by Calculated Risk on 6/08/2008 07:18:00 PM

The previous post excerpted from a Business Week article suggesting Option ARMs are "The Next Real Estate Crisis".

Now, from the Financial Times: Crisis shifts to regional lenders

Home equity loans are rapidly emerging as the next front of the credit crunch, as falling house prices and lax underwriting lead to growing losses for US regional banks that have huge portfolios of such loans on their balance sheets.

The rising defaults on home equity loans, used by people to raise funds by taking out a second mortgage on their houses, underscore how the financial crisis is shifting from big banks’ writedowns on complex derivatives to consumer-related problems for smaller banks.

So is the next crisis Option ARM recasts or HELOCs hitting the regional banks?

The answer is probably both, but in different ways. The Option ARM recasts will lead to more foreclosures, especially in move up areas where the product was very popular, and put more pressure on house prices. HELOC lenders tend to avoid foreclosure, since HELOC lenders frequently experience 100% losses in foreclosure - so the lenders don't bother with the added expense. Instead the HELOC losses will hit the lenders' balance sheets, and will lead to more write-downs and potentially more bank failures.

by Calculated Risk on 6/08/2008 10:00:00 AM

From BusinessWeek: The Next Real Estate Crisis

[T]he next wave of foreclosures will begin accelerating in April, 2009. ... hundreds of thousands of borrowers who took out so-called option adjustable-rate mortgages (ARMs) will begin to see their monthly payments skyrocket as they reset.
...
According to Credit Suisse, monthly option recasts are expected to accelerate starting in April, 2009, from $5 billion to a peak of about $10 billion in January, 2010.
...
The loans automatically recast after five years, but many will recast sooner as loan balances hit specific principal caps—typically between 110% and 125% of the initial loan amount.

Click on image for Business Week graph in new window.

This graph from Credit Suisse (via Business Week) makes a key point. Many of the Option ARMs will recast sooner than originally scheduled, because the loan amount will have hit the principal ceiling (usually 110% of the original loan amount).

Tanta explained this in Negative Amortization for UberNerds:

[Once the loan hits the principal ceiling], the loan must become a fully amortizing loan—no more minimum payment allowed, all payments must be sufficient to pay all interest due and sufficient principal to amortize the loan over the remaining term.

The percent of original balance limitation, in other words, marks the day that neg am is no longer an option for the borrower, and the loan has to start paying down principal from here on out—the borrower is “caught up,” and never again allowed to “get behind.”
...
Note that the loan remains an ARM, even though it is now no longer a neg am ARM. That means that the borrower’s payment can still increase or decrease at future rate change dates. It will simply be, from here on out, an increase or decrease from one fully-amortizing payment to a new fully-amortizing payment.
emphasis added

What matters for the housing market is the gray bars - and we are just starting to see the impact on delinquencies of homeowners moving from NegAm payments to fully amortizing payments on their Option ARMs.

And, finally, the blue bars tell us when these homeowners obtained their loans - usually 5 years before the scheduled recast. Since the peak is in 2011, we know that most of these homeowners bought or refinanced from 2005 through early 2007. Therefore, with falling house prices, most of these homeowners are underwater (owe more than their homes are worth), and selling or refinancing will not be a viable alternatives.

by Calculated Risk on 6/07/2008 09:23:00 PM

From Bloomberg: U.S., Asia Express `Serious Concern' Over Oil Prices

The U.S. and Asia expressed ``serious concern'' over record oil prices, ... in a joint statement issued [by officials from Japan, China, India, South Korea and the U.S.] after a meeting in Aomori in northern Japan today.
...
The governments of China and India, which sell fuels to domestic users below cost, were in agreement with the U.S., Japan and South Korea that ``a gradual withdrawal of fuel subsidies is desirable,'' the statement said.

India, Malaysia, Indonesia and Taiwan over the past month raised fuel prices and cut subsidies, in a move that may reduce Asian demand and slow global oil-consumption growth.

``This is the first time that we can agree on the necessity of abolishing fuel subsidies by steps,'' Japan's Trade Minister Akira Amari told reporters today. ``Each country has different reasons and contexts, so they cannot do that immediately.''

Reducing subsidies is an important step for the Asian countries. With market prices, Asian fuel demand will probably slow or even decline.

by Calculated Risk on 6/07/2008 10:44:00 AM

NY Times: Job Losses and Surge in Oil Spread Gloom on Economy

Many people turn negative again ...

by Calculated Risk on 6/06/2008 10:56:00 PM

From Bloomberg: Australian House Prices Fall Most in Five Years on Higher Rates

The median price for houses fell to A$458,488 ($439,644) in the March quarter, down 2.7 percent from the previous three months, the Real Estate Institute of Australia and Mortgage Choice Ltd. said. ...

Falling residential prices support the central bank's view that Australia's $1 trillion economy will slow this year, helping ease the fastest inflation in 17 years.

From ABC News in Australia: Construction slump points to economic downturn

The Australian Industry Group (AiG) - Housing Industry Association (HIA) Performance of Construction Index (PCI) reveals that building activity fell sharply in May, after also falling heavily in April.

The index now stands at a paltry 36.9 - well below the benchmark number of 50 that separates an expanding industry from a contracting one.

This is the lowest result and the sharpest monthly fall in the index's two and a half year history.

The previous sharpest fall was the month before.

And from Australian TV: Their view is the credit crisis is back - well, it never really went away (hat tip RemiG, 2 min 56 sec). This appears to be from yesterday - before the U.S. market tanked today.



I laugh every time I hear the phrase "dodgy debt".

by Calculated Risk on 6/06/2008 07:14:00 PM

From the LA Times: Housing downturn is a jolt to upscale Temecula

It wasn't supposed to happen here. Not like this. The crashes are expected to hit hard in the Fontanas and the Perrises of the world -- cities marketed more to working-class buyers, first-time buyers or sub-prime buyers. Indeed, Temecula is by no means the hardest-hit area of the Inland Empire; many communities here have plunged into record levels of foreclosure.
...
Today, said Rich Johnston, Temecula's deputy director of building and safety and code enforcement, as many as 15% of Temecula's 22,500 single-family homes are bank-owned or in some stage of foreclosure.

I remember visiting a friend in Temecula about 3 years ago. We were standing in his front yard, and he started telling me what his neighbors did for a living. "A mortgage broker lives there. A real estate agent there. That guy is in construction. Another mortgage broker there" ... and on and on. Over half of the households on his block were dependent on the housing market in way or another.

So it is no surprise that the housing bust is hitting Temecula hard.

But look at Temecula on this map. San Diego is far to the south - living in Escondido is a tough enough commute to work in San Diego. And Orange County is an even more difficult drive to the west. Imagine what $5 gasoline will do.


View Larger Map

by Calculated Risk on 6/06/2008 03:57:00 PM

It's Friday. Do you know if your bank failed today?

Note: Just asking because the FDIC usually announces bank failures Friday afternoon.

by Calculated Risk on 6/06/2008 02:07:00 PM

From MarketWatch: Wal-Mart sees growth both in U.S., overseas

Chief Financial Financial Officer Tom Schoewe also said it's "highly likely" that Wal-Mart's capital spending this fiscal year will be at the low end of its previous estimate of $13.5 billion to $15.2 billion ...

A billion less capital spending here, a billion there ... and the non-residential investment slump is here.

by Calculated Risk on 6/06/2008 10:27:00 AM

From Professor Hamilton: The Oil Shock of 2008

"Time to reassess the potential for recent oil price increases to contribute to an economic downturn.

The sharp spikes in oil prices associated with the 1973-74 oil embargo, the 1978 Iranian Revolution, the Iran-Iraq War in 1980, and the first Persian Gulf War in 1990 were each followed by an economic recession. However, when oil prices started to rise again five years ago, many of us suggested that things would be different this time, in part because the price was rising much more gradually and so should be less disruptive of consumer spending patterns. Others emphasized that, despite the price increases, oil was still cheaper than it had been historically if you took into account inflation. However, once you include the most recent data, neither of those claims would still be true."

From EconbrowserThe graph above shows that the real price of oil is now above the levels of the previous oil shocks.

Hamilton points out that American businesses and consumers are now clearly changing their behavior based on the price of oil. (see his post for more graphs)

Of course oil is a global commodity, and strong demand growth overseas can more than offset declining demand in the U.S. Just today Morgan Stanley analyst Ole Slorer said that he expects strong Asian demand to push prices to $150 by July.

Morgan Stanley analyst Ole Slorer said he expected strong demand in Asia that could drive prices to $150 by July 4. Shipments from the Middle East are mimicking patterns seen in the third quarter last year, when Morgan Stanley based its "oil price spike" predictions on Atlantic Basin draws, he said.

"We made the same call using the same parameters, but now we are starting from much lower inventory levels," Slorer said Friday.

"Asia is taking an unprecedented share" of Middle East exports to build up stocks, Slorer wrote in his report.

Interesting times.

by Calculated Risk on 6/06/2008 08:43:00 AM

From the BLS: Employment Situation Summary

The unemployment rate rose from 5.0 to 5.5 percent in May, and nonfarm payroll employment continued to trend down (-49,000), the Bureau of Labor Statistics of the U.S. Department of Labor reported today. In May, employment continued to fall in construction, manufacturing, retail trade, and temporary help services, while health care continued to add jobs.

The first graph shows the unemployment rate and the year-over-year change in employment vs. recessions.
Click on graph for larger image.

Unemployment jumped sharply and the rise in unemployment, from a cycle low of 4.4% to 5.5%, is a strong recession indicator.

Also concerning is the YoY change in employment is close to zero (the economy has added only 236 thousand jobs in the last year), also suggesting a recession.

Note the current recession indicated on the graph is "probable", and is not official.

The second graph shows residential construction employment.

Note: graph doesn't start at zero to better show the change.

Residential construction employment declined 25,100 in May, and including revisions to previous months, is down 494 thousand, or about 14.3%, from the peak in February 2006. (compared to housing starts off over 50%).

This is the fifth straight month of job losses. This is a weak report, and the jump in unemployment strongly suggests a recession.