by Calculated Risk on 6/15/2008 07:02:00 PM

There was a blurb in the WSJ last week about hedge-fund manager Edward Lampert: Lampert Puts Money On Housing Rebound.

Although Lampert invested in several housing related stocks, the vast majority of his housing related investment is in home improvement (specifically Home Depot).

Let's take another look at home improvement (Important Note: this is not investment advice). Home Depot recently held an investor conference on June 5th, and here is the presentation material from CEO Frank Blake (hat tip Dave). In general I think Mr. Blake was very realistic about the tough economic environment for home improvement.

The first slide from Mr. Blake is very familiar to readers of CR:

Click on graph for larger image in new window.

This graph shows residential investment (RI) as a percent of GDP for the last 60 years. Blake has added the average of 4.8% on the graph, and clearly RI is well below the average.

Note: I usually present the last 50 years, and the average is closer to 4.6%.

This might convince some people that the end is near in the slump in RI. But let's break it down by two key components of RI: new single family structures and home improvement.

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The next graph shows residential investment in new single family structures as a percent of GDP.

As everyone knows, investment in single family structures has fallen off a cliff. This is the component of RI that gets all the media attention - although usually from stories about single family starts and new home sales (related to RI in single family structures).

Currently investment in single family structures is below 1.6% of GDP, significantly below the average of the last 40 years of 2.4% - although still above the low in 1982 of 1.2%.

But what about home improvement?

The third graph shows home improvement investment as a percent of GDP.

Home improvement is at 1.3% of GDP, off the high of 1.4% in Q1 2007 - but still well above the average of the last 40 years of 1.07%.

This would seem to suggest there is significant downside risk to home improvement spending over the next few years.

And finally, Mr. Blake presented this graph on subprime and Alt-A mortgage origination.

This shows the stunning surge in subprime and Alt-A lending starting in 2004 and running well into 2007.

The graph is captioned: "The worst part of the mortgage market is behind us", but it probably should have been captioned "Worst part of mortgage origination is behind us".

The fallout from these poorly underwritten loans happens when these houses fall into foreclosure, and delinquency and foreclosure rates are still rising - and rising sharply for Alt-A and even prime loans. The worst of the origination is definitely behind us, but the worst of the impact on the economy from this poor underwriting is probably still to come.

Read on ... there is much more.

by Calculated Risk on 6/15/2008 05:18:00 PM

From the Financial Times: Barclays seeks to raise £4bn

Barclays is seeking to raise as much as £4bn ($8bn) from outside investors ... Analysts believe Barclays ... is being less conservative than some of its rivals in marking down assets ...

The confessional will still be busy.

by Calculated Risk on 6/15/2008 01:53:00 PM

From the WSJ: AIG Chief Expected to Step Down

The board of American International Group Inc. is meeting today to accept the possible resignation of Chief Executive Martin Sullivan ...

At the heart of AIG's current problems are the record-setting, multi-billion losses AIG has recorded in the last two quarters ...

Another Sunday board meeting. These are never good news.

Update: CNBC is reporting Lehman is meeting this weekend too:

Senior executives at Lehman Brothers, the embattled Wall Street securities firm, have been summoned this weekend for a series of meetings as the firm prepares to release second-quarter earnings on Monday and speculation swirls that the firm may be sold to a larger bank, CNBC has learned.

by Calculated Risk on 6/15/2008 09:49:00 AM

Alec Klein and Zach Goldfarb at the Washington Post present a three part series on the housing boom and bust starting today. The first part, The Bubble, discusses the causes of the housing market crisis. The next two parts will be released Monday and Tuesday.

The full series, with some interactive timeline and other resources is available here.

Note: Tanta receives a nice mention in the resource section.

The young woman who walked into Pinnacle's Vienna office in 2004 said her boyfriend wanted to buy a house near Annapolis. He hoped to get a special kind of loan for which he didn't have to report his income, assets or employment. Mortgage broker [Kevin] Connelly handed the woman a pile of paperwork.

On the day of the settlement, she arrived alone. Her boyfriend was on a business trip, she said, but she had his power of attorney. Informed that for this kind of loan he would have to sign in person, she broke into tears: Her boyfriend actually had been serving a jail term.

Not a problem. Almost anyone could borrow hundreds of thousands of dollars for a house in those wild days. Connelly agreed to send the paperwork to the courthouse where the boyfriend had a hearing. As it happened, he was freed that day. Still, Connelly said, "that was one of mine that goes down in the annals of the strange."

The problem was the strange was commonplace during the boom.

by Calculated Risk on 6/14/2008 06:41:00 PM

The WaPo had a story this morning, Held Back by the House, about a couple who moved from Florida to Washington because of a job change. They have been unable to sell their Florida home, and remarked:

"If we knew then what we know now, we would have stayed where we were."

Of course many homeowners now know they are trapped:

[D]epressed sales and sinking home prices in many parts of the country are complicating relocations and transfers for thousands of workers ... A survey last year by Worldwide ERC, a nonprofit association that represents relocation specialists, found that depressed home values emerged as the No. 1 reason for resisting job transfers for the first time in more than 10 years.

Of the member organizations that reported employee reluctance to move, 71 percent cited the sluggish real estate market as an impediment to a job-related move, up from 16 percent last year.

"This is a dramatic shift," said Cris Collie, the group's chief executive. "The top issue has consistently been family concerns, such as dual-career couples, children at a critical school age or caring for elderly parents who live nearby.

There are probably close to 10 million households currently with zero or negative equity in the U.S. For these homeowners, it will be very difficult to accept a job transfer to a different county or state.

Definition: Negative Equity: a homeowner owes more than their home is worth.

To size the problem: According to the Census Bureau, from 2005 to 2006 (the most recent data), approximately 1.7 million owner-occupied households, moved to a different county or state. If approximately 1 in 8 households (the same proportion as with negative equity) will not accept a transfer now because of depressed home values that would be about 200,000 households per year that will be reluctant to accept job transfers.

This will not only impact the earning potential of these households, but this could also impact the performance of various companies. A significant majority of households that migrate have incomes above the median - and negative equity situations will limit the ability of companies to transfer these senior employees.

by Calculated Risk on 6/14/2008 03:27:00 PM

Mathew Padilla at the O.C. Register has an interesting piece on rapidly rising delinquencies in Orange County, CA: Orange County’s mortgage market distress could soon top the U.S..

The report said O.C.’s delinquency rate of 3.14 percent, was less than California’s 4.34 percent and the nation’s 3.23 percent.

But, unfortunately, the county’s delinquency rate is rising more quickly than for both the state and nation.

Here are some comments from Keith Carson, a senior consultant for TransUnion, on why the delinquency rates are rising quickly in Orange County:

In Orange County, ... the rate at which you are accelerating is reason for concern. I think that is probably a function of the number of adjustable-rate loans that were made in Orange County in the 2005 to 2006 time frame. Some of those have reset (the interest rate has increased) to the point where occupants can’t afford the payments.
...
I think it is mostly due to the price of homes in California. There were a lot more ARMs used so people could afford to get into a home. For a lot of people the only way they could get into a home was with an ARM.

This is not a subprime problem. The reason the delinquency rate is rising rapidly in Orange County is because homes are very expensive, and a large number of recent home buyers used ARMs, especially Option ARMs, as affordability products.

Now that the interest rate is increasing - and in some cases the loans are hitting the maximum allowed principal ceiling - these loans are no longer affordable. Since these same homeowners have negative equity, selling the home is not an alternative.

The important point here is that delinquencies are starting to increase rapidly in middle to upper middle class neighborhoods where buyers used "affordability products" to buy more house than they could really afford.

We are all subprime now!

by Calculated Risk on 6/14/2008 10:27:00 AM

The New Jersey Real Estate Report finds an error in the NAR data for New Jersey:VINDICATION - NJ Q1 Home Sales down 30%

The NAR reported New Jersey sales as flat, but now are correcting the data to show a 30% decline in sales.

This probably has some impact on the national data too. Kudos to James!

by Calculated Risk on 6/13/2008 07:46:00 PM

Northern Trust chief economist Paul Kasriel discusses active MEW:

Economists refer to something called the “wealth” effect. It is hypothesized that households tend to spend relatively more of their income when their wealth is increasing and vice versa. Mind you, households do not have any more cash in hand to spend when the value of their stock portfolios or houses go up. They are just wealthier “on paper.”

In this past cycle, it had become very easy for households to turn their increased “paper” housing wealth into actual cash by borrowing against their increased home equity. This borrowing is called mortgage equity withdrawal, or MEW. Active MEW can be defined as mortgage equity withdrawal consisting of refinancing and home equity borrowing. In contrast, inactive MEW consists of turnover. At an annualized rate, active MEW peaked at $576 billion in the second quarter of 2006. Active Mew has slowed to only $114 billion in the first quarter of this year – the smallest amount since the fourth quarter of 1999 (see Chart 3 [at link]). There is no doubt in my mind that active MEW, which actually puts additional cash into the hands of households, played an important role in boosting consumer spending in this past expansion. And there is no doubt in my mind that the recent and likely continued decline in active MEW will play an important role in retarding consumer spending in this recession. Because it has been easier to borrow against the increased wealth in one’s house than in one’s stock portfolio, dollar-for-dollar, falling house prices will have a more important negative effect on household spending that will falling stock prices.

Note: my graphs have focused on MEW including turnover. Active MEW is a subset of the data I've presented and consists of cash out refis and HELOCs.

And on Fed tightening:

It is conceivable the Fed could engage in a one-off 25 basis point hike in the funds rate, which could not make a material difference on business activity because the Fed has taken radical preemptive action as an insurance against the possibility of a severe economic downturn and/or continued financial market disruptions. ... But, there is a distinctly stronger probability attached to the likelihood of an unchanged federal funds rate well into 2009 ... In other words, in our estimation, the Fed may not need to translate rhetoric into action given the fragile economic environment and the likelihood that inflation will be moderating in the second half of the year.

Goldman Sachs has the same view (no link): Could They? Yes. Will They? We Don't Think So.

[W]e still believe that tightening is both inappropriate and unlikely anytime soon. It is inappropriate because: (1) the economy is fundamentally weak, with tax rebates driving the surge in retail sales; (2) financial markets remain fragile; and (3) worries about inflation are overdone ...

by Calculated Risk on 6/13/2008 04:31:00 PM

It's Friday the 13th, do you know if your bank has failed?

We know WaMu has issued a denial.

Downey Financial put out some ugly non-performing asset numbers.

The parent of Downey Savings and Loan Association said its total non-performing assets (NPAs) rose 14.3 percent of total assets of $12.78 billion as of May 31.

Alistair Barr at MarketWatch recently mentioned Corus and IndyMac as possible candidates.

Reader Brian is also wondering about IndyMac because of the price action today.

The odds are no FDIC insured banks will fail today, and if one does, it will be some bank in Podunk. But it is Friday the 13th, so maybe the FDIC will go for two.

by Calculated Risk on 6/13/2008 01:55:00 PM

Roubini on retail sales:

Click on photo for Bloomberg Interview

The retail sales figures for May - better than expected - were driven by a temporary factor, the tax rebates, whose influence will fade out by early fall.

Instead, more persistent factors will bear negatively on consumption over the summer and especially the fall: the fall in home prices and the collapse of home equity withdrawal (with their wealth effect on spending); the stressed balance sheets and high debt ratios of the household sector (such debt is up to almost 140% of disposable income); the credit crunch in mortgage markets that is now spreading to unsecured consumer credit (credit cards, student loans, auto loans); the rise in debt servicing ratios (following the reset of mortgage rates, and higher interest rates on mortgages and consumer credit); the sharp rise in gasoline and energy prices that is a serious shock to real incomes; the further erosion of real wages through the rise in the inflation rate; the sharp fall in consumer confidence; the drop in employment (now five months in a row) and thus in income generation; the negative wealth effect of the correction in equity markets and the fall in the net worth of the household sector. All these factors will have – over time – a much more significant negative effect on consumption than the temporary boost given by the tax rebates.