by Calculated Risk on 10/08/2009 05:40:00 PM

From Fed Governor Daniel Tarullo: In the Wake of the Crisis

Turning first to the economic outlook, let me begin by stating the obvious: After a period in which there seemed to be only two plausible scenarios--very bad and even worse--financial and economic conditions have steadied. ... As we closed out the third quarter last week, it was apparent that economic growth was back in positive territory. ...

This turnaround is certainly welcome, but it should not be overstated. Although we can expect positive growth to continue beyond the third quarter, economic activity remains relatively weak. The upturns in industrial production and residential investment, for example, follow startling declines in the first half of the year. Improvement is gradual and beginning from very low levels.

The employment situation continues to be dismal. While the pace of job losses has slowed from the extraordinary levels of early 2009, the economy has recently still been losing on average about a quarter of a million jobs each month. Hopes for a steady reduction in the pace of job losses were once again confounded last Friday with release of the September employment report, which showed net job declines well above the consensus expectation of economic forecasters. The unemployment rate has risen to 9.8 percent. ...

Indicators apart from the unemployment rate underscore the weakness of labor markets. The percentage of working-age people with jobs has fallen to a point not seen in a quarter century. Average hours worked have not increased through the spring and summer from what were, by historic standards, unusually low levels.The number of part-time workers who want full-time jobs jumped nearly 50 percent last fall and winter and has remained elevated since. The a>verage duration of unemployment has risen almost 10 weeks since the recession began, to more than six months.

The labor market conditions I have just described reflect the low level of resource utilization in the economy as a whole. In this context, with inflation expected to remain subdued for some time, the Federal Open Market Committee indicated after our meeting two weeks ago that exceptionally low interest rates are likely to be warranted for an extended period. Indeed, with the effects of the February stimulus package diminishing next year, bank lending that is still declining, and continued dysfunction in some parts of capital markets, there is considerable uncertainty as to how robust growth will be in 2010. At the same time, the unconventional policies pursued by the Federal Reserve in order to halt the crisis have produced levels and types of reserves that will eventually require use of the unconventional exit tools discussed on numerous occasions by Chairman Bernanke and Vice Chairman Kohn.

The coincidence of a weak economy and an unusually large balance sheet at the Federal Reserve will require some judgments by the Federal Open Market Committee of a sort for which there are not many historical precedents. Still, just as with conventional monetary policy, decisions on the timing and pace for removing accommodation should and will depend on our ongoing analysis and forecasts of all relevant economic factors.
emphasis added

by Calculated Risk on 10/08/2009 03:47:00 PM

Note: Market graph at bottom.

From HotelNewsNow.com: NorfolkLuxury occupancy holds steady in STR weekly numbers

Overall, in year-over-year measurements, the industry’s occupancy fell 5.8 percent to end the week at 55.8 percent. Average daily rate dropped 8.3 percent to finish the week at US$95.51. Revenue per available room for the week decreased 13.7 percent to finish at US$53.30.

Click on graph for larger image in new window.

This graph shows the YoY change in the occupancy rate (3 week trailing average).

The three week average is off 7.3% from the same period in 2008.

The average daily rate is down 8.3%, and RevPAR is off 13.7% from the same week last year.

Data Source: Smith Travel Research, Courtesy of HotelNewsNow.com

As I noted last week, the comparisons are now easier soon since business travel fell off a cliff last October. Comparing to the same week two years ago, occupancy rates are off 16.4%.

Occupancy rates for October in 2006 and 2007 were close to 68%.

Market update:

The second graph is from Doug Short of dshort.com (financial planner): "Four Bad Bears".

Note that the Great Depression crash is based on the DOW; the three others are for the S&P 500.

by Calculated Risk on 10/08/2009 02:20:00 PM

From MarketWatch: Obama plan claims 500,000 mortgage modifications started

U.S. loan servicers have begun modifying more than 487,081 loans for troubled homeowners on the verge of foreclosure as of the end Sept. 30, according to the report. The program met its 500,000 goal in early October. More than 757,955 modification offers have been extended by loan servicers as part of the program known as the Home Affordable Modification Program, or HAMP.

And from Scott Reckard at LA Land (LA Times):

Stand by ... for answers to the big question: whether these modified loans will hold up or whether “underwater” homeowners will stumble back into default after hitting new bumps along their financial roads.
...
The trial modifications “are simply offers,” [Mark Zandi of Moody's Economy.com notes]. “Many won't turn into actual mods, and those mods that occur will have a high redefault rate.”

As I noted back in July when this goal was announced:

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.

The September industry data is not available yet on the HopeNow website.

by Calculated Risk on 10/08/2009 11:34:00 AM

From Bloomberg: FHA Shortfall Seen at $54 Billion May Lead to Bailout (ht Mike in Long Island, Ron at WallStreetPit)

The Federal Housing Administration, which insures mortgages with low down payments, may require a U.S. bailout because of $54 billion more in losses than it can withstand, a former Fannie Mae executive said.

“It appears destined for a taxpayer bailout in the next 24 to 36 months,” consultant Edward Pinto said in testimony prepared for a House committee hearing in Washington today. Pinto was the chief credit officer from 1987 to 1989 for Fannie Mae ...

Pinto makes several points, including:

"FHA is making much larger loans than in the past. Its top dollar limit is $729,500 versus its old top of $362,000 in 2008." This exposes the FHA more to high risk states like California.

"FHA allows up to a 6% seller concessions before requiring an appraisal adjustment." Pinto notes that Fannie Mae found that allowing concessions above 2% before adjustments led to much higher defaults.

High LTV lending is a higher percentage of loans today (23%) than in 2006 (17%). This is due to the large increase in FHA insured loans.

The first-time homebuyer tax credit is being used as a downpayment, and Pinto draws a comparison to the horrible default performance of the DAPs (downpayment assistance program) loans.

"FHA's early warning database indicates loan performance is deteriorating." See pages 6 and 7 of testimony for details. Note: I posted some data before, see FHA Lenders with High Default Rates

There is more in his testimony.

by Calculated Risk on 10/08/2009 09:05:00 AM

Click on graph for larger image in new window.

Reis reports the strip mall vacancy rate hit 10.3% in Q3 2009; the highest vacancy rate since 1992. And rents are cliff diving ...

From Reuters: Shopping center vacancy rate hits 17-year high: report

"Our outlook for retail properties as a whole is bleak," Victor Calanog, Reis director of research, said. "Until we see stabilization and recovery take root in both consumer spending and business spending and hiring, we do not foresee a recovery in the retail sector until late 2012 at the earliest."
...
The third-quarter vacancy rate at U.S. strip malls, which include local shopping and big-box centers, rose 0.3 percentage points from the second quarter to 10.3 percent, the highest since 1992, Reis said.
...
Factoring in months of free rent and other perks, effective rent fell 0.8 percent from the second quarter to $16.89 per square foot or down 3.8 percent from the third quarter 2008. Rents were the lowest since mid-2007
...
"Since asking and effective rent growth only turned negative about one year ago, it is daunting to observe this acceleration in decline in what has traditionally been regarded as a stable property type," Calanog said.

A grim outlook: no recovery seen in the retail CRE sector "until late 2012 at the earliest".

Malls. Offices. Apartments. The story is the same: rising vacancies and falling rents. Here are the earlier reports this week on offices and apartments:
U.S. Office Vacancy Rate Hits 16.5% in Q3

Apartment Vacancy Rate at 23 Year High

by Calculated Risk on 10/08/2009 08:34:00 AM

The DOL reports weekly unemployment insurance claims decreased to 521,000:

In the week ending Oct. 3, the advance figure for seasonally adjusted initial claims was 521,000, a decrease of 33,000 from the previous week's revised figure of 554,000. The 4-week moving average was 539,750, a decrease of 9,000 from the previous week's revised average of 548,750.
...
The advance number for seasonally adjusted insured unemployment during the week ending Sept. 26 was 6,040,000, a decrease of 72,000 from the preceding week's revised level of 6,112,000.

Click on graph for larger image in new window.

This graph shows the 4-week moving average of weekly claims since 1971.

The four-week average of weekly unemployment claims decreased this week by 9,000 to 539,750, and is now 119,000 below the peak in April.

Initial weekly claims have peaked for this cycle, however the level of weekly claims indicates continuing weakness in the job market. The four-week average of initial weekly claims will probably have to fall below 400,000 before total employment stops falling.

by Calculated Risk on 10/07/2009 09:50:00 PM

From Dow Jones: Pimco Has Quit CIT Bondholder Steering Committee

The future of CIT Group Inc. (CIT) grew murkier Wednesday after the disclosure that bond fund giant Pacific Investment Management Co. had quit a steering committee that's trying to prevent the commercial lender from collapse. ... Boston-based Baupost Group LLC [had quit earlier].
...
The company has an estimated $75 billion in assets, and provides critical short-term financing to about one million small companies.
...
Investors have until 11:59 p.m. Eastern time on Oct. 29 to tender their bonds under the restructuring plan.

Small firms have already been hit hard in this recession, accounting for about 45% of the job losses (see Melinda Pitts at Macroblog: Prospects for a small business-fueled employment recovery):

In a speech [Monday], William Dudley, the president of the Federal Reserve Bank of New York, identified financial constraints for small businesses as a restraint on the pace of economic recovery.
...
Looking ahead, it's not clear whether small businesses will continue to play their traditional role in hiring staff and helping to fuel an employment recovery. However, if the above-mentioned financial constraints are a major contributor to the disproportionately large employment contractions for very small firms, then the post-recession employment boost these firms typically provide may be less robust than in previous recoveries.

As the article mentioned, CIT provides financing for about one million small business. If CIT files bankruptcy, the company will continue to operate, but they may not write any new business. Their competitors will pick up the best of the business, but many small firms will struggle to find new financing.

The clock is ticking.

by Calculated Risk on 10/07/2009 05:50:00 PM

Jim says the "market is hot, real hot." This is worth watching to get a feel for what is happening at the lower end of the housing market (in San Diego at least).

by Calculated Risk on 10/07/2009 04:02:00 PM

From the NAHB:

Extending the credit through Nov. 30, 2010 and making it available to all purchasers of a principal residence would result in an additional 383,000 home sales ...

The NAHB has also been arguing to expand the tax credit from $8,000 to $15,000. But using $8,000 per home buyer - and estimating 5 million home sales over the next year - the total cost of the tax credit would be $40 billion.

According to the NAHB this would result in 383,000 additional home sales. Dividing $40 billion by 383 thousand gives $104,400 per additional home sold!

That is higher than my original estimate that an extension of the tax credit would cost about $100 thousand per additional home sold.

Note: If the NAHB meant $15,000 per home buyer, the cost would be $75 billion - or $157 thousand per additional home sold.

And this doesn't included the costs of the unintended consequences.

The tax credit is simply motivating some renters to become homeowners (not reducing the overall number of excess housing units). This is pushing up the vacancy rent, pushing down rents and leading to more commercial real estate (CRE) defaults and foreclosures - and will lead to more losses for lenders. The additional defaults associated with lower rents will probably be higher than the cost of the tax credit. From the WSJ: Fed Frets About Commercial Real Estate

[Fed economist] Mr. Conway's presentation painted a bleak picture of the sliding real-estate values and enormous debt that will need to be refinanced in the next few years. Vacancy rates in the apartment, retail and warehouse sectors already have exceeded those seen during the real-estate collapse of the early 1990s, Mr. Conway noted. His report also predicted that commercial real-estate losses would reach roughly 45% next year. Valuing real estate has always been tricky for banks, and the problem is particularly acute now because sales activity is practically nonexistent.
...
More than half of the $3.4 trillion in outstanding commercial real-estate debt is held by banks.

Motivating some renters to become homeowners has increased demand at the low end and pushed up house prices (more demand). However when the tax credit eventually ends (it will someday), the price-to-rent ratio will equalize, applying downward pressure on home prices.

Many of the additional sales in 2009 were to buyers who used the tax credit as their downpayment. These were marginal buyers who haven't proven the ability to manage their finances and save for a down payment. The default rates will probably be higher for these buyers than for other buyers.

The housing tax credit raises the risk of deflation. Falling rents will probably already push core CPI close to zero in 2010. An extension of the housing tax credit will probably push rents down further (as those 383,000 additional home buyers move from renting to owning), and that will probably mean core CPI will be negative in 2010. Not only will this impact any program adjusted by CPI (like Social Security), but this could lead to a deflationary mentality for consumers - with consumers holding off purchases waiting for lower prices.

Anyone analyzing the tax credit should call the economists at the BLS and ask about how falling rents will impact owners' equivalent rent and CPI. Then call the economists at the Federal Reserve and ask how CPI deflation will impact consumer behavior and monetary policy. Welcome to the Fed's nightmare.

by Calculated Risk on 10/07/2009 03:00:00 PM

From MarketWatch: U.S. consumer credit falls for 7th straight month

U.S. consumers reduced their debt for the seventh straight month in August, the Federal Reserve reported Wednesday. Total seasonally adjusted consumer debt fell $11.98 billion, or at a 5.8% annual rate ... In the subcategories, credit-card debt fell $9.91 billion, or 13.1%, to $899.41 billion. This is the record 11th straight monthly drop in credit card debt. Non-revolving credit, such as auto loans, personal loans and student loans fell $2.10 billion or 1.6% to $1.56 trillion.

Cash-for-clunkers probably kept non-revolving credit from falling further - just wait for the September numbers!

Click on graph for larger image in new window.

This graph shows the year-over-year (YoY) change in consumer credit. Consumer credit is off 4.4% over the last 12 months. The previous record YoY decline was 1.9% in 1991.

Here is the Fed report: Consumer Credit

Consumer credit decreased at an annual rate of 5-3/4 percent in August 2009. Revolving credit decreased at an annual rate of 13 percent, and nonrevolving credit decreased at an annual rate of 1-1/2 percent.

Note: The Fed reports a simple annual rate (multiplies change in month by 12) as opposed to a compounded annual rate. Consumer credit does not include real estate debt.