by Calculated Risk on 2/21/2008 05:13:00 PM

From Bloomberg: MBIA Advocates Severing Municipal, Corporate Units

MBIA Inc.'s new Chief Executive Officer Jay Brown, under pressure to come up with a plan to rescue the troubled company, said bond insurers must separate their municipal guarantees from asset-backed securities.

...Bond insurers should also stop issuing credit-default swaps, Brown said.

Moody's Investors Service, which has AAA ratings on the insurance arms of MBIA and Ambac, has said it plans to complete a review of the ratings by the end of the month. Standard & Poor's is also considering a downgrade of the companies' ratings.

The three largest insurers all want to split their businesses.

From the WSJ Feb 17th: Ambac in Talks to Split Itself Up

From the WSJ Feb 15th: FGIC Will Request Break-Up

by Calculated Risk on 2/21/2008 03:09:00 PM

From the WSJ: Fitch: Unrealized Subprime Losses For Insurers May Reach $8 Billion

Fitch Ratings said U.S. life insurers have an estimated $7 billion to $8 billion in unrealized losses on subprime and Alt-A investments.

The credit rater said that amount totals 13% of exposure and 3% of total industry capital. Fitch expects the industry to have recorded losses of $2 billion to $3 billion in the fourth quarter.

Just a few billion more here and a few billion more there ... the losses keep adding up.

by Anonymous on 2/21/2008 02:21:00 PM

This is certainly innovative:

The Office of Thrift Supervision is preparing a plan to help mortgage borrowers who owe more than their homes are worth and to discourage them from abandoning those properties, agency officials said yesterday.

Under the regulatory agency's proposal, still in its early stages, these borrowers would refinance into government-insured loans that cover the current value of their homes. The refinancing would pay part of what's owed to the original lender. For the remainder, the lender would get what the plan's backers call a "negative equity certificate." The lender could redeem the certificate if the home is eventually sold at a higher price. . . .

The proposal was briefly mentioned at a regular quarterly news briefing. More details should emerge over coming weeks, Petrasic said. The plan has been extensively analyzed internally and is now being discussed with policymakers and industry officials, he said.

The plan would separate a troubled mortgage into two parts. The first would cover the current fair-market value of the home and would be refinanced by the Federal Housing Administration. The remainder would be issued to the original lender as a certificate.

If the borrower eventually sells the home, the FHA mortgage would be paid off first. Remaining cash would be applied to paying off the value of that certificate. Anything left over would go to the borrower.

If there's not enough profit to pay off the certificate, the original lender would take a loss, which makes this proposal a gamble. However, the plan anticipates that there would be a market where these certificates are traded. That means the lenders could sell them immediately to offset some of the loss or hold them with the hope that they will appreciate, said Jaret Seiberg, an analyst at Stanford Policy Research.

The certificates would likely trade for small amounts, maybe $2 for every $100 in home value, and the amounts would increase as the housing market strengthens, Seiberg said.

But there are still many political and logistical hurdles.

This plan has not been vetted by the White House, Congress or other policymakers. The FHA declined to comment on the specifics except to say it is "regularly looking at new ideas and actively exploring ways to expand the eligible pool of creditworthy borrowers FHA can serve."

Whether investors will embrace the idea depends on many details that aren't resolved, Seiberg said. But it could be a way for lenders to cut their losses. "It beats foreclosure," Seiberg said. "These certificates enable [investors] to share in the upside if the housing market recovers."

For borrowers, avoiding foreclosure means they get to keep their homes and reduce damage to their credit.

"What we tried to do is figure out the best way to create market incentives for all the parties involved," Petrasic said.

That's a real twist on the idea of taking back a lien on a property to recapture any future equity. Apparently, only the FHA mortgage would be a lien against the property, with the certificate being an obligation of FHA? It certainly surprises me that the OTS feels confident it can work out the legal kinks with that quickly enough to make a difference.

by Calculated Risk on 2/21/2008 09:56:00 AM

Mastercard has invested some of their working capital in Auction Rate Securities (ARS). Right now they can't sell the ARS. There is little credit risk, but this could be a liquidity concern for other companies.

From the Mastercard SEC 10-K filing today (hat tip BR):

The Company sold approximately $100 [million] in auction rate securities subsequent to December 31, 2007, however starting on February 11, 2008, the Company experienced difficulty in selling additional securities due to the failure of the auction mechanism which provides liquidity to these securities. The securities for which auctions have failed will continue to accrue interest and be auctioned every 35 days until the auction succeeds, the issuer calls the securities, or they mature. Accordingly, there may be no effective mechanism for selling these securities and the Company may own long-term securities. As of February 15, 2008, the Company had approximately $252 [million] of auction rate securities and at this time it does not believe such securities are impaired or that the failure of the auction mechanism will have a material impact on the Company’s liquidity.

And it appears, according to the following Bloomberg article that the reason the auctions are failing is because the investment banks are no longer backstopping the auctions: Auction Debt Succumbs to Bid-Rig Taint as Citi Flees

The collapse of the auction-rate bond market, where state and local governments go to raise cash, demonstrates that regulators are no match for Wall Street.

Hundreds of auctions have failed this month, sending borrowing costs as high as 20 percent because dealers from Goldman Sachs Group Inc. to Citigroup Inc., UBS AG and Merrill Lynch & Co. stopped using their own capital to support the sales. Regulators, who allowed the manipulation of bids and lack of information to persist even after two probes in the past 15 years, are now watching a $342 billion market evaporate at the expense of taxpayers.

Inadequate disclosure ``may have masked the impact of broker-dealer bidding on rates and liquidity,'' Martha Haines, head of the Securities and Exchange Commission's municipal office, said in an interview. ``The large numbers of recent auction failures, which are reported to have occurred due to a reduction in bidding by broker-dealers, appears to indicate those concerns were well founded.''

This shows the spread of the credit crunch. The banks are suffering a liquidity crisis (because of a solvency crisis). They are not backstopping the ARS, forcing state and local governments to pay higher rates on the ARS or refinance at a higher rate with longer term maturities - and causing a potential liquidity problem for corporations.

by Calculated Risk on 2/21/2008 08:58:00 AM

The 4-week moving average of weekly unemployment insurance claims reached 360,500 this week, indicating a possible recession.

From the Department of Labor:

In the week ending Feb.16, the advance figure for seasonally adjusted initial claims was 349,000, a decrease of 9,000 from the previous week's revised figure of 358,000. The 4-week moving average was 360,500, an increase of 10,750 from the previous week's revised average of 349,750.

Click on graph for larger image.

This graph shows the weekly claims and the four week moving average of weekly unemployment claims since 1989. The four week moving average has been trending upwards for the last few months, and the level is now above the possible recession level (approximately 350K).

Labor related gauges are at best coincident indicators, and this indicator suggests the economy might be in recession.

Note: There is nothing magical about the 350K level. We don't need to adjust for population growth because this indicator is just suggestive and not precise.

by Anonymous on 2/21/2008 08:17:00 AM

Our blogleague James Bednar of New Jersey Real Estate Report gets quoted by ABC News (who fails to provide the blog link in the online version, ahem) on the subject of relitter relisting:

"When you re-list a home, you know, it's still been on the market for X amount of time, but a buyer that comes in with another agent very likely won't know," Niece said.

Here's how it works: Niece cancels house listings when they reach 70 days on the market, and then re-lists them as new, with 0 days on the market.

"So, when the buyer says, 'Well, how long's this one been on the market?' And he looks at a report that normally an agent or a buyer would have when they're showing houses, it only shows the current time on the market," Niece said. "So a buyer's going to be way more positive as they look through a home that says 25 days versus 125 days." . . .

Across the country in Sacramento, California, the problem got so bad that Michael Lyon, CEO of Lyon Real Estate, blew the whistle after he noticed that one third of all "new" listings were re-listings.

"This is just silliness," he said. "I'm sorry, but you can't pull the wool over the buyer's eyes."

Lyon forced his regional listing service to set a new standard. "We let people see all the previous listings, period, there are no secrets," he said. "We want the buyer to know everything about all the times it was listed, so we can allow them to truly investigate the home."

The Sacramento listing service also requires a material change in the house if it is to be re-listed. Other regional listing services have gone one step further, forcing sellers to take their home off the market for 30 days before posting it again. But because listing services are local agencies, each makes its own rules.

And then:

The National Association of Realtors says it hasn't seen a need for regulation on re-listing because it is not aware of a problem.

by Anonymous on 2/21/2008 07:49:00 AM

Bloomberg reports:

Feb. 20 (Bloomberg) -- A record 41 companies with high- yield, high-risk credit ratings are in danger of breaching terms of their loan agreements within 12 months as the slowing economy cuts into corporate profits, Moody's Investors Service said. . . .

The percentage of speculative-grade bonds that are distressed, meaning their yields are at least 1,000 basis points higher than benchmark rates, rose to 20.9 percent as of Feb. 15, about the same ratio as in the months preceding the recession that began seven years ago, according to Merrill Lynch & Co.

Debt is 20 times more likely to default within a year once it's crossed the distressed threshold, according to data by Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York.

Seven borrowers rated by Moody's, including Montreal-based printer Quebecor World Inc., defaulted in January, up from zero in December. The default rate for junk-rated issuers may soar to more than 8 percent this year, the highest since Enron Corp.'s collapse rippled through markets in 2002, according to an analysis of data by Zurich-based UBS AG shows. The rate was 0.9 percent at the end of 2007, the lowest in 26 years, Moody's said.

Then again, there's always a silver lining:

Sharper Image Corp., the seller of $300 electric shavers and $1,999 massage chairs, and catalog retailer Lillian Vernon Corp. filed for bankruptcy protection today after struggling with declining sales. Neither company is on the Moody's list.

Could we be looking at a world without monogrammed silver dog bowls? That'd be the best news I've heard in a long time. . . .

by Calculated Risk on 2/20/2008 06:01:00 PM

From Reuters: Economy.com sees home prices down 20 percent

A rapidly deteriorating U.S. economy will cause home prices to drop by 20 percent peak-to-trough, a leading economist said on Wednesday.

Mark Zandi, chief economist and co-founder of Moody's Economy.com, said he also expects a recession in the first half of this year.

In December, Zandi was forecasting house prices would fall 13% and the economy would "skirt a recession".

by Calculated Risk on 2/20/2008 02:39:00 PM

Note that Martin Feldstein is the (edit: outgoing) President and CEO of the organzation that officially calls economic cycles in the U.S., the National Association of Economic Research (NBER)

Feldstein writes in the WSJ: Our Economic Dilemma (hat tip rtalcott)

Although it is too soon to tell whether the United States has entered a recession, there is mounting evidence that a recession has in fact begun.
...
If a recession does occur, it could last longer and be more painful than the past several downturns because of differences in its origin and character. The recessions that began in 1991 and 2001 lasted only eight months from the start of the downturn until the beginning of the recovery. Even the deeper recession of 1981 lasted only 16 months.

But these past recessions were caused by deliberate Federal Reserve policy aimed at reversing a rise in inflation. In those cases, the Fed increased real interest rates until it saw the economic slowdown that it thought would move us back toward price stability. It then reversed course, reducing interest rates and bringing the recession to an end.

In contrast ... [a] key cause of the present slowdown and potential recession was not a tightening of monetary policy but the bursting of the house-price bubble after six years of exceptionally rapid house-price increases. The Fed therefore will not be able to end the recession as it did previous ones by turning off a tight monetary policy.

Professor Krugman has made this same point: Postmodern recessions

A lot of what we think we know about recession and recovery comes from the experience of the 70s and 80s. But the recessions of that era were very different from the recessions since. Each of the slumps — 1969-70, 1973-75, and the double-dip slump from 1979 to 1982 — were caused, basically, by high interest rates imposed by the Fed to control inflation. In each case housing tanked, then bounced back when interest rates were allowed to fall again.

But this time, as the Fed cuts rates, housing will probably not "bounce back" because prices are still too high, and there is a huge overhang of supply.

Feldstein notes the uncertainty about housing prices, and continues:

[M]arket participants now lack confidence in asset prices, they are unwilling to buy existing assets, thus preventing current asset owners from providing credit to new borrowers.

And until market participants regain confidence in asset price, Feldstein argues Fed policy might be ineffective:

Monetary policy may simply lack traction in the current credit environment.
...
It is not clear what can bring back the confidence in asset prices that is needed for credit to flow again. Some analysts suggest that confidence would return if the financial institutions declare the true market value of their assets by restating balance sheets at the depressed prices at which they could be liquidated today. But this is not a practical solution, since many complex securities are no longer trading in the market. Forcing an actual sale of these securities at fire-sale prices in order to establish market values could also create unnecessary bankruptcies that would further impede credit flows.

Feldstein seems to be solidly in the severe recession camp.

by Calculated Risk on 2/20/2008 02:20:00 PM

Portfolio.com's Felix Salmon takes his turn at correcting the NY Times' Gretchen Morgenson, this time with regards to her article on credit default swaps. (hat tip Martin)

From Salmon: A Misleading Chart on Credit Default Swaps

This graphic ... from Gretchen Morgenson's front-pager in the NYT ... shows the market in credit default swaps, at $45.5 trillion, dwarfing the markets in U.S. stocks ($21.9 trillion), mortgage securities ($7.1 trillion), and U.S. Treasuries ($4.4 trillion).

Morgenson's article makes it clear that it's reasonable to directly compare market sizes like this. Indeed, she refers to CDSs as "securities" in the third paragraph of her piece:

The market for these securities is enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion -- roughly twice the size of the entire United States stock market.

But of course a credit default swap is not a security, it's a derivative. The $45.5 trillion is a notional amount; the size of the stock market is a hard valuation. There's an enormous difference.

Morgenson is right that there are problems in the CDS market. But she over-eggs her pudding so much that it's very hard to separate the good points from the bad.

The bad news is there are serious issues with the CDS market. The good news is we've outsourced the GM Watch feature!