by Calculated Risk on 6/12/2008 05:08:00 PM

From Bloomberg: BMW Buyers in U.S. See a Ford in Their Future (hat tip James)

Purchases of luxury autos were down nearly 100,000 units, or 14 percent, through May 31, compared with an 8.4 percent drop in all U.S. sales.
...
``This gas panic has extended even to luxury buyers who are deciding they'd rather step down to a Ford with all the amenities rather than get a new Mercedes,'' said David Healy, an equity analyst with Burnham Securities Inc.

Gas prices have probably played a role, but I think the decline in MEW (mortgage equity withdrawal) is a more important factor in the decline in luxury car sales.

(see previous post on MEW)

by Calculated Risk on 6/12/2008 03:00:00 PM

Here are the Kennedy-Greenspan estimates (NSA - not seasonally adjusted) of home equity extraction for Q1 2008, provided by Jim Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

Click on graph for larger image in new window.

For Q1 2008, Dr. Kennedy has calculated Net Equity Extraction as $51.2 billion, or 1.9% of Disposable Personal Income (DPI). Note that net equity extraction for Q4 2007 has been revised upwards to $92.3 billion.

This graph shows the net equity extraction, or mortgage equity withdrawal (MEW), results, both in billions of dollars quarterly (not annual rate), and as a percent of personal disposable income.

MEW declined sharply in Q1 2008, however these numbers are not seasonally adjusted. MEW in Q1 2007 was $135.7 Billion, so MEW has fallen over 60% from Q1 2007.

How important is MEW?

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

Here is what I wrote last year:

As homeowner equity continues to decline sharply in the coming quarters, combined with tighter lending standards, equity extraction should decline significantly and impact consumer spending.

So far homeowner equity has declined sharply, lending standards are tighter, and equity extraction has declined significantly.

But that still leaves the most important link; the impact on consumer spending. No one really knows how much MEW impacts consumption, and the estimates vary widely.

I've been using some estimates from Greenspan that about half of MEW flows to consumption and the other half flows to savings and investment. MEW totaled $682 billion, in 2006 and declined to $473 billion in 2007. That is a difference of $209 billion, and if half flowed to consumption - the drag on consumption from declining MEW was about $105 billion in 2007.

Since nominal Personal Consumption Expenditures (PCE) increased $510 billion between 2006 and 2007, we can estimate that if MEW had been steady, consumption would have increased about $615 billion (another $105 billion). Still, PCE increase 2.9% in real terms between 2006 and 2007 - below the average of 3.7% for the previous 10 years - but still pretty strong. Here was my estimate for 2007:

[T]he estimated drag on consumption would be $110 Billion. If we assume 2006 GDP of $13.3 trillion that would mean a drag of about 0.8% in 2007 due to the decline in MEW.

In 2008, MEW will probably decline to around $200 Billion, a decline of $273 billion from last year. So my estimate - doing the same calculation as above - is that MEW will be a drag of about $135 billion on PCE in 2008, or reduce PCE about 1%, all else being equal (of course the economic slowdown will also impact PCE).

But we also have to consider the other half of the decline in MEW; the portion that flows to investment and savings. Some of that investment went to residential investment for home improvement, and declining MEW will also impact this investment spending (I'll have more on this soon).Read on ...

by Calculated Risk on 6/12/2008 02:22:00 PM

From MarketWatch: Fed's Plosser pushes for quick rate hikes

"We need to take steps to insure that inflation does not get out of control," [Federal Reserve President Charles Plosser] said in an interview on the CNBC television network. "We need to act preemptively."
...
Plosser said Thursday the inflation threat facing the U.S. economy "is serious."

"Inflation has been gradually been creeping up and more than just in oil and food," he said. "The base of inflation is broadening."

by Calculated Risk on 6/12/2008 01:23:00 PM

Freddie Mac reported today that 30 year mortgage rates jumped to 6.32% last week, up from 6.09% the prior week.

Housing Wire has the story: Fixed Mortgage Rates Hit Eight-Month High as Inflation Concerns Mount

The following is a comparison between the 30 year mortgage rate and the ten year treasury yield. Usually mortgage rates follow the shorter duration Ten Year treasury yield (with a spread), because most homeowners either sell or refinance before 10 years. The period that a homeowner holds a mortgage does vary over time and that does impact the spread between the 30 year rate and the ten year treasury - so it's not a perfect relationship, but it is pretty close.

The yield on the Ten Year treasury jumped to 4.215% today; up sharply from early March when the yield was 3.328%. What does this mean for 30 year mortgage rates?

The following scatter graph shows the relationship since 1971.

Click on graph for larger image in new window.

The ten year treasury yield is on the x-axis. The 30 year mortgage rate (from Freddie Mac) is plotted on the Y-axis. Note: this is based on monthly data.

The best fit 2nd order polynominal is plotted on the graph.

Y = 2.4773 * X² + 0.6373 * X + 0.0286

With the Ten Year yield at 0.042, this equation yields a 30 year fixed mortgage rate of 6.0%, below the average rate of 6.32% reported by Freddie Mac today.

There are probably three reasons the mortgage rate is somewhat above the normal spread:

some participants believe the Fed will raise rates later this year, as Freddie Mac chief economist Frank Nothaft noted today,

investors are still risk adverse and wary of mortgages and are demanding a premium, and

some investors might believe that mortgages will be held for longer periods as the turnover in the housing market continues to slow.

Whatever the reason, mortgage rates are increasing and that will probably negatively impact sales.

by Calculated Risk on 6/12/2008 12:07:00 PM

The Office of the Comptroller of the Currency (OCC) released their annual survey of underwriting standards today. Here is the Survey of Credit Underwriting Practices 2008

This is similar to the Federal Reserve Senior Financial Officer Survey except this survey is annual and is based on examiner assessments of the institutions underwriting practices, as opposed to the opinions of financial officers:

The 2008 survey included examiner assessments of credit underwriting standards at the 62 largest national banks. This population covers loans totaling $3.7 trillion as of December 2007, approximately 83 percent of total loans in the national banking system.

As expected, the survey showed significantly tightening in most areas (except agricultural loans).

The Office of the Comptroller of the Currency released today its 14th annual Survey of Credit Underwriting Practices and reported that commercial and retail underwriting standards tightened after four consecutive years of eased underwriting standards.
...
Examiner assessments found that risk in both the commercial and retail portfolios increased over the past year and they expect portfolio risk to continue to increase over the coming year.

A key area of concern for 2008 is Commercial Real Estate:

The most prevalent tightening occurred in CRE loans, leveraged loans, and counterparty credit exposure to hedge funds.
...
CRE products include commercial construction, residential construction, and other CRE loans. These products are offered by virtually all of the surveyed banks. Net tightening, which measures the difference between the percentage of banks tightening and those easing, was greatest in residential construction, followed by commercial construction. The following [graph] provide the breakdown by each real estate type.

Click on graph for larger image in new window.

This graph is from the OCC. The blue bar shows the percent of banks tightening lending standards for each category by year.

Note that residential construction has been tightening for two years, but commercial construction just saw a significant jump in tightening.

Examiners most often cited the following as reasons for strengthening of CRE underwriting standards:

weakening economy, specifically the downturn in residential real estate markets.

Declines in market values/prices as a result of oversupply or slow-moving inventory.

Existing credit concentrations, both by type of product and by location.

Use of non-traditional terms and excessive investor speculation.

CRE remains a primary concern among examiners given the rapid growth of these exposures and banks’ significant concentrations relative to their capital. These concerns are compounded by elevated concerns over market conditions in select areas.

Although CRE concentrations are a concern at these larger national banks (with assets greater than $3 billion), most of the bank failures will probably be at smaller banks with even higher CRE concentrations. Update: The highest concentration of CRE loans are for institutions in the $1 billion to $10 billion range (so there is some overlap).

by Anonymous on 6/12/2008 11:30:00 AM

Reports Bloomberg:

June 12 (Bloomberg) -- The U.S. Federal Bureau of Investigation, confronting a surge in mortgage fraud, has ordered more than two dozen of its field offices to stop probing some financial crimes so agents can focus on the subprime crisis. . . .

The 26 field offices were told to temporarily suspend opening new cases dealing with price fixing, mass marketing, wire fraud, mail fraud and environmental crimes, Carter said. Current cases aren't being dropped, he said. The FBI has 56 field offices and about 12,000 agents.

If I weren't afraid of sounding cynical, I'd say there's a new career in mass marketing and environmental crimes for all those out-of-work mortgage bottom-feeders. So I'll just think it instead.

by Calculated Risk on 6/12/2008 10:11:00 AM

Retail sales in April (ex-auto) were strong. From the WSJ: Stimulus Checks Bolster Retail Sales

Retail sales increased by 1.0%, the Commerce Department said Thursday. ... Sales in the previous two months were revised strongly upward. Sales in April increased 0.4%; originally, Commerce said April sales dropped 0.2%. March sales increased 0.5%; earlier, Commerce said March sales rose 0.2%.

The healthy increase in May sales suggested consumers were putting to work some money the government kicked back to them in a plan to stimulate the foundering economy. ... $48 billion in payments were cut in May, Treasury Department numbers indicate.

U.S. retail and food services sales for May were $385.4 billion, up from $381.6 billion in April. That is an increase of $3.8 billion - a small amount compared to the $48 billion in stimulus checks.

This graph shows the year-over-year change in nominal and real retail sales since 1993.

Click on graph for larger image in new window.

To calculate the real change, the monthly PCE price index from the BEA was used (May PCE prices were estimated based on the increases for the last 3 months).

Although the Census Bureau reported that nominal retail sales increased 2.1% year-over-year (retail and food services increased 2.5%), real retail sales declined 0.8% (on a YoY basis).

So despite the strong sales in May, the YoY change in real retail sales is still negative.

by Calculated Risk on 6/12/2008 09:33:00 AM

From Bloomberg: Lehman's Callan, Gregory Step Down, Lowitt Named Finance Chief

Lehman Brothers Holdings Inc. replaced Chief Financial Officer Erin Callan and President Joseph Gregory ...

by Calculated Risk on 6/12/2008 01:40:00 AM

Remember when the Shanghai stock market declined 9% on Feb 27, 2007? That caused shock waves around the world, including a 400 points decline in the DOW index the following day. After falling to 2772 in Feb 2007, the SSE composite index more than doubled!

Click on graph for larger image in new window.

Now the index has fallen back below 3,000 - still above the close after the one day sell off - but 50% below the peak.

This is some serious cliff diving.

This sell off could be in anticipation of a slowing Chinese economy, and I wouldn't be surprised to finally see a slowdown in China after the Olympics this summer. And a Chinese slowdown might lead to lower oil prices - something else to watch later this year.

by Calculated Risk on 6/11/2008 09:24:00 PM

Press Release: MBIA Issues Letter to Owners.

Most of the news stories today focused on MBIA's announcement that it won't make a planned $900 million capital contribution to MBIA Insurance Corporation. But I also found this comment in the letter interesting:

[B]ased on our discussions with the rating agencies and in trying to think about their challenges, what I believe has really changed in the past three months is that both Moody’s and S&P have far less comfort in forecasting a worst case housing-related stress case loss scenario ...

I'm not surprised that Moody's and S&P feel less comfortable forecasting a worst case for housing - every time they've made a forecast, the housing market has surprised to the downside.