by Calculated Risk on 2/19/2008 04:35:00 PM

NAR chief economist Lawrence Yun wrote a column last week on house price indices: Competing Home Price Data — the Inside Story. Yun tries to dismiss the Case-Shiller index, however I believe he draws the wrong conclusions.

Yun wrote:

"... the Case-Shiller price index — which has been gaining more media coverage as of late — covers only 20 markets. Most of these 20 markets coincidentally tend to be located in California, Florida, and other down markets. As a result, the index shows that most of the 20 markets are experiencing price declines."

First, Case-Shiller releases a monthly index (that covers 20 cities) and a quarterly national Case-Shiller index that covers a wider geographical area. Second, the 20 cities are: Phoenix, Los Angeles, San Diego, San Francisco, Denver, Washington, Miami, Tampa, Atlanta, Chicago, Boston, Detroit, Minneapolis, Charlotte, Las Vegas, New York, Cleveland, Portland, Dallas and Seattle. Yes, these are declining price markets now, not because the cities are in California or Florida, but because most of the country is now experiencing price declines.

For an excellent review of house price indices, David Wessel at the WSJ wrote this last week: When Home Values Don't Mesh

Predicting how much worse the U.S. housing market will get is tough. The future is never certain. But when it comes to home prices, getting a clear picture of the recent past turns out to be surprisingly hard as well.

As Wessel notes, it is surprisingly hard to get a clear picture of house prices. It helps to understand the differences between the various data sources.

The NAR, DataQuick and other reports use the median house price; they take all the recent sales, and find the median price. This can be distorted by the mix of homes sold. When the bubble first burst, the median price continued to rise because fewer lower end houses were sold (the low end portion of the market with subprime loans slowed first). Now with jumbos being limited, the high end sales volume has fallen, and the median price has fallen quickly.

There is a better method, as Wessel notes:

The two best -- though far from perfect -- measures of housing prices are the Office of Federal Housing Enterprise Oversight's index and the gloomier Standard & Poor's Case/Shiller index. Both are based on a concept, developed in the 1980s by Karl Case of Wellesley College and Robert Shiller of Yale University, that looks at repeat sales of the same houses.

Using repeat sales, and adjusting for several factors (improvements, sales to family members, and more), gives a much better picture of price changes.

But Case-Shiller and OFHEO still give different results. In an earlier post, I noted the research of OFHEO economist Andrew Leventis House Prices: Comparing OFHEO vs. Case-Shiller.

Case-Shiller offers a national price index (released quarterly) and monthly price indices for 20 cities (with two composites: 10 cities and 20 cities). When comparing to OFHEO, it's important to compare similar indices.

OFHEO releases a national price index quarterly (monthly starting in March) and also provides prices for a number of cities. The OFHEO index is limited to repeat sales in the GSE database (Fannie and Freddie). This is an important difference.

When comparing the national Case-Shiller and OFHEO indices, there are a number of differences: OFHEO covers more geographical territory, OFHEO is limited to GSE loans, OFHEO uses both appraisals and sales (Case-Shiller only uses sales), and some technical differences on adjusting for the time span between sales.

OFHEO economist Andrew Leventis compared the prices in the ten major cities covered by Case-Shiller. He discovered that the main reason for the recent differences between the Case-Shiller and OFHEO indices was that prices for low end non-GSE homes declined significantly faster than homes with GSE loans. This was probably due to the lax underwriting standards on these non-GSE subprime loans.

Note that Leventis' research focused on the recent differences in the indices: he used data from Q3 2006 through Q3 2007.

This is critical. If someone believes the problems are contained to subprime, and that falling low end house prices will not impact the rest of the market, than OFHEO is probably the better index.


However I believe prices will fall across the board, and that the subprime market was just the first segment to see price declines.

Housing markets are intertwined, as this graphic indicates. Not all chain reactions start with a first time buyer using a subprime loan, but I believe the loss of a large number of subprime buyers will impact the entire chain.

I believe Case-Shiller is the better index for the 20 cities covered by the index - because it captures a wider number of sales (not just GSE) - although OFHEO is also useful because it covers a larger geographical area.

However, what everyone wants to know is what will happen in the future. As Wessel noted:

Predicting how much worse the U.S. housing market will get is tough. The future is never certain.

I have no crystal ball, but the key to house prices is supply and demand. Prices may be sticky, but they are not stuck. Prices will continue to fall until the inventory levels decline significantly. Areas with more inventory will likely see larger price declines; areas with less (especially less than 6 months of inventory) will probably see minor or no price declines.

by Calculated Risk on 2/19/2008 03:42:00 PM

From Dow Jones: Bond Insurer Woes May Cause $7-$10 Bln Hit For Banks: Moody's

Downgrades of bond insurers could require banks and securities firms to increase reserves by between $7 billion and $10 billion, rating agency Moody's Investors Service estimated on Tuesday.

If trouble in the so-called monoline business gets even worse, banks may have to set aside $20 billion to $30 billion to boost reserves covering counterparty risks, the agency added.
...
About 20 banks and securities firms have roughly $120 billion worth of hedges with financial guarantors on CDOs that contain asset-backed securities, Moody's said on Tuesday.

"We are currently evaluating these individual exposures to assess how institutions can absorb the additional counterparty reserves that might be required if one or more financial guarantors were downgraded," the agency said in a statement.

The headline states the obvious, but this gives an idea of the size of the problem according to Moody's.

by Calculated Risk on 2/19/2008 01:00:00 PM

Click on graph for larger image. The NAHB reports that builder confidence was at 20 in February, up from 19 in January.

Here are the individual components.

NAHB: Builders Remain Cautious as Buyer Traffic Improves in February

Builder confidence in the market for new single-family homes edged marginally higher in February as traffic of prospective buyers through model homes improved considerably, according to the latest NAHB/Wells Fargo Housing Market Index (HMI), released today. The HMI rose a single point to 20 this month, still close to its recent historic low reading of 18 (the series began in January of 1985).

“While builders remain very cautious about the outlook for new-home sales given today’s economic environment, the fact that more consumers appear to be checking out their options is a good sign,” said Sandy Dunn, a home builder from Point Pleasant, W.Va. and the newly elected 2008 president of the National Association of Home Builders (NAHB).
...
“Some potential buyers who have been sitting on the sidelines are starting to at least research a new home purchase given improving affordability factors and the large selection of units on the market,” said NAHB Chief Economist David Seiders. “That said, builders know there’s a difference between people looking and people buying, and their current outlook remains quite subdued. Additional stimulative measures on the legislative and policy side are definitely needed to bolster consumer confidence and help bring about a housing and economic recovery.”
...
In February, the index gauging current sales conditions for single-family homes rose one point to 20, while the index gauging sales expectations for the next six months declined one point to 27. Meanwhile, the index gauging traffic of prospective buyers rose five points to 19, its highest level since July of 2007.

Three out of four regions posted HMI gains for the month, including a three-point gain to 24 in the Northeast, a two-point gain to 24 in the South and a 2-point gain to 15 in the West. The Midwest registered no change for the month at 16.

by Calculated Risk on 2/19/2008 12:07:00 PM

"If you want to be in AAA, buy an Autoclub membership."
Anonymous

(hat tip BR)

by Anonymous on 2/19/2008 09:52:00 AM

One of the regular battles we'd get into in the comments on this blog in 2005-2006 was the "Good MEW/Bad MEW" thing. It would go like this: CR would post some data on Mortgage Equity Withdrawal and its impacts on consumer spending. Immediately, folks would pipe up to disagree with a claim CR never, actually, made, which is that "MEW" is "bad spending." The favorite "justification" of MEW was that it was being spent on "home improvement," which was--you see--an "investment," not "consumption." This was always opposed to those "bad spenders" who blew it on TVs or something.

So we're pretty thoroughly past that historical moment when the "investment" argument could be unproblematically deployed. My own interest in the subject, like CR's, was not to make some moralistic claim that consumption via MEW was intrinsically "bad," just that it was unsustainable, and the extent to which consumer spending was being brought to you by mortgage debt rather than disposable income did not bode well for the economic future. But I did think--and still do--that is worthwhile to try to distinguish between rehabilitation/renovation of elderly housing stock; luxury modifications of perfectly serviceable newer housing stock; financing routine repair, maintenance, and decorating; and cosmetic fixing-upping (generally a kind of correction for delayed maintenance or decorating, like paint and carpet) for the purpose of flipping the property. All of those things can fall under the rubric of "home improvement," but only the first and to a lesser degree the second really count as capital improvement in my mind. Insofar as these projects truly do increase the value of the real property, they are not MEW, even if they are financed with a cash-out refi or HELOC money; conceptually, MEW is an increase in mortgage debt greater than the increase in value of the property.

The trouble, then, was dealing with that group who were financing repair and maintenance and telling themselves they were doing "home improvements." First, homes require regular repair and maintenance merely to hold value: it's a carrying cost. Second, it becomes clear that too many owners financed repair and maintenance because they simply couldn't afford the cash outlay. Now that cheap interest-only HELOC money is harder to get, and old HELOC debt rolls into its adjustable rate/principal-payment period, some people are realizing that repair and maintenance are recurring costs they simply cannot afford to pay. You Californians get green pools; we Yankees get leaf-choked gutters; Georgians apparently get critters.

In that rather nebulous category between improvement and consumption somewhere in the middle, which we shall call "granite countertop syndrome," we're finally catching up with the reality of what lenders and appraisers call "overimprovement." In essence, overimprovement is cost in excess of value created; the problem can range from the McMansion thrown up on a postage-stamp lot in a neighborhood of 1,200 square foot older homes, to the decreasing marginal value of luxury materials. Every home needs flooring in the bathroom, but hand-painted imported tiles don't always increase the sales price of the home to the extent of their cost. My own belief is that a lot of sellers are setting "unrealistic" sales prices not just because they expect to get 2005-2006 prices, but because they expect to be reimbursed, dollar-for-dollar, for luxury "improvements." Sadly for them, one of the reasons we're all subprime now is that, frankly, we've all got granite countertops now. Why pay retail to an existing-home seller for that when the builders are discounting the wholesale price?

All that's by way of looking at some actual data on "remodeling":

ORLANDO, Fla. – Those fancy home fix-ups touted in cable TV shows and home magazines are losing their luster with consumers.

With the shakeout in the housing market, homeowners are worried they won't get their money back from high-dollar redos.

And lenders are less willing to finance pricey home improvements.

That has caused a decline in nationwide remodeling.

"We saw a downturn in 2007, and 2008 looks every bit as tough for the industry," said Kermit Baker, a researcher with Harvard University's Joint Center for Housing Studies. "After some almost record-breaking growth, the market has stalled."

Per capita home remodeling expenses in the region that includes Texas jumped almost 50 percent between 1996 and 2006. But since then, spending for home upgrades has fallen.

In a quarterly comparison, nationwide home remodeling expenditures have fallen about 10 percent since their high in 2006.

Researchers blame the downturn in the overall housing market for dampening the desire for home redos.

"Homeowners have been scaling back on their remodeling plans as the overall market has weakened," Mr. Baker said.

"Homeowners are concerned that they may be overimproving their homes relative to their neighborhood and prices in the market."

Studies back up those concerns. Average returns on a home remodeling project have fallen from 82.5 percent in 2003 to 70 percent last year.

With home prices depressed in many neighborhoods, homeowners are especially worried that they won't get the bucks back they spend on luxury features such as saunas, European cabinetry and imported tile floors.

"There are some signs that the emerging weakness may be greater at the upper end of the market," Mr. Baker said. "We are seeing more of a return to basics."

That means less costly improvements and standard maintenance, he said, rather than "some of the sexier kitchen and bath projects."

A 70% "return" on remodeling hurts even when you didn't finance the cost with a loan facing a steep increase in the interest rate. When you did . . .

by Calculated Risk on 2/19/2008 02:28:00 AM

From Reuters: Credit Suisse says writing down $2.85 bln

Credit Suisse said it was marking down asset-backed positions by $2.85 billion, which would wipe off $1 billion from its net income, but the bank would remain profitable in the first quarter.

Credit Suisse said on Tuesday an internal review which had identified mismarkings and pricing errors by a small number of traders in its Structured Credit Trading business was continuing.

From the WSJ: Now, Lehman Gets Pelted

... credit markets have worsened, and Lehman believes it is now facing a write-down in the $1.3 billion range, according to people familiar with the matter.
...
Nearly $39 billion [of debt securities and loans that are potentially vulnerable to markdowns] are commercial real-estate loans. Even as it cut way back on making home loans, Lehman continued to lend to buyers of office buildings and other assets. In the fourth quarter of fiscal 2007, ended Nov. 30, Lehman originated $15 billion of commercial mortgages, in line with the average origination in the previous three quarters.

Yet, the firm only sold off $1.5 billion of those loans, compared with more than $10 billion in the third quarter. As a result, its commercial-mortgage holdings have swelled. Now, analysts wonder how much they will have to be marked down.

The confessional is open. And the CRE lenders are queuing up.

by Calculated Risk on 2/18/2008 10:20:00 PM

From the WSJ: Ambac Hopes Capital Infusion Will Save Rating

Ambac ... is discussing a plan to raise at least $2 billion ... The extra cash, to be raised by selling shares to existing investors at a discount, would likely be a prelude to a trickier and lengthier move: splitting itself into two businesses.

The article discusses at length several of the difficult issues related to splitting the business:

Splitting the business between its municipal-bond and its riskier structured-finance operations ... would be financially and legally messy. It would pit policyholders and shareholders against both each other and regulators, and rankle investors, some of whom have been wagering through the credit-derivatives market that bond insurers would fail and default on debt.

So many different parties, and so many different and divergent interests, makes unscrambling the egg very difficult.

by Calculated Risk on 2/18/2008 05:56:00 PM

From the Pension Benefit Guaranty Corporation: New Investment Policy

The PBGC currently has approximately $55 billion to invest in the new investment policy. Under this new policy, the PBGC will allocate 45 percent of its assets to a diversified set of fixed-income investments, 45 percent to diversified equity investments and 10 percent to alternative investment classes. The agency’s previous policy set an equity investment target of 15–25 percent, although the actual level of equity investments was 28 percent at the end of FY 2007.

The PBGC had an accumulated deficit of $14 billion as of year-end FY 2007.

Because the PBGC’s obligations are paid over many years, the new investment policy is designed to take advantage of a long-term investment horizon. The strategy of increased diversification—including use of alternative investments—aims at generating returns, while providing superior protection against ultimate downside risks over time.

The policy was adopted after an extensive review process that began in mid-2007. The review evaluated current and alternative investment policies over 5-, 10- and 20-year periods. The review showed that the diversified portfolio adopted by the Board would have outperformed the current asset mix 98 percent of the time over rolling 20-year periods. The Board reviews the investment policy every two years, with the last review occurring in 2006.

“The PBGC has the ability to accept some degree of short-term volatility to achieve our goal of enhancing assets to pay benefits,” Millard said. “However, the policy is carefully structured to balance risk and returns, and to improve PBGC’s chances of reaching full funding over the long term, while maintaining our ability to meet our obligations to retirees.”

The PBGC does not select individual stocks or bonds, or actively manage its portfolio. Its invested assets are managed by professional money management firms or invested in various market indexes.

The PBGC is not funded by tax dollars, and does not enjoy the full faith and credit of the United States government. The agency is financed by premiums paid by employers, assets from failed pension plans, recoveries from bankruptcies and returns on invested assets.

The PBGC is a federal corporation created under the Employee Retirement Income Security Act of 1974. It currently guarantees payment of basic pension benefits for about 44 million American workers and retirees participating in over 30,000 private-sector defined benefit pension plans.

by Calculated Risk on 2/18/2008 02:06:00 PM

From the AP: Some homeless turn to foreclosed homes

The rise of the bandos!

More seriously - from unkempt yards, to mosquito infected pools, to bandos squatting in the homes, vacant homes are a negative externality for the neighbors.

by Calculated Risk on 2/18/2008 12:15:00 PM

From Bloomberg: Bond Insurer Split May Trigger Lawsuits, Analysts Say

``Despite the regulatory interest in separating the exposures, the essential fact remains that all policy holders, whether municipal or structured finance, entered into contracts backed by the entire entity,'' analysts led by Jeffrey Rosenberg in New York wrote in a note to investors dated Feb. 15. A breakup is ``likely to lead to significant legal challenges holding up the resolution of the monoline issues for years.''
...
``The fact that one group of policy holders' exposures has imperiled the policies of the other does not mean they should forfeit the value of their claims altogether,'' the Bank of America analysts said.

This split isn't being driven just by regulatory interest. It appears that the combined company is worth less than the sum of the parts. Splitting the company will allow the "good bank" to write more business, increasing the value. The goal is to share that increased value equitably among the stakeholders (a difficult task) and minimize the lawsuits.