by Anonymous on 11/09/2007 11:55:00 AM

Thanks to bacon dreamz.

Remember that, as CR says, Up is Down.

by Calculated Risk on 11/09/2007 10:16:00 AM

From Reuters: S&P says State St-managed CDO liquidating assets (hat tips nemo idoc)

The trustee of a $1.5 billion collateralised debt obligation (CDO) managed by State Street Global Advisors has started selling assets, apparently starting a process of liquidation, Standard & Poor's said late on Thursday.
...
The trustee of the Carina CDO has started selling the asset-backed securities -- residential-mortgage backed securities and CDOs -- making up the CDO at the direction of the structure's noteholders, S&P said.

"We believe the liquidation process has begun," S&P said in its statement.

It looks like a busy news day!

by Calculated Risk on 11/09/2007 10:06:00 AM

From MarketWatch: Wachovia sees higher loan losses

Bank says CDO portfolio lost more than $1 bln during October

Due to the October market deterioration, its asset-backed collateralized debt obligations, or CDOs, experienced further declines in value in the month of October 2007 by an amount it currently estimates to be approximately $1.1 billion pre-tax.

In the third quarter, market disruption-related losses totaling $1.3 billion pre-tax included $347 million of subprime-related valuation losses, net of hedges, on CDOs.

by Anonymous on 11/09/2007 09:01:00 AM

See end of post for update.

The plot thickens on the WaMu/eAppraiseIT front. Yves at naked capitalism runs it down: James Lockhart, head of OFHEO, fires off irritated letter to Cuomo about the latter's public involvement of Fannie and Freddie in the mess without conferring first with OFHEO. The money quote (for which I have not seen anyone include the full context in the letter, alas): Lockhart says Cuomo "may not fully understand the difference between mortgages issued by government sponsored enterprises (GSEs) and those issued by other entities."

Yves runs down a preliminary list of what this might be about. I tend to assume that Lockhart is annoyed mightily because the way in which this was handled by Cuomo did, in fact, lead many people to think that Fannie and Freddie were targets of a criminal probe. That didn't help GSE share prices and it won't help calm the troubled bongwater of the credit markets. I also think it's plausible that Lockhart is responding to Cuomo's at least rhetorical linkage of the GSEs and the investment banks, and by extention prime conforming mortgage paper and subprime goofballery.

But I also suspect that Lockhart knows perfectly well that having a large seller/servicer go up in flames isn't any kind of good news for Fannie and Freddie, whether they're "innocent" or not. Seller/servicer concentration is a huge problem for the GSEs, in my view. One result of "800 pound gorilla" industry consolidations is that you have a handful of large operations not only servicing the majority of Fannie and Freddie's loans, you have that same handful making all those repurchase warranties that limit the GSEs' risk of covering guarantees on fraudulent stuff.

So it's one thing for a state AG to kick around somebody like American Home, whose agency servicing book is fairly small (and can be transferred, at least theoretically, to one of the gorillas if it fails). Kicking around a gorilla could put the GSEs in the position of feeling the effects of the concentration risk they have willingly allowed to build up over the years.

And, as I indicated yesterday, I do think part of what's being dragged out into the light of day is not just inflated appraisals but the whole "post purchase due diligence" model that the GSEs depend on (and that they "risk manage" by, exactly, doing a lot of business with big fat depositories who are, presumably, good for those warranties in the way some relatively small-change REIT isn't). Given this structural way of doing the business, there's nowhere an investigation of appraisal risk-offloading (as opposed to mere individual appraisal fraud) can go except to the parties who write the industry-standard rules on appraisal practices and whose upfront due diligence, or back-end due diligence, is or is not structured in a way that can catch bad appraisals before they, and other loose lending practices, wreak havoc in the housing and credit markets.

So I'm not sure what would be "worse" for the GSEs: that Cuomo does not understand how they operate, or that he does. Yesterday we were meditating on the problems created by relying on shallow-pocket counterparties to cover your liability. Today we are meditating on the risks of relying on deep-pocket counterparties to cover your liability. The latter is the classic "moral hazard" problem and it's worth asking whether Fannie and Freddie aren't hip-deep into it.

UPDATE:

Thanks to bacon dreamz, I have the link to Lockhart's letter to Cuomo (see post below [ed note: it's "above" for those of you who aren't standing on your heads]), which was hiding in plain sight on the internet (um, it's early . . .)

I have always had a lot of respect for Lockhart. This paragraph is making me stare in wonder at my monitor. Is it possible for anyone to be that naive about the mortgage business and still be alive? Here's the whole paragraph in question:

After reviewing these materials, I feel that you and your staff may not fully understand the differences between the mortgage-backed securities (MBS) issued by the GSEs and those issued by other entities. In particular, unlike the issuers of private label MBS, when Fannie Mae or Freddie Mac issues an MBS, they retain the credit risk on the underlying mortgages by guaranteeing repayment to MBS holders. Consequently, they have no economic incentive to knowingly purchase or guarantee mortgages with inflated appraisals. The two firms already have programs in place to prevent this and other types of mortgage fraud as well as contract terms to put back mortgages in such situations to the primary lender. For the past several years, OFHEO has been working with the two firms as they have continued to improve these anti-fraud programs.

Well, yes. Nobody has any incentive to knowingly purchase or guarantee fraudulent mortgages. If you know about it, you are party to it, and that put-back thing doesn't work. Does Lockhart seriously wish us to believe that there are no economic incentives for anybody to work extremely hard on not knowing what is going on, while still allowing it to go on because there's money in them transactions?

You do not have to accuse the GSEs of collusion in appraisal fraud to recognize that they have an economic incentive to allow a big counterparty like WaMu to push the envelope on appraisals, and they have a economic incentive to avoid having to "mark" the LTVs of their current outstanding MBS and retained portfolios to a new market (less the "fraud adjustments" on these bad appraisals).

In Lockhart's logic no one would ever have an economic incentive to request inflated appraisals, because no one is ultimately safe from having to cover the loss. Even nickel and dime mortgage brokers face disgorging loan premia that can bankrupt them, not to mention doing some time in the county jail, which is not "economic" for a small self-employed business person.

I argued a while back that the real problem with stated income lending--which the GSEs are implicated in as well as those private issuers Lockhart doesn't want the GSEs to be lumped in with--is that it allows lenders to make very high-risk loans without having to admit they're doing it, and it sets up a bagholder: the borrower who lied. To the accusation that lenders obviously allowed themselves to be lied to, the retort is that "we have no economic incentive" to be lied to. Sure you do.

Low processing costs. Inexpensive due diligence practices. Lower reserves based on "stated" DTIs and LTVs. Ability to compete with other lenders by offering "faster approval" (no hang-ups over the appraisal!) or lower closing costs (no expensive charge for an experienced independent appraiser when you get some appraisal-mill product for cheap). And on and on. How are these not "economic incentives" for the whole industry to know what is going on while not "knowing" what is going on? It's like no one ever heard of the concept of plausible deniability.

I am not suggesting that the GSEs intentionally colluded with anyone to produce bad appraisals. I actually do think they try harder than most other parties to weed that stuff out, precisely because they are motivated to limit their credit losses. But Lockhart himself names the major mechanism in play: put backs. That means that the GSEs manage their risks to the extent that their counterparties will agree to take the risks instead. And that means that if and when a counterparty gets in trouble over the risks it's taking, the GSEs have to put back nuclear waste at the exact time that doing so could conceivably ruin the counterparty, whose warranties on the other eleventy-jillion loans that don't have bad appraisals are now worthless.

Of course Fannie and Freddie don't want to participate in what could potentially be the ruin of WaMu or any other of their major counterparties. I have to think that Cuomo knows that and intentionally created this situation where they now cannot not participate in the investigation. If so, that's because he recognizes an "economic incentive" that Lockhart apparently wants to not know about.

by Calculated Risk on 11/08/2007 11:52:00 PM

From the NY Times: Stores See Shoppers in Retreat

Consumers have rendered a verdict on the coming holiday season: grim.

From discounters like Wal-Mart to luxury emporiums like Nordstrom, the nation’s biggest chains reported the weakest October in 12 years yesterday.
...
Sales at stores open at least a year, a crucial yardstick in retailing, rose just 1.6 percent last month, the slowest growth since October 1995, according to the International Council of Shopping Centers. The poor results — on the heels of a dismal September — have made this one of the worst fall shopping seasons in decades.

From the WSJ: 'Affordable Luxury' Stores Feel Economy's Pinch

Yesterday Nordstrom Inc. reported a rare 2.4% drop in October same-store sales, steeper than the 1% decline many analysts had expected. Morgan Stanley analyst Michelle Clark this week downgraded Nordstrom's shares to "underweight," the equivalent of a sell rating, citing weaker spending by the affluent middle class, rising credit-card delinquencies and the luxury retailer's exposure to risky housing markets in California and elsewhere.

How long will the slowdown last? From the NY Times article:

“We expect the challenging retail environment to continue for the foreseeable future,” [Myron E. Ullman III, chief executive of J. C. Penney] said.

The housing slump is definitely hurting consumer spending in Florida, Nevada, Arizona, and California - all states that are in or near recession - and probably impacting spending in many other places too.

We need to keep watching Mortgage Equity Withdrawal (MEW). MEW is probably declining sharply in Q4 with tighter lending standards and falling house prices, and that will likely directly impact consumer spending. In simpler terms, the Home ATM is running out of cash.

note: the advance MEW estimate suggests that MEW was still been pretty strong in Q3.

by Calculated Risk on 11/08/2007 05:59:00 PM

Tanta wrote another incredible and timely post this morning: WaMu and The Rep War

IMO Tanta's posts on the mortgage industry are the most informative anywhere, and I suggest checking them out at Tanta's The Compleat UberNerd (a directory of her posts). These posts cover Mortgage Servicing, Private Mortgage Insurance, Reverse Mortgages, Mortgage Backed Securities (MBS) and much more.

You can also click on the The Compleat UberNerd in the menu at the top of the blog to access this directory.

Felix Salmon, at Market Movers on Portfolio.com had this to say yesterday about Tanta:

"Tanta is one of the best financial writers in the world, and explains complex ideas with wit and great clarity."

I couldn't agree more. Enjoy her posts!

by Calculated Risk on 11/08/2007 03:43:00 PM

Here are some headlines (hat tip Brian) from the Toll Brothers Conference call:

Click on photo for larger image.

The audio of the conference call should be available here soon.

I miss Ivy Zelman and her KoolAid comments! Note: Ms. Zelman (while at Credit Suisse) confronted Toll Brothers CEO Bob Toll during an analyst conference call in 2006 by asking: "Which Kool-aid are you drinking?"

by Calculated Risk on 11/08/2007 02:04:00 PM

The Census Bureau, during periods of rising cancellation rates, overstates New Home sales and understates the increase in inventory. Conversely, during periods of declining cancellation rates, the Census Bureau understates sales. Here is discussion from the the Census Bureau on cancellations. Note: this shouldn't be confused with revisions that are unrelated to cancellations.

Using cancellation rates from several of the publicly traded home builders, we can estimate the actual new home inventory (as opposed to the inventory reported by the Census Bureau). Note: The Census Bureau breaks down the inventory as Completed, Under Construction, and Not Started. The following chart show the reported and cancellation adjusted inventory levels for the hard inventory (excluding the "Not Started" category).

Click on graph for larger image.

At the end of Q3, this analysis shows the Census Bureau is currently understating the hard inventory of new home sales by about 100,000 units. Even though the Census Bureau data indicated a slight decline in new home inventory in the third quarter, the adjusted inventory increased because of rising cancellation rates.


The second graph shows the reported Months of Supply for new homes, and the adjusted Months of Supply based on homebuilder cancellations. At the end of Q3, the Census Bureau reported the seasonally adjusted Months of Supply for new homes was 8.3 months. Adjusting for cancellations, the actual months of supply was 11.0 months!

However, it isn't just the inventory of new homes for sale that will impact the homebuilders. Existing homes are a competing product for new homes, and the record inventory of existing homes for sale will also pressure home-building activity. Also, it's not just the level of inventory that matters, but also the level of distressed inventory. We are already seeing record levels of foreclosures in some states, and IMO it is about to get much worse. I'll have more on total and distressed inventory soon.

by Calculated Risk on 11/08/2007 11:22:00 AM

From MarketWatch: Toll's home orders drained by cancellations

Toll Brothers ... said Thursday its net orders for new homes in the latest quarter fell 35% from a year earlier as cancellations increased, pointing to further losses in the residential housing market.

"We continue to believe that excess supply created by cancellations, speculative buyers, and overly ambitious builders; customer concerns about selling their existing homes; and a general lack of confidence are the primary impediments to our market's recovery," said Chief Executive Robert Toll in a statement.

He said tighter lending standards and inability to obtain mortgages as a result of the subprime mess do not appear to be a "major factor" affecting its mostly affluent buyers. However, he said a tougher mortgage market may make it more difficult for buyers to sell their existing houses and move into a Toll house.
...
The builder had 417 cancellations during the quarter, while net contracts totaled 656 homes. Toll said the cancellations were heavily concentrated in high-priced markets and product lines.

"Unfortunately, the pace of customer cancellations increased in this fourth quarter," Rassman said. "We, and other reporting builders, have observed that October's activity appeared weaker than September's. These trends suggest that we still have challenging times ahead, which we believe are reflected in our estimates for fourth quarter impairments."

First, these higher cancellations mean the New Home inventory numbers from the Census Bureau will be too low. See this discussion on how the Census Bureau handles cancellations. Note: Toll is one of the companies I use to calculate the adjusted New Home inventory. I should have an update for Q3 soon.

Second, Toll is probably correct about the minimal direct impact of tighter lending standards on high end homes. However, as Toll noted, if the high end buyers can't sell their homes, they can't buy Toll's homes.

by Calculated Risk on 11/08/2007 10:59:00 AM

From MarketWatch: U.S. faces risks of downturn, inflation: Bernanke

The U.S. economy not only faces the risk of a sharp slowdown from the housing market's contraction but also of an inflationary surge from sharply higher crude-oil prices and the weaker dollar, Federal Reserve Chairman Ben Bernanke said Thursday.
...
Bernanke said that he and his colleagues on the policy-setting Federal Open Market Committee expect the economy to slow "noticeably" from the third-quarter growth rate and remain sluggish in the first half of 2008. But Bernanke also suggested that the hawkish members of the Fed might have a point about inflation.

There were downside risks to the subdued growth forecast, and upside risks to the benign inflation outlook, Bernanke said.
...
He noted that prices for crude oil and other commodities have risen sharply in recent weeks and that the dollar has weakened in foreign-exchange markets.

"These factors were likely to increase overall inflation in the short run and, should inflation expectations become unmoored, had the potential to boost inflation in the longer run as well," Bernanke said.
...
Bernanke bluntly said that headline inflation is going to rise in the short term.

Here is Bernanke's Speech: The economic outlook