by Calculated Risk on 6/05/2008 11:05:00 AM

From the MBA: Delinquencies and Foreclosures Increase in Latest MBA National Delinquency Survey (hat tip Ed)

The percent of loans on which foreclosure actions were started during the quarter was 0.99 percent on a seasonally adjusted basis, 16 basis points higher than the previous quarter and up 41 basis points from one year ago.

The seasonally adjusted total delinquency rate is the highest recorded in the MBA survey since 1979 ...

Once again this quarter, the rate of foreclosure starts and the percent of loans in the process of foreclosure are the highest recorded since [the survey started in] 1979.

ARMs are a key problem, both subprime and prime:

“[W]hile subprime ARMs represent 6 percent of the loans outstanding, they represented 39 percent of the foreclosures started during the first quarter. Prime ARMs represent 15 percent of the loans outstanding, but 23 percent of the foreclosures started. Out of the approximately 516,000 foreclosures started during the first quarter, subprime ARM loans accounted for about 195,000 and prime ARM loans 117,000, but the increase in prime ARM foreclosures exceeded subprime ARM foreclosures with increases of 29,000 and 20,000 respectively over the previous quarter.” [said] Jay Brinkmann, MBA’s Vice President for Research and Economics.

That last comment is important - even though there were still more subprime than prime ARM foreclosures in Q1, the problems are really accelerating in the prime ARM segment.

by Calculated Risk on 6/05/2008 10:54:00 AM

Fed Vice Chairman Donald L. Kohn testified today: Condition of the banking system. A short excerpt:

Consistent with trends in commercial banks overall, conditions at state member banks have weakened over the past year. Problems in residential mortgage, home equity, and loans to home builders have pushed the nonperforming assets ratio at these banks to 1.57 percent, more than twice the level of one year ago and the highest rate since 1993. Loan loss provisions have also accelerated, rising to a high of 1.14 percent of average loans during the first quarter of 2008 in large part reflecting the deterioration in residential real estate-related loan portfolios.
...
Over the coming months, we expect banking institutions to continue to face deteriorating loan quality. House prices are still declining sharply in many localities and losses related to residential real estate--including loans to builders and developers--are bound to increase further. In addition, weak economic conditions could well extend problems to other segments of lending portfolios including consumer installment or credit card loans, as well as corporate loan portfolios. Moreover, banking organizations must be prepared for the possibility that liquidity conditions become tighter if uncertainties in the capital markets fail to subside or if credit conditions deteriorate significantly. Accordingly, we anticipate that the number of banks with less than satisfactory supervisory ratings will continue to increase from the relatively low levels that have existed in recent years and we are monitoring developments at all supervised institutions closely.
emphasis added

This is why the FDIC is gearing up for many more bank failures.

by Calculated Risk on 6/05/2008 09:57:00 AM

From the WSJ: Backstage at a Bank Funeral (hat tip FFDIC).

This is a story (and slide show) about how the FDIC handles a bank failure:

It isn't easy for 75 federal officials and contractors to slip into a small town undetected and liquidate an 89-year-old bank without anyone knowing. But that's what just happened in this old railroad town, population 3,200. It's a scene that's likely to repeat itself across the country as banks struggle through a painful credit cycle, overwhelmed by troubled mortgages and soured construction loans.
...
In its role as receiver for failed banks, the FDIC acts as a SWAT team, playing equal parts secret agent, medical examiner, salesman and grief counselor. The first 48 hours are typically the most frantic, as the agency must turn a failed bank inside out and oversee its sale -- or its orderly burial.

This is a story that will probably be repeated frequently over the next couple of years.

by Calculated Risk on 6/05/2008 09:39:00 AM

From the WSJ: Some Chains Posts Strong Sales Despite Gas Prices, Low Confidence

Retailers posted stronger-than-expected same-store sales for May [despite a] surge in gasoline prices and tumbling consumer confidence.

Leading the way was Wal-Mart Stores Inc., which reported a 3.9% jump, excluding fuel, in U.S. same-store sales -- double the high end of its forecast of flat to up 2% ...

Even Wal-Mart's home-goods sales, which have been weak for some time, perked up last month and posted its first same-store-sales gain in more than two years.

Overall retailers reported fairly strong sales in May. It looks like $4 gasoline didn't use up the entire stimulus.

by Calculated Risk on 6/05/2008 01:31:00 AM

Definition of Negative Absorption: The absorption rate for a community is the number of new household formed per year. If there are 100 new households formed in a community, then the annual absorption rate would be 100 units (house or apartments).

A negative absorption rate means that there are fewer households in the community each year. This is usually because more families move out of the community than move in. Since housing is durable, a negative absorption rate implies there is always more supply than demand.

I spoke with a land developer tonight (the same one involved in the 15 cents on the dollar land deal in the Inland Empire earlier this year). He told me about two deals he is working on with lenders for foreclosed land at about 20 cents on the dollar. He said the lenders are still in shock at the price.

He also mentioned that his company's analysis shows that Santa Maria (a small town about 75 miles north of Santa Barbara) is facing 5 years of negative absorption for residential real estate. This means there are a declining number of households in Santa Maria - as people leave to find jobs elsewhere - and my source believes Santa Maria will need fewer houses each year for the next five years.

Right on cue, Peter Hong writes in the LA Times: Santa Maria house bought with no money down goes into foreclosure

Prado bought a $412,000 house with a so-called 80/20 mortgage. Those mortgages are actually a pair of loans -- one for 80% of the purchase price and another for the remaining 20%.
...
Property values, of course, began falling sharply last year. And that left people such as Prado, who bought near the top of the market, owing more in loans than their homes were worth.
...
She acknowledged that she stated her monthly income as $7,500 on the loan application -- nearly double what she was actually earning ... her husband ... was earning $20 an hour as a carpenter as builders turned the area's broccoli fields into housing developments.
...
Financially, Prado says she hasn't really lost anything, since she put no money down to get her mortgage. She's looking for a place to rent.

Houses like hers are now renting for between $1,300 to $1,600 a month ...

This brings up a couple of key points:

This is fraud. Yes, it is fraud for housing, as opposed to fraud for profit, and fraud for housing is rarely prosecuted. But this is still fraud. (I recommend reading Tanta's UberNerd piece on fraud from last year: Unwinding the Fraud for Bubbles)

To reach a cap rate of 7% (similar to the REO in Oceanside), this house would have to sell for from $157K (rent of $1300 per month) to $192K (rent of $1600 per month). That is about 55% to 60% off the price the house sold for two years ago. And with negative absorption, the rents may fall much further.

There is almost no bottom for prices in an area with negative absorption. Just ask the residents of Detroit.

by Calculated Risk on 6/05/2008 12:00:00 AM

Here is a video from TheStreet.com concerning that buy one house, get a second one free offer in Escondido, California. The video features Paul Kedrosky of Infectious Greed.

I've driven by the row homes, and they are on the corner of two busy streets - "Conveniently located on the corner of Midway Drive and Grand Avenue in Escondido" according to the builder - and not in the best neighborhood.

This is obviously just a gimmick to generate interest ... and it accomplished that goal.

by Calculated Risk on 6/04/2008 08:00:00 PM

An article in the WSJ today reminded me of the residential construction employment conundrum. From the WSJ: Housing Slump Hits Hispanic Workers, But Most Immigrants Remain in U.S.

The housing slump has disproportionately hurt Hispanic workers, provoking a jump in unemployment that has hit the immigrants among them the hardest, according to a new study.
...
Many undocumented workers don't appear on employment rosters because they work as independent contractors or are hired indirectly by big developers through subcontractors or labor brokers who don't officially hire every worker. "They were ghosts to begin with," says Rose Quint, an economist at the National Association of Homebuilders. Thus, she says, "the decline in employment is probably bigger than numbers are showing."

Here is the report: Latino Labor Report, 2008: Construction Reverses Job Growth for Latinos

This graph shows the construction employment conundrum: why have starts and completions declined about 50% from the peak in 2006, and yet residential construction employment is off only 14%?

Click on graph for larger image in new window.

Note that starts are shifted 6 months into the future since it takes a little over 6 months to complete a typical residential unit.

Last year Greg Ip at the WSJ reviewed an analysis from Deutsche Bank economists suggesting that the illegal immigrant explanation accounts for most of the missing job losses:

[E]conomists at Deutsche Bank estimate construction employment should have fallen about 900,000 since early 2006 when in fact it’s only down 150,000. They conclude 500,000 of the unexplained gap is attributable to layoffs of illegal Hispanic workers.

To update the numbers, residential construction employment is off 477,000 from the peak, but there are still close to 1 million too many jobs based on starts and completions.

The uncounted illegal immigrant argument is important for the impact on the economy, but it doesn't seem to explain why the BLS employment numbers haven't fallen more. Although the BLS is missing the job losses for illegal workers on the way down, they also didn't count them on the way up either.

Although miscounted illegal workers probably explains some of the fewer than expected BLS reported job losses, there are two other explanations that make sense:

Some construction employees have moved from residential to commercial work, but they are still being reported as residential construction employees to the BLS.

Many workers are still employed, but they are working far fewer hours.

The answer is probably a combination of all of the above.

by Calculated Risk on 6/04/2008 06:43:00 PM

From the LA Times:



Merced provides a great contrast to Oceanside. Both areas have been inundated with foreclosures, and REOs are driving prices sharply lower.

In Oceanside (at least some areas), the prices have reached levels attractive to some investors. The rental market is tight in coastal north county San Diego, and these investors will provide somewhat of a floor on prices.

However in Merced, it appears there are simply more homes than households. This is farm land, and is definitely not a 2nd home location.

by Calculated Risk on 6/04/2008 05:36:00 PM

Here is an email from Accredited:

Dear Valued Brokers, In recent months, the associates at Accredited Home Lenders, Inc. (Accredited) have made great strides to carry the Company through the challenging business climate our industry is facing and to position Accredited for a successful future.  Today, we will be taking steps that will further enable us to allocate our resources in the most efficient manner possible with minimal disruption to our brokers.  Accordingly, Accredited's operations centers in Orange, California; Beaverton, Oregon; St. Petersburg, Florida; and Woodcliff Lake, New Jersey will be closing today.  Loan files currently on site at these locations will be expedited to our Headquarters in San Diego, California, where they will continue to be processed with the high levels of service you have come to expect from Accredited.  We are committed to working diligently toward ensuring there are no delays in the underwriting, closing, or funding of these re-routed files, or the files currently in process in San Diego. Accredited will be providing brokers affected by these closures with more specific information and contacts in the San Diego office this afternoon. As always, we appreciate your business and look forward to continuing a successful partnership in the future.

by Calculated Risk on 6/04/2008 03:50:00 PM

From Fed Chairman Ben Bernanke: Remarks on Class Day 2008

The oil price shock of the 1970s began in October 1973 when, in response to the Yom Kippur War, Arab oil producers imposed an embargo on exports. Before the embargo, in 1972, the price of imported oil was about $3.20 per barrel; by 1975, the average price was nearly $14 per barrel, more than four times greater. President Nixon had imposed economy-wide controls on wages and prices in 1971, including prices of petroleum products; in November 1973, in the wake of the embargo, the President placed additional controls on petroleum prices.

As basic economics predicts, when a scarce resource cannot be allocated by market-determined prices, it will be allocated some other way--in this case, in what was to become an iconic symbol of the times, by long lines at gasoline stations. In 1974, in an attempt to overcome the unintended consequences of price controls, drivers in many places were permitted to buy gasoline only on odd or even days of the month, depending on the last digit of their license plate number. Moreover, with the controlled price of U.S. crude oil well below world prices, growth in domestic exploration slowed and production was curtailed--which, of course, only made things worse.

It was a crazy time. I wasted both gas and time driving around looking for open gas stations, and then waiting in long lines.

In addition to creating long lines at gasoline stations, the oil price shock exacerbated what was already an intensifying buildup of inflation and inflation expectations. In another echo of today, the inflationary situation was further worsened by rapidly rising prices of agricultural products and other commodities.

Economists generally agree that monetary policy performed poorly during this period. In part, this was because policymakers, in choosing what they believed to be the appropriate setting for monetary policy, overestimated the productive capacity of the economy. I'll have more to say about this shortly. Federal Reserve policymakers also underestimated both their own contributions to the inflationary problems of the time and their ability to curb that inflation. For example, on occasion they blamed inflation on so-called cost-push factors such as union wage pressures and price increases by large, market-dominating firms; however, the abilities of unions and firms to push through inflationary wage and price increases were symptoms of the problem, not the underlying cause. Several years passed before the Federal Reserve gained a new leadership that better understood the central bank's role in the inflation process and that sustained anti-inflationary monetary policies would actually work. Beginning in 1979, such policies were implemented successfully--although not without significant cost in terms of lost output and employment--under Fed Chairman Paul Volcker. For the Federal Reserve, two crucial lessons from this experience were, first, that high inflation can seriously destabilize the economy and, second, that the central bank must take responsibility for achieving price stability over the medium term.
emphasis added

Fast-forward now to 2003. In that year, crude oil cost a little more than $30 per barrel. Since then, crude oil prices have increased more than fourfold, proportionally about as much as in the 1970s. Now, as in 1975, adjusting to such high prices for crude oil has been painful. Gas prices around $4 a gallon are a huge burden for many households, as well as for truckers, manufacturers, farmers, and others. But, in many other ways, the economic consequences have been quite different from those of the 1970s. One obvious difference is what you don't see: drivers lining up on odd or even days to buy gasoline because of price controls or signs at gas stations that say "No gas." And until the recent slowdown--which is more the result of conditions in the residential housing market and in financial markets than of higher oil prices--economic growth was solid and unemployment remained low, unlike what we saw following oil price increases in the '70s.

For a central banker, a particularly critical difference between then and now is what has happened to inflation and inflation expectations. The overall inflation rate has averaged about 3-1/2 percent over the past four quarters, significantly higher than we would like but much less than the double-digit rates that inflation reached in the mid-1970s and then again in 1980. Moreover, the increase in inflation has been milder this time--on the order of 1 percentage point over the past year as compared with the 6 percentage point jump that followed the 1973 oil price shock. From the perspective of monetary policy, just as important as the behavior of actual inflation is what households and businesses expect to happen to inflation in the future, particularly over the longer term. If people expect an increase in inflation to be temporary and do not build it into their longer-term plans for setting wages and prices, then the inflation created by a shock to oil prices will tend to fade relatively quickly. Some indicators of longer-term inflation expectations have risen in recent months, which is a significant concern for the Federal Reserve. We will need to monitor that situation closely. However, changes in long-term inflation expectations have been measured in tenths of a percentage point this time around rather than in whole percentage points, as appeared to be the case in the mid-1970s. Importantly, we see little indication today of the beginnings of a 1970s-style wage-price spiral, in which wages and prices chased each other ever upward.

A good deal of economic research has looked at the question of why the inflation response to the oil shock has been relatively muted in the current instance. One factor, which illustrates my point about the adaptability and flexibility of the U.S. economy, is the pronounced decline in the energy intensity of the economy since the 1970s. Since 1975, the energy required to produce a given amount of output in the United States has fallen by about half. This great improvement in energy efficiency was less the result of government programs than of steps taken by households and businesses in response to higher energy prices, including substantial investments in more energy-efficient equipment and means of transportation. This improvement in energy efficiency is one of the reasons why a given increase in crude oil prices does less damage to the U.S. economy today than it did in the 1970s.

Another reason is the performance of monetary policy. The Federal Reserve and other central banks have learned the lessons of the 1970s. Because monetary policy works with a lag, the short-term inflationary effects of a sharp increase in oil prices can generally not be fully offset. However, since Paul Volcker's time, the Federal Reserve has been firmly committed to maintaining a low and stable rate of inflation over the longer term. And we recognize that keeping longer-term inflation expectations well anchored is essential to achieving the goal of low and stable inflation. Maintaining confidence in the Fed's commitment to price stability remains a top priority as the central bank navigates the current complex situation.

Although our economy has thus far dealt with the current oil price shock comparatively well, the United States and the rest of the world still face significant challenges in dealing with the rising global demand for energy, especially if continued demand growth and constrained supplies maintain intense pressure on prices. The silver lining of high energy prices is that they provide a powerful incentive for action--for conservation, including investment in energy-saving technologies; for the investment needed to bring new oil supplies to market; and for the development of alternative conventional and nonconventional energy sources. The government, in addition to the market, can usefully address energy concerns, for example, by supporting basic research and adopting well-designed regulatory policies to promote important social objectives such as protecting the environment. As we saw after the oil price shock of the 1970s, given some time, the economy can become much more energy-efficient even as it continues to grow and living standards improve.

It is worth reading Bernanke's views because that is the general consensus of the Fed. His comments on the Fed fighting inflation in the "medium term" further suggests the rate cuts are over for now - even if the economy weakens further. Inflation, and inflation expectations are just too high.

Bernanke also spoke about productivity.