by Anonymous on 11/28/2007 09:38:00 AM

Given the tizzy certain segments of the press and internet commentariat went through over a handful of Federal District Court Judges sending foreclosing lenders back to the office to dig up the correct paperwork, I anticipate similar tizzy over this, from Gretchen Morgenson:

The federal agency monitoring the bankruptcy courts has subpoenaed Countrywide Financial, the nation’s largest mortgage lender and loan servicer, to determine whether the company’s conduct in two foreclosures in southern Florida represented abuses of the bankruptcy system. . . .

In court documents, the trustee said that it intended to examine the procedures Countrywide used to determine that it had a valid claim to the properties and that it had correctly calculated the amounts it said the borrowers owed. The trustee’s office asked Countrywide to produce a copy of the notes and mortgages, a payment history on both loans and the correspondence it had with the borrowers.

So what does this mean?

First, it is perfectly possible that the charges to the borrowers were intentionally inflated. If so, this action by the trustee will remove a major incentive for lenders to do that, and is therefore to be applauded.

Second, it is perfectly possible that the charges to the borrowers were wholly and completely effed up beyond all recognition by a servicing operation that doesn't bother to assemble all the right documents, review each item for accuracy, and cross-check with the payment history (the printout of all transactions on the account since inception). PJ at Housing Wire makes a good case that the foreclosure filing dustups in Ohio have a lot to do with the way the operations are structured and a "timeline" built into them that encourages attornies to file first, review the case later.

Item the second here is not, by the way, a "defense" of Countrywide or anyone else. Frankly, it'd be better news for all of us if this turned out to be a case of intentional misconduct. I'm betting, frankly, that it's probably a case of operational slovenliness, undertrained staff, bad "timeline" policies, and low-bid contract legal work on the ground being unmanaged by a huge national servicer headquartered a continent away. This is the worst case because, well, that's how the business model of the 800-pound gorilla mortgage servicer works.

Force the giant, "efficient" servicers to do their homework--which is what both the bankruptcy trustees and the foreclosure judges are doing--and you just "added back" the costs of doing business that the consolidation and automation and outsourced-legal work processes were supposed to subtract out of the whole thing. Do enough of that, and all of a sudden it's as expensive for a Countrywide to service a $1.5 trillion mortgage portfolio as it is for ten small regional servicers to handle $150 billion a pop.

Now is that bad news? It depends on your point of view. If you think deconsolidation would manage risk better, improve customer service, and slow down the magic refi machine by sending mortgage transaction costs back to their appropriate levels, then you probably don't think this is bad news at all. If you have a financial or political interest in keeping the punch bowl out, you will find this a distressing idea.

Please, let's be clear here. This kind of thing is going to do a real number on mortgage lending, servicing, and securitization profitability not, in my view, because that profitability has been exclusively due to inflated BK bills. That profitability has been due to "efficiencies" that result, among other things, in inflated BK bills (and insufficiently documented foreclosure filings). In other words, this is going to end up like Sarbanes-Oxley, I suspect: it'll hurt not because it will flush out a bunch of Enrons, but because it will force everyone to pay their risk management and operational control costs.

So let's please skip the uproar over "Countrywide has to prove it owns the loans!" That's not the point here with requiring copies of the notes and mortgages and payment histories and correspondence files. The point of all that is making Countrywide--and everyone else, eventually--"show its work" in its filings. If you present a bill to the trustee, you back it up with documentation of the charge. That's a perfectly unexceptional requirement. That the industry will spin as "red-tape paperwork burdens" is inevitable and should be dismissed as the usual defensive piffle.

What we are seeing here on both the foreclosure and the bankruptcy front is a movement toward having to deal with the true costs of secured lending: the costs involved in maintaining one's security and liquidating it in the event of default. That is going to change the math of securitization economics as well as the profitability of mortgage servicing operations, and that is going to directly impact the consumer in terms of curtailing easy credit and increasing the cost of mortgage financing. Not all of us think that's a bad outcome. If it means servicers hiring specialists with deep skill sets instead of paper-pushing temps, then I for one have no problems with it. I'd like to see the costs of that come out of executive bonuses and dividends rather than new fees to consumers, of course, but no bankruptcy trustee or foreclosure judge is going to make that happen. That'll take a shareholder revolt. Good luck.

by Calculated Risk on 11/28/2007 09:24:00 AM

From Fed Vice Chairman Donald L. Kohn: Financial Markets and Central Banking

... uncertainties about the economic outlook are unusually high right now. In my view, these uncertainties require flexible and pragmatic policymaking--nimble is the adjective I used a few weeks ago.

That sounds like Kohn supports a rate cut in December.

by Calculated Risk on 11/27/2007 06:54:00 PM

From Reuters: Freddie Mac cuts dividend, slates $6 billion preferreds

Freddie Mac ... said it halved its quarterly dividend and will sell $6 billion in preferred stock to bolster capital in anticipation of mortgage-related losses.

No surprise.

by Calculated Risk on 11/27/2007 06:50:00 PM

From MarketWatch: Wells sets aside $1.4 bln to cover home loan losses (hat tip crispy&cole)

Wells Fargo & Co., the second-largest U.S. mortgage lender, said late Tuesday that it will set aside $1.4 billion during the fourth quarter to cover higher losses on home-equity loans caused by deterioration in the real estate market.
...
The special reserve covers an $11.9 billion portfolio of loans that the bank originated or acquired through indirect sources such as mortgage brokers, Wells explained. That portfolio will be sold off under the guidance of a dedicated management team, the bank added.

by Calculated Risk on 11/27/2007 05:34:00 PM

Goldman Sachs Chief Economist Jan Hatzius released a new report on housing today: Housing (Still) Holds the Key to Fed Policy

There is no link available.

Note: The following excerpts are used with permission.

In this new report, Goldman revised down their housing outlook significantly (here is their August forecast). Goldman now sees housing starts falling to 750K (their earlier forecast was for starts to fall to 1.1 million units).

On housing prices:

Home prices are also likely to decline substantially. If the economy narrowly escapes a full-blown recession—as we continue to expect in our baseline forecast—a peak-to-trough decline of 15% in house prices is the most likely outcome. This would imply price declines in states such as Florida of up to 30%. If the economy does enter a recession, prices could decline as much as 30% nationwide.

On the impact of less Mortgage Equity Withdrawal (MEW) on consumer spending:

Consumer spending growth has remained stable over the last 1-2 years as rising equity prices and sturdy income growth have offset the drag from falling mortgage equity withdrawal (MEW) and slowing home prices. Nevertheless, consumption has underperformed income growth, as predicted by our MEW-augmented consumption model. Going forward, our model points to a more substantial drag of housing on real consumer spending growth, with a slowdown from the recent 3% pace to a 1% annualized rate in early 2008.

Click on graph for larger image.

On negative equity:

The basic problem is that house price declines create large amounts of negative equity. Homeowners with negative equity lose their ability to respond to adverse financial events such as job loss or mortgage reset by refinancing or selling their home, and they therefore become much more likely to default. The importance of this problem is illustrated in Exhibit 16, which shows the distribution of home equity among US mortgage holders at the end of 2006 according to an analysis by First American CoreLogic, Inc. About 7% of US mortgage holders had negative equity at that point, and another 14% had equity of less than 15%. Thus, 21% of all mortgage holders—holding about $3 trillion in aggregate mortgage debt given the average mortgage debt held by the vulnerable borrowers—would be put into a negative-equity position if home prices fell by 15%.

There is much more in the report. Goldman now puts the odds of a recession in 2008 at around 40%, and they see the unemployment rate rising to 5.5% by the end of 2008.

In the past, such a rise in the unemployment rate has invariably come in the context of an overall recession ... The risk that it would do so again is high ... however, our analysis does not imply a recession when taken at face value. Instead, it points to a long period of below-trend growth.

I'll post more on the details of their analysis - and offer my view - later this week. Goldman has definitely turned significantly more bearish on housing and the economy.

by Calculated Risk on 11/27/2007 02:59:00 PM

The S&P Case-Shiller National home price index was released this morning. (See note at bottom).

The reported Case-Shiller numbers are nominal; not adjusted for inflation. Most people think in nominal terms, but it's also important to look at real house prices.

Click on graph for larger image. The first graph shows the nominal Case-Shiller index. The index peaked in Q2 2006, and nominal prices have declined about 5% from the peak.

The second graphs shows real prices according to the Case-Shiller index (adjusted using CPI less Shelter). Real Prices peaked in Q1 2006, and are off about 8% from the peak.

The second graph probably provides a better first estimate of how far prices still need to fall (for the Case-Shiller universe). If prices fall to 120 (in real terms) that is about another 25% from the current level.

This could happen with falling nominal prices, or from several years of inflation, or a combination of both. Say nominal prices fall 15% over the next three years, with a 2% per year inflation rate, then real prices would fall to about 130 on the Case-Shiller index.

This suggests to me that price declines have just started, and that the process will last several years. It's important to remember that different areas will see different percentage price declines - the bubble areas will see the largest declines - and the time frames for each location will be different.

NOTE: There are significant differences between the OFHEO HPI and the Case-Shiller National index. This is an excellent summary by OFHEO economist Andrew Leventis: A Note on the Differences between the OFHEO and S&P/Case-Shiller House Price Indexes. The OFHEO note suggests that the primary reason for the difference between Case-Shiller and OFHEO price indices is geographical coverage (not the loan limitations for OFHEO).

by Calculated Risk on 11/27/2007 01:35:00 PM

Peter Y. Hong at the LA Times writes: Homeowners' big question: How low will prices go?

Click on graph for larger image.

The LA Times article focuses on California. This graph shows the Case-Shiller home price index for several selected cities. If SoCal prices fall 25%, then prices in other areas - like Miami and Las Vegas - will probably decline a similar amount. These are nominal prices, I'll have more on Real vs. Nominal prices later today.

From the LA Times:

No one knows how severe the slump will be, but economists and real estate experts interviewed by The Times, and who were willing to make predictions, said prices could fall 15% to 25% before turning back up.

Most said values would continue falling through at least next year, and some thought the market wouldn't reverse course until 2010.

That could translate to big declines for home buyers who bought at the peak of the market, which various measures place in late 2006 or early 2007.
...
Some analysts, including UC Berkeley professor Kenneth Rosen, believe the severity of the downturn will vary by region.

Areas such as the Central Valley and the Inland Empire will be the hardest hit, he said, because these attracted a higher percentage of new buyers with shaky credit, and many of them are now defaulting on their loans. He believes values in these communities could fall by 15%.

But "in areas where there is very little new housing, where it's hard to build and a lot of wealthy people live, there will be little decline or maybe none at all."
...
But others call this wishful thinking, saying low prices eventually work their way to even the most affluent areas.

"Every place takes the hit in the long run," said Christopher Thornberg of Beacon Economics, a consulting firm in L.A.
...
[Edward E. Leamer of UCLA's Anderson Forecast] and Thornberg are among the most bearish of analysts, saying the recently ended housing boom pushed prices out of sync with incomes.

Los Angeles County median home prices are about 40% to 50% higher than the median income justifies, Thornberg said. He said the market would settle when prices and incomes became more closely aligned.

"Southern California prices will fall 25% from their peak and won't find their bottom until the end of 2009," Thornberg said.

Leamer also sees a drop-off at the high end of the range -- 20% to 25% -- and sees the downturn lasting into 2010.

by Calculated Risk on 11/27/2007 11:08:00 AM

From OFHEO: 2008 Conforming Loan Limit $417,000

Office of Federal Housing Enterprise Oversight Director James B. Lockhart today announced the maximum 2008 conforming loan limit for single-family mortgages purchased by Fannie Mae and Freddie Mac (the Enterprises) will remain at the 2007 level of $417,000 for one-unit properties for most of the U.S. Higher limits apply to Alaska, Hawaii, Guam and the U.S. Virgin Islands as well as to properties with more than one unit.

The conforming loan limit determines the maximum size of a mortgage that an Enterprise can buy or guarantee. By law the maximum conforming loan limit is based on the October-to-October change in the average house price in the Monthly Interest Rate Survey (MIRS) of the Federal Housing Finance Board (FHFB). The FHFB reported the decline in the average price was $10,685 or 3.49 percent, from $306,258 in October 2006 to $295,573 in October 2007. The combined two-year decline is now 3.65 percent.

“While the house price survey data used in determining the conforming loan limit show a decline over the past year, as previously announced and consistent with the proposed new conforming loan limit guidance, the level will remain at $417,000 for the third straight year,” said Lockhart.

The FHFB is reporting the year over year national price decline was 3.49%.

by Calculated Risk on 11/27/2007 09:58:00 AM

From MarketWatch: Home prices falling everywhere: S&P

U.S. home prices were falling in every region of the country in September, according to a closely watched index of home prices released Tuesday.

Home prices fell in September in all 20 major cities covered by the Case-Shiller price index, even in cities that had been holding up before the August freeze in mortgage markets, Standard & Poor's reported.

"There is no real positive news in today's data," said Robert Shiller, chief economist at MacroMarkets LLC, and the co-developer of the index.

For the national Case-Shiller home price index, prices fell 1.7% in the third quarter compared with the second quarter, and were down a record 4.5% in the past year. It was the largest quarter-to-quarter price decline in the 20 years covered by the index.

by Calculated Risk on 11/27/2007 12:35:00 AM

From the WSJ: Abu Dhabi to Bolster Citigroup With $7.5 Billion Capital Infusion

Citigroup Inc. ... is receiving a $7.5 billion capital infusion from the investment arm of the Abu Dhabi government.
...
As a result of the deal, the investment authority known as ADIA will become one of Citigroup's largest shareholders, with a stake of no more than 4.9%.
...
In exchange for its investment, ADIA will receive convertible stock in Citigroup yielding 11% annually. The shares are required to be converted into common stock at a conversion price of between $31.83 and $37.24 a share over a period of time between March 2010 and September 2011.