by Calculated Risk on 3/28/2008 01:32:00 AM

Federal Reserve Governor Frederic S. Mishkin spoke tonight: Comfort Zones, Shmumfort Zones. Mishkin tries to answer the question of why 1% to 2% inflation it better than zero inflation:

Can Inflation Be Too Low?
While the benefits of low inflation are now widely recognized, somewhat less attention has been given to the pitfalls of maintaining inflation rates very close to zero, so I will now discuss this issue in somewhat greater detail. Specifically, if the average inflation rate is too low, then the economy faces a greater risk that a given adverse shock could distort labor markets, induce debt deflation, or cause monetary policy to become constrained by the zero lower bound on nominal interest rates. These risks imply that undershooting a zero inflation objective is potentially more costly than overshooting that objective by the same amount, and that setting the inflation objective at a rate a bit above zero provides some insurance against these risks.

Downward nominal wage rigidities. Inflation at rates close to zero might create nonnegligible costs to the economy because firms may be relatively reluctant to cut nominal wages. Sticky nominal wages can prevent labor markets from reaching the optimal equilibrium. However, empirical evidence from Switzerland and Japan indicates that in an environment of deflation or very low inflation, downward nominal wage rigidities become less prevalent.

Debt deflation. Keeping the average inflation rate close to zero increases the likelihood that the economy will experience occasional episodes of deflation. Deflation can be particularly dangerous for an advanced economy, in which debt contracts often have long maturities. As described by Irving Fisher (1933), an episode of deflation can lead to "debt deflation," that is, a substantial rise in the real indebtedness of households and firms, because the nominal values of debt obligations are largely predetermined whereas the nominal values of household income and business revenue are falling together with the general price level. Indeed, the deterioration of the balance sheets of households and firms can result in financial turmoil that contributes to further deflation and greater macroeconomic instability.

The zero lower bound. With a very low average inflation rate, monetary policy is also more likely to encounter circumstances in which short-term interest rates are constrained by the so-called zero lower bound on nominal interest rates. Specifically, investors will never choose to lend money at a negative nominal interest rate because they always have the option of simply holding cash at a zero interest rate; thus, nominal interest rates cannot fall below zero.

by Calculated Risk on 3/27/2008 10:57:00 PM

From Kevin Hall at McClatchy Newspapers: Home prices may not rebound till 2010 (hat tip John)

U.S. home prices are unlikely to recover until at least 2010, [Frank Nothaft, the chief economist for government-sponsored mortgage buyer Freddie Mac] said Thursday, adding that home building this year is likely to post its worst year in five decades.

Check out Nothaft's presentation: The Mortgage and Housing Market Outlook - all kinds of interesting data and charts.

by Calculated Risk on 3/27/2008 04:44:00 PM

After the Census Bureau releases the preliminary New Home sales estimate, they revise the estimate three times (over the next three months) as more data becomes available.

Historically the revisions can be in either direction - higher or lower - but beginning in 2005 I noticed that most of the revisions were down. All of the revisions (between preliminary and final) were down in 2006 and for most of 2007. It appeared that the Census Bureau had a systemic error in estimating preliminary sales during periods of rapidly declining sales.

Click on graph for larger image.

This graph shows the percent difference between the final revision and the preliminary release since the beginning of 2003.

Although we don't have the final revisions for December '07 and January '08, I've plotted the intermediate revisions - and the revisions are up slightly.

This suggests - tentatively - that the period of rapid declines in New Home sales may be over. This doesn't mean sales can't fall further - they might, or that sales will recover to 2005 levels any time soon - they won't. This is just a hint of a change in trend (I was using the same hint in '05 arguing the sales bubble might be over).

Another indication that we might be nearing a bottom in sales is that builder cancellation rates appear to be falling. As an example, Lennar reported today that their cancellation rate had declined to 26% in fiscal Q1 2008, from 33% in fiscal Q4 2007.

Earlier today, Stuart Miller, President and Chief Executive Officer of Lennar Corporation, said,

"Market conditions have remained challenged and continued to deteriorate throughout our first quarter of 2008. The housing industry continues to be impacted by an unfavorable supply and demand relationship, which restricts the volume of new home sales and, concurrently, depresses home prices in most markets across the country."

This "unfavorable supply and demand relationship" will probably continue for some time, but this may mean sales stay near this level rather than fall further. Also note, a spike down due to the recession is possible, but then I'd expect a fairly quick recovery back to the 600K level.

by Calculated Risk on 3/27/2008 12:50:00 PM

Excerpts from Atlanta Fed President Dennis P. Lockhart: Current Economic Situation, Outlook, and Recent Actions

... the economy is in a slowdown that resembles past periods that were the leading edge of a recession.
...
Looking ahead, my forecast has been affected both by an economic slowdown that has been sharper than I had expected and the recurring spells of financial market turmoil. A few months ago our forecast at the Atlanta Fed saw growth slow in the first half of 2008, then pick up in the second half of the year. But it now appears to me that the contraction in housing and the dampening effects of financial turmoil on household and business spending could persist through the remainder of this year. The recovery in growth I had expected in the second half of this year may be delayed.
emphasis added

It appears Lockhart is still too optimistic on house prices:

I expect it will take much of the rest of the year for house prices to bottom out and financial markets to restore the necessary preconditions of stability—that is, confidence in asset values and confidence in transaction counterparties.

by Calculated Risk on 3/27/2008 11:51:00 AM

The Oregonian is reporting this morning on a JPMorgan Chase memo titled "Zippy Cheats & Tricks". The Oregonian obtained a copy of the memo, and the memo apparently offers tips on how to get loans through Chase's in-house automated loan underwriting system:

The document recommends three "handy steps" to loan approval:

Do not break out a borrower's compensation by income, commissions, bonus and tips, as is typically done in a loan application. Instead, lump all compensation as the applicant's base income.

If your borrower is getting some or all of a down payment from someone else, don't disclose anything about it. "Remove any mention of gift funds," the document states, even though most mortgage applications specifically require borrowers to disclose such gifts.

If all else fails, the document states, simply inflate the applicant's income. "Inch it up $500 to see if you can get the findings you want," the document says. "Do the same for assets."
...
"This is not how we do things," [Chase spokesman Tom Kelly] said. "We continue to investigate" the memo, Kelly said. "That kind of document would neither be condoned or tolerated."

Added: the article very clearly states this was for stated income loans - and that Chase no longer offers these loans. In no way do I think this was Chase's policy - instead this shows how some people (possibly Chase insiders) were helping borrowers (or mortgage brokers) commit mortgage fraud.

by Calculated Risk on 3/27/2008 09:39:00 AM

From homebuilder Lennar's press release:

Stuart Miller, President and Chief Executive Officer of Lennar Corporation, said, "Market conditions have remained challenged and continued to deteriorate throughout our first quarter of 2008. The housing industry continues to be impacted by an unfavorable supply and demand relationship, which restricts the volume of new home sales and, concurrently, depresses home prices in most markets across the country."

"Home inventories have been expanding due to the high number of foreclosures, negotiated 'short sales,' and stretched homeowners looking to sell homes they can no longer afford. While sales are occurring and clearing prices are being reached, the pace of overall housing inventory growth is exceeding absorption at the current time."

"Concurrently, lower consumer confidence has quieted demand among prospective homebuyers and deterred them from a buying decision, while contraction in the lending markets has reduced the availability of credit for those prospective homebuyers that do wish to buy a home."
emphasis added

by Anonymous on 3/27/2008 08:58:00 AM

This morning we have Vikas Bajaj in the NYT reporting on second-lien lenders refusing to go quietly:

Americans owe a staggering $1.1 trillion on home equity loans — and banks are increasingly worried they may not get some of that money back.

To get it, many lenders are taking the extraordinary step of preventing some people from selling their homes or refinancing their mortgages unless they pay off all or part of their home equity loans first. In the past, when home prices were not falling, lenders did not resort to these measures.

Um. This isn't really a very helpful way to put it, you know. In the very concept of the "lien" is the idea that the lender gets to demand payment if you sell the property that is securing the loan, and in the very concept of "refinance" lurks the idea that you pay off the existing loan with the proceeds of the new one. These concepts are not "extraordinary."

What we mean here, I take it, is short sales and short refinances (or subordinations behind a distressed first-lien refinance). If so, we really ought to say that, because "in the past, when home prices were not falling," we didn't have a lot of short sales and short refis, so the occasion for second lienholders to object to them just didn't arise much.

The reason to insist on some clarity here is that I don't think it helps much to build up certain people's sense of entitlement on the matter. Or at least their occasionally fundamental confusion about what rights you give up to a lender when you sign this mortgage thingy.

There is an example in the Times article, of a couple who attempted a short sale which was derailed because the second lienholder wouldn't play nice:

Experts say it is in everyone’s interest to settle these loans, but doing so is not always easy. Consider Randy and Dawn McLain of Phoenix. The couple decided to sell their home after falling behind on their first mortgage from Chase and a home equity line of credit from CitiFinancial last year, after Randy McLain retired because of a back injury. The couple owed $370,000 in total.

After three months, the couple found a buyer willing to pay about $300,000 for their home — a figure representing an 18 percent decline in the value of their home since January 2007, when they took out their home equity credit line. (Single-family home prices in Phoenix have fallen about 18 percent since the summer of 2006, according to the Standard & Poor’s Case-Shiller index.)

CitiFinancial, which was owed $95,500, rejected the offer because it would have paid off the first mortgage in full but would have left it with a mere $1,000, after fees and closing costs, on the credit line. The real estate agents who worked on the sale say that deal is still better than the one the lender would get if the home was foreclosed on and sold at an auction in a few months.

I'm not here to make up details not in evidence in a newspaper story, so bear that in mind. But my attention was caught by that detail about retiring due to an injury. As presented, the story seems to be that the McLains took out a HELOC in January of 2007, and at some point "last year" the borrowers fell behind in payments because of the disability. We aren't told by the Times whether the income troubles led to drawing down the HELOC, and then being unable to keep up payments, or if the HELOC had been drawn to the full $95,000 back in January of 2007, and subsequently the income troubles led to the McLains being unable to keep up the payments.

I bring this up only because the following item caught my eye yesterday (via Mish), from someone who apparently purports to be a source of personal finance advice:

As many readers know, I’m a proponent of keeping an untapped home equity line of credit (HELOC) at my disposal for major emergencies. This isn’t my emergency fund. It’s what I call my catastrophe fund.

I’ve always believed that keeping a HELOC readily available is the best insurance policy and the back-up plan for if / when the emergency fund runs empty. Think about it… being able to tap this money could buy us time in the event of job loss or illness. And time is money. . . .

The HELOC is there strictly as a backup plan. For a catastrophe. Period. End of story. But with that said, I’ve always looked at that line of credit as my money. Money I could access at any time. . . .

So it came as a surprise yesterday when we got the letter from Citibank about our $168,000 line of credit:

We have determined that home values in your area, including your home value, have significantly declined. As a result of this decline, your home’s value no longer supports the current credit limit for your home equity line of credit. Therefore, we are reducing the credit limit for your home equity line of credit, effective March 18, 2008, to $10,000. Our reduction of your credit limit is authorized by your line of credit agreement, federal law and regulatory guidelines.

Reduced to $10,000!? Hello!? Please don’t f-ck with my house in Newport Beach…

Of course, I’m calling them today to dispute it.

I left out the parts about how this writer is such a great credit risk now, and was when she qualified for the HELOC originally. I am merely struck by how unaware she is of the essential problem in her understanding of a HELOC as a kind of disability insurance: she is saying that she qualified for the line of credit as an employed, cash-flush borrower, but plans to use it only if she becomes . . . the kind of borrower who couldn't qualify for a HELOC.

Now, let me say that lenders were fully complicit in this idea; I heard more than a few sales pitches for HELOCs over the boom years based on this "do it just in case you need it" idea. But it was a self-defeating plan then and it is so clearly still one now: how do you get out of problems making your mortgage payment by increasing your mortgage debt--and not coincidentally decreasing your odds of selling your home should you need to?

More to today's point, how do you ask the HELOC lender to advance you money to pay the first lien lender with--I assume that's the idea of using the HELOC to "tide you over" in a bad patch, you're borrowing the first lien mortgage payments from the HELOC lender--knowing you aren't really (currently, at least) in any position to pay it back, and then ask the HELOC lender to let the first lien lender get all the proceeds in a short sale? Don't get me wrong: I fully understand why people hate lenders these days and think they're just getting what they "deserve." I'm just shocked at the naive assumption that they wouldn't fight back a little here.

As I said, I don't really know what the McLains' situation was, since we don't get much detail. But one can understand Citibank's near-total erasure of Ms. Newport Beach's unused HELOC as a sensible precaution on Citi's part, and not simply because home values are falling. Now is probably not a good time for HELOC lenders to be sitting on their duffs waiting for borrowers to run into financial trouble and use those HELOCs as a way to limp along to the point where the HELOC lender gets nothing in a foreclosure.

Of course Ms. Newport Beach believes that her potential use of a HELOC as "insurance" wouldn't be doomed to failure. Nobody ever believes that doubling down is doomed to failure; that's why they do it. But if in fact that's what the McLains did, it doesn't seem to have done anything for them except buy them time to negotiate a short sale that then fell through because CitiFinancial didn't like being the patsy at the table.

by Calculated Risk on 3/26/2008 07:09:00 PM

From Bloomberg: Clear Channel, Bain, Lee Sue Banks Over Buyout Plan

Clear Channel Communications Inc., Bain Capital LLC and Thomas H. Lee Partners LP sued banks financing the $19.5 billion buyout of Clear Channel to force them to honor funding commitments.
...
The banks stand to lose at least $2.7 billion because loan prices have fallen since they agreed to finance the transaction last year.

The banks have about 2.7 billion reasons to find a way out of this deal.

by Anonymous on 3/26/2008 06:47:00 PM

Apparently, the accounting firms never learn. From Vikas Bajaj in the NYT:

In a sweeping accusation against one of the country’s largest accounting firms, an investigator released a report on Wednesday that said “improper and imprudent practices” by a once high-flying mortgage company were condoned and enabled by its auditors.

KPMG, one of the Big Four accounting firms, endorsed a move by New Century Financial, a failed mortgage company, to change its accounting practices in a way that allowed the lender to report a profit, rather than a loss, at the height of the housing boom, an independent report commissioned by a division of the Justice Department concluded. . . .

The 580-page report documents how New Century lowered its reserves for loans that investors were forcing it to buy back even as such repurchases were surging. Had it not changed its accounting, the company would have reported a loss rather a profit in the second half of 2006. The company first acknowledged that its accounting was wrong in February 2007 and sought bankruptcy protection less than two months later as its lenders stopped doing business with it.

The profit was important because it allowed executives to earn bonuses and convince Wall Street that it was in fine shape financially when in fact its business was coming apart, the report contended. But the report stopped short of saying that the company “engaged in earnings management or manipulation, although its accounting irregularities almost always resulted in increased earnings. . . .

“I saw e-mails from the engaged partner saying we are at the risk of being replaced,” Mr. Missal said in a telephone interview about a KPMG partner assigned to work on the audit of New Century. “They acquiesced overly to the client which in the post-Enron era seems mind-boggling.”

I have to say I have, really, no desire to read a 580-page report on this subject. But doesn't that seem like a lot of report to find one problem--under-reserving for repurchases that doesn't rise to the level of earnings management or manipulation?

(hat tip, sk)

by Anonymous on 3/26/2008 05:14:00 PM

Some of you have wondered from time to time what all the employment casualties of the credit and housing busts are going to do next.

This ought to keep you up at night:

NEW YORK (CNNMoney.com) -- When Heidi Sadowsky quit the finance sector, she abandoned a job market on the verge of collapse for one that may be air-tight: nursing.

"I was never happy in my life in finance," said Sadowsky, 39, a former liaison for institutional investors and money managers at Citibank and Invesco. "I always felt like a square peg in a round hole. I decided I had to get out of this business. I was never cut out for this."

Inspired by the compassion of nurses who cared for her terminally ill father, Sadowsky took up training last year at New York University's College of Nursing. Since she already had an undergraduate degree, she was accepted into the nursing school's accelerated 15-month bachelors program and she expects to graduate in May. . . .

Sadowsky picked the right time to switch careers. The finance sector has shed 124,000 jobs since the beginning of 2007, according to the Department of Labor, including 22,000 jobs in the first two months of this year. Major firms like Bear Stearns (BSC, Fortune 500), Merrill Lynch (MRL) and Sadowsky's old employer Citigroup (C, Fortune 500) have been hard-hit by the subprime collapse, and analysts expect up to 30,000 more job cuts in finance by the end of the year.

Meanwhile, hospitals, clinics and nursing schools are scrambling to fill vacant positions for nurses and teaching staff. The Department of Labor estimates the number of vacancies for registered nurses will expand to 800,000 in 2020, from its 2005 tally of 125,000.

I can pretty much vouch for the fact that having an undergraduate business degree and years of experience in finance qualifies you to give other people heart attacks. But is it really the kind of experience that should let you cram nursing school into 15 months?

"Tradition holds that a guy's going to be a doctor, and the female is going to be a nurse," Neville Lewis, 40, an NYU nursing student who is married to an RN.

Like Sadowsky, Lewis abandoned finance to take up nursing. Since he already had a bachelor's, he qualified for NYU's accelerated 15-month program. Lewis said he majored in political science and mass communications at Midwestern State University in Texas, and then embarked on a 15-year career in the bond and IPO sector at the investment firms Equiserve (now Computershare) and Fidelity Investments.

"I kind of fell into finance after graduation," said Lewis, who had felt the lucrative pull of the finance sector. "You make a lot of money, but do you enjoy it? I was not happy."

After getting laid off from Equiserve in 2002, Lewis took a job at Fidelity and considered going back to school to pursue tax law. But he changed his mind, quit Fidelity in 2007, and started at NYU's nursing school in January, 2008. He expects to graduate in 2009.

"I felt like I could accomplish more by working to heal people, then by helping people fight over money," he said. And as he watched his former sector collapse, Lewis realized that altruism wasn't the only motive to get into nursing.

"Seeing what's happening now, I have no regrets in leaving finance," he said. "People are always going to be sick. We live in an aging society."