by Calculated Risk on 7/29/2009 09:06:00 AM

From David Streitfeld at the NY Times: Recovery Signs in Housing Market Stir Some Hope

After a plunge lasting three years, houses have finally become cheap enough to lure buyers. That, in turn, is stabilizing prices, generating hope that the real estate market is beginning to recover.

From Peter Hong at the LA Times: Home prices may be stabilizing, market tracker shows

Another sign emerged that the nation's struggling housing market may be nearing its bottom as a widely followed national home-price index posted its first gain in nearly three years.

The S&P/Case-Shiller index of home prices in 20 metropolitan areas was up slightly in May over its April level for the first time since 2006.

Now this is the same news as yesterday, but I just want to point out the widespread reporting of a possible bottom in housing prices. And because of the way Case-Shiller is constructed (with a three month moving average) there is a good chance prices will look positive for the June report too (to be released in August).

These are influential writers.

Streitfeld has been writing about the housing bubble and collapse for years. The Atlantic named him "The Bard of the Bubble" in 2006.

Hong has only been covering housing for a couple of years, but he has also done a very good job.

Of course I think house prices will continue to decline in the Fall, and that the May report was distorted by seasonal factors.

by Calculated Risk on 7/28/2009 10:45:00 PM

From the NY Times: Feds Push Mortgage Companies to Modify More Loans

The Obama administration, scrambling to get its main housing initiative on track, extracted a pledge from 25 mortgage company executives to improve their efforts to assist borrowers in danger of foreclosure.

In an all-day series of meetings Tuesday at the Treasury Department, government officials reached a verbal agreement with the executives for a new goal of about 500,000 loan modifications by Nov. 1 and stressed the program's urgency.

The sessions came amid concerns that the Obama administration will fall far short of its original goal of helping up to 3 million to 4 million troubled borrowers with modified loans.

As of this week, only about 200,000 borrowers were enrolled in three-month trial loan modifications ...

A "verbal agreement"?

Counting the number of mods might make for useful PR, but some mods are more effective than others. A capitalization of missed payments and fees, along with a rate reduction and/or extended term, are the most common modifications. But for homeowners with significant negative equity that is just "extend and pretend" and leads to a high redefault rate and just postpones foreclosure.

by Calculated Risk on 7/28/2009 07:30:00 PM

Nick Timiraos at the WSJ writes: Study Finds Underwater Borrowers Drowned Themselves with Refinancings (ht Jack)

Why are so many homeowners underwater on their mortgages?
...
Michael LaCour-Little, a finance professor at California State University at Fullerton, looked at 4,000 foreclosures in Southern California from 2006-08. He found that, at least in Southern California, borrowers who defaulted on their mortgages didn’t purchase their homes at the top of the market. Instead, the average acquisition was made in 2002 and many homes lost to foreclosure were bought in the 1990s. More than half of all borrowers who lost their homes had already refinanced at least once, and four out of five had a second mortgage.

Here is the study: Follow the Money: A Close Look at Recent Southern California Foreclosures

The conventional wisdom is that households who purchased at the top of the market during the recent housing bubble are those most at risk of default due to recent price declines, upward re-sets of adjustable rate mortgage instruments, the economic downturn, and other factors. Here we use public record data to study Southern California borrowers facing foreclosure in late 2006 and 2007. We estimate property values at the time of the scheduled foreclosure sale with the automated valuation model of a major financial institution and then track actual sales prices for those properties that actually sold, either at auction or as later as REO. We find that virtually all of the borrowers had taken large amounts of equity out of the property through refinancing and/or junior lien borrowing with total cash extracted exceeding $300 million. As a result, losses to lenders exceed those of borrowers by a substantial margin, calling into question policies aimed at protecting borrowers.
emphasis added

It may seem unfair that these homeowners receive help from the bank (or from the government), but as far as slowing foreclosures it really doesn't matter why the homeowner is underwater. I think the research from the Boston Fed suggesting the costs of foreclosure are less than the costs of modifications is a stronger argument against many mods.

by Calculated Risk on 7/28/2009 05:43:00 PM

To preface this post, here are my notes from the April 2008 Milken conference:

Sam Zell started by saying we need to separate commercial from residential. Commercial will be fine in his view (not my view). Also Zell thinks losses are overstated for investment banks and CDOs.

Zell isn't talking about new construction (CRE), rather he is talking about prices for existing CRE. He feels there is too much global demand ("liquidity") for prices to fall too far - especially for Class-A buildings.

A little over a year later several Class-A owners are just walking away.

Now today, from CNBC: Real Estate Bottom Will Turn Around Economy: Zell

After posting three straight months of positive data, the residential real estate market has reached an equilibrium where prices will stop falling, said Sam Zell, founder and chairman of Equity Group Investments. This, in turn, will spark stabilization throughout the rest of the economy.

If single family housing starts and new home sales have found a bottom, then that will remove a key drag from the economy and employment. That is a positive. But I think Zell is wrong on house prices. I think the pace of declines will slow, but that there will be a long tail for real prices.

I could be wrong ... and I think different areas will bottom at different times, and some lower priced areas with heavy foreclosure activity might be at or near a bottom (same with some non-bubble areas). But in general, I think prices will fall further.

by Calculated Risk on 7/28/2009 03:43:00 PM

This is very different for me ...

First, if I've let a little hubris slip into my recent posts, I apologize. My goal is to be the most humble blogger in the world (an old joke).

Second, I am not an investment advisor and I do not offer investment advice. I try to provide some hopefully useful data with sources - especially concerning real estate - and then add my own analysis. Nothing here is intended as investment advice.

Please keep the above in mind ... and although I rarely discuss investing, I'd like to quickly explain why I went mostly long in my own portfolio in late February and early March. Several readers can vouch for my change in view (like Brian and Michael). I only share my investment ideas with people I know - and who I know are responsible for their own actions.

Sentiment in February and March was for a Great Depression II, and it was clear to me that several key indicators were about to change: auto sales, single family starts and new home sales were three I mentioned frequently on this blog. I figured when that data changed, the sentiment would change. Buying at the time was difficult. And yes, I'm still long (although that could change at any time, and I will not disclose it).

The reason I bring this up is the Case-Shiller report today really bothered me. To be more accurate, the reporting on the Case-Shiller report bothers me. As I mentioned earlier today, there is a strong seasonal component to house prices, and although the seasonally adjusted Case-Shiller index was down (Case-Shiller was reported as up by the media) - I don't think the seasonal factor accurately captures the recent swings in the NSA data.

I have no crystal ball - and maybe prices have bottomed - but this potentially means a negative surprise for the market later this year - perhaps when the October or November Case-Shiller data is released (October will be released near the end of December). If exuberance builds about house prices, and the market receives a negative surprise, be careful. Just something to watch later this year (I will post about house prices, but I will not mention the possible impact on the stock market in future posts).

And a few comments on the reporting today. The WSJ reported: Home Prices Post Monthly Increase, Data Are Latest to Signal a Bottom in the Property Market

The Case-Shiller index of home prices in 20 metropolitan areas, produced by Standard & Poor's, rose 0.5% in May from the month before, the first increase after 34 straight months of decline.

No mention that they are using the NSA data. And this would be a weird housing cycle if residential investment and house prices bottomed at almost the same time. See: Housing: Remember the Two Bottoms!

And from MSNBC: Crescenzi: Case-Shiller Supports Risk Assets

If there’s one indicator that investors are likely to embrace as their yardstick for the housing market predicament it is the Case-Shiller home price index. This is the index that turned lower in 2006, presaging the eruption of the credit crisis. Its apparent stabilization hence marks a turn in the housing dilemma.

Although a plethora of data have pointed to stabilization in housing of late, only the Case-Shiller index has the power to sway doubters, chiefly because it captures trends in the subprime mortgage market better than other indicators.

Like I said, I could be wrong about prices ... but this is the kind of information that is being disseminated by the MSM, and that means a negative surprise is possible.

Not to just pick on the MSM reporting. I was sent (by several readers) a housing analysis yesterday. It was some sort of weird mash up between the excellent David Rosenberg and some blogger. The charts are great, but the analysis is sometimes inaccurate. The "research" made comments like this for the NAHB HMI: “Sales outlook is stuck at 26, and anything under 50 is a contraction”. Not correct. The NAHB index is a sentiment indicator and doesn’t indicate contraction. Any number under 50 indicates more builders view sales as poor than good. See this chart - the index moves with new home sales and housing starts. And another example: "Architectural billings Index slipped five points last month to 37.7 - a sign residential construction is just bouncing along bottom". The ABI is primarily for non-residential construction.

I'm not trying to pick on or embarrass any particular publication or blogger. But it helps to know your sources. And I could be wrong about prices; we will know when the October and November data is released (a six month wait!)

Best to all. Now back to my regular posts ...

by Calculated Risk on 7/28/2009 03:24:00 PM

From the SF Gate: S.F. tower's owners will forfeit it to lender (ht John, Jay)

The owners of a premier San Francisco office tower plan to forfeit the property to their lenders, the city's second distressed transaction involving a major commercial building in recent weeks ...

Hines and Sterling American Property decided to transfer their interest in 333 Bush St. to the original financers, following the surprise dissolution of law firm Heller Ehrman in September ... The 118-year-old law firm defaulted on its 250,000-square-foot lease, leaving the nearly 550,000-square-foot property 65 percent vacant.

... Hines and Sterling bought the tower for $281 million in 2007, near the top of the market, when it was 75 percent leased.

The partnership is handing the property to Brookfield Real Estate Finance and Munich Hypo Bank ...
...
More distressed deals are expected. Nearly three-quarters of Class A office buildings downtown sold between 2005 and 2007 ...

Probably another half off sale (or worse) coming up. It is amazing that 75% of downtown San Francisco Class A office building were sold between 2005 and 2007.

Walking away in the City by the Bay will become common. At least it's a nice place to take a walk ...

by Calculated Risk on 7/28/2009 12:36:00 PM

From San Francisco Fed President Janet Yellen: Outlook for the U.S. Economy and Community Banks. A few excerpts:

[T]he normal dynamics of the business cycle are turning more favorable. Some sectors are poised to rebound simply because they have sunk so low. For example, the auto industry has cut production so far that inventories have begun to shrink, even in the face of historically weak demand. Just slowing the pace of inventory liquidation will bolster economic activity. This story holds for many sectors of the economy where spikes in inventories occurred as cautious consumers cut back on purchases of durable goods, and businesses slashed spending on equipment and software. Looking forward, the demand for houses and durables should also eventually revive as old and broken-down goods need to be replaced. The resulting demand will help the economy recover.

But that recovery is likely to be painfully slow. History teaches that it often takes a long while to recover from downturns caused by financial crises. Financial institutions and markets won’t heal overnight. And it will take quite some time before households have repaired their tattered finances. Until recently, households were saving less and borrowing more in response to wealth gains in both stocks and housing. This pattern made their balance sheets vulnerable to adverse developments and the crashes in both house and stock prices during the last two years destroyed trillions of dollars of their wealth. Not surprisingly, the personal saving rate has now shot higher and I expect to see subdued consumer spending for some time. The unprecedented global nature of the recession also will act as a drag. Countries recovering from financial crises often receive a boost from foreign demand, but neither the United States nor its trading partners can count on such external stimulus this time.

A gradual recovery means that things won’t feel very good for some time to come. The unemployment rate currently is 9½ percent, and this figure is likely to rise further. Moreover, even after the economy begins to grow, it could still take several years to return to full employment. The same is true for capacity utilization in manufacturing, which has declined so far that it has fallen “off the charts”—now standing at its lowest level in the postwar period.

Finally, even though downside risks to the outlook have diminished, there remains some chance that economic conditions could turn out worse than what I’ve sketched. High on my worry list is the possibility of another shock to the still-fragile financial system. Commercial real estate is a particular danger zone...

And on community banks:

Now let me turn to the business environment facing banks. The industry is going through one of the most difficult periods in modern times. ... Bank profits are down, loan delinquencies are up, and failures are climbing.

... Recessionary effects normally take some time to work their way through loan portfolios. So, even though I expect economic growth to resume in the second half of this year, banking conditions are likely to remain quite weak for another year or two.

To date, the community banks under greatest financial stress are those with high real estate concentrations in construction and land development lending. Banks that liberally funded speculative housing and condominium construction, and those that funded land acquisition and development, have been hardest hit. Over 20 District financial institutions have failed since last year. The vast majority of them had high concentrations in residential construction and development lending. In fact, these banks had construction loans that averaged about 40 percent of their loan portfolio, well above the District average of 16 percent. Unfortunately, some banks that aggressively pursued these loans had weak appraisal and risk-monitoring systems.

The next area of significant vulnerability for the banking system, particularly for community and regional banks with real estate concentrations, is income-producing office, warehouse, and retail commercial property. Market fundamentals in most western states are deteriorating. Vacancy rates are rising and rent pressures are hurting property cash flows. Office vacancy rates in both Boise and Portland are expected to reach or exceed 20 percent over the next year or two, the highest rates these cities have seen in many years. Retail shopping centers are struggling with falling occupancy rates and pressures to grant rent concessions. Property values are falling sharply across wide areas of the country, including the Pacific Northwest. Some analysts forecast that commercial property values could experience falls similar to housing of 30 to 40 percent.
...
Our biggest concern now is with maturing loans on depreciated commercial properties. In many cases, borrowers seeking to refinance will be expected to provide additional equity and to have underwriting and pricing adjusted to reflect current market conditions. In some cases, borrowers won’t have the resources to refinance loans.

by Calculated Risk on 7/28/2009 10:48:00 AM

Case-Shiller released the May house price index this morning, and most news reports focused on the small increase, not seasonally adjusted (NSA), from April to May. As I noted earlier, the seasonally adjusted (SA) data showed a small price decline from April to May.

Case-Shiller reported that prices fell at a 2.5% annual rate in May (SA).

However I think the seasonal factor might be insufficient during the current period.

The following graph shows the month-to-month change of the Case-Shiller index for both the NSA and SA data (annualized). Note that Case-Shiller uses a three-month moving average to smooth the data.

Click on graph for larger image in new window.

The Blue line is the NSA data. There is a clear seasonal pattern for house prices.

The red dashed line is the SA data as provided by Case-Shiller.

The seasonal adjustment appears pretty good in the '90s, but it appears insufficient now. I expect that the index will show steeper declines, especially starting in October and November.

The second graph compares the Case-Shiller Composite 10 SA index with the Stress Test scenarios from the Treasury (stress test data is estimated from quarterly forecasts).

NOTE: I'm now using the Seasonally Adjusted (SA) composite 10 series.

The Stress Test scenarios use the Composite 10 index and start in December. Here are the numbers:

Edit correction: All data for May.

Case-Shiller Composite 10 Index, May: 151.13

Stress Test Baseline Scenario, May: 150.85

Stress Test More Adverse Scenario, May: 143.81

So far house prices are tracking the baseline scenario, but I believe the seasonal adjustment is insufficient and prices will decline faster in the Fall.

by Calculated Risk on 7/28/2009 09:41:00 AM

Just a note to the previous post.

Case-Shiller has released the Seasonally Adjusted house price index.

Prices fell slightly in May (compared to April) for the Composite 10 and Composite 20 indexes.

Seasonally adjusted, prices fell in 12 of the 20 Case Shiller cities.

There is a strong seasonal pattern to house prices, and it is important to use the SA data. Unfortunately Case-Shiller did not release the SA data earlier this morning. This has lead to numerous incorrect headlines about prices increasing from April to May. That is correct, if they mention the data is Not Seasonally Adjusted.

by Calculated Risk on 7/28/2009 09:00:00 AM

Important Note: Case-Shiller hasn't released the Seasonally Adjusted data yet for May. There is a strong seasonal pattern for prices and this is the NSA data.

S&P/Case-Shiller released their monthly Home Price Indices for May this morning.

This monthly data includes prices for 20 individual cities, and two composite indices (10 cities and 20 cities). Note: This is not the quarterly national index.

Click on graph for larger image in new window.

The first graph shows the nominal seasonally adjusted Composite 10 and Composite 20 indices (the Composite 20 was started in January 2000).

The Composite 10 index is off 33.3% from the peak, and up slightly in May.

The Composite 20 index is off 32.3% from the peak, and up slightly in May.

NOTE: This is the NSA data, prices probably fell using the SA data.

The second graph shows the Year over year change in both indices.

The Composite 10 is off 16.8% over the last year.

The Composite 20 is off 17.1% over the last year.

This is still a very strong YoY decline.

The third graph shows the price declines from the peak for each city included in S&P/Case-Shiller indices.

Prices increased (NSA) in 14 of the 20 Case-Shiller cities in May. In Phoenix, house prices have declined 54.5% from the peak. At the other end of the spectrum, prices in Dallas are only off about 8% from the peak. Prices have declined by double digits almost everywhere.

I'll compare house prices to the stress test scenarios soon.