by Anonymous on 10/08/2007 11:30:00 AM

I've been updating some old spreadsheets of mine, and I thought some of you might be interested in having some of the numbers. Data like the following, which involve national averages over entire years, are awfully blunt instruments for a lot of analytical purposes; I'm not offering these as "proof" of any particularly detailed claim about the world, nor am I suggesting that any particular set of numbers in this table can "explain" any other set in completely reliable ways.

Nonetheless, broad-brush numbers like these do provide a kind of context for certain discussions of the mortgage market. I tend, personally, to cringe a lot when certain numbers are reported in the press, because I possess a sense of context that, frankly, non-insiders don't have. It is second nature to me, for instance, to distinguish between origination volume and level of loans outstanding at the end of a period, but you will find press reports moving back and forth from originations and outstandings in blithe disregard of the issues.

So make of this what you will. A few nerdly observations about the data:

1. Total originations are hard to pin down; there's often a lot of vapor as well as volatility in those numbers. I pick what I think is the most reliable, but you should know that data collection and reporting practices change over time, and so a lot of the older numbers are pretty approximate. That's one reason why I don't care to go back before 1988.

2. The ownership rate statistical calculation changed significantly in the early 90s. The pre-1993 numbers should be thrown around with even more caution than the 1993-2006 numbers.

3. There are a lot of different rates you can use to establish an average mortgage interest rate. I chose the FHFB conforming fixed contract rate because it can be considered an index of "refinance incentive."

4. Mortgage FOR is a statistical measure of mortgage debt, property taxes, and insurance divided by disposable personal income for all homeowners with a mortgage. As a level, it's not particularly helpful, but it does help establish trends, and it is certainly more consistently calculated than DTI.

5. Refinance percent is all refinances. I am not yet ready to try to sort out the cash-out issue over this time period, and I may never be. But general refi share is a useful bit of context for those changes that you see in the other numbers.

A couple of general observations I would make about this data:

1. Notice the volatility of origination volume compared to mortgage outstandings. A large part of some of the knotty issues we've talked about on this blog, like use of brokers, barriers to entry (or the lack thereof) for mortgage originators, and historical changes in quality of mortgage origination personnel (including loan officers and appraisers), has to do with that volatility. The short version is that originators staff up and staff down in the cycle, and that loan quality (not just borrower credit quality, but accuracy of paperwork, depth of documentation, clarity of disclosures) zigs and zags along that cycle. In the early part of those big booms, for instance, you can see a lot of novice work. In the troughs, you can see a lot of desperate commission-paid people doing desperate things. That's something to take into account when you look at, say, vintage charts of loan performance. I believe, for instance, that a lot of the problems with the (in)famous 2001 vintage had to do with a huge crop of brand-new brokers and loan officers and appraisers getting into the business to cope with the volume. A lot of the problems with the 2000 vintage is that a bunch of originators who had been, in the past couple of years, making plenty of money off the refi boom started scraping the bottom of the barrel when volume dropped off. The 1993-1994 period had a similar problem.

2. There has always been much more stability on the servicing side; the problems there in terms of expertise are more a function of technological "productivity" changes and outsourcing reducing the cadre of gray-haired veterans of past crises. The thing to notice here is the level of turnover in the outstandings. In 2003, for instance, around a third of the outstanding mortgage book turned over in refinances. Mortgage sevicers can do a lot of work to stay in the same place, let alone to grow a servicing portfolio.

3. Whatever generalizations you want to make about earlier periods, the 2004-2006 period confounds them.

by Calculated Risk on 10/08/2007 10:39:00 AM

Jon Lansner writes at the O.C. Register: Distressed properties 12% of O.C. housing supply

Market watcher Steve Thomas at Re/Max Real Estate Services in Aliso Viejo notes the impact of distressed properties in his biweekly summary of housing supply ...

After finding a new way to search for short sales and foreclosures on the market and in escrow, the new findings are disconcerting. Currently, short sales and foreclosures in Orange County account for 12% of the active inventory and 15% of all escrows opened within the prior month.

Thomas also calculates “market time,” a benchmark of how many months it theoretically takes to sell all the inventory in the local MLS for-sale listings at the current pace of pending deals being made. This index shows the inventory-to-selling ratio continuing to erode. By this Thomas logic, it would take 15.17 months for buyers to gobble up all homes listed for sale at the current pace of deals vs. 14.73 months two weeks earlier and vs. 7.10 months a year ago.

by Anonymous on 10/07/2007 11:09:00 AM

A lot of people have raised questions in the comments regarding proposed changes to federal bankruptcy law to accommodate modifications of mortgage loans.

Here's the issue, in a nutshell. Until the 2005 bankruptcy reform, insolvent homeowners could choose Chapter 7 (liquidation) or Chapter 13 (repayment plan) bankruptcy. After the reform bill, for practical purposes most homeowners are limited to Chapter 13.

Chapter 7 filings usually do not result in borrowers keeping their homes, although they can (if the borrower reaffirms the mortgage debt, the court accepts the reaffirmation, and the borrower has the financial capacity to continue to make mortgage payments). In most cases, the BK stay is lifted and the loan is foreclosed.

You can think of Chapter 13 as itself a kind of loan modification: the court establishes a 3-5 year repayment plan for all the borrower's debts, with the unpaid remainder discharged at the end of the repayment plan period. In Chapter 13, the debtor can keep a mortgaged home, as long as he continues to make mortgage payments throughout the plan period, and makes up any past-due amounts (including fees) during the repayment period as determined by the repayment plan. If the borrower does not or cannot continue to pay the mortgage, the stay is lifted and the lender can foreclose.

However, secured debts can be restructured or modified in a Chapter 13 bankruptcy, and secured creditors, except the mortgage lender on a principal residence, can be subject to what is called a "cram down." This happens when the amount of the debt is greater than the value of the collateral securing it; the court reduces the value of the secured debt to the market value of the collateral, with the remainder being treated as unsecured (and subject to the same repayment plan/discharge terms as any other unsecured debt). The prohibition of court-ordered modifications for mortgages on principal residences was created in 1978; between 1978 and 1993 most bankruptcy courts interpreted the law to mean that while interest-rate reduction or term-extension modifications were not allowed, home mortgages could still be crammed down.

In 1993, with Nobleman v. American Savings Bank, the Supreme Court held that the prohibition on modifications of principal-residence mortgage loans also included cram downs. The result is that borrowers who are upside down and who have toxic, high-rate mortgages are simply, in practical terms, unable to maintain their homes in Chapter 13.

According to the Center for Responsible Lending:

The language we seek to change was enacted in 1978, a time when virtually all home mortgages were fixed-interest rate instruments with low loan-to-value ratios. The loans were rarely the source of a family’s financial distress. As originally introduced, the House legislation permitted a plan to modify any secured indebtedness, including that represented by a home mortgage.21 During Senate hearings on the proposed legislation, advocates for secured lenders suggested that home-mortgage lenders were “performing a valuable social service through their loans,” and “needed special protection against modification.” At their urging, the original proposal was subsequently amended to insert the exception for mortgages on primary residences. 22 This claim likely succeeded through effective lobbying since, as described below in section III, the merits of the argument are groundless. Whatever the merits of this claim in 1978, however, when home mortgage loans were responsibly underwritten thirty-year fixed rate loans, it plainly does not apply to the practices of subprime mortgage lenders during the last decade.

As far as I'm concerned, if you believe that prior to 1978, when modifications of home mortgages were unrestricted, and in the period of 1978-1993, when term modifications were restricted but cram downs were widely practiced, mortgage lenders offered higher-rate (relative to prevailing market), higher-LTV mortgage terms than they have in the post-1993 period, when they are safe from any restructurings, I would like to discuss a bridge purchase with you. Nonetheless, that reliable source of comic relief, the Mortgage Bankers Association, wants you to think that allowing cram downs or other kinds of loan restructuring would, um, ruin the party:

“Giving judges free rein to rewrite the terms of a mortgage would further destabilize the mortgage backed securities market and will exacerbate the serious credit crunch that is currently hindering the ability of thousands of Americans to get an affordable mortgage,” said Kurt Pfotenhauer, Senior Vice President for Government Affairs and Public Policy for MBA. “The current legislation gives no guidance as to the proper parameters for judges to modify existing loan contracts.”

By allowing judges to rewrite loan contracts and provide whatever relief they individually deem appropriate, HR 3609 would cast doubt on the value of the asset against which the mortgage loan is secured. As a result, lenders and investors would likely demand a higher premium for offering these loans. This premium could come in the form of higher fees, a higher interest rate or the requirement for a larger downpayment, all of which would serve to make the American dream of homeownership less attainable for many Americans.

In other words, the MBA implicitly admits that in the post-1993 era lenders have made low- or no-down loans at interest rates that, while high enough in terms of the blood they extract from strapped borrowers, are still lower than what they would have been if the lenders had had a healthy fear of BK court restructurings. Of course it's beyond ludicrous to argue that being forced to take what they can reasonably get by a BK judge is the "destabilizing" factor here, but you can count on the mortgage industry be ludicrous when dollars are on the table.

In fact, I have some sympathy with the view that mortgage lenders "perform a valuable social service through their loans." That's why, when they stop doing that and become predators, equity strippers, and bubble-blowers instead of valuable social service providers, I like seeing BK judges slap them around. Everybody talks a lot about moral hazard, and the reality is that you're a lot less likely to put a borrower with a weak credit history, whose income you did not verify and whose debt ratios are absurd, into a 100% financed home purchase loan on terms that are "affordable" only for a year or two, if you face having that loan restructured in Chapter 13. If you are aware that your mortgage loan can be crammed down, I'm here to tell you that you will certainly not "forget" to model negative HPA in your ratings models, and will probably pay more than a few seconds' attention to your appraisals. You might even decide that, if a loan does get into trouble, you're better off working it out yourself, via forbearance or modification or short sale, rather than hanging tough and letting the BK judge tell you what you'll accept. That would be a major bummer, right?

But I think my favorite part of the MBA lament is this: "HR 3609 would cast doubt on the value of the asset against which the mortgage loan is secured." Translation: lenders mark to model, but if you let them, BK judges will mark to market.

Is it possible that BK judges would use the lowest plausible "distressed liquidation value" to determine the secured part of the mortgage loan? Sure it is. BK judges don't have parts of their job descriptions that refer to supporting home values or keeping those comps up or controlling "price discovery." The cram down is, precisely, the "mark to market" you don't want to get, which is why the risk of it used to function as a brake on lender stupidity.

I am fully in favor of removing restrictions on modifications of mortgage loans in Chapter 13, but not necessarily because that helps current borrowers out of a jam. I'm in favor of it because I think it will be part of a range of regulatory and legal changes that will help prevent future borrowers from getting into a lot of jams, which is to say that it will, contra MBA, actually help "stabilize" the residential mortgage market in the long term. Any industry that wants special treatment under the law because of the socially vital nature of its services needs to offer socially viable services, and since the industry has displayed no ability or willingness to quit partying on its own, then treat it like any other partier under BK law.

by Calculated Risk on 10/06/2007 05:56:00 PM

From BusinessWeek: Housing: That Sinking Feeling (hat tip seminole83). This article asks if the recent significant price cuts by home builders will shorten the duration of the slump. Here are a few excerpts:

For the first time, big builders are offering massive, often six-figure, price cuts in overbuilt developments nationwide, giving the industry a kind of shock treatment designed to move inventory off the books fast. It remains to be seen whether these radical measures will revive the market or deepen the slump, but it's certainly having an impact on the local communities.
...
The real question is whether the drastic price-cutting will short-circuit the usual long, painful downturn builders seem destined to undergo in this economically sensitive business. ... If by doing so the builders can force the market to accept the reality that housing values have fallen--and accept it fast--there's at least the possibility of emerging from the current bust sooner than in earlier down cycles.
...
When builders cut their prices in one fell swoop, rather than letting them drift slowly downward, they in essence force sellers of existing homes to do the same. At the very least, that can be a severe psychological blow that in earlier slumps was absorbed over a period of time rather than all at once. For some homeowners, it's a catastrophic financial blow as well. With new, clearly established market prices, troubled homeowners who paid peak prices will have a harder time refinancing. ... As painful as such situations are, however, the excesses must be wrung out of the market before the sector or the broader economy can recover.
...
Homeowners are almost always slower than builders to bite the bullet and cut their asking prices. That's why prices on sales for existing homes haven't dropped as precipitously as prices for new homes. ... The resale market will eventually have to realign--meaning homeowners will have to cut their prices--before the slump can end.
...
The current housing downturn and the damage it's inflicting on the overall economy are far from over. With a slew of risky, adjustable-rate mortgages still to reset next year, foreclosure rates could climb even higher. ... "Builders definitely responded more quickly this time, and that's a good thing," says Banc of America Securities analyst Daniel Oppenheim. "But the inventory overhang is so great, it's going to take a long time to work through this. They still have a ways to go before there's a recovery."

Reducing prices is a necessary first step towards a recovery, but the builders are in a trap of their own making: so many builders bought into the "land bank" fallacy during the boom, and those builders now find themselves having to keep building too many homes - and sell them at a loss - just to liquidate land to make their debt payments. This means the builders are still starting far too many homes to make a dent in the current huge inventory overhang.

And the new price realities will put even more existing homeowners upside down in their homes, either trapping them in their homes for years or forcing more distressed property on the market. This will undoubtedly keep pressure on home prices, probably for years.

by Anonymous on 10/06/2007 02:05:00 PM

Advice for all you UberNerds: if your PC is already acting squirrelly, and your dsl connection is slower than usual, it is not a good time to decide to download a giant MIRS dataset from the Federal Housing Finance Board, because three hours later after you've finally restored your system and rebooted in normal mode and retrieved the fragments of your damaged spreadsheet, you will have forgotten what the hell you needed that data for.

This isn't the tune I had planned for today, but under the circumstances it will do.

by Calculated Risk on 10/06/2007 12:34:00 AM

From the WSJ: Merrill's $5 Billion Bath Bares Deeper Divide. This article is mostly about internal issues at Merrill Lynch. A few excerpts:

Merrill Lynch & Co.'s announcement Friday that it would take a $5.5 billion hit to third-quarter earnings is exposing the weak oversight exercised by top Merrill executives as it became a big force in the mortgage-securities business.
...
In July, before the market worsened, Merrill's chief financial officer, Jeff Edwards, said in a conference call with investors that the firm's exposure to subprime mortgages was "limited, contained and appropriate."
...
Credit-rating agencies maintained Merrill Lynch's current credit ratings but revised the outlook to negative. Standard & Poor's said Friday's announcement "raises concerns over Merrill Lynch's risk-management practices in allowing such a large exposure to build."
...
The write-down means Merrill will report a loss of about $450 million, or 50 cents a share, for the third quarter, after showing quarterly operating profits averaging over $2.1 billion for the past four quarters.

Are the problems now behind Merrill and the other banks?

by Calculated Risk on 10/05/2007 08:15:00 PM

First, what is normal economic growth? To answer that question, look at this graph of the distribution of four quarter real GDP growth since 1956 (the last 50 years).

Note: this graph uses each moving four quarter period as a data point. Each quarter will eventually be in four different events (they are not all independent).

Click on graph for larger image.

The bars represent the number of times the four quarter real GDP growth was within a certain range. As an example, the ">1%" range is for a four quarter growth rate of 1% to 2% real GDP.

In general, the probability of real GDP growth is a bell curve distribution centered around 3% to 4% real GDP growth.

Most forecasts start with trend GDP growth and then try to decide why growth in the next period will be higher or lower than trend. Instead of trying to forecast a specific number for GDP growth, I usually try to forecast in one of the four circles market on the graph. These are arbitrary definitions that I use: Booming Growth, Trend Growth, Sluggish Growth / mild Recession, and Severe Recession.

For 2007 my forecast was for Sluggish Growth / mild Recession, and I've tried to break it down a little further by saying it is pretty much a coin flip between a mild recession and sluggish growth, but I lean towards a recession. Although there is a bright line between a recession and no recession, the economic difference between sluggish growth and a mild recession is pretty minor.

What is a Recession?

In the U.S., recessions are identified by the National Bureau of Economic Research (NBER), a private, nonprofit, nonpartisan research organization. Here is the NBER’s Recession Dating Procedure. Here are some excerpts:

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.
...
Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER's recession dating procedure?

A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. According to current data for 2001, the present recession falls into the general pattern, with three consecutive quarters of decline. Our procedure differs from the two-quarter rule in a number of ways. First, we consider the depth as well as the duration of the decline in economic activity. Recall that our definition includes the phrase, "a significant decline in economic activity." Second, we use a broader array of indicators than just real GDP. One reason for this is that the GDP data are subject to considerable revision. Third, we use monthly indicators to arrive at a monthly chronology.

For the four quarter period ending in Q2 2007, real GDP growth was 1.9% (for the Q1 ending period, four quarter GDP growth was 1.5%). So the U.S. economy is currently in the Sluggish Growth / mild Recession category.

If we go back to the graph, 5 out of the 19 events with 1% to 2% growth happened during a NBER defined recession. For the 0% to 1% category, 9 out of 11 events happened during a recession. This suggests that the U.S. economy is skating just above a recession, and if the four quarter real growth rate falls below 1%, there is a good chance the NBER will declare a recession.

So do Recessions matter?

What matters is what happens when the economy slows. With a slow economy, the unemployment rate will rise as is currently happening in the U.S. If the economy slides into a recession, then employment will actually decline month after month.

Another key impact is profit growth slows - or profits even decline - as the economy slows. We are already seeing declining profits in housing related sectors, and we will probably see declining profits for the financials too. Note: many analysts are arguing S&P earnings will still be strong, even if the U.S. economy slows, because so many earnings are from strong overseas economies. This is part of the "decoupling" debate.

Also, during an economic slowdown, many problems that were hidden during the previous expansion will be exposed. As an example, sales growth will slow at many companies exposing various structural problems - especially in highly leveraged companies. Some of these companies will go bankrupt making investors more cautious, increasing the spread between high and low quality debt. The recent bank failures are an example of a slowing economy exposing problems.

So recessions do matter in that economic activity slows down, but the key point here is that there is very little difference between sluggish growth and a mild recession (my current forecast). There is a significant difference between the current economic environment and either booming growth or a severe recession; however I think both of those scenarios are unlikely in the near future. Even trend growth seems unlikely over the next year.

by Calculated Risk on 10/05/2007 04:37:00 PM

From Jon Lansner at the O.C. Register on Orange County: Late-Sept. home prices at April ‘05 level

DataQuick’s latest sales update reveals a serious disruption to the O.C. housing market created by the mid-summer credit crunch. These new stats — for the 22 business days through Sept. 21 — show an O.C. median selling price of $590,000. If that held for the full month, that would be the lowest since April ‘05. ...

The sales activity news is no better with house buying through Sept. 21 off 36% vs. the ‘06 pace. If that pattern holds for the full month, September will be the slowest selling month since Jan. 1995 (and the second slowest in DataQuick’s 20-year record.)

I think this is how prices will be tracked - comparing the current prices to an earlier date.

Click on graph for larger image.

If we use the OFHEO house price index for Orange County, it would take a drop of 18% from the peak to reach Q2 2005 house prices. The OFHEO index probably excludes most transactions in Orange County because OFHEO only uses repeat transaction below the conforming limit.

DataQuick probably provides a better measure of house prices in Orange County.

by Calculated Risk on 10/05/2007 03:18:00 PM

From MarketWatch: U.S. consumer credit rises in August

Outstanding U.S. consumer debt rose at an annual rate of 5.9% in August, pushed higher mostly by a hefty gain in credit-card debt, the Federal Reserve reported Friday.
...
Revolving debt such as credit cards was the biggest driver behind the overall rise in August, the data show. That debt climbed by 8.1% in August, or by $6.1 billion. In July, credit-card debt rose by a revised 7.4%

by Calculated Risk on 10/05/2007 01:29:00 PM

From Fed Vice Chairman Donald L. Kohn: Economic Outlook. A few excerpts (video of speech at bottom of post).

... Our policy action will not be able to avert all of the weakness in the economy that may be in train for the next several months. Monetary policy works with a lag, and the effects of our easing action will have their maximum effect only after several quarters. In particular, housing markets are likely to remain depressed in coming months as housing demand is restrained by the difficulty in obtaining mortgages and perhaps also by spreading expectations on the part of buyers that house prices will fall, as they already have in a number of markets. And, although builders have reduced housing starts sharply, they have made very little progress in reducing the number of unsold new homes on the market. As a result, even absent a further deterioration in sales, residential construction would probably decline further in the months ahead, imparting a significant drag on overall growth in real gross domestic product.

Beyond housing, it is too early to tell what effect financial market turmoil is having on household and business spending, though very preliminary and partial information suggest that thus far the effects seem to be limited. Moreover, the available data indicate that the economy entered this period still expanding at a moderate pace. For example, consumption held up well this summer supported by solid growth in real incomes. And, the recent data on orders and shipments of capital goods and on nonresidential construction indicated further growth in capital outlays in August. That said, credit availability is likely to be tighter than before, consumer confidence is down, and businesses will probably be a little more cautious for a while, suggesting that these components of aggregate demand could become more subdued in coming months.

... To be sure, households are likely to start to save more out of their current incomes as they come to realize that they cannot count on a rise in the value of their real estate to build their retirement nest eggs. However, households have been surprisingly resilient to recent economic shocks, and any rise in the saving rate probably would be gradual. More generally, consumer spending should continue to be supported by ongoing growth in employment and income. In the business sector, balance sheets are in good shape, and most firms are not likely to face an appreciable tightening of credit availability. As a result, I anticipate that they will expand their investment spending to keep pace with rising household demands and with strength in export markets. In sum, once we get through the near-term weakness caused by the extra downleg from the housing contraction and any spillover from tighter credit conditions, I am looking for moderate growth with high levels of employment.

But you should view these forecasts even more skeptically than usual. The FOMC emphasized the considerable uncertainty in the outlook.

... Of course, we would not have eased policy if the outlook for inflation had not been favorable. The recent data on consumer price inflation have been encouraging. ... And, it will be critical for inflation expectations to remain well contained.

That said, I do not want to minimize the upside risks to inflation either. Rates of resource utilization are still relatively high, and the slower rates of productivity growth over the past two years, coupled with a pickup in compensation growth, have led to a noticeable acceleration in unit labor costs. Moreover, the decline in the exchange value of the dollar has put upward pressure on prices of imported goods, which have both direct and indirect effects on overall consumer prices.

Click image for video.

Kohn Says Fed Must Be `Nimble' in Setting Interest Rates: Video October 5 (Bloomberg) -- Federal Reserve Board Vice Chairman Donald Kohn speaks at the Greater Philadelphia Chamber of Commerce Annual Meeting in Philadelphia about the Fed's half-point reduction in the benchmark lending rate to 4.75 percent last month, the outlook for the U.S. economy and the need for policy makers to be "nimble" in setting interest rates. (Source: Bloomberg)