by Calculated Risk on 8/18/2007 12:50:00 AM

WaPo: Fannie Mae Predicts Price Decline Will Accelerate in '08

Fannie Mae, the mortgage finance giant, yesterday predicted that housing prices will decline by 2 percent on average this year and by 4 percent next year as mortgage delinquencies rise, lenders tighten borrowing standards and the volume of unsold homes approaches record levels.

"This is clearly a market poised for more severe overall credit losses," Enrico Dallavecchia, Fannie Mae's chief risk officer, said in a conference call with investment analysts.

Adding to the trouble, Dallavecchia said, is that many borrowers with adjustable-rate mortgages are facing rising monthly payments, which could drive them into foreclosure. "This could have a cascading effect in the market," he said.

A 2% price decline nationwide - as measured by OFHEO - sounds about right for 2007. I also expect the pace of price declines to increase next year.

by Calculated Risk on 8/17/2007 08:09:00 PM

From the WSJ: Using Discount Window Is Sign of Strength, Fed Says

... the Federal Reserve held a conference call with major banks to encourage them to consider borrowing from the central bank’s discount window.

... Fed officials know the discount window action will only be effective if banks either use it, or the knowledge of its availability, to expand their own lending to high-quality counterparties such as high quality mortgage borrowers.

The participants from the banking world included ABN AMRO; Bank of America; The Bank of New York Mellon; The Bank of Tokyo-Mitsubishi UFJ, Ltd.; The Bear Stearns Companies Inc.; Citigroup; Deutsche Bank Group; Goldman Sachs; JPMorgan Chase & Co.; Lehman Brothers; Merrill Lynch; Morgan Stanley; UBS; U.S. Bank; Wachovia; and Wells Fargo.

by Calculated Risk on 8/17/2007 04:08:00 PM

From Paul Krugman: Workouts, Not Bailouts. Excerpts are from Economist's View.

... if historical relationships are any guide, home prices are still way too high. The housing slump will probably be with us for years, not months.

Meanwhile, it’s becoming clear that the mortgage problem is anything but contained. ... Many on Wall Street are clamoring for a bailout — for Fannie Mae or the Federal Reserve or someone to step in and buy mortgage-backed securities from troubled hedge funds. But that would be like having the taxpayers bail out Enron or WorldCom when they went bust — it would be saving bad actors from the consequences of their misdeeds.

And Krugman argues for workouts, not bailouts:

Consider a borrower who can’t meet his or her mortgage payments and is facing foreclosure. In the past, ... the bank that made the loan would often have been willing to offer a workout, modifying the loan’s terms to make it affordable, because what the borrower was able to pay would be worth more to the bank than its incurring the costs of foreclosure and trying to resell the home. That would have been especially likely in the face of a depressed housing market.

Today, however, the ... mortgage was bundled with others and sold to investment banks, who in turn sliced and diced the claims to produce artificial assets ... And the result is that there’s nobody to deal with.
...
The federal government shouldn’t be providing bailouts, but it should be helping to arrange workouts. ... Say no to bailouts — but let’s help borrowers work things out.

Tanta has written about the servicer issues. For an overview of how servicing works, see: Mortgage Servicing.

Tanta also wrote about some of the servicer vs. investor conflicts in SFAS 140: Like A Bridge Over Troubled Bong Water. Tanta concluded:

The time to have gotten fired up about the real issues around off balance sheet securitization--the great "de-linking" of risk that was openly advertised as the benefit to the investor of all of this--was back when those 2/28s were being originated. We here at Calculated Risk were on it back then, and being dismissed as "bubbleheads." Absolutely nobody, as far as I know, is happy with any of the bad choices we now have since we've gone into cleanup mode. But this desperate attempt to keep the moral hazard in place, whether it's Cramer begging for a rate cut or bond investors demanding that FASB shoot the wounded, sink the lifeboats, and close the gates of mercy to protect the interests of the AAA crowd, is a little hard to take.

Sit down, boys and girls. There has always been an "information asymmetry" issue with mortgage-backeds. The originator has always known more than you know. The servicer has always known more than you know. The auditors have always known more about the balance sheet ingredients than you have. This problem did not arise a couple of months ago when the ABX tanked.

It has also always been the case that the party on the other side of that cash-flow is Joe and Jane Homeowner. Taxpayer, voter, citizen, parent, child, grannie and gramps, your neighbor. This is a group of folks it's a bit hard to demonize. We've been trying, with this "it's all subprime and all subprime borrowers are deadbeats" meme, but except for a few dead-ender holdouts, that dog is no longer barking. No one will be less surprised than I to find many politicians doing the wrong thing here, out of a misguided sense that something must be done, and seen to be done. Possibly someone will do something sane and useful.

Perhaps Krugman is proposing something 'sane and useful'.

UPDATE: Here is an example of bad ideas from Senator Schumer yesterday.

Senator Charles E. Schumer today renewed his call on the Bush administration to immediately lift the portfolio cap on Fannie Mae and Freddie Mac to help ease the liquidity concerns in the mortgage markets. Schumer added that if Fannie and Freddie’s regulator doesn’t act soon to temporarily allow the companies to provide more liquidity, he will introduce legislation to do so as soon as Congress reconvenes in early September.

by Anonymous on 8/17/2007 01:23:00 PM

Or mortgage brokers will get like totally bummed out.

CHICAGO (MarketWatch) -- There's more at stake in Countrywide's health than the future of the company -- if it isn't able to keep making loans, the psychological impact of the loss would be felt directly by consumers, participants in a California Association of Mortgage Brokers news conference said on Thursday.

"The consumer will feel that there is no loan availability if companies like Countrywide can't keep their doors open. This isn't some small company that decided to start up yesterday that had a risky business plan. This is America's leading lender," said Ed Craine, the public relations chairman of the group.

"The credit crunch is working its way through the whole market, taking companies we've seen as solid companies that nobody would ever expect to have problems and putting them on the brink of disaster."

As it is, certain mortgage products have been drying up and lending guidelines have been tightened -- "changing almost hourly," as the California group said in a news release. Lenders who have shut their doors this year have also reduced consumer options.

The problems Countrywide is having are proof of the depth of the market's current troubles, said John Marcell, who served as the group's president from 2005 to 2006.

"It just goes to show you the state that the market is in right now when you have the largest mortgage lender in the United States having these kind of difficulties," Marcell said. "We're going to have to get some relief some place to keep companies like this still in business."

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."