by Calculated Risk on 6/17/2009 08:21:00 PM

Note: Downey Savings & Loan was seized by regulators on Nov 21, 2008, at an estimated cost to the Deposit Insurance Fund (DIF) of $1.4 billion.

From E. Scott Reckard at the LA Times Money & Co blog: Report: Lax oversight allowed Downey Savings' loan binge

Federal regulators responded inadequately from 2005 on as billions of dollars in high-risk mortgages piled up at weakly managed Downey Savings and Loan, the U.S. Treasury Department inspector general said in a report on last year’s failure of the Newport Beach thrift.

The Office of Thrift Supervision ... began warning Downey management in 2002 about its heavy issuance of pay-option adjustable-rate mortgages but failed to rein in the practice, the report said.
...
Yet despite the warnings, "OTS examiners did not require Downey to limit concentrations in higher-risk loan products," said the 71-page inspector general report, posted Tuesday on the Treasury Department’s website.

Here is a Downey ad from the loose lending period (not in report):



Click on Ad for larger image in new window.
Not sure of the exact date of this advertisement, but thanks for the memories! (hat tip Elroy).

From the report:

The primary causes of Downey’s failure were the thrift’s high concentrations in single-family residential loans which included concentrations in option adjustable rate mortgage (ARM) loans, reduced documentation loans, subprime loans, and loans with layered risk; inadequate risk-monitoring systems; the thrift’s unresponsiveness to OTS recommendations; and high turnover in the thrift’s management. These conditions were exacerbated by the drop in real estate values in Downey’s markets.

And oversight from the OTS was insufficient:

OTS examiners did not require Downey to limit concentrations in higher-risk loan products. We believe that in light of the OTS’s repeated expressions of concern and management’s unresponsiveness to those concerns, OTS should have been more forceful, at least by 2005, to limit such concentrations. In interviews, OTS examiners commented that this would have been difficult since there was no history of losses in Downey’s option ARM, low documentation, and layered-risk loans from 2002 to 2006. However, both ND Bulletin 02-17 and the successor ND Bulletin 06-14 provide that examiners can direct thrifts to discontinue activities that lead to a specific high-risk concentration when proper oversight and controls are not in place. We believe that if there is one lesson to be learned from Downey’s failure it is that a lack of losses in the short term should not negate the need to address risk exposure such as high concentrations.

This graph from the Inspector General's report (with color added) shows the shift over time to reduced documentation loans. This add risk to already risky products and should have been a huge red flag.

"Reduced documentation" is code word for borrower underwritten, as opposed to lender unwritten loans. Not surprisingly, reduced documentation loans perform worse than full documentation loans.



At the same time Downey was shifting to more and more reduced doc loans, they were also increasing the percentage of Option ARMs.

(See the ad above)

This was a toxic combination of risk layering.

by Calculated Risk on 6/17/2009 06:01:00 PM

A couple of quotes from The Times: Mervyn King presses his case to limit size of banks

Mervyn King said he wanted a restriction on the size of banks, and that investment banks might have to be split from retail banks. ... he said banks should not be allowed to grow so large that they were deemed too big to fail.
...
“It is not sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an implicit state guarantee against failure,” Mr King said.

The State could limit providing a guarantee for depositors to high street banks that offered straight-forward services. Alternatively, riskier banks should have to hold much more capital. Finally, banks may have to provide their own plan for how they could be wound down in the event of failure. “Making a will should be as much a part of good housekeeping for banks as it is for the rest of us,” Mr King said.

... he was not sure how the Bank [BofE] would use its enhanced authority because its new tools were limited to issuing warnings that were likely to be ignored. “The Bank finds itself in a position rather like that of a church whose congregation attends weddings and burials but ignores the sermons in between,” he said.

That last sentence shows King's frustration - after the crisis is over, it will be business as usual, unless the regulatory reforms have teeth.

Even then it is just a matter of time - and lobbying. The banks are notorious for having no institutional memory.

by Calculated Risk on 6/17/2009 04:05:00 PM

UPDATE: State Street repaid $2 billion according to Bloomberg, so the total is $68.3 billion.

From DOW JONES: Financial Firms Repay $66.3B In TARP Funds

Ten banks were given $68.3 billion last fall and received approval last week to repay the funds. So far, just State Street Corp. (STT) - which ranked 9th in terms of the amount it received at $2 billion - has yet to announce its repayment.

JPMorgan, U.S. Bancorp (USB), American Express Co. (AXP), Bank of New York Mellon Corp. (BK), BB&T Corp. (BBT) and Northern Trust Corp. (NTRS) also announced plans to buy back the related warrants associated with TARP. Goldman, Morgan Stanley and Capital One Financial Corp. (COF) didn't address the warrants.

It is a little confusing because Northern Trust (NTRS) wasn't one of the 19 stress test banks.

Name	TARP Amount	Repay
Bank of America	$52.5 billion	No way!
Citigroup	$50 billion	No way!
JPMorgan Chase	$25 billion	Repaid
Wells Fargo	$25 billion	-
GMAC	$12.5 billion	No way!
Goldman Sachs	$10 billion	Repaid
Morgan Stanley	$10 billion	Repaid
PNC Financial Services	$7.6 billion	-
U.S. Bancorp	$6.6 billion	Repaid
SunTrust	$4.9 billion	-
Capital One Financial Corp.	$3.6 billion	Repaid
Regions Financial Corp.	$3.5 billion	-
Fifth Third Bancorp	$3.4 billion	-
American Express	$3.4 billion	Repaid
BB&T	$3.1 billion	Repaid
Bank of New York Mellon	$3 billion	Repaid
KeyCorp	$2.5 billion	-
State Street	$2 billion	Repaid
MetLife	None	-

Bailout amounts from Pro Publica : Eye on the Bailout

by Calculated Risk on 6/17/2009 02:10:00 PM

From DataQuick: Southland median sale price inches up for first time since ‘07

Southern California home sales rose for the 11th consecutive month in May as sales of $500,000-plus homes started to come back. The median price paid increased slightly from the prior month for the first time since July 2007, the result of a shift in market activity where sales of deeply discounted foreclosures waned and mid- to high-end purchases rose, a real estate information service reported.
emphasis added

Yesterday I noted that Cramer was fooled by the rise in median prices (as reported by NAR). DataQuick makes this clear that the increase was because of a slight change in mix. Prices are still falling.

A total of 20,775 new and resale houses and condos closed escrow in San Diego, Orange, Los Angeles, Ventura, Riverside and San Bernardino counties last month. That was up 1.3 percent from 20,514 in April and up 22.8 percent from 16,917 a year ago, according to San Diego-based MDA DataQuick.

Sales have increased year-over-year for 11 consecutive months.

May’s sales were the highest for that month since May 2006, when 30,303 homes sold, but were 21.2 percent below the average May sales total since 1988, when DataQuick’s statistics begin.

Foreclosure resales – homes sold in May that had been foreclosed on in the prior 12 months – accounted for 50.2 percent of all Southland resales. That was down from 53.5 percent in April and from a peak of 56.7 percent in February. May’s figure was the lowest since foreclosure resales were 50.9 percent of all resales last October.

The remarkably sharp declines in the Southland’s median sale price over the past year have been exacerbated by a shift toward an above-average number of sales occurring in lower-cost inland markets rife with discounted foreclosures. However, the number of homes lost to foreclosure declined over the winter, leaving fewer for bargain hunters to scoop up this spring. Meantime, sales have begun to rise a bit in many mid- to high-end markets, which could be due at least in part to sellers dropping their asking prices.

Last month 83 percent of the existing Southland houses sold were purchased for less than $500,000, compared with 84.8 percent in April. Conversely, sales $500,000 and above rose from 15.2 percent of sales in April to 17 percent in May. The last time the $500,000-plus market made up more than 17 percent of all sales was last October, when they were 19.9 percent of sales.
...
“We appear to be in the early stages of the market gradually tilting back toward a more normal balance of sales across the home price spectrum. As more sellers get realistic, more buyers get off the fence and more lenders offer reasonable terms for high-end purchase financing, we’ll see a more normal share of sales in the more established, higher-cost areas that have been nearly comatose,” said John Walsh, MDA DataQuick president.

...
Absentee buyers, including investors who will have their property tax bills sent to a different address, bought 19.4 percent of the Southland homes sold last month. That’s up from 16.9 percent a year ago and 18.6 percent in April. The monthly average since 2000: 15 percent.
...
Foreclosure activity remains near record levels ...

by Calculated Risk on 6/17/2009 12:55:00 PM

From the Treasury: President Obama to Announce Comprehensive Plan for Regulatory Reform

President Obama will lay out a comprehensive regulatory reform plan this afternoon to modernize and protect the integrity of our financial system. ... The President will be joined by Treasury Secretary Tim Geithner, representatives from the regulatory community, consumer groups, the financial industry and members of Congress for an event in the East Room later this afternoon.

And a little reading material ...

White Paper: Requiring Strong Supervision And Appropriate Regulation Of All Financial Firms

Strengthening Consumer Protection

Providing The Government With Tools To Effectively Manage Failing Institutions

Improving International Regulatory Standards And Cooperation

A few excerpts:

We propose the creation of a Financial Services Oversight Council to facilitate information sharing and coordination, identify emerging risks, advise the Federal Reserve on the identification of firms whose failure could pose a threat to financial stability due to their combination of size, leverage, and interconnectedness (hereafter referred to as a Tier 1 FHC), and provide a forum for resolving jurisdictional disputes between regulators.
...
Any financial firm whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed (Tier 1 FHC) should be subject to robust consolidated supervision and regulation, regardless of whether the firm owns an insured depository institution.
...
Capital and management requirements for FHC status should not be limited to the subsidiary depository institution. All FHCs should be required to meet the capital and management requirements on a consolidated basis as well.
emphasis added

CR: No off balance sheet nonsense and they propose to regulate the shadow banking system.

On derivatives:

All OTC derivatives markets, including CDS markets, should be subject to comprehensive regulation that addresses relevant public policy objectives: (1) preventing activities in those markets from posing risk to the financial system; (2) promoting the efficiency and transparency of those markets; (3) preventing market manipulation, fraud, and other market abuses; and (4) ensuring that OTC derivatives are not marketed inappropriately to unsophisticated parties.

by Calculated Risk on 6/17/2009 11:58:00 AM

Here is a fairly positive outlook. I think they are overly optimistic on house prices (forecasting an increase of 0.9% nationwide in 2010). Note: the Anderson forecast has a pretty good track record, but they missed the current recession (a major miss!)

From Reuters: U.S. poised for weak recovery : UCLA forecast

"The free-fall stage of the recession appears to be over and in fact we anticipate that the economy will record positive, albeit minimal, growth as early as the third quarter," ... We are forecasting the weakest economic recovery of the post-war era with real growth on the order of 2 percent to 3 percent," the report said.

"Simply put, we believe that the economy will be weighed down by newly chastened consumers attempting to increase their saving rate and a wrenching structural adjustment in the financial services, automotive and retail industries,"

More from Jeff Collins at the O.C. Register:

The lion’s share of the housing decline is behind us, the UCLA Anderson Forecast reports today.

U.S. home prices have fallen 31% from the peak and are still falling. But home prices should start rising again by late 2009 or early 2010, the forecast said.

In addition:

•New home prices will increase 0.9% nationwide in 2010 and 2.9% in 2011, according to the forecast. The 2011 price still is forecast to be 13% below the peak, however.

[CR: This seems too optimistic. I think prices will fall through 2010 nationally, and for a longer period in some higher priced bubble areas]

•The forecast warns: “Because house price bear markets tend to have ‘long tails,’ do not expect any swift rise in prices over the next several years. Indeed, there are still more ’shoes to drop’ as a new round of Alt-A mortgage resets hits the market in 2010-11 and foreclosures rise on prime mortgages weighed down by high unemployment.”

•The supply of homes listed for sale has gone down faster in Orange County than in the nation as a whole, said Jerry Nickelsburg, co-author of the Anderson Forecast.

•“People are on the sidelines, and they’ll come back into the market when they see the benefit of waiting is no longer there,” Nickelsburg said.

•In Orange County, that’ll start to happen later this year, he said.

•New home construction bottomed out in California in the first quarter of this year, and in the second quarter nationwide, the forecast said.

[CR: This could be correct. I've been expecting new home construction to bottom sometime this year.]

•Developers now are under-building, and the market is primed for growth since homebuilding is failing to keep up with population growth.

•Nickelsburg said that while there is pent-up demand for new homes, potential buyers are on the sidelines — living with their parents, for example — and have yet to jump back into the market.

by Calculated Risk on 6/17/2009 10:23:00 AM

Owners' equivalent rent (OER) is a major component of CPI (23.8% of CPI, see Cleveland Fed), and even though rents are falling in most areas, OER is still increasing (up 2.1% Year-over-year and up 1.8% annualized in May).

For a discussion from the BLS of rent measures see: How the CPI measures price change of Owners’ equivalent rent of primary residence (OER) and Rent of primary residence (Rent)

The expenditure weight in the CPI market basket for Owners’ equivalent rent of primary residence (OER) is based on the following question that the Consumer Expenditure Survey asks of consumers who own their primary residence:

“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

UPDATE: I misread the BLS document.

The survey question above is for weighting. The price relative for OER is calculated by sampling non rent-controlled renters every six months. These average rents are divided by the sample six months earlier - and converted to a monthly change (by taking to the 1/6th power).

From the BLS document above: "The first step is standardizing the collected (market) rents, putting them on a monthly basis, and adjusting them for a number of circumstances that should not affect the CPI."

I apologize for any confusion.
END UPDATE.

The following graph shows the year-over-year (YoY) in the REIT rents (from Goldman Sachs), Owners' equivalent rent of primary residence and Rent of primary residence (both from the BLS). The Apartment Tightness Index from the National Multi Housing Council is on the right Y-axis.

Click on graph for larger image in new window.

This graph shows that the Apartment Tightness Index leads REIT rents, and that the BLS measures of rent follow.

This suggests further declines in the YoY REIT rents, and future disinflation for the BLS measures of rent.

by Calculated Risk on 6/17/2009 08:34:00 AM

From Rex Nutting at MarketWatch: Consumer prices inch 0.1% higher in May

U.S. consumer prices increased a seasonally adjusted 0.1% in May as higher gasoline prices were largely offset by falling food prices, the Labor Department reported Wednesday.

It was the first increase in the consumer price index in three months.

The core CPI ... also rose a seasonally adjusted 0.1% in May.

The CPI has fallen 1.3% in the past year, the sharpest decline in prices since April 1950.

by Calculated Risk on 6/17/2009 07:47:00 AM

The MBA reports:

The Market Composite Index, a measure of mortgage loan application volume, was 514.4, a decrease of 15.8 percent on a seasonally adjusted basis from 611.0 one week earlier.
...
The Refinance Index decreased 23.3 percent to 1998.1 from 2605.7 the previous week and the seasonally adjusted Purchase Index decreased 3.5 percent to 261.2 from 270.7 one week earlier.
...
The average contract interest rate for 30-year fixed-rate mortgages decreased to 5.50 percent from 5.57 percent ...

The Purchase Index is now at the level of the late '90s.

With the 10 year yield moving down (3.67% yesterday from 3.99% a week ago), 30-year fixed mortgage rates decreased slightly this week. But mortgage rates are still significantly higher than three weeks ago (4.81%), and that increase in mortgage rates has led to significantly fewer refinance applications.

Click on graph for larger image in new window.

This graph shows the MBA Purchase Index and four week moving average since 2002.

Although we can't compare directly to earlier periods because of the changes in the index, this shows no pick up in overall sales activity.

by Calculated Risk on 6/16/2009 09:52:00 PM

The WaPo has the document: Near-Final Draft of Document on Regulatory Overhaul (pdf)

From the WaPo: Financial Regulatory Overhaul Is Detailed

The plan is an attempt to overhaul an outdated system of financial regulations, according to senior administration officials.

It would vastly increase the powers of the Federal Reserve ... It also would create a new agency to protect consumers of mortgages, credit cards and other financial products.

President Obama is expected to formally unveil the proposal [Wednesday]. The administration also plans to release an 85-page white paper detailing the plans and justifying each element as a direct response to the causes of the financial crisis.
...
The proposed Consumer Financial Protection Agency would have broad authority to regulate the relationship between financial companies and consumers of mortgage loans, credit cards, checking accounts and other financial products. It would define standards, police compliance and penalize delinquent firms. Other agencies, particularly the Federal Reserve, would surrender some powers.

From MarketWatch: Fed may become systemic regulator, hike capital requirements

The proposal will also call for the elimination of the Office of Thrift Supervision and the Federal Thrift Charter, subsuming the agency into a new "National Bank Supervisor," agency based on the Office of Comptroller of the Currency that will supervise all federally chartered depository institutions.