by Calculated Risk on 7/16/2008 05:27:00 PM

Reading the Fed minutes today, it appears that as of the last FOMC meeting in June, most FOMC members were once again missing the downside risks to the economy. Chairman Bernanke somewhat corrected that mistake in his testimony over the last two days as he acknowledged the "significant downside risks to the outlook for growth".

As of yesterday - before the stock market rally today - market participants were expecting the Fed to hold rates steady at 2.0% through September, and a rate cut is now more likely (in their view) than a rate hike by the September meeting.

Click on graph for larger image in new window.

This graph from the Cleveland Fed shows the implied probability of what Fed Funds futures market participants expect the most likely outcome to be at the Fed meeting in September.

I also think the Fed will hold rates steady - probably through the end of the year.

by Calculated Risk on 7/16/2008 02:32:00 PM

Note that foreclosure resales were 41.1% of all resales in June!

From DataQuick: Southland home sales drag along bottom

Home sales in Southern California continued at their slowest pace in more than two decades last month ... A total of 17,424 new and resale houses and condos sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties last month. That was up 3.0 percent from 16,917 the previous month and down 13.6 percent from 20,166 for June a year ago, according to DataQuick Information Systems.

While last month's sales were the highest in ten months, it was still the slowest June in DataQuick's statistics, which go back to 1988. The June average is 28,488 sales, the peak was reached in 2005 when 40,156 homes sold.
...
The median price paid for a Southland home was $355,000 last month, down 4.1 percent from $370,000 in May and down 29.3 percent from $502,000 for June 2007. The peak of $505,000 was reached in March, April, May and July of last year.

The median has fallen because of depreciation, especially in inland markets, and because of the steep dropoff in home financing in the so-called jumbo category, which until recently was defined as loans above $417,000.
...
Foreclosure resales continue to be a dominant factor in today's Southern California market accounting for 41.1 percent of all resales. That was up from 39.2 percent in May, and up from 7.3 percent in June a year ago. Foreclosure resales ranged from 18.9 percent in Orange County last month to 62.3 percent in Riverside County.
...
Foreclosure activity is at record levels ...

by Calculated Risk on 7/16/2008 01:44:00 PM

M&I reported this morning. From MarketWatch: Marshall & Ilsley posts second-quarter loss of $394 million

Here are some comments from the conference call:

As we discussed earlier this month, M&I, like other banks, has experienced continued deterioration in the national residential real-estate markets during the second quarter. In addition, we have noted some stress among our consumers with conventional non accruals picking up but with home equity remaining stronger. Our commercial lending portfolio has maintained its strong credit profile

We have already realized partial charge-offs of $386 million against our nonperforming loans, representing a 27% haircut, which is up from 18% last quarter. Within our loan portfolios, we continue to focus on our residential related construction and development categories. These loans are in both our commercial real estate and residential real estate portfolios depending on the underlying collateral. As of quarter end we had had $661 million in construction and development loans on nonperforming status representing 63% of our total nonperforming loans. ... [O]f these nonperforming construction and development loans, two-thirds are in the Arizona , west coast of Florida , and correspondent businesses.

We have seen further deterioration in the residential land portfolio during the second quarter. ... M&I has $2.3 billion in residential land loans to individuals and developers. $1.5 billion, or 66%, are located in Arizona . The bulk of the Arizona loans, nearly 70%, are in Maricopa County . ... LTVs are approximately 115%. Residential land accounts for $219 million of nonperforming loans of which 55% are based in our Arizona business unit. ...

With regard to conventional mortgages, we have noted deterioration as individuals are feeling increased economic stress. As we've noted before, we maintained our underwriting discipline through the cycle, have never originated subprime loans, and have avoided many of the more risky loan products. Nonetheless, during the quarter, our nonperforming residential loans have increased to $21 million, or 2.1% of the portfolio. Within the residential portfolio, we have seen some deterioration in many of our markets with the Arizona market being most notable. We continue to aggressively monitor and manage this portfolio. To provide further granularity on our Arizona residential portfolio, the average loan is around $300,000, and the average nonperforming loan is slightly higher. The average refreshed FICO score on this portfolio is 716. The average updated LTV is approximately 90%.
emphasis added

Note the large concentration of land loans in Arizona with LTV of 115%. Ouch. During housing busts, land prices usually fall a great percentage than existing home prices. So many of these 115% LTV loans will probably be much higher soon.

Also note that M&I is fairly conservative, and the nonperforming residential loans are NOT subprime.

From the Q&A:

Analyst: Can you give us [the loss severity] number on Construction & Development (C&D)?

M&I: You know, I would rather not put that out there. I would tell you that the C & D haircut is going to be higher than the 27%.

by Calculated Risk on 7/16/2008 01:00:00 PM

The NAHB reports that builder confidence was at 16 in July, down from 18 in June. Usually housing bottoms look like a "V"; this one will probably look more like an "L". (this refers to activity like starts and sales, but will probably also be apparent in the confidence survey).

Current sales activity is at a record low of 16. Traffic of Prospective Buyers
at a record low of 12!

NAHB Press Release: Builder Confidence Declines Further In July (excerpts below graph)

Builder confidence in the market for newly built single-family homes fell for a third consecutive month in July, according to the National Association of Home Builders/Wells Fargo Housing Market Index (HMI), released today. The HMI fell below its previous record low of 18 in June to a new record low of 16 in July, with each of its three component indexes also hitting record lows.

“The worsening housing slump and the near-meltdown in financial markets last week makes it even more urgent for Congress to complete action on the housing bill now, a move that will help stabilize and restore confidence in housing and the U.S. economy,” said NAHB President Sandy Dunn, a home builder from Point Pleasant, W.Va.
...
“Builders are reporting that traffic of prospective buyers has fallen off substantially in recent months,” said NAHB Chief Economist David Seiders. “Given the systematic deterioration of job markets, rising energy costs and sinking home values aggravated by the rising tide of foreclosures, many prospective buyers have simply returned to the sidelines until conditions improve,” he said.
emphasis added

by Calculated Risk on 7/16/2008 10:57:00 AM

From MarketWatch: Crude falls over $6 as inventories show surprise increase

U.S. crude inventories gained surprisingly in the week ending July 11, up 3 million barrels to 296.9 million, the U.S. Energy Information Administration reported on Wednesday.

As I noted yesterday, the difference between a moderate and severe recession might be what happens with oil prices:

One of the keys to the base case is that oil prices decline in the 2nd half of 2008 (something I've been predicting for some time). This prediction is based on demand destruction, lower subsidies in certain Asian countries, weaker demand growth in China, and a few other reasons. The fundamentals of supply and demand for oil suggests a small decrease in demand could led to a fairly large decrease in price. If this happens, then that will hopefully lead to Kasriel's "sharp deceleration in inflation".

Usually the headline measure of inflation (CPI) and the core inflation measure (CPI less food and energy) track pretty well with just short periods of divergence due primarily to changes in oil prices. But for the last few years oil prices have risen relentlessly, and CPI has been substantially above Core for an extended period as shown on the following graph.

Falling oil prices would move CPI below Core inflation and might keep the economy out of a severe recession (although the period of economic weakness would still linger for some time).

by Anonymous on 7/16/2008 08:14:00 AM

And the results are, of course, ugly. The LAT reports on police calls to restore order to lines outside some IndyMac branches yesterday. The surliness seems to have stemmed from actual or perceived instances of someone cutting in line.

And why are all these people spending days in line at a bank already operated by the FDIC? More than a few of them appear to have accounts over the insured limit. Perhaps. Sort of.

Take Mr. Bash (no, really, that's his name):

Todd Bash, a 43-year-old teacher from San Gabriel, was worried about IndyMac's viability after reading about its woes in the media, so he had gone into his branch in West Covina on July 8 -- three days before regulators seized the bank. He had two certificates of deposit, a savings account and a checking account, totaling more than $180,000.

Bash said he had been ready to pull his funds, but the teller told him that he could add beneficiaries to get extra insurance. He added his mother to one account and his sister to another.

But after IndyMac was seized, an FDIC hotline operator said the extra insurance wasn't necessarily valid, Bash said. That landed him in line Monday. After eight hours, the bank closed and he went home.

He went on the FDIC website again and used the system's deposit insurance calculator, which said all of his deposits were fully covered.

Bash returned to the bank Tuesday more confident, but when he finally talked to a teller, she showed him that more than $80,000 was missing from one account. Why? The teller didn't know. She referred him to an FDIC official in the branch, who also couldn't tell him what happened, he said.

"One person finally suggested that maybe there was a hold on my account, but when I asked if it was a hold, why wouldn't they just say there was a hold? . . . Nobody could give me any answers," he said.

FDIC spokesman David Barr said most of the problems stemmed from trust accounts that have been put on hold until the agency determines that beneficiaries have been properly named. In most cases, those funds will be released in full after the depositor confers in person with the FDIC, he said.

Frozen trust accounts also caused tellers to fail to credit interest payments to some borrowers. "We apologize for that," Barr said, adding that the FDIC is checking accounts where that may have occurred and will mail missing interest to depositors. "It may take us a few days, but we will get it out."

I love this little anecdote. It has everything in it.

The big moral hazard problem that existed back when deposit insurance was first invented was, of course, the nasty information asymmetry between depositors and the banks. The banks knew what ridiculous risks they might be running with your savings account, but you didn't. "Bank runs" start because the information about risk gets out suddenly (and often incompletely) to depositors at the moment of crisis, leading to depositor panic.

In the New Era here, Mr. Bash actually got information from the media about the riskiness of his bank before it managed to create widespread depositor panic. So he goes to the bank to withdraw his money--or at least that part of it over the $100,000 deposit insurance limit--but when the helpful teller points out to him that he can make perfectly meaningless changes to names on his accounts and get more "free insurance," he decides that makes more sense. His concern about the management of his bank and its risk tolerance does not extend to looking that gift horse in the mouth.

Then IndyMac compounds the "problem" by, you know, having to treat this sham transaction (adding names to an account just to get around insurance limits) by, you know, having to pretend like it's really a transfer of ownership of funds and putting the old perfectly usual "hold" on the account until . . . well, you know. Until the bank has verified that this is not a "fraudulent" transaction. Whatever that means in the current environment.

Mr. Bash is quite upset that the price of nearly doubling his deposit insurance coverage at no monetary cost to him is several days worth of red tape. Defeating the purpose of deposit insurance limits should, we all know, be smooth and flawless. For heaven's sake, this is 2008. Can't someone just type in some numbers and hit the "enter" key? It's one thing to read in the WSJ that your bank's lending activities may be jeopardizing its safety and soundness--to the point of Congress asking some nasty questions about it in public--and to remain calm enough to believe that the teller can fix your problem by adding your mother's name to an account. It is another thing entirely to get cruddy customer service from the damned FDIC.

Of course all the FDIC can do is abjectly apologize and pretend like anybody should really care about Mr. Bash's tribulations at this point. It has to: the rule of the day is No More Panic and FDIC officials and staffers manning those teller lines will have to play the whole "customer service" game until their back molars grind down to stumps and they've emptied all the bottles of Pepcid they keep next to the check printers. One cannot lecture people like Mr. Bash about moral hazard and the costs of free insurance in the middle of a bank takeover.

Not when the other "overinsured" are out front starting to throw their lawn chairs at each other, you can't.

by Calculated Risk on 7/15/2008 09:28:00 PM

From the Financial Times: Martinsa asks for creditor protection (hat tip ratefink)

One of Spain's largest property companies yesterday filed for creditor protection owing €5bn ($7.9bn), spurring a Madrid stock market sell-off and forcing banks to admit to an initial €550m in related bad loan provisions.

And from the WSJ: Global Economic Decline Appears to Be Spreading

The rising risk of recession in Europe shows that despite the strength of emerging-market economies such as Russia and China, the economic downturn that began in the U.S. last year is spreading to other regions, battering hopes that the global economy might have "decoupled" just enough that the rest of the world could coast through a U.S. downturn relatively unscathed.

More containment.

by Calculated Risk on 7/15/2008 05:42:00 PM

The download for the July U.S. Economic Outlook from Northern Trust's Paul Kasriel doesn't seem to work. Here is the outlook: Base Case vs. Checkmate

Here are my comments earlier today.

by Calculated Risk on 7/15/2008 04:47:00 PM

Video: Roubini on Bloomberg TV

Roubini provides a summary of his views "that this will turn out to be the worst financial crisis since the Great Depression and the worst US recession in decades ..."

Here are a few of Roubini's points:

This is by far the worst financial crisis since the Great Depression

Hundreds of small banks with massive exposure to real estate (the average small bank has 67% of its assets in real estate) will go bust

Dozens of large regional/national banks (a’ la IndyMac) are also bankrupt given their extreme exposure to real estate and will also go bust

I agree this is the worst financial crisis since WWII, but I think this crisis pales in comparison to the Great Depression.

As far as the number of small banks that will fail, my guess is on the order of 100 to 200 over the next few of years, but Roubini's "hundreds" is possible. Clearly many small institutions are very exposed to Construction & Development (C&D) and Commercial Real Estate (CRE) loans. BTW, bank failures are a trailing indicator of financial problems.

Fannie and Freddie are insolvent and the Treasury bailout plan (the mother of all moral hazard bailout) is socialism for the rich, the well connected and Wall Street; it is the continuation of a corrupt system where profits are privatized and losses are socialized. Instead of wiping out shareholders of the two GSEs, replacing corrupt and incompetent managers and forcing a haircut on the claims of the creditors/bondholders such a plan bails out shareholders, managers and creditors at a massive cost to U.S. taxpayers.

This will be the most severe U.S. recession in decades with the U.S. consumer being on the ropes and faltering big time as soon as the temporary effect of the tax rebates will fade out by mid-summer (July). This U.S. consumer is shopped out, saving less, debt burdened and being hammered by falling home prices, falling equity prices, falling jobs and incomes, rising inflation and rising oil and energy prices. This will be a long, ugly and nasty U-shaped recession lasting 12 to 18 months, not the mild 6 month V-shaped recession that the delusional consensus expects.

Equity prices in the US and abroad will go much deeper in bear territory. In a typical US recession equity prices fall by an average of 28% relative to the peak. But this is not a typical US recession; it is rather a severe one associated with a severe financial crisis. Thus, equity prices will fall by about 40% relative to their peak. So, we are only barely mid-way in the meltdown of stock markets.

I disagree that this recession will be worse than the '73 to '75 and early '80s recessions - although a more severe recession is possible, especially if oil prices stay elevated, or there is a further collapse of the dollar, or a global recession. I agree with Roubini that there will be no quick recovery (no V-shaped recession).

I need more details on the Paulson plan.

by Calculated Risk on 7/15/2008 04:29:00 PM

A quote via Dow Jones (no link):

"[A]lthough the majority" [of credit deterioration] "was driven by residential real estate, home building and related industries, the economic slowdown and rising commodity prices have had an impact on some of our commercial customers. Given these conditions, we anticipate that our nonperforming assets will continue to rise."
U.S. Bancorp Chief Executive Richard Davis on conference call, July 15, 2008

This is obviously not a bank specific problem. M&T Bank's CEO made similar comments yesterday.

Which brings us to Bernanke's testimony today. From the WSJ Real Time Economics blog: Bernanke: About That Housing Crisis Being Contained ...

Fed Chairman Ben Bernanke may never be allowed to forget his onetime expectation about how the subprime housing mess would affect the broader economy.

Sen. Robert Menendez (D., N.J.), asking about the housing crisis during a Senate hearing Tuesday, cited Mr. Bernanke’s March 2007 comment that “the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”

Replied Mr. Bernanke wryly, invoking Capitol Hill terminology: “Of course, I would like to revise and extend my remarks.”