by Calculated Risk on 3/03/2008 12:29:00 AM

From the WSJ Heard on the Street: Wall Street Gears for Its New Pain

After suffering a beating from their exposure to home loans, banks and securities firms are about to take their lumps from office towers, hotels and other commercial real estate. And the losses could last longer than those from the subprime shakeout.

As the economy wobbles and financing costs rise because of the credit crunch, commercial-real-estate values are starting to slide, with analysts at Goldman Sachs Group Inc. projecting a decline of 21% to 26% in the next two years. That means misery for securities firms with exposure to commercial-real-estate loans and commercial- mortgage-backed securities.

by Calculated Risk on 3/02/2008 11:31:00 AM

Gretchen Morgenson at the NY Times provides us with some employment data from TrimTabs: The Buck Has Stopped

TRIMTABS, which estimates employment growth using data from an online job index and an analysis of income tax withheld versus job creation rates, has been far more accurate than the Bureau of Labor Statistics. For example, in 2006, the government’s initial estimates of employment growth came in at 1.52 million jobs. But the bureau revised that data upward in February 2007, for a total of 2.24 million.

By comparison, TrimTabs’ estimates of 2006 employment growth, using real-time data, totaled 2.39 million jobs. The firm reported those figures to clients contemporaneously.

Last week, TrimTabs told clients it estimated that 77,000 jobs would be lost in February; Wall Street economists are calling for a gain of 30,000 for the month.

Since October 2007, TrimTabs estimates, the economy has lost about 175,000 jobs, the first sustained employment drop since early 2003.

I don't know about the accuracy of the real time TrimTab estimates, but this reminds us that the BLS methodology is subject to signficant revisions (that might be lagged by a year), and that the BLS will almost certainly miss any turning point.

The BLS had acknowledged this weakness:

The most significant potential drawback ... is that time series modeling assumes a predictable continuation of historical patterns and relationships and therefore is likely to have some difficulty producing reliable estimates at economic turning points or during periods when there are sudden changes in trend.

This is something to think about for those that argue - because the BLS employment numbers haen't been consistently negative - the economy isn't in recession yet. Just wait for the revisions.

And on recessions, the NY Times reports in "A Rerun, Maybe, but of What Show?" that Citigroup's Tobias Levkovich and Byron Wien of Pequot Capital are also predicting a recession. Welcome to the dark side.

by Calculated Risk on 3/01/2008 08:45:00 PM

Professor Shiller writes in the NY Times: How a Bubble Stayed Under the Radar

Shiller discusses “information cascades” that can lead rational people to make investment errors (like not realizing there was a bubble in the housing market).

Last year, in response to a speech by Minneapolis Federal Reserve President Gary H. Stern, I wrote:

Stern's subject was economic education. He appears to suggest policy makers overestimated the skills of American consumers, and therefore underestimated the need for more regulation - obviously referring to the housing slump.

This assertion seems absurd.

It was the policy makers who didn't recognize rampant speculation in the housing market. While we joked about "liar loans" here on Calculated Risk, the policy makers were congratulating themselves on the "ownership society". I'd argue home buyers who used no money down option ARMs were making a rational choice: they were balancing the odds of a big payday with little financial risk - if the property continued to appreciate - with the stigma of a foreclosure on their record. Obviously many home buyers felt the stigma was worth the risk. I don't see that as a lack of economic education, rather a rational choice given the circumstances.

But I can't think of a good excuse for the inaction of the policy makers.

Shiller provides a possible explanation for the inaction of policy makers.

by Anonymous on 3/01/2008 01:30:00 PM

Some of you could stand to know in somewhat more detail how repayment plans for delinquent mortgages work. The rest of you are reading this for reasons I am still unable fully to understand, but I have come to accept that Calculated Risk junkies have a tolerance for outright nerdiness that never fails me.

I am still getting emails directing my attention to this post of Mish's from last week, which claims to be "evidence of walking away" based on a set of monthly numbers from a gnarly old (2007) WaMu Alt-A pool:

The chart shows performance by month since July, 2007. Rows 2-6 are delinquencies through REO (Real Estate Owned). In theory, this should work like an assembly line: Mortgages enter 30 days delinquent, the next month that subset goes into 60 days, then 90 days, then foreclosure, then REO. It's a process that takes time.

Look at this most recent jump from December, 2007 to January, 2008. Foreclosures increased a whopping 4.92%, yet in December, 2007 the 90 days delinquent bucket was only 3.79% (If every 90 day delinquent loan went to foreclosure, the jump would only have been 3.79%) How could this happen? The evidence suggests that people are walking away 30 days or 60 days delinquent without even waiting for foreclosure.

I'm sorry Mish, but this isn't "evidence of walking away," nor is your theory on foreclosure timelines quite right. I'm not here to beat up on Mish, but as I was the one who got snotty and demanded evidence for the "walking away" story, I suppose I need to explain why this isn't it.

First off, I am going to perform the incredibly tedious act of demanding that we define our terms. Yes, I'm one of those. "Walking away" is hardly a precise term, and it undoubtedly means different things to different people. The claim I am having a problem with has been made in slightly different ways by different people; this is the WSJ's formulation of it (which I think we can call the new "conventional wisdom"):

As home prices plummet, growing numbers of borrowers are winding up owing more on their homes than the homes are worth, raising concerns that a new group of homeowners -- those who can afford to pay their mortgages but have decided not to -- are starting to walk away from their homes. . . . some homeowners in weak markets are concluding that house prices won't recover anytime soon, and therefore they are throwing good money after bad.

Let us understand the elements of this claim. In this sense, the "walking away" group are:

1. Upside down on their mortgages.
2. Fully aware that they are upside down on their mortgages.
3. Fully convinced that this is a long-term problem.
4. Able to make their mortgage payments under existing mortgage terms.
5. Ceasing to pay those mortgages, and making no attempts to postpone or prevent foreclosure by working with the servicer beyond, possibly, requesting (successfully or not) a deed-in-lieu (a/k/a "jingle mail") or short sale.
6. Either occupying the property "rent free" until the sheriff shows up, or simply abandoning the property (presumably renting elsewhere or perhaps buying a cheaper one) to sit vacant until the servicer can foreclose.

This is a strong set of claims. There is no reason to think this set of claims cannot be empirically verified. However, we need to get straight on what might or might not constitute empirical verification.

It is not enough to point to foreclosure rates, vacancy rates, or servicer reports of "no-contact borrowers." You can have a "no-contact borrower" because the borrower is dead, in jail, in the hospital, in another state looking for work, or in the middle of a nervous breakdown caused by financial distress that leads him or her to refuse to answer the phone. You can have servicers with the wrong phone number on their databases, and phone service that has been disconnected. You can have servicers who don't really actually try very hard, and you can have servicers whose collections staff are such unmitigated horse's asses or rank incompetents (I would here include those with limited command of the borrower's spoken language) that borrowers who have had prior contacts with them simply see no point in talking to them any further, and this might be a rational decision. I am not saying that all no-contacts are these cases; I am saying that the fact of a borrower reported as "no contact" is not direct evidence of the walk-away claim. Large numbers of no-contact borrowers being reported may support this claim, or is at least consistent with it, but it doesn't prove it.

Vacancy of the subject property doesn't prove the strong walking away claim, either. It's quite likely many of these vacant properties were speculative purchases. Speculators walk away from mortgages quite frequently in an RE downturn, but that is often because they are speculators: they did not buy this property as a long-term investment, and are therefore entirely unprepared, financially as well as emotionally, to hang onto it. It was and is a huge scandal of the last several years that we made mortgage loans for speculative real estate purchases to people who couldn't possibly ever carry that mortgage payment if the flip didn't flip on schedule. There is something a great deal more than a little odd about including this group in the "people who can afford their mortgage" bucket.

Otherwise, you can quite frequently find that financially-distressed borrowers end up vacating their homes, because they lost their jobs and are looking for or have accepted employment elsewhere, or they are so distressed that they can't even keep the lights on or feed themselves even while skipping the mortgage payment, and have moved in with family or something. Again, I am not making a claim about whether all or most vacated properties fall into this group; I am saying that it happens this way in at least some cases, and therefore while vacant properties may be consistent with "walking away," they are not proof of "walking away" in the strong sense.

Of course it should be clear to everyone that the strong claim involves assertions about the borrower's knowledge and motivations that could only be proven or disproven by interviewing those borrowers. Items 2 and 3 are not verifiable in reference to any source of information other than the contents of the borrowers' own minds. You simply cannot get there from statistics on foreclosures gleaned from remittance reports or property listings. Yet items 2 and 3 are central to the claim being made: you cannot say borrowers are doing the "ruthless put" unless you are saying that they know what the situation is and have done the personal cost/benefit analysis.

Such evidence as we might get for that is likely to be anecdotal. Enough anecdotes, rigorously analyzed and uncontaminated by preconceived notions of the story-teller or reporter are not, in my view, worthless as evidence. I am, however, still waiting for even one that fits all the conditions of the strong claim and provides enough detail about the facts of the case that we can assure ourselves it isn't an after-the-fact interpretation of a series of events. And let me observe that even with a round handful of such unambiguous anecdotes (I have ten fingers, myself, so let's call that ten), you still have some trouble with the "trend" part. There are in the vicinity of 40 million first-lien mortgage loans outstanding in this country at the moment. It is, statistically, almost certain that you could find a dozen ruthless defaults. I suspect you could find a dozen mortgages that are delinquent because the borrower made a donation he couldn't afford to the New Universal Church of Jesus On a UFO. You could probably find at least one loan that was 90 days down but the borrower was saved from foreclosure at the last minute by buying a winning lotto ticket. Trends, folks. Mean bigger numbers that what I've seen thrown around in the anecdote department.

Does the very existence of this YouWalkAway.com website prove that it has a lot of takers? Does the very existence of websites offering to take several hundred of your dollars to provide you with a sure-fire way to avoid paying your income taxes prove that the non-tinfoil-hat crowd is flocking to those sites in startling numbers? Some days I do worry about the conclusions drawn by reporters who don't really hang out on the Internet much.

Any serious investigator would start, not with stories passed around on the Internet, but with servicer logs. It is hard to get your hands on that kind of information, but it's there and serious investigators--hi, Fed guys!--surely ought to be able to work up a project. You really need to look at real case histories, to see if servicers have ever been able to document a case like the one described here in items 1-6. Perhaps a collector made one contact with the borrower, who said he wasn't going to bother to pay the mortgage because he was upside down, so there. (That would be documented in the collector's call log.) Perhaps the servicer had contact with a listing agent or appraiser, who provided this information about the borrower. Perhaps a servicer really did get one of those letters prepared by the YouWalkAway.com clowns.

Even with that, you also need some evidence that these folks are truly not financially distressed. That could come in a number of ways, but I warn you right now that if you look at one of these things and see that the original loan was made on stated income at a DTI of 45% using an interest-only loan and no down payment because the borrower had zero savings at the time, I am going to question your claim that affordability isn't an issue. You will have to prove that the borrower's finances improved since loan closing, as far as I'm concerned. I did not spend a whole mortgage boom arguing that loans like that were evidence that people cannot afford homeownership at current prices, only to roll over for you now and say people who have such loans can afford to carry their debts and just don't feel like it.

So let's get back to Mish's claim. It has to do, basically, with the assertion that a fast foreclosure is indirect evidence of walking away. The claim, I think, is that if large numbers of loans go to a status of foreclosure after only a 30- or 60-day delinquency, that means that the servicer has concluded that the borrower "just walked away" and there is no point to anything other than immediate foreclosure proceedings. (I don't know how else to interpret "without even waiting for foreclosure," since he's looking at loans in a foreclosure status.)

The problem is that this is drawing conclusions without enough information. For starters, we need to distinguish between "days delinquent" and "time." Mish is correct that on the whole, most servicers don't start foreclosure proceedings until a loan is 90 days or more past due. That means, technically, that the "last paid installment date" (LPI) on the servicing system is 89 or more days in the past (depending on the method you use; that part isn't important right now). It does, indeed, take three months to rack up a consecutive 90-day delinquency. It can, however, take a year, if the borrower skips payments that are not made up but does not do so consecutively. That is why the reference point is LPI: servicing systems do not assign payments to the month you mailed them, they assign them to the earliest due date. If you skipped the February payment and then made a payment in March, the payment received in March would be applied to the February 1 due date, moving the LPI from January 1 to February 1, and meaning that you are still "30 days delinquent." If you make the next six consecutive payments on time, but never make up that missing payment, you will be "30 days delinquent" for six months. In some states it is actually possible for a servicer to start foreclosure proceedings against you for being 30-days down for six months. Whether it is likely that a servicer would chose to do that is another matter. In my experience it is more likely that a servicer would initiate foreclosure on an uncured rolling 60 than on an uncured rolling 30.

It is also important to bear in mind that "foreclosure" is a process, not a discrete event in time, in this context. The reports you see like the one Mish captures from Bloomberg are based on servicer remittance reports to the security trust, and what is reported in the "FC" bucket is loans for which the foreclosure process has been started. The "start" in this particular context (reporting to the investor) is the day the servicer turns the file over to its foreclosure counsel or a public trustee (for non-judicial power-of-sale foreclosures). As a general rule, this step occurs after a whole lot of other nasty things have already happened, such as the borrower getting a "breach letter" that "accelerates" the mortgage (demands all sums due and payable). The exact sequence of events is different in different states; the point for purposes of reading remittance data is that the loan goes into a status of "FC" when this legal process commences, and it stays in that status for as long as it takes to get to the day the property is sold on the courthouse steps. (After that, the loan either goes away--it is liquidated via application of proceeds from the purchase of the property by a third party, or it becomes REO. These days nearly all loans become REO. They stay REO until someone buys the property from the servicer, at which point the loan goes away.)

It is therefore typical that loans can stay in FC status for months--even years in the uglier cases--and that loans can go in and out of that status. If a borrower sells the home, brings the loan current, or agrees to some workout plan after the file was referred to the legal people, then the loan can be taken out of FC status and put back to plain old seriously delinquent of the relevant number of days or current, depending on the circumstances. "Loans in Foreclosure" is a pipeline, not a report of final dispositions of loans. Final dispositions would be reported in some category like "foreclosures completed for period x," and you don't get that on remittance data displayed on Bloomberg. This is why, over time, that "FC" bucket starts to pile up. In the current environment we have FC starts seriously outpacing FC completions, so month-to-month the FC pipeline gets bigger. (Same goes with "REO": if you are completing FCs faster than you're selling the REO, the inventory piles up and you see the REO category getting larger every month.) Someday we'll get to the point where we're closing cases faster than opening them, and those numbers will begin to shrink.

The really important thing here is that we do know that servicers are busy offering some sort of workouts. We know from the MBA that most of them, at the moment, don't seem to be permanent modifications; they're repayment plans or forbearance. Often, a repayment plan is a precursor to modification: the servicer agrees to permanently modify the mortgage only if the borrower successfully completes a repayment plan first, so the two categories aren't mutually exclusive.

I refuse to take responsibility for the way other people throw terms around, but I will take responsibility for my own terms. A repayment plan is an agreement to allow the borrower to resume making regular payments and make up past-due payments on an installment basis for a limited period of time. The resumed payments might temporarily be at a lower rate, which would be appropriate if the servicer is offering the plan prior to a permanent modification; this servicer wants to see you make three to six or nine payments at the reduced interest rate before permanently modifying the mortgage terms. In other cases the resumed payments are at the original contractual terms.

A forbearance is a short-term agreement to let you make no payments, or less than the contractual payments, as long as you bring the account current by the end of the forbearance period. This is, for instance, the one we might see with a borrower who has a documented hardship and a real sale pending: it gets the collections people off the borrower's case while waiting for the sale to settle. Or the borrower is temporarily disabled but will go back to work once the stitches come out. It is not the most widely available kind of workout by any means. In most data sources, forbearances are lumped in with repayment plans, as they are in the MBA data, but it's important to know that the number of true forbearance arrangements is small; almost all temporary workouts are repayment plans.

That matters because the terms of the temporary plan will affect how the loan's delinquency status is reported. Imagine a loan that goes 90 days down (three consecutive payments missed), and then is given a 90-day forbearance agreement some time in the month preceding the 90th day of delinquency. That means that the servicer will report that loan for the next three months as 90, 120, and 150-days down until the expiration of the forbearance; at that point either the borrower brings the account current or foreclosure is initiated. This is why you would see loans reported as 90+ days down but not in FC status.

Take the same situation (a borrower three payments behind) who is given a nine-month repayment plan. Typically, this borrower would be required to 1) bring current all outstanding fees immediately, 2) make scheduled payments each month, on time, for the next nine months, plus 3) make a payment equal to one-ninth of the past-due payments each month for nine months. For the next nine months this loan would be reported as 90, 90, 60, 60, 60, 30, 30, 30, current. (One-ninth of the past due amount or one-third of a payment accumulates in a suspense account until you have enough to apply a whole payment, which advances that LPI another month.)

This kind of thing complicates the assumption that Mish is operating under about the "normal" movement of loans to successive delinquency statuses. The picture is further complicated because nobody I know of ever offers a borrower who is 90 days or more down any forbearance or repayment plan without forcing the borrower to sign an agreement, usually called a "stipulation," that says that the servicer is suspending, not dismissing, foreclosure proceedings, and that allows the servicer to restart the FC process at the original point of suspension if the borrower defaults on the repayment plan. In other words, the "clock" does not restart at zero, requiring another three months (or whatever is required in a state) before FC can be refiled; the "clock" resumes at wherever we were when the repayment plan was signed. Honestly, folks. Servicers can be stupid, but they've never been that stupid.

So take our repayment plan borrower, and assume he only makes it for six months in his plan and then misses a payment again: his loan goes from 90 to 60 to 30 to FC, because missing a repayment plan installment "puts him back" to where he was in the foreclosure process.

If you have a servicer who is doing a lot of repayment plans, and the MBA data suggests we have that, then you're going to see a lot of delinquency statuses going "in reverse," and you're also going to see, unfortunately, a lot of loans going from 30-days or 60-days down straight to FC, because the MBA data tells us that 29% of all FCs in the third quarter of 2007 happened after a repayment plan failed. That nasty fact may tell us something about the wisdom or practicality of these repayment plans. It may tell us that borrower financial distress just keeps increasing. It may tell us that borrowers get demoralized long before they're done with the repayment plan and just give up. It may tell us that some borrowers entered the repayment plan in less than complete good faith. We'd need more evidence to decide that. But the last thing it tells us is that borrowers are "just walking away" with no attempt to save their homes.

Reading and analyzing real-time remittance reports is a complicated matter that can lead you down the wrong path if you aren't well-versed in how it all works. I fault no one, certainly not Mish, for not being an expert in remittance analysis. It is only recently that this became something non-experts were interested in, after all. (For most of my years in this business I'd have called you a liar if you'd said the day would come when huge numbers of civilians would avidly read websites that post long treatises on boring technical mortgage-related crap when they were not forced to. I'd have been wrong.)

To return to the MBA report:

During the third quarter [2007], mortgage servicers put in place approximately 183 thousand repayment plans and modified the rates or terms on approximately 54 thousand loans. Lenders modified approximately 13 thousand subprime ARM loans, 15 thousand subprime fixed rate loans, 4 thousand prime ARM loans and 21 thousand prime fixed-rate loans. In addition, servicers negotiated formal repayment plans with approximately 91 thousand subprime ARM borrowers, 30 thousand subprime fixed-rate borrowers, 37 thousand prime ARM borrowers and 25 thousand prime fixed-rate borrowers. During this period the industry did approximately one thousand deed in lieu transactions and nine thousand short sales.

Plus this one reporter found this one guy who said, "I don't think that house is going to recover in value any time soon . . . I'd just be throwing the money away."

Even if only 20% of all those repayment plans and modifications were appropriately done only for borrowers with a commitment to keeping the house, not just tossed out like candy to someone who only wants to delay the sheriff's sale, Dr. Data says that "being dragged kicking and screaming" borrowers are outnumbering reported cases of "walking away" borrowers. I've read about more cases of borrowers bitterly contesting foreclosures (with more or decidedly less heart-wrenching situations) than I have borrowers who just don't care whether the lender takes the house or not.

I do not claim that "just walking away" isn't increasing; I don't have enough facts one way or the other. I remain convinced, however, that it's pretty damned convenient for the mortgage industry to convince you that these folks can afford their loans and are not even trying to get caught up. Blaming it on borrower ruthlessness deflects attention from lender ruthlessness, like the ruthlessness of making loans to people who cannot display any particular evidence that they can afford the payments. I simply refuse to play into their hands here.

I certainly agree that the industry is scared to death that "just walking away" will become fashionable. But that's a slightly different matter. We are having more than enough troubles with borrowers who simply cannot afford to keep making house payments and can't sell. It will surely be Armageddon if the better-heeled among us just walk off. On the other hand, these people with money are going to have to live somewhere, and if they're walking away in order to rent from struggling investors or buy REO, then while they're passing the losses onto the lenders, they're not so clearly contributing to further price drops. It's possible to imagine--just as an exercise--that the whole thing stabilizes only when the moneyed walk-aways make it stabilize, at the expense of lenders and investors as bagholders. My guess is that's the kind of ending the industry didn't have in mind. But you can easily imagine that the industry is sounding the alarm about "walk-aways" because they're rather desperate to show their lawmakers and their regulators and their monetary policymakers that they're the "real" victims here.

by Calculated Risk on 3/01/2008 01:20:00 AM

This is pretty amazing. Check out the graph at the WSJ!

From the WSJ: Hedge Funds' Fire Sales Send Muni-Bond Yields To Historic High Levels

Months of turmoil in the municipal-bond market, long a placid haven for individual investors, reached a boiling point Friday -- as hedge funds were forced to unwind complicated bets and in the process dump billions of dollars of the securities.

As a result of that surprising forced selling, yields on debt from municipalities and other tax-exempt issuers jumped to their highest levels in history, when compared with safe debt issued by the U.S. government. The average AAA-rated, 30-year municipal bond yielded 5.14% Friday afternoon, compared with 4.42% on a U.S. Treasury 30-year bond.

I checked with Schwab tonight, and they are offering some AAA 30-year munis yielding close to 5.5%, and some AAA 10-year munis at 4.4%. Talk about a liquidity crisis!

by Calculated Risk on 2/29/2008 09:06:00 PM

From the 2008 U.S. Monetary Policy Forum

"Leveraged Losses Lessons from the Mortgage Market Meltdown" by David Greenlaw (Morgan Stanley), Jan Hatzius (Goldman Sachs), Anil Kashyap (Chicago GSB) and Hyun Shin (Princeton).

Hatzius summarizes (via email):

Our story is as follows. While the mortgage credit losses still don’t look huge relative to the size of the economy or the financial markets -- the baseline assumption in the paper is $400bn in losses ... they are nevertheless responsible for much of the financial and economic turmoil of the past 6 months. We estimate that roughly half of the total losses are likely to be borne by leveraged US financial institutions ... Assuming that these institutions will aim to lower their leverage by 5%, our baseline estimate is that they will scale back their lending by close to $2 trillion in response to these losses, even if we assume that they manage to “replace” 50% of the lost equity via inflows of unlevered capital, e.g. from sovereign wealth funds. Further, we estimate that just under $1 trn of this credit supply hit is a “ Main Street ” event and will hit unlevered entities such as households and nonfinancial businesses; the remainder is a “Wall Street” event and will hit other leveraged institutions. Finally, we (very tentatively) estimate that the credit supply hit could shave 1-1½ points from real GDP growth over the next year, over and above the “traditional” hit from reduced homebuilding demand, a negative wealth/MEW effect on consumer spending, and the multiplier effects working via the labor market.

by Calculated Risk on 2/29/2008 04:49:00 PM

I’ve reluctantly discarded the notion of my continuing to manage the portfolio after my death abandoning my hope to give new meaning to the term “thinking outside the box.”
Warren Buffett, Feb 29, 2008

Here is Buffett's letter to shareholders.

I should mention that people who expect to earn 10% annually from equities during this century – envisioning that 2% of that will come from dividends and 8% from price appreciation – are implicitly forecasting a level of about 24,000,000 on the Dow by 2100. If your adviser talks to you about doubledigit returns from equities, explain this math to him – not that it will faze him. Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many as six impossible things before breakfast.” Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.

Numbers are fun. Let's see, 1.08 (8% price appreciation) for 92 years = 1188. Then multiply by 12,266 (today's close), and I only get 14.6 million on the Dow. Oh well ... underperforming Buffett again!

The actual number sounds huge, but much depends on the size of the economy - and that will be many many times larger in 92 years.

Buffett is always fun to read.

by Calculated Risk on 2/29/2008 03:47:00 PM

Last week, the NY Times mentioned the recent estimate from Dr. Mark Zandi, chief economist at Economy.com, of 8.8 million homeowers currently with zero or negative equity.

Here is an overview of the calculation from Zandi's Plan to Take Bolder Action on Mortgages (excerpted with permission from Mark Zandi):

By the end of March, an estimated 8.8 million homeowners, equal to 10.3% of the single-family housing stock, are expected to have zero or negative equity. This calculation is based on estimates of homeowner equity across more than 40,000 Zip codes nationwide. The amount of first and second mortgage debt outstanding, including both home equity lines of credit and closed-end second loans, is derived from credit file data. The estimates of housing values are based on repeat-sale house price indices from Fiserv Case Shiller, which are benchmarked to house prices available from the 2000 Census. In those Zip codes where repeat sales price data are not available, Moody’s Economy.com's estimates of county house prices are used. The current distribution of homeowner equity across Zip codes also highlights the risks posed by further price declines. If prices fall 20% from their peak to their expected trough next spring, some 13.8 million households will be under water by then, equal to 15.9% of the stock.

The following graph shows my estimates from last December of the number of homeowners with zero or negative equity based on several different price declines. This was based on data from First American.

At the end of 2006, there were approximately 3.5 million U.S. homeowners with no or negative equity. (approximately 7% of the 51 million household with mortgages).

By the end of 2007, I calculated the number would have risen to about 5.6 million. However, prices fell further than I expected in 2008, and this actually is very close to Zandi's estimate for the end of March 2008.

With a 20% price decline (peak to trough), I calculated 13.6 million homeowners with zero or negative equity; Zandi's updated numbers put that at 13.8 million.

Zandi didn't provide an estimate for a 30% peak to trough price decline, but my 20 million estimate is probably pretty close. Note: I calculated the percent of homeowners with mortgages with no or negative equity; Zandi calculated the percent of the total single-family housing stock.

by Calculated Risk on 2/29/2008 01:58:00 PM

From MarketWatch: S&P may downgrade 1,887 classes of Alt-A mortgage securities (hat tip crispy&cole)

Standard & Poor's said on Friday that it may downgrade 1,887 classes of mortgage securities backed by so-called Alt-A home loans. ... There's been a persistent increase in delinquencies on the loans underlying these securities, S&P said.

From Reuters: S&P may cut $14 bln of subprime debt, eyes CDOs (hat tip Barley)

Standard & Poor's on Friday said it is reviewing $14 billion of subprime-related debt for a ratings cut and may act on related collateralized debt obligations within "days," the rating company said.

S&P took the action due to rising delinquencies on higher quality mortgage loans known as "Alt-A loans," ...

by Calculated Risk on 2/29/2008 01:41:00 PM

From St. Louis Fed President William Poole: Panel Discussion on Balancing Financial Stability, Price Stability and Macroeconomic Stability: How Important Is Moral Hazard?

We have known for many years that moral hazard is a potentially serious issue. If a firm believes that it will be bailed out if it gets into trouble, that expectation encourages excessive risk-taking and increases the probability of trouble. There are two complementary ways to deal with moral hazard. First, firms in trouble ought not to be bailed out, unless the bailout takes a form that imposes heavy costs on managers and shareholders. Second, firms subject to government regulation ought to be compelled to maintain adequate capital to reduce the probability of failure. U.S. banks entered the period of turmoil last year pretty well capitalized and have been able to withstand large losses.

I am more skeptical of the financial strength of the GSEs, and believe that we could see substantial problems in that sector. According to the S&P Case-Shiller home value data released earlier this week, as of December 2007 average prices had declined by 15 percent or more over the past 12 months in Phoenix, San Diego, Miami and Las Vegas. We can add Detroit to the danger list as the home price index for that city is down by almost 19 percent over the 24 months ending December 2007. With house prices falling significantly in a number of large markets, many prime mortgages issued a few years ago with a loan-to-value ratio of 80 percent may now have relatively little homeowner equity, which increases the probability of default and amount of loss in event of default.

As I emphasized some time ago, GSE losses will depend on the variance as well as the mean of changes in national home prices. Losses in markets with home prices falling more than the national average will not be offset by gains in markets with price changes above the national average. I do not have a new message here; we have known for a long time that advance preparation and a strong balance sheet are the keys to riding out a financial storm. As I have emphasized before, the Federal Reserve can deal with liquidity pressures but cannot deal with solvency issues. I do not have any information on the GSEs that the market does not also have. Nevertheless, in assessing the risk of further credit disruptions this year, I would put the GSEs at the top of my list of sources of potentially serious problems. If those problems were realized, they would be a direct result of moral hazard inherent in the current structure of the GSEs.
emphasis added

Note that Poole is no longer a voting member of the FMOC. He concludes:

[A] financial firm cannot expect targeted aid for just the firms in trouble. An exception to this general statement is that, unfortunately, the GSEs probably can expect targeted aid. ... the GSEs ... might get assistance directly from Congress ...