by Calculated Risk on 4/20/2008 10:45:00 PM

On Friday I posted a video of an interview of Professor Roubini on Canadian TV. It is well worth watching.

On Saturday, I posted a few comments on why I thought Professor Roubini might be a little too pessimistic. I gave three reasons: 1) I believe starts of single family homes built for sale has finally fallen below the current level of new home sales (note: I'll have more on the housing starts vs. new home sales issue soon.) 2) I think we may be a little further along in the write down process than Roubini, and 3) I felt Roubini might be overestimating the number of homeowners that "walk away'.

Clearly we agree on more points than we disagree, and I hold Professor Roubini in the highest regard (for those that don't know, Roubini is very well respected among his peers).

Today Roubini wrote: The worst is ahead of us rather than behind us in terms of the housing recession and its economic and financial implications. Here is an excerpt on the write downs:

[M]y most recent estimates have been that credit losses on mortgages could be as high as $1 trillion and total credit losses for the financial system could be as high as $1.7 including all the other losses (commercial real estate loans, credit cards, auto loans, student loans, leveraged loans, industrial and commercial loans, corporate bonds, muni bonds, losses on credit default swaps). How many of these losses are borne by banks (I meant both commercial and investment banks in my use of the term “banks”) depends on the allocation of these impaired assets among banks and non-banks.

The argument for a trillion dollar of losses on mortgages alone is based on the following three parameters (two of which an undisputed while a third is more subject to uncertainty. First, let’s conservatively assume that home prices fall about 20% rather than 30% so that only 16 million households are underwater; this assumption is not very controversial as most now would agree that a cumulative fall in home prices of 20% is a floor, not a ceiling to such price deflation. Second, lets assume – as Goldman Sachs does – that a foreclosed unit causes a loss of 50 cents on a dollar of mortgage for the lender as, in addition to the fall in the home price one has to add the large legal and other foreclosure costs including loss of rent on empty properties, risk of the property being vandalized and cost of maintaining an empty property before resale. Third, lets assume – and this is more controversial – that 50% percent of households who are underwater eventually walk away or are foreclosed. Then, since the average US mortgage is $250k total losses from borrowers walking away from their homes are $1 trillion. Goldman Sachs agrees with me on two parameters (20% fall in home prices and 50% loss on a mortgages) but more conservatively assumes that only 20-25% of underwater home owners will walk away. In this case mortgage losses would be “only” $500 billion. But home prices may likely fall more than 20% and with a 30% fall in home prices 21 million households (40% of the 51 million with a mortgage) would be underwater. So, there is certainly uncertainty on how many underwater households will walk away but given the recent evidence of subprime but also near prime and prime borrowers walking away even before they are foreclosed one can be pessimistic on this.

This uncertainty is why Tanta and I have been begging for better data on how many homeowners are actually resorting to ruthless default. Tanta wrote a great primer for the media: Let's Talk about Walking Away (hint to the media!!!)

I certainly agree Roubini's scenario is possible. Last December, I wrote:

If every upside down homeowner resorted to "jingle mail" (mailing the keys to the lender), the losses for the lenders could be staggering. Assuming a 15% total price decline, and a 50% average loss per mortgage, the losses for lenders and investors would be about $1 trillion. Assuming a 30% price decline, the losses would be over $2 trillion.

Not every upside down homeowner will use jingle mail, but if prices drop 30%, the losses for the lenders and investors might well be over $1 trillion.

Although possible, I felt this was somewhat the worst case.

On recourse loans and 'walking away', Roubini argues:

I have for a while argued that in the US mortgages are de-facto, if not always de-jure, non recourse. Indeed, even in states where mortgages (or refinanced ones) are de jure recourse loans these mortgages become de facto non-recourse as the legal cost for lenders to pursue such legal action against jingle mail borrowers can be massive.

Tanta commented on this, and generally agreed with Roubini:

Back in my day working for a servicer, we never went after a borrower unless we thought the borrower defrauded us, willfully junked the property, or something like that. If it was just a nasty RE downturn, it rarely even made economic sense to do judicial FCs just to get a judgment the borrower was unlikely to able to pay. You could save so much time and money doing a non-judicial FC (if the state allowed it) that it was worth skipping the deficiency.

But notice the "willfully junked the property" phrase - aren't these the homeowners that we are talking about when we say someone will "walk away"? Aren't these the solvent homeowners who can make the payment, but decide not to simply because they are underwater? This is one of the great uncertainties, or as I wrote last year:

One of the greatest fears for lenders (and investors in mortgage backed securities) is that it will become socially acceptable for upside down middle class Americans to walk away from their homes.

This is a critical issue, and hopefully someone will provide some research on the number of homeowners actually walking away.

by Calculated Risk on 4/20/2008 09:23:00 PM

The WSJ reports: NatCity Close To $6 Billion Cash Infusion

National City Corp was closing in Sunday night on a capital infusion of more than $6 billion from a private-equity firm and a number of large shareholders ...

The plan calls for the investors to pay about $5 a share ... In 4 p.m. New York Stock Exchange composite trading Friday, National City shares fell 16 cents to $8.33.

Hey, that is only 40% below market. Ouch.

by Calculated Risk on 4/20/2008 04:17:00 PM

From Financial Week: Big rise seen in unoccupied office space

According to the real estate services firm Grubb & Ellis, first-quarter office vacancies rose to an average 13.6% nationally, up from 13% in the previous three quarters.

“With demand turning negative at the same time that the construction pipeline will deliver the 94 million square feet still underway, vacancy is expected to peak at 18% by the end of 2009,” Grubb & Ellis economist Robert Bach wrote in a research note ...

The recession’s impact on employee levels “is just getting started, so the office market is reacting pretty quickly and I would suspect that it will rise to a vacancy rate of 15% to 16% by year end.”

As I mentioned earlier, this week I was driving along the 405 freeway in Orange County at sunset - the sun was shinning at the perfect angle through the buildings - and I was amazed at how many of the new office buildings have no tenants; See-through buildings - reminiscent of the '80s.

The CRE slump has arrived.

by Calculated Risk on 4/20/2008 03:06:00 PM

From the Star Tribune, start with this 1+ minute audio slide show: Development dreams dashed (hat tip dryfly)

Here is the article: Minnesota's new ghost towns

The roots of that financial crisis can be found in places like Wright County, where the combination of affordable land, cheap money and boundless optimism lured builders and families chasing big homes in the kind of brand-new subdivisions they thought were beyond their reach.
...
But the boom has unraveled as quickly as it began. While many established Wright County neighborhoods have avoided the worst of the housing market collapse, the county ranks as one of the state's worst areas hit by foreclosures. Pockets of this county, about 30 miles northwest of the Twin Cities, have seen home prices fall 30 percent or more in the past year.

See-through homes. Kind of like the see-through office buildings in the '80s.

And speaking of office buildings: I was driving along the 405 freeway in Orange County at sunset this week - the sun was shinning at the perfect angle through the buildings - and I was amazed at how many of the new office buildings have no tenants; See-through Buildings, The Sequel.

by Calculated Risk on 4/20/2008 11:37:00 AM

From the WSJ: Bank of England Will Unveil Bailout Plan for U.K. Banks Monday

The Bank of England will announce Monday a scheme which will see it lend money to banks in return for collateral in a bid to help the troubled U.K. mortgage market, U.K. Chancellor of the Exchequer Alistair Darling said Sunday.

"The Bank of England will be making an announcement tomorrow in which what it will do is effectively lend banks money to unfreeze the [mortgage market] situation we've got at the moment," Mr. Darling said in a television interview on the British Broadcasting Corporation.
...
The Chancellor said ... "The idea ... is that it will open up the market and it will begin the process of opening up the mortgage market which of course will help house owners...if that doesn't happen, then I think there is every chance that the situation will get worse."

There was an article in The Times last Wednesday that suggested this program from the BofE would allow lenders to use mortgage-backed assets as collateral to borrow government bonds - so the "scheme" will probably be similar to the programs the Fed has implemented.

by Anonymous on 4/20/2008 08:31:00 AM

Like anyone else with even a modest dash of common sense, I am not sure I really want to wade into the issues Yves raises in this post. But having been personally wished on the inoffensive British--who have as far as I know done me and mine no particular harm since at least 1812, if you don't count LIBOR and Diana--as a final rhetorical fillip, I feel as if I were already in one of the pitfalls, so there's limited upside to trying too hard to avoid them.

Yves is, of course, talking about Wall Street. Even now, after the last several years of more than usually unholy more than usual alliance between the mortgage industry and the investment banks, it is still true that only ever a small slice of mortgage industry people have any direct contact with the Street and its culture. Some of those who do take to it immediately, rather like those suddenly exuberant freshmen at a large and urban campus, who shake off the persona of small-town straight-A valedictorian and throw themselves into the libertine ways of the university--beer! everywhere you look!--without looking either backwards or forwards all that carefully. Others cringe in horror and are only too grateful to return to their quieter Main Street offices, where the unglamorous but reassuring touch of the files and hum of the worker-bees steadies a mind reeling from too many bright young aggressive deal-makers flicking their laser pointers at too many garish hockey-stick-laden PowerPoint slides.

The other 90% of the industry never left Main Street to begin with, and hears these snippets of gossip and bullet-point about how we're now writing loans to "Wall Street standards" with bemusement and amusement in roughly equal measure. Depending on the sense and sensibility of local management, by and large most of the rank and file roundly ignore such things and get on with their days. Except for the very young, all corporate workers have lived through enough management fads and buzz-word fashions to know that this, too, shall pass.

"They're not going to re-engineer us, are they?" asks my administrative assistant, leafing through the pile of stuff I've tipped out of my briefcase on return from the latest secondary marketing conference.

"No, I don't think so this time," I mutter, staring at 283 unread email messages. "But if they do, I've still got all the stuff from last time in the lower left drawer of my credenza. If it's not worth doing, it's certainly not worth not plagiarizing."

I shall posit that it has simply been a different trajectory for women in the mortgage business, and retail banking generally, than it has been for our sisters on Wall Street. Not only have there been more of us on Main Street; we did not, by and large, enter this business to "pursue careers." Most of us of a certain age simply "got jobs" in an industry that has always needed a lot of pink collars. Generalizations are of course rightfully fearful things, but I am inclined to think there's a reason why so many laid-off mortgage middle managers are heading for nursing and teaching, and it has nothing to do with especially "nurturing" personalities or gender identities. We have always been of that pink-collar sisterhood, even as some of us broke a bit past the top of its salary band and even found our well-coiffed hair flattened against the glass ceiling.

That is, indeed, why so many of us have been held in such contempt--open or camouflaged--by the senior managerial class and those wannabees who adopt its favored postures. I have never entered a mortgage operation--a bank or a mortgage banking firm--as employee, client, or consultant, without encountering manifestations of that "taint" carried by those who know, fully and in detail, how the sausage is actually made. Precisely because, whatever their current job is, the tainted ones used to make sausage.

I am, in fact, one of the very few women I know in this industry who was hired directly into a "professional" position (writer of policies and procedures) based almost solely on academic credentials. At that first job of mine, the underwriting manager was a woman--who had started years and years ago as an underwriter trainee. The production manager was a woman--curiously enough, also one with a humanities degree--who had begun as a lowly FHA loan originator twenty years before. The female loan sale and pricing manager had started on the teller line, as had the female servicing manager.

They were--I became--the accidental managers of the business. Having one as a production manager was rare then and is still rare now: if you took all the women managers in the mortgage business and separated out the ones in processing, underwriting, closing, post-closing review, and servicing, you wouldn't have many left. Some women have certainly risen to the heights of senior management, but nearly all of them did so with responsibility for the "back office" functions out of which they arose. Back office functions that are, crucially, cost centers, not profit centers.

In an industry that has always--to its own detriment--most empowered those who "bring in the bacon," this has generally functioned to severely curtail the power these women can exercise in the corporate culture. They know how to do things; they get things done; their orientation is nearly always "conservative": they limit the risks, double-check the entries, enforce the rules. They often have the largest staffs, while also having the largest number of low-paid, less-educated people who are first in line for any layoffs going. They are "costs"; they get "cut."

To a mind trained to a certain traditional gender stereotype--and we have our share of those, alas--female mortgage managers are the gatherers and domesticators, and males are the hunters and risk-takers. It is no wonder that a culture that does not value such things as raising reasonably well-behaved children as an accomplishment does not value the risk-limiters much. It is the rhythm of these meetings, and has been for a long time:

He: My branch generated $45MM in gross revenues this quarter!

She: Well, my underwriters tried to stop you.

To return to Yves' suggestion, there's certainly a lot to be said for regulators recruiting from this pool of women mortgage managers. We know where the bodies are buried. We know how they got to be buried. We know how they died. We've got the reports in our lower-left desk drawer.

The thing is, I see two sides of this. Certainly a passel of middle-aged women who earned their stripes managing mortgage back-offices would be more effective, probably by an order of magnitude, than the pool of examiners the regulatory agencies mostly currently have. Quite possibly they might feel sufficiently vindicated at this point--we did, you know, tell you where this was heading while you were busy not listening--to exercise their new regulatory empowerment with sufficient hard-headedness to overcome both senior management and political-appointee resistance. But that's the other side of this: senior management at the banks and political appointees at the agencies aren't known for hanging their heads, admitting their faults, and going along meekly with the house-cleaning.

I don't know that women are going to be able to fix that; men are going to have to demand more of--and give less to--the hunters and risk-takers. My own personal experience suggests that while there's a certain passing pleasure in being able to say "I told you so," no one is less welcome in the meetings than those of us who told you so--and who took the damned minutes to prove it, too.

It does leave me with a lingering sense that now that the party is over, we are casting about for house-cleaners in the usual place that domestic help is found. That is not, of course, what Yves is saying at all; it is merely the context in which the other edge of the sword cuts. For it is surely not young women just entering the business we want here--of course we want them for other things, but we're not just looking for women, we're looking for women veterans. I profoundly doubt that the few on Main Street who have achieved senior management status will want to leave for a job as a bank regulator if they can hang on to the job they have. You're talking about middle-aged women just below the executive ranks, here. Should there be some real effort to recruit us to the ranks of regulators, how do we prevent regulatory work from becoming yet another pink-collar cost-center?

by Calculated Risk on 4/19/2008 05:20:00 PM

Yesterday I posted three videos of an interview with Professor Nouriel Roubini on Canadian TV. Professor Roubini believes the U.S. is currently in a recession, and that the recession will be deep and long - "the most severe recession and financial crisis that the US has experienced for decades" - lasting 12 to 18 months.

I agree that the economy is probably already in a recession, but I think Roubini may be too pessimistic. My view is the recession will be less than severe (with unemployment peaking at less than 8%), although I agree the effects - especially related to employment - will probably linger for some time.

Let me point out a few points in the interview where I believe Roubini is too pessimistic:

Professor Roubini on new homes sales vs. starts:

"The production of new homes - housing starts - has already fallen by 50%, but the problem is the demand for new homes has fallen by more, 60%."

Actually the number of single family starts has fallen slightly more than new home sales.

Click on graph for larger image.

This graph shows New Homes sales (seasonally adjusted annual rate) vs single family housing starts (SAAR). These two series can't be compared directly because single family housing starts includes homes built by owners - but the graph does show that starts have fallen as much or more than sales.

If you dig into the data and adjust for cancellations, it appears starts of single family homes (built for sale) have fallen below the current new home sales rate. See: More on Housing Starts

Even though Roubini is correct that inventories are at or near record levels (especially distressed existing home inventory), it's important to note that builders have finally cut production enough to start reducing the inventory of new homes. So we are probably a little further along in the process than Roubini suggests.

Roubini on walking away:

"In the United States, if you walk away from your home - what's called jingle mail because you put the keys in the envelope, you send it the banks and say goodbye - you don't have to pay the remaining balance between the value of your mortgage and the value of your home. So if you are really into negative equity - underwater - you have a huge incentive, especially if you don't have income you've lost your jobs - do to that."

This is not completely accurate.

Although I agree with Roubini that changing attitudes towards default for middle class Americans is a significant risk - something we haven't been able to quantify - the consequences are more complicated than Roubini's description and might limit the number of homeowners who actually engage in ruthless default. Note: anyone considering walking away should probably consult a lawyer and a tax accountant.

In California, purchase money is non-recourse. If the borrower walks away and mails in the keys (Fleckenstein's "jingle mail"), the lender is stuck with the collateral. However, if the California borrower refinanced, then the lender has recourse, and can pursue a judicial foreclosure (as opposed to a trustee's sale), and seek a deficiency judgment.

The lender can enforce that deficiency judgment by attaching other assets, or by garnishing the borrower's wages. Historically lenders rarely pursued (or enforced) deficiency judgments, but that could change if many middle class borrowers, with solid jobs and assets, resort to jingle mail.

For purchase money, state law determines the recourse vs. non-recourse issue. Refis are always recourse, and there was significant refi activity in recent years. So a homeowner who chooses to "walk away" might be liable for some or all of the debt owed the lender. And the home buyers credit will be impacted - and there might be tax consequences too.

I still believe one of the greatest fears for lenders (and investors in mortgage backed securities) is that it will become socially acceptable for upside down middle class Americans to walk away from their homes. But my guess is the fear is far greater than what will really happen.

Roubini on the write down process:

"Major banks in the United States have already done something like $230 billion of write downs, but my estimate is when you are going to add it up those losses are going to be more like the order of $1 trillion. We are only at the beginning of the process of recognizing those losses. We might have a systemic banking crisis."

It's hard to compare the investment bank write downs directly to the potential total losses, since many of the losses will be taken by hedge funds, regional banks, insurance companies, and wealthy individuals and others. The following table shows the IMF's estimate of losses by institutional category.

From the IMF's Global Financial Stability Report (via Econbrowser):


Notice the IMF's estimate of losses at the banks is on the order of $440 to $510 billion. This includes all banks, and my guess is the investment banks are further along in the process than many of the regional banks. I think we are well past halfway in write downs for residential mortgages at the investment banks, although there are many other credit losses still coming (like for consumer credit cards and auto loans, construction & development and commercial real estate loans, and corporate bonds).

Therefore I believe Roubini is a little too pessimistic when he says "We are only at the beginning of the process."

So as bearish as I am - especially on housing - I am less pessimistic than Dr. Doom!

by Anonymous on 4/19/2008 04:46:00 PM

So it seems:

April 19 (Bloomberg) -- National City Corp., Ohio's largest lender, may seek capital from private investors or a non-U.S. bank to avoid a takeover by in-state competitors KeyCorp and Fifth Third Bancorp.

The bank may seek a transaction that will ``enable senior management to keep their jobs and allow thousands of employees at NCC to keep working,'' Oppenheimer & Co. analyst Terry McEvoy said in an interview and an e-mail, referring to National City by its stock ticker.

by Anonymous on 4/19/2008 07:57:00 AM

Our Brian forwarded this email to me yesterday, and I haven't stopped chuckling yet. It's very well done and certainly appears to be a legitimate "memorandum" from Accredited. Apparently no one has yet managed to get it posted on Accredited's website, which would formalize the joke nicely, but that's no reason not to share it:

April 18, 2008 - San Diego , CA

Accredited Home Lenders is pleased to announce the promotion of Miss Helen Busta to the newly created position of Chief Advisor of Things Both Relevant and Interesting in the Non-Conforming Loan Market.

The position was created to help set the record straight in a market that's been turned upside down. Miss Busta will apply her vast knowledge and years of industry experience to bust the subprime myths that are so prevalent today.

As a young woman, Miss Busta arrived in San Diego from the Midwest and took a job in the mortgage industry as a temp. She was soon hired by Accredited to help out in the company's first office above an auto repair shop. Miss Busta earned her B.A. in History from San Diego State University while working full-time at Accredited.

Her duties will include advising Accredited staff and helping brokers build their non-conforming business. Miss Busta will soon launch her own Web site, where she will answer any and all questions regarding the mortgage industry. Her long-standing service to Accredited and wealth of knowledge from 20 years in home lending have made Miss Busta a solid performer in any type of economic climate.

Please extend your congratulations to Miss Helen Busta on her significant achievement.

Welcome to the world wide wacky web, Miss Busta. We do look forward to your Relevant and Interesting posts.

by Calculated Risk on 4/18/2008 08:07:00 PM

Professor Nouriel Roubini was interviewed by Steve Paikin, the anchor of The Agenda, a public affairs program on Canadian TV (three parts, about 25 minutes total).

Part 1:


Part 2:


Part 3: