by Anonymous on 8/28/2007 07:32:00 PM

One of the things we've noticed--not to say beaten like a dead horse from time to time--is that in the last several years a lot of people who aren't very good money managers got much bigger loans that they could reasonably be expected to carry. A lot of people are out for the blood of these borrowers, demanding that they be "punished" for having done something powerfully dumb.

I am often reminded of this little gem, "Unskilled and Unaware of It: How Difficulties in Recognizing One's Own Incompetence Lead to Inflated Self-Assessments," by Justin Kruger and David Dunning. They argue:

People tend to hold overly favorable views of their abilities in many social and intellectual domains. The authors suggest that this overestimation occurs, in part, because people who are unskilled in these domains suffer a dual burden: Not only do these people reach erroneous conclusions and make unfortunate choices, but their incompetence robs them of the metacognitive ability to realize it. Across 4 studies, the authors found that participants scoring in the bottom quartile on tests of humor, grammar, and logic grossly overestimated their test performance and ability. Although their test scores put them in the 12th percentile, they estimated themselves to be in the 62nd. Several analyses linked this miscalibration to deficits in metacognitive skill, or the capacity to distinguish accuracy from error. Paradoxically, improving the skills of participants, and thus increasing their metacognitive competence, helped them recognize the limitations of their abilities.

I remain convinced that there's something wrong with blaming the financially inept for not realizing that they are financially inept, when those who are supposed to be financially ept--loan officers, brokers, financial counselors, advice columnists in business publications--spent the last several years refusing to tell them that they were financially inept.

Of course people who are in over their heads are surprised. They lacked the skills necessary to understand what "over their heads" might mean.

by Calculated Risk on 8/28/2007 05:39:00 PM

From Newsday: Ex-American Home Mortgage manager going to prison

A U.S. District Court in Alaska Monday sentenced a former American Home Mortgage branch manager to serve more than 2 years in prison ... in connection with wire fraud charges after he falsified documentation to secure "stated income" mortgage loans from American Home and Countrywide Financial.
...
In the American Home case, Partow, 41, helped a client refinance his home in 2006. Despite the client having provided accurate information about his income, Partow listed the income as $20,000 per month -- "an amount that significantly overstated [the client's] true income," according to Partow's plea agreement.

In the Countrywide case, he admitted to knowingly overstating an applicant's income to qualify the client for a loan in April 2004.
...
By misstating applicants' financial statuses, Partow enabled them to qualify for loans they might not otherwise have gotten.

Back in March, Tanta pointed out that there are two types of mortgage fraud: “Fraud for Housing” and “Fraud for Profit.”

In this case, it appears the mortgage broker overstated the borrower's income without the borrower's knowledge. So this would be a fraud for profit scheme, and I expect to see many more prosecutions of this type soon. If the borrower had overstated their own income, the borrower would probably not be prosecuted. Prosecuting fraud for housing usually isn't worth the effort, and it is difficult to distinguish between whether the borrower was committing "fraud for housing", or if the borrower was just overly optimistic (i.e. delusional) about the potential income from that side job cutting lawns.

I recommend reading Tanta's piece on mortgage fraud: Unwinding the Fraud for Bubbles

by Calculated Risk on 8/28/2007 05:30:00 PM

Here is the Countrywide 8-K filing regarding the BofA investment.

The Convertible Preferred Securities are convertible at the option of the holders, at any time or from time to time, into a number of shares of common stock equal to the Liquidation Preference of the Convertible Preferred Securities being converted, divided by the Conversion Price (as defined below), plus cash in an amount equal to any accumulated and unpaid dividends on such securities. The "Conversion Price" of the Convertible Preferred Securities is $18.00 per share, subject to customary adjustments.

Note: this is NOT a floorless convertible.

by Anonymous on 8/28/2007 04:39:00 PM

Here's another little bit of data to fit into the big picture on refinances. It doesn't solve any problems or prove anything conclusively. It's from a Countrywide Capital Markets newsletter that I get (not on the web, I'm afraid.)

What this means is that, of the refinances into a 30-year fixed-rate conforming loan that Countrywide did in the six months prior to December 2005, 3.2% were borrowers refinancing out of an Option ARM. By June 2007, the number had increased to 11.4%.

At the same time, the percent of new FRM refis that were originally subprime seems to be slowing down.

This suggests that the number of subprime borrowers who can refinance into a conforming fixed is decreasing as we get toward a "residual" pool of subprime loans that either do not qualify for a 30-year fixed or whose monthly payment cannot be lowered with one.

by Calculated Risk on 8/28/2007 01:22:00 PM

From David Streitfeld at the LA Times: Blight moves in after foreclosures

Houses abandoned to foreclosure are beginning to breed trouble, adding neighbors to the growing ranks of victims.

Stagnant swimming pools spawn mosquitoes ... Empty rooms lure squatters and vandals. And brown lawns and dead vegetation are creating eyesores in well-tended neighborhoods.

We tend to think of REOs as "inventory", but to the neighbors they are a nuisance.

by Calculated Risk on 8/28/2007 12:59:00 PM

For reference, here are a couple of ARM reset charts.

Here is a chart from BofA analyst Robert Lacoursiere via Mathew Padilla at the O.C. Register. Please see Mathew's discussion from June 29th: BofA Analyst: Mortgage correction just 'tip of the iceberg'.

This fits with Tanta's post this morning on Subprime Borrower Refi Options.



Another chart, from March, is from Ivy Zelman at Credit Suisse (Zelman has since left CS). The March Credit Suisse report, Mortgage Liquidity du Jour: Underestimated No More is available at Bill Cara's site (see page 47 for reset chart).

by Calculated Risk on 8/28/2007 10:51:00 AM

From AP: Home Prices: Steepest Drop in 20 Years

U.S. home prices fell 3.2 percent in the second quarter, the steepest rate of decline since Standard & Poor's began its nationwide housing index in 1987, the research group said Tuesday.

The decline in home prices around the nation shows no evidence of a market recovery anytime soon, one of the architects of the index said.

MacroMarkets LLC Chief Economist Robert Shiller said the declining residential real estate market "shows no signs of slowing down."

by Anonymous on 8/28/2007 09:50:00 AM

Bank of America's RMBS Desk has a research note out (not publically available) that attempts to estimate the realistic refinance options, if any, for outstanding subprime ARMs that are facing reset in the immediate future.

The analysis looks at both credit standards and current interest rates on alternative loans, and concludes that refinancing into a new subprime loan or, for those borrowers whose credit profile has improved since loan origination, a new Alt-A loan, is essentially not an option. The interest rates on new subprime and Alt-A, given the current environment, are simply too high to offer any improvement in the monthly payment.

Therefore, the report concludes that FHA and Fannie Mae's "Expanded Approval" program (EA, its existing program for "near prime") are the only realistic options, given pricing structures. BoA estimates that approximately 18% of outstanding subprime ARM borrowers could qualify for an FHA refi (on both credit guidelines and rate reduction), and approximately 36% could qualify for Fannie Mae's EA. (That's best understood as 36% qualifying for either FHA or EA, not a total of 54%.) The larger bucket of loans qualifying for EA is mostly a matter of the larger GSE maximum loan amount compared to the FHA maximum, as well as a slice of the highest-credit class for which EA, at least in theory, offers 100% financing in contrast to FHA's 97% maximum.

Still, BoA's analysis is assuming an effective interest rate (including FHA or private mortgage insurance premiums) of around 8.50% for FHA and 8.50%-9.50% for the EA loans. In other words, the refi rate for these borrowers, at best, is enough to keep them at pre-reset payment levels. It isn't enough to bail out anyone who cannot carry the pre-reset payment.

It is always possible to change the eligibility and qualifying rules on either FHA or EA so that more borrowers can be accommodated, and there are certainly demands out there, especially for FHA, to do this. How, exactly, we will price the risk so that these borrowers are in the money is, as far as I can tell, the unmentioned part that probably matters.

by Anonymous on 8/28/2007 08:01:00 AM

The official story on Bank of America and Countrywide is, apparently, still in flux. That's always the trouble with mythologizing in real time; events often catch up with one in troublesome ways. Mythic narrative, of course, is only comprehensible in "ageless" terms. A story with a shelf life of a couple of weeks may invoke grand narrative structures and heroic motifs, but that, as we say in literary land, is short-term financing.

David Weidner at Marketwatch struggles with conflicting stories about BoA and its CEO:

NEW YORK (MarketWatch) -- Sentiment is growing that Bank of America Corp.'s Kenneth Lewis may have won a place in the pantheon of great Wall Street titans by using his financial clout to help the country avoid economic ruin.

If you found yourself at this point wondering who the hell else was in that pantheon of great Wall Street titans who saved the country from economic ruin, you'll probably have noticed that we had to go back to 1907 to find one. I'd say, if you're not familiar with the story of J.P. Morgan and the Panic of 1907, you might want to brush up on the details. This may well become mythological motif du jour for some while, so you'd best be prepared.

Me, I just skip to the last paragraph:

Maybe there's a modern-day Morgan out there. We can all pitch in and buy him a railroad.

I suspect we're going to get so worried about pitching in to buy Joe Spendthrift an affordable mortgage that we'll allow ourselves to get suckered into buying some Morgan a railroad, but I undoubtedly read too much.

by Calculated Risk on 8/27/2007 06:12:00 PM

From the Financial Times: Credit-card defaults on rise in US

US consumers are defaulting on credit-card payments at a significantly higher rate than last year ...

Credit-card companies were forced to write off 4.58 per cent of payments as uncollectable in the first half of 2007, almost 30 per cent higher year-on-year. Late payments also rose, and the quarterly payment rate ... fell for the first time in more than four years.
...
But Moody’s said the rate of losses remained well below the 6.29 per cent average seen in 2004 ...

Recent increases in credit card losses can in part be ascribed to a steady rise in personal bankruptcy filings since 2005. According to the Administrative Office of the US Courts, quarterly non-business bankruptcy filings have been rising since the first quarter of 2006.

As an aside, business bankruptcy filings are rising too, from Barron's Business-Bankruptcy Blues (hat tip Viv)

For the second quarter, such bankruptcies rose 38% from the same quarter in 2006, and first-half bankruptcies were up a full 45% from the 2006 half, to 12,985. That's according to ... data from the U.S. Bankruptcy Courts.

The new bankruptcy law in October 2005 caused some distortions in the data, but it appears the trend is negative.

Update: Just a few months ago we saw this Bloomberg story: Subprime Borrowers More Apt to Pay Card Debt, Ignore Mortgages (hat tip BR)

"The number of people with subprime credit ratings whose home payments were overdue by 30 days or more rose 13.2 percent in the past four years, while bank-card delinquencies among the group dropped 25.4 percent."

And from the Chicago Tribune: As home loan market tightens, mounting credit card debt could spur new crisis (hat tip Gort)