by Calculated Risk on 6/03/2008 10:49:00 AM

From Fed Chairman Ben Bernanke: Remarks on the economic outlook

On the sources of the financial turmoil:

Although the severity of the financial stresses became apparent only in August, several longer-term developments served as prologue for the recent turmoil and helped bring us to the current situation.

The first of these was the U.S. housing boom, which began in the mid-1990s and picked up steam around 2000. Between 1996 and 2005, house prices nationwide increased about 90 percent. During the years from 2000 to 2005 alone, house prices increased by roughly 60 percent--far outstripping the increases in incomes and general prices--and single-family home construction increased by about 40 percent. But, as you know, starting in 2006, the boom turned to bust. Over the past two years, building activity has fallen by more than half and now is well below where it was in 2000. House prices have shown significant declines in many areas of the country.

A second critical development was an even broader credit boom, in which lenders and investors aggressively sought out new opportunities to take credit risk even as market risk premiums contracted. Aspects of the credit boom included rapid growth in the volumes of private equity deals and leveraged lending and the increased use of complex and often opaque investment vehicles, including structured credit products. The explosive growth of subprime mortgage lending in recent years was yet another facet of the broader credit boom. Expanding access to homeownership is an important social goal, and responsible subprime lending is beneficial for both borrowers and lenders. But, clearly, much of the subprime lending that took place during the latter stages of the credit boom in 2005 and 2006 was done very poorly.

A third longer-term factor contributing to recent financial and economic developments is the unprecedented growth in developing and emerging market economies. From the U.S. perspective, this growth has been a double-edged sword. On the one hand, low-cost imports from emerging markets for many years increased U.S. living standards and made the Fed's job of managing inflation easier. Moreover, currently, the demand for U.S. exports arising from strong global growth has been an important offset to the factors restraining domestic demand, including housing and tight credit. On the other hand, the rapid growth in the emerging markets and the associated sharp rise in their demand for raw materials have been--together with a variety of constraints on supply--a major cause of the escalation in the relative prices of oil and other commodities, which has placed intense economic pressure on many U.S. households and businesses.
...
The current economic and financial situation reflects, in significant part, the unwinding of two of these longer-term developments--the housing boom and the credit boom--and the continuation of the pressure of global demand on commodity prices.

And on the dollar and inflation:

The challenges that our economy has faced over the past year or so have generated some downward pressures on the foreign exchange value of the dollar, which have contributed to the unwelcome rise in import prices and consumer price inflation. We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations and will continue to formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations.

It unusual for a Fed Chairman to comment so directly on the dollar, and this probably means rate cuts are off the table for now - even if the economy weakens further.

by Calculated Risk on 6/03/2008 10:06:00 AM

“Since the first of this year, however, U.S. economic and market conditions have become significantly more difficult. Higher gasoline prices are changing consumer behavior, and they are significantly affecting the U.S. auto industry sales mix.”
GM Chairman Rick Wagoner, June 3, 2008

From the NY Times: G.M. Closing 4 Plants in Shift From Trucks Toward Cars

General Motors said Tuesday that it would stop making pickup trucks and big S.U.V.s at four North American assembly plants and would consider selling its Hummer brand.

... the company ... will slash 500,000 units from the automaker’s overall production ...

More bad news for the auto industry (although shifting away from large SUVs is probably good news in the long run).

by Anonymous on 6/03/2008 08:31:00 AM

Several readers have sent me the link to this Milwaukee Journal Sentinel story about a wretched tale of mortgage fraud. It's worth reading, both for an understanding of how many parties need to be complicit for such a blatantly fraudulent transaction to occur, but also for the way it tracks the hardening of attitudes of the lender over time, from an initial spontaneous recognition that this borrower got fleeced but good to a later tendency to blame the victim. Kudos to the Journal Sentinel for digging into the details of this one.

by Calculated Risk on 6/02/2008 08:47:00 PM

"We've always said we were a home builder and not a land speculator. We probably got a little bit off our basics because we were being a little greedy."
Larry Seay, COO, Meritage Homes, June 1, 2008

A little greedy?

by Calculated Risk on 6/02/2008 04:51:00 PM

This morning I posted some graphs on the price distribution of distressed homes (short sales, REOs) in Orange County.

Here is some similar data on the Minneapolis area, from a recent report by MAAR Research Manager Jeff Allen and Aaron Dickinson: Foreclosures and short sales in the Twin Cities Housing Market (hat tip Jeff)

Click on graph for larger image in new window.

Just like for Orange County, there are many more distressed homes for sale at the low end; over 50% of inventory priced below $120,000 is distressed. Many of these distressed homes were probably purchased with subprime loans.

Naturally the areas with a higher percentage of distressed properties have seen faster price declines. Of course - just like for Orange County - those areas also saw the most appreciation because of loose underwriting for subprime lending. Here is a graph showing the real Case-Shiller prices in Minneapolis for three price ranges.

This graph show the real Case-Shiller prices for homes in Minneapolis by price range.

The low price range is less than $176,486 (current dollars). Prices in this range have fallen 27.0% from the peak in real terms.

The mid-range is $176,486 to $250,300. Prices have fallen 21.9% in real terms.

The high price range is above $250300. Prices have fallen 20.8% in real terms.

This is the common pattern: the low end saw the most appreciation, the most foreclosures, and now the fastest price declines. This higher distressed property activity at the low end is also distorting some of the median price measures, as Jeff and Aaron report:

[The] higher market share places a heavy downward weight on aggregate sales price figures, giving many the erroneous impression that the housing market in its entirety is seeing massive declines in value. In reality, the lender-mediated market and the traditional seller market are experiencing stark differences.

As has been widely reported in recent months (including in our own research products), the median sales prices of Twin Cities homes in the first quarter of 2008 were 10.3 percent below the first quarter of 2007—a sizeable and conspicuous decline. But lost in the hub-bub—and partly because no one had the data until now—is that the traditional sales market that does not include foreclosures and short sales saw only a 3.9 percent decline in median sales price during the same time period.

I spoke with Jeff Allen today, and just like for some REOs in Oceanside, the low end REOs in Minneapolis are seeing a significant pickup in buyer interest, possibly from investors, as the lenders have started to price these homes aggressively. This suggests that prices are approaching a bottom in some of these low end areas.

by Calculated Risk on 6/02/2008 04:01:00 PM

Ken Lewis is speaking on a conference call sponsored by Deutsche Bank today.

Greg Morcroft at MarketWatch has the details:

Countrywide deal remains "compelling transaction"-B of A CEO

Problem loans likely to peak this year: Bank of America CEO On problem loans:

"I think we'll see some spikes in the second quarter, then some leveling later this year, and some declines next year."

And on CRE:

Lewis also said that the firm's commercial real estate loan portfolio remains in generally good shape ... "In commercial real estate, homebuilders is the spot we see the losses and the non-performers," he said. Other than that, he said, "we haven't seen many cracks in the commercial real estate portfolio."

And on HELOCs: Bank of America targets 8 - 8.5% Tier 1 capital ratio

Lewis ... said he sees home equity losses going above 2% of the firm's home equity portfolio, and said credit card charge offs "could be slightly above 6% in the next quarter or two."

So problem loans will "spike" in the second quarter, and then level off. Let me be the first to predict Q3 will "surprise" and be worse than Q2!

And on Countrywide: the deal may remain "compelling" to Lewis, but I wonder if he has asked why the Countrywide REO inventory is declining - while REOs for everyone else are increasing substantially? I've heard a rumor that Countrywide has simply stopped foreclosing on loans, and some analysts think they might be under reporting their delinquencies.

by Calculated Risk on 6/02/2008 01:48:00 PM

From Bloomberg: Morgan Stanley, Merrill, Lehman Ratings Cut by S&P

Morgan Stanley, Merrill Lynch & Co. and Lehman Brothers Holdings Inc. had their credit ratings lowered by Standard & Poor's on expectations the securities firms will be forced again to write down the value of their assets.
...
``The negative actions reflect prospects of continued weakness in the investment banking business and the potential for more write-offs, though not of the magnitude of those of the past few quarters,'' Tanya Azarchs, an S&P analyst, said today in a statement.

Also the outlooks for just about the entire large financial institutions sector are now negative.

Contained. Problems behind us. ... Not!

by Calculated Risk on 6/02/2008 12:12:00 PM

From Lawrence Lindsey: Everything you always wanted to know about the housing crash, but were afraid to ask.. Lindsey covers a number of topics (hence the title), but here are some short excerpts on inventory and demand:

There are 129 million housing units in the United States, comprising owner-occupied, rented, and vacant units. Of these, 18.5 million are empty. This vacancy rate is 2.5 percentage points higher than it has been at any point in the half century the data have been tracked, translating into at least 3 million too many empty housing units in the country. This number, moreover, is rising. This is the most intractable part of the real estate bubble, for we cannot find a true bottom to home prices until this inventory of empty units starts to clear, and we cannot find a bottom to the mortgage finance market until home prices bottom out.

No question - there is a huge overhang of inventory in the U.S., but I think Lindsey's analysis overstates the problem. Here is my estimate:

*******************

Click on graph for larger image in new window.

This graph shows the homeowner vacancy rate since 1956. A normal rate for recent years appears to be about 1.7%. There is some noise in the series, quarter to quarter, so perhaps the vacancy rate has stabilized in the 2.7% to 2.9% range.

This leaves the homeowner vacancy rate almost 1.2% above normal, and with approximately 75 million homeowner occupied homes; this gives about 900 thousand excess vacant homes.

The rental vacancy rate increased to 10.1% in Q1 2008, from 9.6% in Q4. It's hard to define a "normal" rental vacancy rate based on the historical series, but we can probably expect the rate to trend back towards 8%. According to the Census Bureau there are 35.7 million rental units in the U.S. If the rental vacancy rate declined from 10.1% to 8%, there would be 2.1% X 35.7 million units or about 750,000 units absorbed.

This would suggest there are about 750 thousand excess rental units in the U.S. that need to be absorbed.

If we add this up: 750 thousand excess rental units, 900 thousand excess vacant homes, and 200 thousand excess new home inventory, this gives approximately 1.85 million excess housing units in the U.S. - very high, but well below Lindsey's estimate of 3 million units.

And Lindsey on demand:

The math of the housing market is fairly clear. Each year roughly half a million homes are destroyed to make better use of the land on which they sit. Population growth also helps whittle down inventory. The household formation years--ages 25 to 34--have 39.5 million people in them forming 19 million households, a group that creates demand for 1.8 to 1.9 million units each year. On the other hand, households pass from the scene later in life, and the homes they used to live in go onto the market. There are 11.6 million households of 65- to 74-year-olds and 9 million households of 75- to 84-year-olds. Their departure increases supply by around 1.1 million units per year. On net, therefore, demographic realities add about 850,000 units to demand on top of the half-million homes that are destroyed and removed from supply.

The home building industry is in a deep recession, with additional yearly new home supply cut in half since 2006. But homebuilders are still adding nearly a million units per year. The math is simple: Build a million, tear down half a million, form 850,000 households, and the country only whittles down its excess inventory by 350,000 units per year. This is one reason to expect a further drop in new home construction, but it will still take years to get our housing inventory back to normal. The economic, social, and financial damage over that time could be staggering.

It's important to understand that during a recession (or economic slowdown) fewer household are formed than normal, and also fewer housing units are demolished. Lindsey is estimating the demand for a normal economy (some people get confused by temporary changes in demand due to economic conditions, as opposed to the demand during more normal times).

Once again, I think Lindsey is a little too pessimistic. But this does illustrate the key problem for housing; it will take years to work off the current excess inventory.Read on ... there is much more.

by Calculated Risk on 6/02/2008 11:18:00 AM

Update: for Minneapolis, see Minneapolis: Price Distribution of Distressed Homes

Jon Lansner at the O.C. Register writes: Distressed homes 63% of O.C.’s cheaper supply

As a percent of all listed homes for sale, distressed properties were 38.7% of the market last week vs. 36.7% two weeks earlier ...

It appears distressed inventory is continuing to increase in Orange County similar to the national trend (see the WSJ: Number of Foreclosed Homes Keeps Rising). Note: distressed sales include short sales and REOs.

What is interesting is the numbers are broken down by price range. Here is a graph showing the numbers from Lansner:

Click on graph for larger image in new window.

Not surprisingly, there are many more distressed homes for sale at the low end; over 70% of inventory is distressed in some of the poorer areas of Orange County (like Santa Ana). Although the lowest category for the graph is less than $500K, many of these distressed homes are probably significantly below the previous conforming limit and were probably purchased with subprime loans.

Naturally the areas with a higher percentage of distressed properties have seen faster price declines. Of course those areas also saw the most appreciation because of loose underwriting for subprime lending. Here is a graph (from a post on Saturday) showing the real Case-Shiller prices in Los Angeles for three price ranges.

This graph show the real Case-Shiller prices for homes in Los Angeles by price range.

The low price range is less than $417,721 (current dollars). Prices in this range have fallen 34.9% from the peak in real terms.

The mid-range is $417,721 to $627,381. Prices have fallen 30.7% in real terms.

The high price range is above $627,381. Prices have fallen 22.8% in real terms.

by Calculated Risk on 6/02/2008 10:11:00 AM

Construction spending declined in April for residential, but increased to for non-residential private construction.

From the Census Bureau: March 2008 Construction Spending at $1,123.5 Billion Annual Rate

Spending on private construction was at a seasonally adjusted annual rate of $823.8 billion, 0.5 percent below the revised March estimate of $827.7 billion.

Residential construction was at a seasonally adjusted annual rate of $435.8 billion in April, 2.3 percent below the revised March estimate of $445.8 billion.

Nonresidential construction was at a seasonally adjusted annual rate of $388.0 billion in April, 1.6 percent above the revised March estimate of $381.8 billion.

Click on graph for larger image.

The graph shows private residential and nonresidential construction spending since 1993.

Over the last couple of years, as residential spending has declined, nonresidential has been very strong. It appeared earlier this year that the expected slowdown in non-residential spending had arrived.

However, non-residential spending in April set a new nominal record (seasonally adjusted annual rate). This is a little surprising given tighter lending standards and reduced capital spending plans.