paid in arrears on a mortgage loan.)

The index used will have a “maturity” equivalent to the frequency of the rate adjustments once the loan gets past its initial fixed period (if it has one). A true 3/1 ARM will adjust every year after the first three years, and so it will be indexed to some kind of 12-month money. The 2/28 and 3/27 are so-called to distinguish them from a 2/1 and 3/1; the 2/28s reset every six months after the first two years, not every year thereafter. (This convention is not consistent across the industry, I’m afraid. There are many, many Alt-As out there labeled as 5/1s that are really 5/25s.)

The “traditional” ARM was indexed to constant-maturity Treasuries (CMT). Almost all ARMs with a 6-month reset are indexed to LIBOR, but plenty of loans these days with a 1-year reset are indexed to LIBOR. LIBOR comes in 6-month and 12-month versions, just like Treasuries.

So the note for a 2/28 will say that the new interest rate will be equal to the 6-month LIBOR value plus the margin, usually rounded to the nearest eighth, subject to the adjustment caps, as of a certain date. Most 2/28s have caps you will see indicated as “2/1/6.” That means that the rate cannot go up or down more than 2.00 points at the first adjustment; it cannot go up or down more than 1.00 point at any adjustment after the first one; and it cannot go up more than 6.00 points over the life of the loan. (Unless you’re dealing with a real slimy lender who puts a “floor” on your ARM, so that it cannot go up or down more than 6.00 points over its lifetime. That’s all too common in subprime, but not in Alt-A or prime. The GSEs will not allow “floors” on an ARM: the rate can go down as far as the formula index plus margin can go down.)

The note will also indicate the time that the new index value is established. This is called a “lookback period,” although you will not see the term “lookback” in your note. All ARMs indexed to the one-year Treasury, and some other ARMs, will have a 45-day lookback period, which means that the new index value will be “the most recent index figure available as of the date 45 days before each Change Date.” This 45-day period was established as “standard” back in the old days, when lenders got information about indices from statistical releases published by the Fed on paper and sent out in snail mail; the servicer often didn’t have the “most recent” index value until some point in the month prior to that Change Date, which occurs on the first. But to keep things uniform and fair to the borrower, the value was the one in effect 45 days prior to the change, even if the lender didn’t get that info until two weeks before the change, when it could start updating its index tables on its servicing system (or having Marge in servicing get out the ledger book and a sharp pencil).

Almost all ARMs with a LIBOR index, on the other hand, have a “first business day” lookback. That means that the index value used is “the most recent value as of the first business day of the month immediately preceding the month in which the change occurs.” These notes specify that the source of the LIBOR index is the Wall Street Journal; there wasn’t much of a time delay in getting the WSJ for servicers even back before the internet.

So anybody with an annually-adjusting ARM with a reset date of October 1 will have gotten the August 15 index value. Anybody with a semi-annual ARM (like a 2/28) will get the index value in effect on September 3. In both of those cases the new payment at the adjusted rate will start on November 1.

Margins on prime ARMs are usually 2.75 for Treasury ARMs and 2.50-2.75 for LIBORs. Alt-A is generally 2.75-3.50 or thereabouts; the “risk-based pricing” adjustments will vary by the amount of risk-layering on the loan. Subprime can range from 3.50 to 6.50, again depending on loan quality and other terms.

A 2/28 with a start rate of 8.50% that has its first adjustment on September 1 and a margin of 6.50% will have a “fully-indexed” value of 11.82688 (6 Month WSJ LIBOR on 8/1/07 = 5.32688). Rounded to the nearest eighth that’s 11.875%. Since that is more than the maximum first adjustment cap of 2.00% allows, the rate adjusts to 10.50%. At the next 6-month adjustment, it can go up another 1.00 point. It does not stop going up unless and until it hits a fully-indexed rate of 14.50%, which is the lifetime cap (start rate plus 6.00%).

A lot of the modifications that are going on right now involve servicers taking a look at that 6.50% margin. If, in fact, the borrower did make the first 24 payments on time, there’s an argument to be made that that margin could come down to something closer to Alt-A or near-prime. If you modified the note to bring the margin on the example loan above down to 3.50%, you’d get the rate resetting to 8.875% instead of 10.50%. On a $100,000 loan, that would be a payment of $807.49 versus $924.50. If you made that modification subject to future modification back to 6.50% if the borrower doesn’t perform, you are, possibly, offering an incentive for continued performance. And if the borrower continues to perform, it’s hard to understand why you’d still call it “subprime.” Credit grades are snapshots in time, not prisoner tattoos.

“Normally,” of course, people who take subprime loans and manage to perform for at least 24 months are supposed to refi into a nice cheap prime loan. Now that LTVs are just too high for that, some people are going to have to stay in the loan they’re in. There may only be a few subprime borrowers who fit this case—who have made the first 24 payments on time, can handle an adjustment from 8.50% to 8.875%, and want to continue to own the home—but I’m damned if I can see why we shouldn’t do margin-mods for those few. 350 bps is a fair margin over credit risk-free money for someone who is making the payment every month. Sure, it might mess up your excess spread calculations on your ABS, but foreclosing will mess it up worse.

That said, please note that we’d have to have a miraculous LIBOR rally to help out anyone with a 6.50% margin and an 8.50% start rate: the 6-month LIBOR would have to hit 2.00% on the first business day of the month before the reset date to keep that loan flat. Those nasty neg am ARMs with rates that reset monthly, based on a monthly index, might get some short-term slowing in the rate of negative amortization, but it’ll take a long, long stretch of low short rates to bail those things out.

by Calculated Risk on 8/16/2007 10:44:00 PM

From the WSJ: Markets Fear U.S. Woes Will Hit Global Growth

"Today is the first day that markets are asking questions as to whether global growth is going to be significantly affected," said Jim O'Neill, head of global economic research at Goldman Sachs. "Today feels quite scary, frankly."

It was only three weeks ago that the International Monetary Fund raised its outlook for global economic growth this year and next. While the IMF acknowledged that U.S. growth would fall short of its earlier forecasts, it predicted that fast-rising China and India, helped by a cyclical upswing in Japan and Europe, would more than pick up the slack.

The scenario that worries investors around the world starts with a U.S. slowdown set off by lower housing prices and tougher lending standards. That would lead the U.S. to import fewer computers, cars and sneakers, hurting big exporters such as China and South Korea.

Those countries have been big buyers of commodities, driving up the prices of oil and metals. If they eased back, that would hurt big commodity producers such as Brazil and put some large, risky commodity ventures around the world at risk.

Mohamed El-Erian, head of the company that invests Harvard University's $29 billion endowment, believes the more-optimistic picture of global growth still has merit -- as long as the U.S. economic slowdown is gradual and doesn't result in a recession. "The next few weeks will be a test of this thesis," he said.

This is a key question. I started the year arguing that housing would lead to a U.S. slowdown, and also a lower trade deficit as imports slowed, eventually slowing growth in exporting companies, and leading to a global slowdown. I'll have more on this possibility tomorrow.

by Calculated Risk on 8/16/2007 06:51:00 PM

Freddie Mac reports that mortgages rates were up slightly during the last week:

Freddie Mac today [said] the 30-year fixed-rate mortgage (FRM) averaged 6.62 percent with an average 0.4 point for the week ending August 16, 2007, up from last week when it averaged 6.59. Last year at this time, the 30-year FRM averaged 6.52 percent.

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 Ten Year treasury yield for every month since Jan 1987 (last 20 years).

The grey blocks are pre-2001 (before the Fed started aggressively cutting rates). The light blue blocks are after Jan 2001. The Red block is this week.

It appears 30 year rates for prime conforming fixed-rate mortgages are still within the normal range when compared to 10 year treasury yields. The graph might tell a very different story for jumbo prime loans, or non-prime loans, but I don't have the data for jumbos.

Note: This shows rates are still low compared to the last 20 years. Rates were even higher in the late '70s and early '80s. Mortgage rates in '50s and '60s were on the low end of the scale, but Freddie Mac doesn't provide any data for those periods.

by Calculated Risk on 8/16/2007 06:19:00 PM

From MarketWatch: Moody's downgrades 691 mortgage-backed securities

Moody's Investors Service said on Thursday that it downgraded 691 mortgage-backed securities because of "dramatically poor overall performance." These residential mortgage securities were originated in 2006 and backed by closed-end, second-lien home loans, Moody's said. ... The downgraded securities had an original face value of $19.4 billion, representing 76% of the dollar volume of securities rated by Moody's in 2006 that were backed by subprime closed-end second lien loans ... "The actions reflect the extremely poor performance of closed-end second lien subprime mortgage loans securitized in 2006," Moody's said. "These loans are defaulting at a rate materially higher than original expectations."

by Calculated Risk on 8/16/2007 03:23:00 PM

Fitch Places $12.1B of U.S. Second-Lien RMBS on Rating Watch Negative (hat tip James Bednar)

Fitch Ratings has placed all classes of 58 U.S. RMBS subprime transactions backed by pools of closed-end second-liens (CES) on Rating Watch Negative. This action includes all classes from these transactions previously placed on Rating Watch Negative. The 58 transactions have an aggregate outstanding balance of approximately $12.1 billion. 35 of the transactions were originated in 2005, 22 were originated in 2006, and one this year. These transactions comprise the entirety of Fitch's rated portfolio of CES RMBS from those vintages.

Too much news, not enough time!

by Calculated Risk on 8/16/2007 12:58:00 PM

We need better phrases than "pre turmoil" and "post turmoil" to describe incoming data. This story on the Philly Fed today describes most of the data as before the "changes in the financial markets".

From Reuters: Philly Fed factory activity stagnates in August

Factory activity in the Mid-Atlantic region stagnated in August, with a measure of growth falling to its weakest level this year, a survey showed on Thursday.

The Philadelphia Federal Reserve Bank said its business activity index was at 0.0 in August, its weakest in since December 2006, versus 9.2 in July. Economists polled by Reuters had forecast a reading of 9.0.
...
A Philadelphia Fed spokesman said the index may not fully take into account recent turmoil in the financial markets caused by tighter credit conditions.

"We had a limited number of firms that were reporting since the changes in the financial markets," said Michael Trebing, senior economic analyst at the Philadelphia Fed.

We need to be aware, when looking at incoming data, whether the sample was taken before or after (during?) the changes in the financial market. For example, the recent Fed Senior Officer Loan survey was pre-turmoil, even though the data was ugly. And this Philly Fed report is mostly pre-turmoil too, and ugly too.

by Calculated Risk on 8/16/2007 12:30:00 PM

UPDATE: From the WSJ: Has the Fed Secretly Cut U.S. Interest Rates?

Speculation intensified that the U.S. Federal Reserve is going to cut interest rates soon -- or even has already done so secretly -- without any clear signal from the Fed to encourage it.

Maybe the Fed will cut soon, but they haven't cut rates in secret. As noted below, it is not that unusual for the Fed to let the Fed Funds effective rate drift away from the target rate for a few days. Besides, with the Fed's emphasis on transparency, they simply would not cut rates in secret. Right now, it's best to assume the Fed's intention is to bring the Fed funds rate back to 5.25%.

Original post: For the last few days, the Effective Fed Funds rate has been well below the target rate.

Click on graph for larger image.

This graph shows the Fed Funds target rate vs. the effective funds rate. There have been other short periods when the Fed didn't defend their target rate, like after 9/11. This was true for short periods in the '90s too.

This morning the Fed did a repo at 5.1% (for MBS), suggesting that the effective rate is already back above 5%.


As of yesterday, the probabilities for a rate cut in September had increased sharply (see the Cleveland Fed). However this was before Fed President William Poole spoke:

Barring a "calamity," there is no need to consider an emergency rate cut, Poole said.

With the effective rate rising back above 5%, I expect that the odds of a rate cut in September have diminished, barring a "calamity" of course. But I do expect a rate cut later this year as the economy weakens further.

by Anonymous on 8/16/2007 10:43:00 AM

There is a great deal of information in this Fannie Mae report on its outstanding mortgage book.

On Alt-A:

As of June 30, 2007, we have purchased or guaranteed approximately $310 billion of Alt-A loans, or 12 percent of our single-family mortgage credit book of business, where Alt-A loans are defined as loans that lenders, when delivering mortgage loans to us, have classified as Alt-A based on the reduced documentation requirements or other product features of these loans. We usually guarantee Alt-A loans from our traditional lenders that generally specialize in originating prime mortgage loans. Alt-A loans originated by these lenders typically follow an origination path similar to that used for their prime origination process. In addition, Alt-A loans we guaranty must comply with our guidelines and the terms of our seller-servicer agreements. Accordingly, we believe that our guaranteed Alt-A loans have more favorable credit characteristics than the overall market of Alt-A loans, based on the following data for Alt-A loans in our single-family mortgage credit book of business (as of June 30, 2007):
• Average loan amount is $172,545.
• Adjustable rate loans represent 33% of the book.
• High FICO scores – 720 weighted average; 1 percent has a FICO score of less than 620.
• Approximately 39 percent of the loans have credit enhancement.
• Low exposure to loans with high LTV ratios – 5 percent of our Alt-A loans have original LTV ratios greater than 90 percent.
• Estimated weighted average mark-to-market LTV is 64 percent.
• Approximately 1.01 percent of the Alt-A book is seriously delinquent.
• Guaranty fees on Alt-A loans are generally higher than our average guaranty fee to compensate us for the increased risk associated with this product. Our Alt-A loans are currently performing consistent with expectations used in establishing our guaranty pricing.

On total book:

We believe our conventional single-family mortgage credit book has characteristics that reflect our historically disciplined approach to risk management. Our book is highly diversified based on date of origination, geography and product type. Some salient data (as of June 30, 2007) include:
• Total conventional single-family mortgage credit book of business is $2,338 billion.
• Average loan amount is $138,736.
• Geographically diverse, with no region representing greater than 25% of the single-family mortgage credit book of business.
• Approximately 0.64 percent of the book is seriously delinquent.
• Weighted average original loan-to-value (LTV) ratio is 71 percent, with 9 percent above 90 percent.
• Estimated weighted average mark-to-market LTV ratio is 57 percent, with 4 percent above 90 percent. Less than 1 percent of our book has a mark-to-market LTV ratio greater than 100 percent. Mark-to-market LTV reflects changes in the value of the property and amortization of the principal balance subsequent to origination.
• Weighted average FICO score of borrowers is 722, with 5 percent below 620 FICO score.
• Fixed rate loans total 88 percent of the book; adjustable rate loans total 12 percent.
• Loans to owner-occupants make up 90 percent of our book; the balance is investor and second home properties.
• Second lien mortgages are 0.1 percent of the book.
• Credit enhancement exists on 20 percent of the book.