by Anonymous on 6/01/2007 07:28:00 AM

We've talked a lot about the individual and community misery generated by housing busts, irresponsible lending, and waves of loan failures. We have pondered the potentially devastating effects on employment, residential investment, and consumer spending. We have surely noted the damage to shareholders of bankrupt mortgage originators and investors--true bagholders--in mortgage-backed bonds.

Evidently we have forgotten to spare a tear for those poor hedge funds, whose honest day's work of betting on failure, without having to pony up any real capital, apparently, is under threat. Yes, friends, there's a conspiracy afloat to put the interests of homeowners--the people who supply that cash-flow--and actual capital investors--the people who supply the actual loan funds--ahead of the credit default swap punters. I don't know that I've ever been so moved.

From the Financial Times, "Fears Over Helping Hand for Mortgage Defaulters":

The hedge funds are worried about modifications that mortgage administrators, or servicers, sometimes make to home loans for troubled subprime borrowers – for example, changing the interest rate, or extending the repayment term.

Some investment banks are active in the mortgage servicing business as well as being mortgage lenders, underwriters for mortgage-backed securities and derivatives traders.

The hedge funds claim that the banks’ ability to modify the terms of individual mortgage loans could go beyond helping borrowers and enable them to profit – or avoid losses – on the derivatives contracts sold to the hedge funds.

“Manipulation is a charged term, but there are concerns that the potential for manipulation is there,” said Karen Weaver, global head of securitisation research at Deutsche Bank.

This is because, in contrast to other strategies for managing troubled mortgages, these loan modifications show up in performance reports as no longer in arrears. Loans modified in this way would not trigger writedowns of bonds backed by such mortgages, and in turn, this could mean an investment bank would not have to pay out on derivatives contracts tracking those bonds.

Oh, my. Someone stands to profit from "helping borrowers." And a bunch of hedgies stand to lose some bets if those borrowers get back on their feet. Why, this is predation.

Ms Weaver at Deutsche Bank said: “The bottom line is that when a servicer modifies a loan, they have to represent that they believe they can maximise the value of the loan by doing a modification as opposed to choosing another option. There’s a fiduciary responsibility there.”

Moreover, whatever their motivation for modifying loans, dealers can only make changes if borrowers agree.

“A lot of the most problematic mortgages were taken out in late 2005 and 2006, when many borrowers took on huge loans on the belief that house prices were going up,” said Ms Weaver. “That hasn’t happened and those homes have become albatrosses, so a lot of borrowers may just walk away.”

Part of the problem is a lack of specialist knowledge on the part of some hedge funds, one dealer said. “There are participants in the derivatives market that don’t understand the servicing process and don’t understand the mortgage process. They are great macro players that made a great call on a sector that was going to underperform but they didn’t take into account that servicers have options to modify the loans.”

Ah, yes. Risk always ends up where it is most understood. And who'd have thunk that Mary Ellen in the Servicing Department could be causing all this grief for the big-money punters just by servicing a loan?

Oh, the humanity. I am driven, as I am so often, to take refuge in the consolations of great literature.

"I suggest, Headmaster, that Potter is not being entirely truthful," he said. "It might be a good idea if he were deprived of certain privileges until he is ready to tell us the whole story. I personally feel he should be taken off the Gryffindor Quidditch team until he is ready to be honest."

"Really, Severus," said Professor McGonagall sharply, "I see no reason to stop the boy playing Quidditch. This cat wasn't hit over the head with a broomstick. There is no evidence at all that Potter has done anything wrong."

Dumbledore was giving Harry a searching look. His twinkling light-blue gaze made Harry feel as though he were being X-rayed.

"Innocent until proven guilty, Severus," he said firmly.

Snape looked furious. So did Filch.

"My cat has been Petrified!" he shrieked, his eyes popping. "I want to see some punishment!"

Harry Potter and the Chamber of Secrets

by Calculated Risk on 5/31/2007 06:57:00 PM

There is no question that investment in non-residential structures is still strong. As an example, from the Orange County Register: Commercial real estate still roars

"Orange County is one of the high spots for commercial real estate," said Scott MacIntosh, a senior economist with the National Association of Realtors. "There's low vacancies and high investor interest."
...
"Commercial drivers are stronger than ever, and I have never seen so much money pouring into Orange County,"[ CB Richard Ellis' Barry Katz] said. "There's still billions of dollars chasing Orange County property."

The construction spending report today showed that private non-residential construction investment was still very strong in April. And investment in non-residential structures for Q1 was revised upwards in the GDP release today. Both reports confirmed what we already knew - CRE is booming.

However, the above article goes on to note that the Orange County office market is "facing [a] glut" later this year. That is also true nationwide, in fact vacancy rates have already started to rise, and there is significant more supply scheduled to be delivered later this year. From a personal perspective, when I drive around Orange County (where I live), I see commercial construction projects everywhere, and I also see more and more "For Lease" signs on existing buildings. An interesting combination: more supply coming while vacancies appear to be increasing.

It was just two weeks ago that I asked: Commercial Real Estate: Slump Ahead? I tried to connect the dots: rising vacancies, significant supply coming on line later this year, lower demand reported for CRE loans, many banks over exposed to CRE lending, etc.

Click on graph for larger image.

Here is an update to the second chart in the previous post, including the revision to the GDP report today. This graph shows the YoY change in Residential Investment (shifted 5 quarters into the future) and investment in Non-residential Structures. In the typical cycle, non-residential investment follows residential investment, with a lag of about 5 quarters. Residential investment has fallen significantly for four straight quarters (following two minor declines). So, if this cycle follows the typical pattern, non-residential investment will start declining later this year.

I believe that continued strong non-residential investment (both structures and equipment and software) is one of the keys to avoiding a recession this year.

by Calculated Risk on 5/31/2007 02:19:00 PM

From the FDIC Quarterly Banking Profile

• Industry Reports Year-Over-Year Earnings Decline
• Rising Loan Loss Provisions Reduce Profits at Larger Institutions
• Net Interest Margins Decline at Small Institutions, Rise at Large Banks
• Loan Growth Slows for Fourth Consecutive Quarter
• Mortgage Assets Decline for Second Quarter in a Row

Click on graph for larger image.

This is Chart 7 from the FDIC banking profile for Q1 asking a key question.

From the FDIC report it appears small institutions are struggling. But mid-sized institutions ($1 to $10 Billion) have improved their margins by taking on more risk, mostly associated with commercial real estate.

by Calculated Risk on 5/31/2007 12:16:00 PM

Some excerpts from Professor Roubini: Q1 Growth Revised Down to 0.6%: We Are Already in a Growth Recession

On housing:

In brief, [the view of four senior analysts at a 10 global financial institution]: the housing market is still weakening and - based on their May survey of traffic - housing sales traffic is close to dead; it would take developers to shut down all new construction for almost a year to get rid of the excess supply of unsold homes; thus, downward home price action may continue for the next two years; the credit crunch in the mortgage market is only at its early stages and the distress and crunch is spreading from sub-prime to Alt-A and near prime mortgages; the major mortgage lenders have not yet started to get a reality check on how bad their assets are and properly mark them to market; the ABX index (the BBB- tranche) collapsed from near parity down to 60 in the last few months and has now recovered to close a still low 67; but, given how lousy were mortgage originations in 2005 and 2006, deliquencies in subprime will further increase in the next few months and further downward pressure in the ABX indexes may be expected.

This writer has been a serious bear on housing for a long time: but after listening to these most sophisticated analysts of housing, mortgage lending and the MBS markets from a top global financial firm my concerns seemed almost not bearish enough. The main message from these analysts and the data is that the housing recession, the subprime carnage and the broader mortgage mess are getting worse, not better; and things will get worse well into 2008. There is no end in sight to the housing recession and we are only in the first innings of the mortgage credit crunch.

This fits very closely with my view: there is no end in sight to the housing slump.

And on the economy:

The latest macro data are certainly mixed with some supply side indicators showing an improvement while consumption and housing have been weakening. ... unless there is a massive recovery of net exports, capital spending by the corporate sector, inventory rebuilding, Q2 growth will remain in the growth recession range. The current soft landing consensus argues that such recovery in these components of aggregate demand may be underway. I am not convinced - for reasons I will flesh out next week.

I'm looking forward to Roubini's future posts. So far non-residential investment is holding up pretty well, although, with the typical lags, we might expect non-residential investment to start to decline about now. As far as consumption, we are still waiting to see the impact of declining MEW (and the end of the "home ATM").

by Calculated Risk on 5/31/2007 11:07:00 AM

From OFHEO: U.S. House Price Apprecation Rate Remains Slow, but Positive

The rate of home price appreciation in the U.S. remained slow but positive in the first quarter of 2007. The OFHEO House Price Index (HPI), which is based on data from sales and refinance transactions, was 0.5 percent higher in the first quarter than in the fourth quarter of 2006. This is moderately below the revised growth estimate of 1.3 percent from the third to the fourth quarter of 2006. Prices in the first quarter of 2007 were 4.3 percent higher than they were in the same quarter in 2006.

OFHEO’s purchase-only index, which is based solely on purchase price data, indicates less price appreciation for U.S. houses than the HPI does over the past year. The purchase-only index increased 3.0 percent between the first quarter of 2006 and the first quarter of 2007, compared with 4.3 percent for the HPI.

The underlying purchase-only and a seasonally-adjusted purchase-only U.S. index can be downloaded here.

Purchase-only indexes (both seasonally-adjusted and not-seasonally adjusted) are now also available for every Census Division and are downloadable here.

Purchase-only indexes are available for each state here.

by Calculated Risk on 5/31/2007 10:22:00 AM

From the Census Bureau: April 2007 Construction Spending at $1,190.0 Billion Annual Rate

The U.S. Census Bureau of the Department of Commerce announced today that construction spending during April 2007 was estimated at a seasonally adjusted annual rate of $1,190.0 billion, 0.1 percent above the revised March estimate of $1,188.9 billion. The April figure is 2.0 percent below the April 2006 estimate of $1,214.4 billion.

During the first 4 months of this year, construction spending amounted to $345.1 billion, 2.5 percent (±1.8%) below the $353.8 billion for the same period in 2006.

The decline in spending is due to the slump in residential construction. However private non-residential construction spending has remained strong:

Nonresidential construction was at a seasonally adjusted annual rate of $335.9 billion in April, 1.5 percent above the revised March estimate of $331.1 billion.

Click on graph for larger image.

This graph shows the YoY change for the three major components of construction spending: Private Residential, Private Non-Residential, and Public.

While private residential spending has declined significantly, spending for both private non-residential and public construction has remained strong.

As I noted last month, continued strength in non-residential investment is probably necessary to keep the economy out of recession. In the revision to the GDP report today, the headline number was revised down to 0.6% real growth (way below most forecasts), but the good news was non-residential investment was revised upwards: non-residential structure investment was revised up to (UPDATE: corrected numbers) 5.1% from 2.2%, and investment in software and equipment was revised up to 2.0% (from 1.9%). For those of us arguing there is a reasonable chance of a soft landing, this is good news.

Before people start thinking I've changed my views - I haven't. I still think the odds of a recession in '07 are about a coin-flip. And I still think Bernanke's downward revised view of 2.5% to 3.0% growth in '07 is too optimistic.

by Anonymous on 5/31/2007 09:52:00 AM

Our loyal commenter Yal directed my attention to this piece from CNNMoney, "Wow, I could've had a prime mortgage." I was going to get right on it, but I was a touch queasy yesterday, and the minute my mind processed the allusion to the famous V-8 commercial--I hate all forms of vegetable juice, with or without vodka--I had to reprioritize.

But it's a new day.

"I reviewed several hundred [subprime] loans recently for our wholesale division," said Allen Hardester, regional director of development for mortgage-broker, Guaranteed Rate, "and all of them, with one exception, qualified for a prime-rate loan."

Freddie Mac, a government-sponsored mortgage-loan buyer, estimated that borrowers of 15 to 35 percent of all subprime loans it bought in 2005 could have qualified for prime-rate loans.

Fannie Mae, another government-sponsored loan buyer, estimated up to 50 percent of the borrowers, whose subprimes it bought that year, had credit profiles that could have qualified them for prime rates.

There are any number of things one can say about reports such as the ones above, from highly-informed industry participants with very, very big databases and the ability to perform professional, in-depth due diligence review on a loan file. So what does CNN say?

No one to blame but yourself

"You" here means you, the hapless borrower, not me, the person who is expected to know what product you can qualify for and what the market rate might be for it.

Then there is the obligatory denial from the vested interests:

[Doug Duncan, chief economist for the Mortgage Bankers Association], however, doubted that very many prime customers do get put into subprime products.

"I have yet to see any scientific evidence that that is true," he said. "If you only see credit scores, that doesn't capture the whole story."

Jim Nabors, past president of the National Association of Mortgage Brokers, said, "[Fannie Mae and Freddie Mac] may not be seeing the whole picture. They didn't take into account a lot of things that help determine the kind of loan a borrower receives."

These factors include items such as "seasoning" of loans, which takes into account how long a buyer had a down payment on a house and the source of that money, the borrower's debt ration [sic] and the appraisal value [sic] of the property.

Nabors said that, undoubtedly, some borrowers qualified for prime did get subprimes, but the extent has probably been exaggerated. [Emphasis added]

Welcome to the wonderful world of mortgage industry logic, as mediated by the press. Duncan sees no "scientific" evidence here, even though he is being confronted with estimates that are derived from much more than a simple credit score. Nabors seems to think that Fannie and Freddie use automated underwriting systems that don't capture DTI or appraised values. The GSE systems, of course, don't simply "capture" appraised values; they have internal AVMs that subject those reported numbers to a plausibility check. Nor do they "look at" FICOs. They do "capture" FICOs in the dataset. But what they "look at" is the entire contents of at least one and usually three full credit reports (from each of the three major repositories). Plus about a thousand other data elements.

But if you're an underinformed sucker, you can read these statements by Duncan and Nabors--which are blaming you for not knowing enough--and think that the claims being made by Guaranteed Rate, Fannie, and Freddie are based solely on looking at FICO scores. If you're a reporter or editor who uses "ration" instead of "ratio" and "appraisal value" instead of "appraised value," it is possible you haven't had enough exposure to the industry and its lingo to know when smoke is being blown in your direction. And if I say you have no one to blame but yourself for printing nonsense from an industry shill, you better not start trying to explain to me why people who read CNNMoney are at fault if they don't know more about their mortgage eligibility than their lender appears to. You are a reporter. You could have called Fannie and Freddie and asked them on what basis they have made these estimates. You could have asked Mr. Hardester about the exact nature of the "file review" he performed. You could have identified Guaranteed Rate as a mortgage banker who buys loans from brokers, not as a broker itself. You could have had a V-8.

What you did, though, is give us another "he said/she said" piece of tripe.

by Calculated Risk on 5/30/2007 03:08:00 PM

From the FOMC minutes of the May 9th meeting:

The incoming data on new home sales and inventories suggested that the ongoing adjustment in the housing market would probably persist for longer than previously anticipated.
emphasis added.

Remember, these minutes are for the May 9th meeting - before the stunning increase in inventory reported on May 25th. Here is the complete paragraph:

The incoming data on new home sales and inventories suggested that the ongoing adjustment in the housing market would probably persist for longer than previously anticipated. In particular, the demand for new homes appeared to have weakened further in recent months, and the stock of unsold homes relative to sales had increased sharply. That said, participants also noted that sales of existing homes appeared to have held up somewhat better since the beginning of the year. Moreover, the turmoil in the subprime market evidently had not spread to the rest of the mortgage market; indeed, mortgage rates available to prime borrowers remained well below their levels of last summer. Nevertheless, most participants agreed that, although the level of inventories of unsold homes that homebuilders desired was uncertain, the correction of the housing sector was likely to continue to weigh heavily on economic activity through most of this year--somewhat longer than previously expected.

by Calculated Risk on 5/30/2007 10:31:00 AM

On June 14th, the Fed will hold a hearing under the Home Ownership and Equity Protection Act.

Hearing participants will discuss whether the Board should use its rulemaking authority to address concerns about certain terms and practices related to home mortgage loans, including:

• Prepayment penalties
• Escrow accounts for taxes and insurance on subprime loans
• "Stated income" or "low doc" loans
• Consideration of a borrower's ability to repay a loan

Participants will also discuss the effectiveness of state laws that have prohibited or restricted these and other terms or practices, and whether the Board should consider adopting similar regulations to curb abusive lending practices. The Board is also soliciting written comments from the public. Comments are due August 15, 2007.

Some of the questions are interesting:

• Should stated income or low doc loans be prohibited for certain loans, such as loans to subprime borrowers?
• Should stated income or low doc loans be prohibited for higher-risk loans, for example, for loans with high loan-to-value ratios?

Oh well, more hearings.

by Calculated Risk on 5/30/2007 12:10:00 AM

From the WaPo: An ATM That's Out of Money

For years ... people used their homes as glorified ATMs, pulling out money for all sorts of reasons. The trend helped support continued economic growth and recovery from the 2001 recession.

But now people are reining in their spending, raising concern that their collective decisions could nudge a sluggish U.S. economy into recession.

This has all been discussed here before, but it is now on the front business page of the WaPo. As an aside, I believe Fleck was the first writer to refer to mortgage equity withdrawal as the "housing ATM".

by Calculated Risk on 5/29/2007 07:59:00 PM

From CNNMoney: Pulte to slash work force by 16% (hat tip Brian)

Pulte Homes, the nation's fourth-largest homebuilder, announced a restructuring plan Tuesday, saying it plans to further trim its work force by 16 percent.

The Bloomfield Hills, Mich.-based homebuilder said it would also take a pretax charge between $40 million and $50 million.
...
"The homebuilding environment remains difficult and our current overhead levels are structured for a business that is larger than the market presently allows," Richard J. Dugas, Jr., the company's president and CEO said in a statement.

"Despite reducing our work force by approximately 25 percent in 2006 and early 2007, we find it necessary at this time to further reduce overhead expenditures, including, unfortunately, reducing an additional sixteen percent of our jobs," he added.

I think the builders are moving past denial, and entering the depression phase for housing (in two meanings of the word!). From M-W:

1) a state of feeling sad,
2) a period of low general economic activity marked especially by rising levels of unemployment.

Hope, according to Home Builders chief economist David Seiders, is still years away.

by Calculated Risk on 5/29/2007 02:20:00 PM

From AP: Home price index shows first quarterly drop in 16 years

U.S. home prices fell 1.4 percent in the first quarter compared to a year ago, the first time since 1991 prices have shown a quarterly decline, according to a housing index released Tuesday by Standard & Poor's.

"We still don't see anything that looks like a clear bottom," S&P index committee chairman David Blitzer said. "We're still headed down."

The S&P/Case-Shiller U.S. National Home Price Index showed the 1.4 percent drop in the price for sales of existing single-family homes in metropolitan markets in nine U.S. census divisions.

For March, S&P's 10-city and 20-city composite indices, which measure a smaller number of cities than the national index, also fell, by 1.9 percent and 1.4 percent respectively over the last year.

When compared to February, the March sales figures show that 16 of 20 cities reported prices had dropped or remained flat, S&P said.

The most widely followed index (OFHEO House Price Index) will be released on Thursday.

by Calculated Risk on 5/29/2007 10:35:00 AM

From Bloomberg: Home Construction Bust May Last Until 2011, U.S. Builders Say

New home construction in the U.S. may take until 2011 to return to last year's level, said David Seiders, chief economist for the National Association of Home Builders in Washington.
...
"We've fallen way below trend because we soared way above trend during boom times," Seiders said in an interview. "The upswing will be relatively slow, unlike earlier cycles."

by Calculated Risk on 5/28/2007 04:49:00 PM

From David Streitfeld at the LA Times: Getting a fix on foreclosure data

RealtyTrac's numbers tend to top all other figures because the company counts every step in the foreclosure process — the notice of default, the auction, the house reverting to the lender — separately. One house might be tallied several times as a foreclosure.

This is highly misleading, the company's critics say. A Colorado housing official recently called RealtyTrac's numbers "ridiculous and irresponsible." ...

"No one is measuring the truth," said Mark Zandi, chief economist for Moody's Economy.com. "This is a problem when formulating policy."

Zandi takes issue not only with RealtyTrac for numbers he says are too high but also with DataQuick Information Systems, a La Jolla, Calif.-based research company frequently cited in The Times, for numbers he says are too low.

I've been using the DataQuick numbers for consistency - but they may be too low.

by Anonymous on 5/28/2007 08:45:00 AM

I’ve never written about reverse mortgages before on this blog, in part because they aren’t usually included in the category of “toxic” mortgages. Reverse mortgages are most assuredly weird, compared to your bog-standard “forward” mortgage, and “exotic” might apply, but they aren’t “toxic” in the same way that interest only, negative amortization, and “exploding” ARMs are. I can imagine reverse mortgages becoming toxic, however, and that should concern us all. The toxicity of the IOs and OAs, for instance, is largely a matter of a product that made some required daily allowance of sense when it was offered to a highly affluent and financially stable borrower class, but that indeed became worrisome as a “middle market” mania and an outright horror as an “affordability” boost. In that sense, the claim of lenders that these are “good products” that have been misused by “bad lenders” has some truth to it, although I for one find the term “good product” disingenuous and the idea that it has been misused only by the lowest of the bottom-feeders risible.

Reverse mortgages, as they currently exist, are limited to a highly specific borrower class, which happens, not coincidentally, to be a highly vulnerable one. Unlike the other exotics, it’s not in danger of becoming predatory because it might migrate from the well-heeled to the down-at-the-heel. I’d be more worried about it becoming a target for low-skill, high-margin, under-regulated originators and brokers who think they are selling a certain “service.” The last thing you can say about the reverse mortgage target borrower class is that it can be expected to be 1) more sophisticated than anyone else and 2) “busy” enough to gain anything from an “efficient” service that trades money for time. “Buyer beware” is not an assumption on which you can safely originate reverse mortgages. They are also much more expensive to originate and service than any “forward” mortgage, which means they won’t become fully “cost-effective” until we’ve made so many of them that we can become efficient at it, which will be too damned late if it turns out to be a kind of financing that ought to have stayed expensive. But that idea won’t make any sense at all until you understand what they are.

Reverse mortgages are truly Different. They are really the first mortgage product that was “engineered” for a highly specific borrower and situation. That borrower is of retirement age or older, is on a fixed and low-to-moderate income, and is the owner of a free-and-clear home. “House rich and cash poor” sums it up. Most importantly, this borrower wishes to remain in his or her home, but struggles to do so given limited income and the escalating costs of taxes, insurance, maintenance and repair on a property that no longer carries mortgage debt. You might get one or two golfin’ grannies who really just want to buy tickets to the next AARP cruise or blow it all in Vegas, but mostly you get elderly Social Security recipients whose property tax bill, thanks to the “unqualified buyer auction” that life has become lately, is too expensive on a fixed income.

The Fannie Mae reverse mortgage is actually called the “Home Keeper,” and that really does hit the major issue: these borrowers do not wish to sell their homes to realize their equity in cash, nor do they necessarily want to do “home improvements” beyond maintenance or, possibly, retrofitting for safety or accessibility. They want to be able to tap into equity for the purpose of simply staying where they are, physically and financially. They are not looking to leverage the purchase of a home with debt; they did that 30 or more years ago and paid the thing off like they were supposed to. They “built the wealth” everyone keeps talking about, and now they have to deal with what it costs in actual cash-flow-type money to hang onto that “wealth,” which these borrowers, in their unsurprisingly old-fashioned point of view, keep thinking of as “where they live” instead of “capital gains.” The reverse mortgage is not something that these “savvy” boomers who took out a 40-year Option ARM at the age of 52 to buy the big house with the media room are ever going to have to worry about getting, I suspect.

The FHA version of the reverse mortgage, the original one, is called the Home Equity Conversion Mortgage, or HECM (which, unfortunately, is universally pronounced “Heck ‘em”). That leads a fair number of people to confuse it with a HELOC or Home Equity Line of Credit. It isn’t at all the same thing. The reason that a “forward” mortgage like a conventional closed-end refinance or a HELOC is not a good option for these borrowers is that such loans require repayment during their terms, and the fixed-income borrowers could probably handle their housing expense already if they could handle the payments on a normal mortgage. Also, a “payable” mortgage runs the risk for these borrowers that if they cannot make periodic payments before maturity of the loan, they can lose their homes via foreclosure. Certainly, any borrower who can handle a “forward” mortgage ought to get one, since they’re much cheaper.

What the reverse mortgage “reverses” is who pays whom when. The reverse mortgage places a lien on the property, as any mortgage does, that begins with no balance (beyond closing costs and fees, which are substantial, and possibly an initial disbursement), like a HELOC does. The borrower receives disbursements of funds on an annuity-like schedule or on request like a line of credit, and interest accrues on the cumulative balance. There the similarity to a HELOC ends, because the reverse mortgage is “due and payable” only on the borrower’s death, the voluntary sale of the home, or the borrower’s failure to occupy the home as a principal residence. A “forward” mortgage has a “maturity date”; a reverse mortgage has a “maturity event.” The only “event of default” that can trigger foreclosure is the borrower’s inability or unwillingness to continue to maintain the property at minimally acceptable standards or keep the taxes and insurance current. When a “maturity event” occurs, the lender is repaid from the proceeds of the sale of the home, with any proceeds over the full amount of the debt due to the borrower or estate.

The reverse mortgage obviously has some similarity to the negative amortization mortgage, since all accruals of interest and fees are added to the outstanding mortgage balance. A major difference is that while disbursements to the borrower will stop when the contractual maximum principal limit of the loan is reached, interest continues to accrue without limitation on the outstanding total balance until the “maturity event.” However, reverse mortgages cannot be “upside down” by definition: the borrower or estate never owes more than the current appraised value of the property to the lender, regardless of loan balance outstanding. The lender accepts either sales proceeds equal to the appraised value or a deed-in-lieu (i.e., the lender accepts title to the property as repayment of the debt), even if the accrued interest has long exceeded the value of the property. There is never “recourse” to other assets of the borrower or estate. The lender’s risk is “actuarial”: if Grannie lives to be 105, Fannie writes off a lot of interest income if Grannie’s house price appreciation didn’t keep up with Grannie’s longevity. Of all the many, many things to cherish about those tough old birds, the idea of them blowing a mortgage lender’s balance sheet to kingdom come just by getting up every morning has to appeal to you. It has a tendency to annoy Grannie’s heirs, but we’ll get to that.

Calculating the maximum principal amount that can be borrowed is very complex, and HUD and Fannie Mae provide special software that must be used. The programs are half negative amortization schedules and half actuarial tables. The amount that can be borrowed crucially depends not just on the appraised value of the property, but on the age of the borrower, number of borrowers, and disbursement plan selected. The younger the youngest borrower (with a minimum age of 62), the less principal that can be borrowed; the more the property is worth, the more principal that can be borrowed. All calculations take into account “scheduled” rather than “potential” negative amortization. (These loans can be prepaid in whole or in part, but it is assumed that they won’t be; any “payment” at all of principal or interest on a reverse mortgage is a “prepayment.”)

It has exactly nothing to do with the borrower’s income, other assets, or credit history, which are not considered. This is purely a “collateral-dependent” loan, with no expectation of repayment from income or other assets—that’s the point of it all—and therefore no consideration of those things as “qualification” for the loan. Certainly the suitability of a reverse mortgage for a given borrower has to depend on what that borrower’s other resources are. But there’s the big deal about reverse mortgages: they both raise the issue of predation and neatly knee-cap all the self-serving slogans of the predators who have no time for the idea of “fiduciary duty.” You can, in a sense, only “qualify” for a reverse mortgage to the extent that it is “suitable” for you. Nobody offers a “stated birth certificate” or “stated property inspection” reverse mortgage. Everybody requires extensive “homebuyer counseling,” part of which is to assure that the mortgage can do what the borrower wants or expects it to do.

What does that mean? Well, if you are 62 and female, your home is older, smaller, less desirably located and more “functionally obsolescent” than the average existing home, and your current income is both fixed and inadequate to carry the property while still allowing you to eat, a reverse mortgage isn’t likely to do you much good for very long. You may not be able to borrow enough to keep you going for the next twenty years, absent some meaningful changes to the way cost of living adjustments are made to Social Security and the way taxing authorities and insurance regulators might cap inflation for elderly homeowners. Alternately, if you are a 90-year-old male and your house has four walls and a roof, you can probably borrow enough to have a damned good time in Vegas, and as long as you are deemed competent to execute contracts in a court of law, nobody can stop you. “Suitability” in this context is not a moral judgment on what 90-year-olds have the right to do with their “wealth” if they damned well feel like it. It is a question of “making the loan work” in a way that is, truly, the reverse of the way the predators approach “forward” mortgages.

The Comptroller of our Currency observed the other day that it’s funny how lenders claim that verification of income “doesn’t matter” until they have to make a foreclosure versus workout decision; then, all of a sudden, the first thing they want to do is verify income. If you want to know how much lenders really believe in endless, faster-than-non-housing-inflation house price appreciation, go ask what a reverse mortgage lender will lend to a recent retiree. Turns out they weren’t really drunk, they were just acting like drunks.

There are largely two groups of folks who are worried about reverse mortgages. The first group is the sort of party pooper who thinks that if a 28-year-old college graduate can’t spot the problem with a “free money” pitch, or read a Truth-in-Lending disclosure or promissory note with sufficient comprehension get the part about how much it actually costs, your great aunt Euelna, who talks to dead people, owns 47 cats, and has too many cataracts to be able to see the note, let alone read its fine print, is maybe not going to “beware” of a reverse mortgage. You can bloviate about the “free market” all day long, but nobody is going to let you throw great aunt Euelna to the wolves, so save your breath.

Group number two provides the real amusement value. These are the “heirs” who blow a gasket when they find out that Grannie and Fannie between ‘em cooked up a plan to spend that “wealth” that Grannie built up with the magic of homeownership, and not on presents for the grandkiddies. Those who natter on about “wealth building” via homeownership in the context of justifying insane leverage aren’t, actually, the ones that really make me want to pull my hair out. It’s the ones who natter on about “intergenerational wealth building,” particularly when accompanied by the acknowledgement that housing is “the only way the poor can build wealth.” If the best many hard-working honest decent people have ever been able to do is end up house rich and cash poor, with the regrettably poor taste to do so while they’re still alive and “consuming,” then what, realistically, is there going to be to bequeath?

My own grandmother’s home netted enough at the estate sale, after expenses, to reimburse each of her six children’s share of the taxes, insurance, repairs, maintenance, and replaced lawnmowers and appliances they’d all ponied up for over the years, reverse mortgages not having been available back then and my family not being the sort who would have allowed it, anyway. Certainly no one in any generation wanted to actually live in a small one-bathroom three-bedroom 60-year-old two-story with a single carport and gravel drive. And formica countertops, well-used (the old girl could cook). Even allowing for the sentimental value and the recently reshingled roof. I am aware that my family might have been the last one in America to have experienced upward mobility between generations, but that’s the point, isn’t it? A family who had been counting on receiving “wealth” after probate would have been sorely disappointed. Heirs who made sure the property stayed "free and clear" by dutifully helping to support the elderly relative did not "inherit wealth," they got "paid back."

Reverse mortgages have to be heavily regulated. There really can be no serious argument against that. But the preoccupations of this blog are many. There is how debt-booms substitute for disposable income (the MEW problem). How housing “assets” do get marked to market (the RE bust problem). How we got such an excess inventory of housing units (the resource allocation problem). Given all that, it’s a good time to think about where this reverse mortgage thing is going before it gets there. This time around. So here are your facts:

1. People who keep getting older.
2. Houses that keep getting older, one-third of which are currently owned free and clear.
3. Medicare, prescription drugs, cat food, and everything else old folks don’t stop consuming.
4. 401(k)s with stocks and bonds in them. “Pensions” of course no longer appear on the list of “facts.”
5. A whole bunch of subprime and Alt-A and home improvement mortgage market participants who are or are about to be out of work, but not yet ready to retire, even if you are.
6. “The next big thing.”

If the “fixing up Social Security” and “death tax” fiascos have proven anything, it is that 1) it is harder to mess with old people than is often thought by those who haven’t been around that block yet and 2) there are a lot of people who stand to profit off of messing with old people and 3) don’t be stupid. Of course we’re going to borrow our way out of the problem. The question is how we’re going to do that. If you really think the tedious details of mortgage market regulation have nothing to do with the big economic picture, you’re a couple of recession bars short of a good CR chart.

If that didn’t give you people, young and old, something to argue about in the comments, I really will quit blogging.

Coda, for this Memorial Day: Tanta’s grandma’s house was built, in part, by the love of Tanta’s grandma’s life, a man who volunteered for service in WWII. He had to; he was too old for the draft. He lost most of his hearing on his tour of duty, but came back, with the recipe for SOS that Tanta still uses to this day. “Euelna” was a neighbor of grandma’s, a founding member of the local chapter of the Air Force Mothers Club. The dead people she talked to included her son, who returned from Vietnam in the wrong part of the transport plane. There were giants in the earth, in those days.

And there are giants still. I want them to have a home to come back to. I want them to come back. Now.

by Calculated Risk on 5/27/2007 01:42:00 PM

The OFHEO House Price Index for Q1 2007 is due to be release on May 31st. Here is an article on the FHFB data (hat tip Walt):

From the Chicago Tribune: Price slide nationally hides big gains in some metro areas

The first government housing-price numbers are in, and they're not pretty. ...

According to the Federal Housing Finance Board's quarterly survey of the 32 largest metropolitan areas, the average price of new and resale houses dipped 1.4 percent in the first quarter. That's the first decline recorded by the board in decades.

And here is some info on the FHFB data:

... the housing finance board's figures tend to be higher than those of other studies is that it includes new homes. Despite the giveaways and other come-ons used by builders to reduce inventories, new homes still lead the way when it comes to setting the price pace.

Another factor is that the survey covers the entire range of home sales, not just those with a mortgage at or below $417,000. That's the benchmark placed on Fannie Mae and Freddie Mac, two key suppliers of funds for home loans. But the quasi-government, federally chartered companies cannot buy loans above that amount from local lenders.

Coincidentally, the board's price survey is used to set the limit, also known as the conforming loan ceiling, on the loans Fannie and Freddie can purchase or roll into securities for sale to investors worldwide. But unlike the price survey conducted by the Office of Federal Housing Enterprise Oversight, the agency that regulates the two government-sponsored companies, the finance board's count is not limited to loans touched by Fannie and Freddie.

Another key distinction is that the finance board's survey covers a wider swath because it includes sales made with loans from all types of lenders. It is not limited to sales that involve Fannie Mae and Freddie Mac, which now touch, in one way or another, less than 50 percent of mortgages.

It also isn't limited to houses sold through multiple-listing services. A good many, but certainly not all, existing homes are sold through an MLS affiliated with the National Association of Realtors.

And finally, the housing finance board's research covers metropolitan areas as opposed to regions, even if the metro areas viewed are only the largest ones. So it tends to be more targeted than other studies.

Despite the problems with the OFHEO index, it is the most widely followed index. So here is a look ahead to Thursday:

Click on graph for larger image.

This is a graph of the OFHEO index based solely on purchase transactions (excludes refinance loans) through 2006. The Chicago Tribune article above suggests that the Q1 2007 OFHEO change will be negative. However it is unlikely that the YoY change will be negative yet. That will probably happen for the first time in Q2.

by Anonymous on 5/26/2007 01:19:00 PM

From the New York Times, "As Condos Rise in Florida, Investors Try to Flee":

Frank Scarfone, a retired engineer who bought two preconstruction units at Hollywood Station, a complex going up in Hollywood, is seeking to cancel his contracts. Each unit is priced at $300,000. The developer promised a city view from both units, Mr. Scarfone said, but now another building in the complex is blocking it — a change that he said made the contracts unenforceable.

He sent a letter demanding his total deposit of $120,000 back, and after getting no reply, picketed the developer’s office. Then Mr. Scarfone called a lawyer, Matthew Schlesinger, who has been unable to recoup the deposit so far.

“If we have to sue,” Mr. Scarfone said, “we’re planning on suing.”

by Anonymous on 5/26/2007 11:17:00 AM

Via Bloomberg:

May 24 (Bloomberg) -- Merrill Lynch & Co.'s Matthew Whalen, who was responsible for providing lines of credit to mortgage lenders and turning their loans into bonds, said he resigned from the firm earlier this month.

Whalen, 42, was part of a group that helped New York-based Merrill become the largest creator of subprime mortgage bonds just as delinquencies soared. Merrill's $1.3 billion purchase of First Franklin Financial Corp. in December was the biggest of a U.S. home lender to people with poor credit or high debt.

``I waited until the market felt like it was calming down to make my exit,'' Whalen, a managing director who was also responsible for persuading lenders to sell their mortgages to Merrill, said in an interview.

by Anonymous on 5/26/2007 08:43:00 AM

In a fairly anti-climactic development Friday, Coast Bank of Florida managed finally to get slapped with a Cease and Desist Order by the FDIC. The share price plummeted 5.7% late in the day, which would have been more dramatic if that didn't equal 17 cents. The CEO, whom everybody but Coast, the FDIC and the CEO had pretty much already decided back in January lacked the ability to run a Christmas Club account, let alone a state-chartered bank, was given a cardboard box to collect the mementos of his 20-year career in banking, which apparently never at the relevant point accrued enough "experience" to enable him to distinguish between a "construction loan" and "speculating with deposits."

Now, to be fair, this wasn't "anti-climactic" to everybody. Apparently Tramm Hudson, the local Florida éminence grise to whom Coast has been paying $25,000 a month in consulting fees since that day in February when the Chairman of the Board was hospitalized for chest pains, was still convinced back on May 12 that a C&D wasn't inevitable:

Jim Schutz, a bank analyst with Birmingham, Ala.-based investment services firm Sterne Agee, said he thought it possible the FDIC will issue a "cease and desist" order to the bank, which may prohibit certain activities including hiring, branch expansion, making certain investments, making acquisitions, or raising certain types of funds, including broker deposits.

Hudson said the expected regulatory action could also be an "MOU," or a "memorandum of understanding," between the bank and regulators which would stipulate "certain agreed-upon actions."

Of course you want to put these things into perspective. According to James K. Toomey, Chairman of the Board of Coast Financial Holdings, Inc.:

“While a C&D order is a directive for the bank to take certain actions, in many respects it may also enhance our plans to resolve recent issues which have impacted the performance of the bank.”

I myself often view a C&D as an "enhancement of the plan." Actually, so does the FDIC:

IT IS HEREBY ORDERED, that the Bank, its institution-affiliated parties, as that term is defined in section 3(u) of the Act, 12 U.S.C. § 1813(u), and its successors and assigns cease and desist from the following unsafe and unsound banking practices and violations of laws and/or regulation:

(a) operating with a board of directors that has failed to provide adequate supervision over and direction to the active management of the Bank;

(b) operating with inadequate management;

(c) operating with inadequate equity capital in relation to the volume and quality of assets held;

(d) operating with an inadequate allowance for loan and lease losses (“ALLL”);

(e) operating with ineffective audit programs;

(f) operating with inadequate oversight of the loan portfolio and concentrations of credit;

(g) operating with an excessive volume of poor quality loans;

(h) following hazardous lending practices and operating with an inadequate loan policy;

(i) operating with inadequate liquidity and funds management;

(j) operating with inadequate strategic planning;

(k) operating in such a manner as to produce low earnings;

(l) operating with excessive exposure to interest rate risk;

(m) operating in violation of laws and regulations and in contravention of Statements of Policy as more fully described on pages 21 through 30 of the Report of Examination dated January 29, 2007 (“Report”); and

(n) operating with an information security program, risk assessment of the Information Technology (“IT”) area, IT audit, and a Disaster Recovery Plan that are inadequate.

Not only did they have an inadequate Plan B, they apparently didn't back it up on a disk, either. But fear not, the consultant is on the case:

"We believe this order provides a good road map for the bank for working through these problems, " spokesman Tramm Hudson said.

There's nothing like a good road map.

by Calculated Risk on 5/25/2007 02:49:00 PM

For more existing home sales graphs and analysis, please see the previous two posts ...

April Existing Home Sales
More on Existing Home Sales

Click on graph for larger image.

One of the rarely mentioned stories, related to the housing boom, was the increase in turnover of existing homes. This graph shows sales and inventory normalized by the number of owner occupied units.

Note: all data is year-end except 2007. For 2007, the April sales rate and inventory are used. For owner occupied units, Q1 2007 data from the Census Bureau housing survey was used for April 2007.

This graph shows the extraordinary level of existing home sales for the last few years, reaching 9.5% of owner occupied units in 2005. The median level is 6.0% for the last 35 years.

Some of the sales were for investment and second homes, but normalizing by owner occupied units probably provides a good estimate of normal turnover. A decline in sales to 6% of owner occupied units would result in about 4.6 million sales. If sales fall back to the level of 1998 to 2001 (7.3% of total owner occupied units sold) that would be about 5.6 million units in 2007.

Also look at inventory as a percent of owner occupied units; an all time record of 5.6%!

And this takes us back to the inventory and months of supply graph from the previous post.

As I noted, the 'months of supply' metric is now above the level of the previous housing slump in the early '90s, but still below the levels of the housing bust in the early '80s.

However both the numerator and denominator are moving in the wrong directions. Supply is increasing, and will most likely continue to increase through the summer months. And sales are still high (based on percent of owner occupied units) and will probably continue to fall. Right now I'm expecting 'months of supply' to reach 9.5 months by mid-summer.