by Calculated Risk on 6/20/2007 10:27:00 AM

Reported on CNBC: JPMorgan Started Selling Stearns Hedge Fund Assets Tuesday Night

update: CNBC also reporting that Deutsche Bank and others are selling hedge fund assets.

by Calculated Risk on 6/19/2007 11:33:00 PM

More from the WSJ: Two Big Funds At Bear Stearns Face Shutdown

Two big hedge funds at Bear Stearns Cos. moved toward the brink of closing down ... as a bailout plan ... fell apart ...

The funds, which once controlled more than $20 billion in a combination of investor and lender money ... had invested heavily in various securities backed by subprime loans ...

... the funds had effectively paid down $2.25 billion of their $9 billion in outstanding credit. The first two lenders to exit their positions, Goldman Sachs Group Inc. and Bank of America Corp., agreed to unwind complicated transactions with Bear without dumping lots of bonds on the broader market. ...

By unwinding those loans in an orderly manner, rather than through a series of fire-sale auctions, Bear's fund managers ... could help stave off painful ripple effects in the broader market for mortgage-backed securities and related instruments. ...

Merrill, on the other hand ... opted to revive a planned auction for hundreds of millions of dollars worth of collateral from the Bear funds.

by Calculated Risk on 6/19/2007 06:18:00 PM

From the WSJ: Merrill Lynch To Dump Bear Stearns Fund's Assets

A day after managers of a troubled internal hedge fund at Bear Stearns Cos. presented lenders with a last-ditch plan to reinvigorate the fund with additional financing, creditor Merrill Lynch & Co. pushed forward with plans to sell hundreds of millions of dollars in collateral assets out of the fund, said traders late Tuesday.

Merrill has indicated plans to sell off at least $850 million worth of collateral assets, mostly mortgage-related securities, Wednesday afternoon, according to documents reviewed by the Wall Street Journal.

Brian sent me this link with the comment: "Look out below!"

Added: Bill Fleckenstein wrote the following today before the Merrill announcement (Fleck's site):

"I have to wonder why Wall Street is working overtime to rescue a $600 million fund. On the other hand, I think we all know the answer: In a liquidation scenario, lots of people fear what would happen to leveraged portfolios across Wall Street and the world if sales of some of the fund's paper were marked to
market.
...
I can't recall a fund of this size ever being bailed out. Liquidation is the usual outcome when a fund is down 25% to 30%, as this one supposedly is. Of course, it might be down a lot more if real prices were used.
...
Apparently, all sorts of games are being played and attempts being made to avoid marking mortgage slices-and-dices to market -- in addition to the fact that many funds aren't required to mark their positions to market until the ratings agencies say so."
Posted with permission.

First, it appears the fear will now become reality - assets will be sold. However Fleck appears to suggest that hedge funds aren't required to mark-to-market until the "rating agencies say so". We have seen a wave of downgrades recently, but overall the rating agencies have been slow to react to the subprime implosion. So if the hedge funds have to wait for the rating agencies, this will take some time to play out.

by Calculated Risk on 6/19/2007 09:37:00 AM

From the LA Times: Report from UCLA team skirts the R-word

"We suspect that the weakness in the housing market is finally spilling over into consumption spending," wrote senior economist David Shulman in the quarterly forecast being released today. "Retail sales appeared to stall in April and automobile sales have become decidedly weak.

"This is not a recession, but it is certainly close," Shulman said.

And on California housing:

In a separate report on the California economy, UCLA forecasters predicted home values would continue to fall slightly or remain flat in most parts of the state as many homeowners struggled to make higher payments on adjustable-rate mortgages.

"The pipeline of mortgage resets suggests it may be mid-2009 before California sees a normal housing market again," said the report by economist Ryan Ratcliff.

This fits with this Financial Times article: Bernanke hints at thinking on housing (hat tip Roubini)

Changes in house prices could have a bigger effect on consumption than the traditional “wealth effect” suggests, Ben Bernanke said on Friday in comments that offer some insight into how the Federal Reserve may think about the continuing problems in the US housing market.

The Federal Reserve chairman told a conference hosted by the Atlanta Fed that, in addition to making homeowners richer or poorer, changes in house prices might influence the cost and availability of credit to consumers.

This is because people with equity in their homes have more at stake in avoiding default. That, in turn, reduces the premium char-ged by lenders owing to their imperfect knowledge of their borrowers’ financial circumstances.

If this theory is correct, Mr Bernanke said, “changes in home values may affect household borrowing and spending by somewhat more than suggested by the conventional wealth effect”.

by Calculated Risk on 6/19/2007 09:13:00 AM

The Census Bureau reports on housing Permits, Starts and Completions. Seasonally adjusted permits increased:

Privately-owned housing units authorized by building permits in May were at a seasonally adjusted annual rate of 1,501,000. This is 3.0 percent above the revised April rate of 1,457,000, but is 21.7 percent below the revised May 2006 estimate of 1,918,000.

Starts declined:

Privately-owned housing starts in May were at a seasonally adjusted annual rate of 1,474,000. This is 2.1 percent below the revised April estimate of 1,506,000 and is 24.2 percent below the revised May 2006 rate of 1,944,000.

And Completions declined slightly:

Privately-owned housing completions in May were at a seasonally adjusted annual rate of 1,534,000. This is 0.5 percent below the revised April estimate of 1,542,000 and is 19.3 percent below the revised May 2006 rate of 1,901,000.

Click on graph for larger image.
The first graph shows Starts vs. Completions.

As expected, Completions have followed Starts "off the cliff". Completions are now at the level of starts. Starts will probably fall further, based on housing fundamentals of excess supply and falling demand, and completions will most likely again follow the next decline in starts.



This graph shows starts, completions and residential construction employment. (starts are shifted 6 months into the future). Completions and residential construction employment were highly correlated, and Completions used to lag Starts by about 6 months.

Both of these relationships have broken down somewhat (although completions have fallen to the level of starts). Why residential construction employment hasn't fallen further is a puzzle. Also the time between start and completion has increased recently.

This report shows builders are still starting too many projects, and that residential construction employment is still too high.

by Anonymous on 6/19/2007 09:12:00 AM

It's 6:00 am. Do you know where your webmaster is?

From Dow Jones Newswire, via Brian (no link):

The Web site that takes in mortgage payments for New Century Financial Corp. was down for five days last week because the company didn't have staff capable of running it, according to a hedge fund that agreed to buy the mortgage provider's loan-servicing business.

The hedge fund, Carrington Capital Management, is set to complete its $188 million purchase of the loan-servicing business on June 29. . . .

Carrington said the Web site was out of service from June 9 through June 13 because the bankrupt company "did not have the appropriate personnel."

Among the thousands who lost or left their jobs when New Century filed for Chapter 11 protection April 2 were the people who designed system security, the hedge fund says.

A collapse of the loan servicing platform, Carrington said, could cost it $300,000 to $500,000 each day it can't use the technology to track troubled borrowers and collect on their loans.

Of course, I'm sure it's just the "people who designed system security" who walked out on the place. No reason to worry about the accounting department . . . or the file room . . .

by Calculated Risk on 6/19/2007 12:02:00 AM

From the WSJ: Bear-Led Fund Gets Reprieve

Lenders granted a beleaguered Bear Stearns Cos. hedge fund an additional day to finalize a last-ditch rescue plan ...

During a meeting at Bear's Madison Avenue headquarters that lasted nearly three hours, creditors were presented with a bailout plan that included $1.5 billion in new loans from Bear, backed by the fund's assets. The plan also would bring an infusion of $500 million in new equity capital from a group of other banks, and will allow some lender's to reduce their exposure by 15%, said people briefed on the meeting.

The soap opera continues ... This fund started last August with $600 million in equity and $6 Billion in borrowed capital (talk about leverage).

According to the article the fund lost 23% from the beginning of the year through the end of April. Add: Perhaps the 23% is referring to losses on the equity, but then the fund must have suffered more losses since that time based on the size of the bailout. If the 23% refers to the entire fund, then 23% of $6.6 Billion is about $1.5 Billion - not only wiping out all the equity in the fund, but almost $1 Billion in debt too.

UPDATE: From the NY Times: Mortgages Give Wall St. New Worries. This article covers the Bear Stearns hedge fund, but also wonders about the impact on mortgage lending:

After the first cracks in the subprime mortgage business appeared late last year, several large lenders were forced into bankruptcy.

Now, the stress is sending tremors down Wall Street, as investment funds that bought a stake in those loans are starting to wobble.

Industry officials say they expect this second act to be longer and slower, unwinding over the next 12 to 18 months. The fallout could further constrict consumers with weak, or subprime, credit while helping to prolong the housing downturn.

On Wall Street, the impact could be far more significant: It could force banks, hedge funds and pension funds to acknowledge substantial losses, which had been tucked away in complex investment vehicles that are hard to evaluate. In turn, that could limit the money available for mortgage lending.

by Calculated Risk on 6/18/2007 07:50:00 PM

Click on graph for larger image.

NAHB Press Release: Builder Confidence Slips Again in June

Ongoing concerns about subprime-related problems in the mortgage market and newfound concerns about rising prime mortgage rates caused builder confidence to decline two more points in June, according to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI), released today. With a reading of 28, the HMI now is at the lowest level in its current cycle and has reached the lowest point since February 1991.

“Builders continue to report serious impacts of tighter lending standards on current home sales as well as cancellations, and they continue to trim prices and offer a variety of nonprice incentives to work down sizeable inventory positions,” said NAHB President Brian Catalde, a home builder from El Segundo, California.

“It’s clear that the crisis in the subprime sector has prompted tighter lending standards in much of the mortgage market, and interest rates on prime-quality home mortgages have moved up considerably during the past month along with long-term Treasury rates,” added NAHB Chief Economist David Seiders. “Home sales most likely will erode somewhat further in the months ahead and improvements in housing starts probably will not be recorded until early next year. As a result, we expect housing to exert a drag on economic growth during the balance of 2007.”

Derived from a monthly survey that NAHB has been conducting for more than 20 years, the NAHB/Wells Fargo HMI gauges builder perceptions of current single-family home sales and sales expectations for the next six months as either “good,” “fair” or “poor.” The survey also asks builders to rate traffic of prospective buyers as either “high to very high,” “average” or “low to very low.” Scores for each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view sales conditions as good than poor.

All three component indexes declined in June. The index gauging current single-family sales slipped two points to 29, the index gauging sales expectations for the next six months fell two points to 39, and the index gauging traffic of prospective buyers fell one point to 21.

Three out of four regions posted declines in the June HMI. The Midwest posted a three- point decline to 19, the South posted a one-point decline to 32 and the West posted a five- point decline to 27. The Northeast recorded a three-point gain to 35 following a six-point loss in May.

by Anonymous on 6/18/2007 04:34:00 PM

Hey! Calculated Risk got an honorable mention by the Associated Press, for which we apparently have Barry Ritholtz to thank (don't worry, Barry, I don't think this is your fault). Here we are:

Calculated Risk -- A philosophical blog on finance and economics. No stock tips or fancy charts -- just an anonymous business executive seeking the truth about the market. Some of it is worrisome, and blunt. Investment banks have been selling the riskiest slices of debt to pension funds, he says, which are entrusted with providing for the retirement of public workers. He calls these debt offerings, called unrated collateralized debt obligations "a pig of a pig, distilled essence of pig, ur-pig, Total Ultimate X-Treme Mega Pig" and says that buying them is "playing with matches."

"No fancy charts?" What does it take to get recognition for CR's excellent and legendary charts? Animated recession bars?

We will pass over in silence the true authorship of the cascade of pig jokes. Ahem.

We may now resume being philosophical.

by Anonymous on 6/18/2007 11:39:00 AM

Everybody's all fired up about this report this morning from Fannie Mae's Berson's Weekly Commentary. I'm not, frankly, sure why; the insight about prepayments (specifically, refinance options) and subprime loan performance is not exactly news. But it does include a nice chart, helpful for those who don't tend to think in terms of mortgage flows.




The pie on the left represents 2/28s closed in late 2003 to late 2004 (which gives them a first payment adjustment date in calendar year 2006). The pie on the right represents 2/28s closed in late 2004 to late 2005. The clear implication is that delinquency and default in the earlier vintage was mitigated by refinance (or home sale) opportunities that are sorely lacking in the later vintage.

One has to remember, though, that separating the vintages like this does not mean the two pie charts include two mutually-exclusive groups of borrowers. Because these are two sequential years and the loan type in question is a 2/28, it is likely that most of the refinances of the earlier vintage do not appear as new loans in the later vintage; they would appear in a "future" pie with a reset in 2008 (or later). The point, though, is that what you see in the left-hand pie, for instance, is a very big pile of refinances that were originated in 2006, a year notorious for wretched underwriting guidelines. The slowing of the prepayments in the right-hand pie suggests that that party's over, but it also clearly means that we still have a lot of loans that "rolled" to a new loan in 2006 and 2007 and that may or may not have an escape route in 2008 or 2009 when the next reset problem arises.

by Anonymous on 6/18/2007 10:32:00 AM

I don't often find myself making confident predictions these days--the market can stay irrational longer than I can--but I will do so on this subject: some hedge funds are about to discover what is Different about home mortgage lending, with unfortunate results for the hedgies.

Bloomberg, via John M. (thanks!):

June 18 (Bloomberg) -- James E. ``Jimmy'' Cayne helped make Bear Stearns Cos. the mortgage king of the securities industry by packaging home loans into bonds and selling them to clients like Michael Vranos. Now Vranos, who manages $29 billion at Ellington Management Group LLC, is cutting Cayne out of the middle and buying mortgages on his own.

On Wall Street, they call that disintermediation, and it's eating into almost $9 billion of fees that firms including New York-based Bear Stearns earn from securitizing mortgages. Instead of buying such bonds at markups of 1 percent or more, hedge funds expect to make better returns by taking over bad debts and pressing borrowers to pay up.

Well, guys, welcome to the most-regulated lending industry in history, with the biggest middle-class political constituency imaginable, and some major honkin' participants who happen to be giant financial institutions whose calls are taken by the Federal Reserve.

Hope you find enough "inefficiencies" to make it fun while it lasts.

by Anonymous on 6/18/2007 09:47:00 AM

The New York Times does us the major favor of helping to define the term "housing bust" as distinct from the less threatening "housing slump"(thanks, Walt!).

Two economists with the Federal Deposit Insurance Corporation, Cynthia Angell and Norman Williams, have studied housing cycles since 1978 and have come up with a definition of a housing bust. In a paper published in February 2005, they called it a decline of at least 15 percent in nominal prices, meaning not adjusted for inflation. While economists tend to focus on real prices over time, the authors argue that in housing, nominal prices are a better measure of distress because homeowners, rarely think in inflation-adjusted terms in assessing market conditions.

Other economists, however, argue that 15 percent may be too restrictive a definition. Mark Zandi, chief economist of Moody’s Economy.com, says a better one would be a decline of 10 percent or more from peak to trough. “When you see a decline in home prices of 10 percent, you get significant credit problems and it’s enough to wipe out equity in most cases,” he said.

Mr. Zandi also said that once prices have dropped 10 percent, there tends to be a self-reinforcing downward cycle. If borrowers can’t afford their mortgages and banks foreclose, their homes are generally sold at significant discounts to the market. That creates an added drag on overall prices, resulting in greater numbers of foreclosures, followed by even greater price slides.

Another reason Mr. Zandi argues for 10 percent is the tendency of housing-price measurements to underestimate declines. Sellers often provide discounts that may not show up in the measured price, but are still significant. Today, some homebuilders are discounting the sales price of new homes by an average of 5 percent, Mr. Zandi said.

My own undoubtedly naive view of the matter is that there ought to be a terminological difference between a decline of any appreciable magnitude in the presence of measurable stress to the local economy, on the one hand, and what from all appearances is a housing price decline that has caused itself. I propose a "housing funk."

by Anonymous on 6/18/2007 07:07:00 AM

Mamas, don't let your babies grow up to be marketers who send "test mailings" to reporters:

Just consider the direct-mail solicitation I recently received from GMAC Mortgage. The letter was addressed to me as a "Washington Mutual Customer"- I have a 30-year, fixed-rate mortgage with WaMu - and it began ominously: "You've probably read about it in the newspaper or seen it on the nightly television news. Many mortgage lenders all across the country are heading for financial trouble because they have made too many questionable loans. Some lenders may even go out of business. And what will become of the people who trusted those lenders if that happens?"

Then came the kicker: "Allow us to help you refinance your mortgage with the rate and term that best suits your needs."

GMAC's pitch is absurd on so many levels I barely know where to begin. First off, the letter implies if you have a conforming mortgage, as I do, that you could somehow lose your mortgage should your lender go bankrupt. That's simply untrue. Sure, there could be some servicing glitches should your loan be acquired by another bank, but that's more an annoyance than a genuine financial safety issue.

Even more troubling was the impression GMAC gave of the lender its letter appeared to be targeting, Washington Mutual. WaMu spokeswoman Libby Hutchinson calls the mailing "false and misleading," and she's absolutely right. GMAC - now majority-owned by private equity firm Cerberus Capital, with General Motors retaining a minority stake - touts itself as "a stable and established lender" in its mailing, but its below-investment-grade credit rating is actually several notches below that of WaMu.

To be sure, WaMu's home-loan business is struggling - subprime-related losses contributed to a 20 percent decline in bank profit during the last quarter. However, WaMu's overall exposure to the subprime market pales in comparison to GMAC's own. At the end of last year, subprime comprised 10 percent of WaMu's mortgage portfolio - about $20 billion total. GMAC, meanwhile, reported $48 billion in subprime loans, 76 percent of its total home-loan portfolio.

So what does GMAC have to say for itself? I called the company to ask about the letter, and GMAC spokesman Stephen Dupont sounded genuinely apologetic. The letter was part of "test mailing," Dupont said. "It's not something that we're going to be repeating."

Looks like GMAC needs a new statement-stuffer marketing strategy. Something tells me the Calulated Risk commenters are probably bubbling over with good ideas . . .

by Calculated Risk on 6/18/2007 01:23:00 AM

From the WSJ: Ills Deepen in Subprime-Bond Arena

A few weeks ago, the market for bonds backed by risky home loans looked like it was calming down. Now, problems are quickly mounting.
...
On Friday, credit-rating firm Moody's Investors Service slashed ratings on 131 bonds backed by pools of speculative subprime loans because of unusually high rates of defaults and delinquencies among the underlying mortgages. The ratings company also said it is reviewing 247 bonds for downgrades, including 111 whose ratings it had just lowered. All the bonds were issued as recently as last year.

The latest moves by Moody's affected around $3 billion worth of bonds, which represent less than 1% of the over $400 billion in subprime mortgage-backed bonds that were issued in 2006.
...
"The wave of downgrades will continue" among subprime bonds issued in 2006, says Jay Guo, director of asset-backed research at Credit Suisse ...

These downgrades are mostly for bonds backed by second-lien loans:

Just 1.5% of bonds from 2006 that are backed by first-lien subprime mortgages have been downgraded or are being reviewed by Moody's for downgrades.

by Calculated Risk on 6/17/2007 11:07:00 PM

From the WSJ: A 'Subprime' Fund Is on the Brink (hat tip to many - thanks!)

Concerned that an internal hedge fund at Bear Stearns Cos. wouldn't be able to meet a margin call, Merrill Lynch & Co., one of the fund's biggest lenders, seized $400 million of its assets and is preparing to auction them off.

This follows the sale of $4 Billion investment-grade bonds by the same hedge fund last week.

Bids for the securities are scheduled to be negotiated starting at noon on Monday.

This could be interesting.

by Calculated Risk on 6/17/2007 11:01:00 PM

From the LA Times: It's the New Normal Sellers try for the right price off the bat, while buyers take their time deciding. (hat tip Neal)

By a widely used measure of inventory, there has been an average 8.3-month supply of homes on the market in Los Angeles County over the last 19 years, according to the California Assn. of Realtors. That's how long it would take for the supply of homes to be exhausted at the prevailing sales pace. In April, that supply was 12.1 months in L.A. County and 22 months in Orange County.

12.1 months of inventory in L.A. County? 22 Months of inventory in Orange County? That is higher than I realized.

by Calculated Risk on 6/17/2007 01:41:00 PM

Rex Nutting at MarketWatch previews the coming week: Housing market hasn't bottomed yet

The depression in the home building sector is no longer news; even Federal Reserve officials seem resigned to months if not years of weak activity.
...
The data in the coming week "will be a sobering reminder that the housing market has yet to bottom out," said Brian Bethune and Nigel Gault, economists for Global Insight ...

There is no way the news will be "good" for housing. If starts decline - as expected - that means more weakness in the housing sector. And if starts unexpectedly increase that just means more supply and more weakness to come.

Few analysts see any bottom in home building.

It might be hard to remember, but the consensus view at the end of '06 was that housing would bottom in Q1 or Q2 of '07. Oops.

by Anonymous on 6/16/2007 12:54:00 PM

Because we cannot but pause to mourn the passing of Ronco . . .

by Anonymous on 6/16/2007 09:20:00 AM

The New York Times has a marginally interesting article out this morning on mortgage fraud, "Web Help for Getting a Mortgage the Criminal Way." It's in the technology section, not the business section, apparently because the focus is on websites that quite brazenly advertise fraudulent services--fake bank statements, fake pay stubs, credit report "piggybacking"--and that makes it a technological problem.

Want to buy a home, but hampered by bad credit, an empty bank account or no job? No problem!

That may sound like an exaggeration of a late-night infomercial. But it is, in effect, the pitch that a number of Web sites are making to consumers, saying insolvent home shoppers can be made to look more attractive to lenders.

You know, it does rather sound like an infomercial. And one of those four-color flyers I have to pluck from under my windshield wipers periodically. Sure, my own spam burden is overwhelmingly black-market prescription drugs, Nigerian princes, and religious visionaries, but I get the odd home equity loan solicitation. Not one has yet offered to rent me a bank account, but it's probably best to get ahead of the trend.

Industry experts say these sites, which are relatively new, played a role in fueling the rampant mortgage fraud that has caused a huge spike in loan defaults in recent months because people bought homes they could not afford. . . .

Regulators and the mortgage industry are now vowing to crack down on aggressive lending practices that have led to a rising number of foreclosures. But that greater scrutiny, including lenders requiring more documentation than they have in the past, may actually increase demand for some of the services that these Web sites offer.

We went for a long period of time not requiring any documentation of income and not requiring any downpayment. This created quite the problem. Apparently some people are willing to claim that websites providing false documentation of income and assets had something significant to do with that. Now that the regulators are going to make us go back to verifiying stuff, the websites that offer a service that wasn't that necessary under the "stated" regime will now have some demand. Okay.

“We think these types of Web sites are increasing,” said Frank McKenna, chief fraud strategist at BasePoint Analytics, which helps banks and mortgage lenders identify fraudulent transactions.

Policing them is difficult, partly because it is unclear which laws, if any, the Web sites might be breaking (for their customers, though, the laws are clear — anybody who uses fake paycheck stubs or other false documents to misrepresent financial status to a bank or mortgage lender is committing fraud).

The people who operate these sites can also be hard to track down. At the first whiff of trouble, they can easily shut down and then quickly start a new Web site with a different name.

No statistics exist on the number of these Web sites and how many people use them, or whether any of the operators of such sites have been prosecuted.

An examination of loans made last year, including prime and subprime, in which some sort of fraud occurred, showed that incidents of false tax or financial statements had risen to 27 percent from 17 percent in 2002; fraudulent verifications of deposit had climbed to 22 percent from 15 percent four years ago; and false credit reports rose to 9 percent from 5 percent in 2002, according to a report issued this spring by the Mortgage Asset Research Institute based in Virginia.

If any documents were required, it was unclear whether the bogus documents were created by do-it-yourselfers or whether they turned to the products and services sold over the Internet.

Still, Joan E. Ferenczy, director of institutional investigations at Freddie Mac, said there had been a growing discussion in recent months among industry investigators about Web sites offering false identifications and income statements.

“Either it has been underground all along, or there has been a spike of activity there,” she said.

A representative of a company that will sell you web-based software that will help you find web-based fraud will tell you that "we think" this problem is on the rise. We have no statistics on that, of course. We aren't sure if most of these fraudulent loans even required any documents. If they did, we don't know whether folks were buying fake paystubs on the net or just creating the sort of perfect tax returns any hobbyist can do with a copy of TurboTax and a few hours of free time. According to Freddie Mac, it's either been there all along or it hasn't. There's a foolproof rhetorical strategy.

One service that appears to have grown exponentially in recent months, investigators say, are sites that offer to improve an individual’s credit score by adding them onto the credit cards of individuals with good credit scores and histories.

The practice, known as piggybacking, started innocently enough with individuals adding their spouses or children to their credit card accounts as authorized users.

This credit-card piggybacking thing has, of course, been all over the news lately. I only wish to say that I don't actually know many people in the mortgage industry who thought that this authorized-user business "started out innocent." Nobody I know has ever objected to parents who wish to help their children establish a credit history by co-signing loans or acting as joint applicants on a credit card. In those cases, the child is the primary user of the credit account, receives the bills, and is responsible for paying them; only if the primary account-holder fails to pay does the creditor go after the co-signer or joint applicant. There is, therefore, some presumption that if the account is paid as agreed, the child was managing to get that accomplished. This "authorized user" thing has never been anything other than worthless for establishing a child's credit standing; the authorized user can make purchases with a card, but does not get the bill and is not responsible for paying it. Authorized user accounts should never have been included in FICOs to start with; that's a Fair, Isaacs problem. And middle-class parents who want their children to inherit a credit history instead of establish one should be told to flake off. But is anyone examining the "original" corruption of the system of middle-class entitlement here? Nope. Evil websites make for better copy.

We get another example:

One Web site that prompted mortgage regulators in Nevada to issue an alert to consumers and the mortgage industry two years ago offered to set up a bank account that could be “rented out” and verified to creditors or lenders at a cost of about 5 percent of the value of the assets. The people renting the assets did not actually have access to them.

While that site has disappeared, fraud experts say others have moved in to replace it.

“We’re seeing now a lot of checking accounts where funds are going in and out,” said Mr. McKenna of BasePoint. “Borrowers begin the month with $4 in the account and end the month with much, much more.”

No, for real? Are we seeing a lot of fake checking accounts with highly suspicious deposits, or just a bunch of real checking accounts with highly suspicious deposits? Are we all aware that there have been checking accounts with highly suspicious deposits since the invention of the checking account? That the reason why, in them bad old days, we used to require three consecutive most recent months' worth of bank statements from borrowers was to catch stuff like that? Or that while it might require a nefarious website for someone to scrape up the money to appear, temporarily, in those accounts, it has a tendency to be pretty damned obvious when you see the statement with the $4 starting balance and the $50,000 ending balance? That the cost of this particular fraud does become prohibitive when lenders merely ask to see three statements instead of one? That a moderately-awake underwriter trainee can usually compare bank statement deposits to, say, pay stubs, and catch most fake bank statements pretty quickly? That a moderately-awake closing agent can merely require that the check brought to closing be issued from the account verified on the application to put a stop to a great deal of this? That you can do things like this without buying fancy web-based fraud-detection software?

For $55, for example, the company that operates VerifyEmployment .net will ostensibly hire a person as an independent contractor, providing a paycheck stub showing an “advance,” with the corporate name and address. Another $25 will assure telephone verification of employment when a lender calls to check.

Last year, a Florida-based company that operated a Web site called NoveltyPaycheckStubs.com agreed to stop using the name of the payroll company ADP after it was sued in federal court by ADP for trademark infringement.

“It is plain that defendants are peddling counterfeit ADP earnings statements for others to use to engage in fraudulent financial transactions,” ADP claimed in its lawsuit.

NoveltyPaycheckStubs.com has since disappeared, but people looking for fake IDs or payroll stubs can still find them at FakePaycheckStubs.com.

I know, I know. You're going to tell me that it is insane for a lender to use a paystub to verify the employment of an independent contractor. Why yes, it is. For some decades we have been requiring those folks to come up with tax returns. And in a somewhat more recent (approximately five-year-old) technological development, we've been able to make them sign that neat little IRS Form 4506-T that can return the transcript of the actual tax return filed within 24 hours. And a simple request for a bank statement that shows the amount of that paystub deposited somewhere will usually stop this one in its tracks. That is, the ones you don't catch by the simple expedient of making that phone verification of employment only with a phone number you can independently find in the phone book, not just off the paystub. But we stopped doing sensible things like that. And therefore fly-by-night websites are to blame.

Of course technology advances. It is much easier to forge a W-2 with a high-quality color printer and a decent piece of desktop publishing software than it used to be with a 9-pin dot matrix and Lotus 123. That the mortgage industry should have decided to utterly relax its customary and time-tested methods of verification, documentation, and elementary vigilance right at the time that the internet made it easier for buyers of forgery to meet up with sellers of it does, you know, seem a bit odd.

To blame the perfectly predictable and in fact predicted blowup in recent mortgage vintages on some small-time internet crooks, even tentatively, does, you know, seem a bit convenient. I hasten to add, ritually, that of course fraud is fraud and that it's no less illegal just because lenders appeared to be up on their hind legs begging for it. The Nigerian scam is illegal, and should be. But how much sympathy do most of us have for people who fall for it? Well, some, perhaps, if those who fall for it are innocent, gullible, not highly-sophisticated souls who just got their first Yahoo! email account.

You know something's being pulled over on you when the mortgage industry is willing, implicitly, to allow itself to look like a bunch of innocent, gullible, not highly-sophisticated souls who just got their first Yahoo! email account. This reminds me of those famous CEOs who earn their obscene millions of dollars a year in compensation by apparently having no idea how their business works or what goes on in it on an average day. Or at least that's what they've asked a few courts of law to believe.

So, yes, I am violating my "No Enron Comparisons" rule here, but I think I have a good reason for it. It is appropriate to ask how the $10 trillion mortgage industry can be so unsophisticated as to be completely helpless in the face of some pissant internet crook with a fake ADP logo jpg. Either we're the grownups in this situation or we aren't. There will always be a small amount of really good, really sophisticated fraud that will be hard to detect. Any industry who wishes to get you to believe that it is the hapless victim of this kind of crudity on a major scale is willing to look pretty stupid. You would want to ask why.

by Calculated Risk on 6/15/2007 05:47:00 PM

From Bloomberg: Perceived Subprime-Mortgage Risk Surges After New Bond Sale

The perceived risk of owning low-rated subprime-mortgage bonds surged on speculation that a block of about $700 million of bonds from so-called collateralized debt obligations was put up for sale.
...
An index of credit-default swaps linked to 20 subprime-mortgage bonds with the lowest investment-grade rating and created in the second half of 2006 fell about 1.5 percent to a record low of 60.95 today, according to administrator Markit Group Ltd. The ABX-HE-BBB- 07-1 index is down 11 percent this month, suggesting that concern about defaults is increasing.
...
Another ABX index linked to 20 similar securities from the first half of 2006 plunged 1.5 percent today and is down 7.6 percent this month.

No link yet, but the above article was from this afternon (hat tip Brian). This may seem like a broken record - from 3 days ago: Subprime-Loan Risk Reaches Record

The perceived risk of owning low- rated subprime-mortgage bonds created in the second half of 2006 rose to a record as loan delinquencies and mortgage rates climb, according to an index of credit derivatives.

An index of credit-default swaps linked to 20 bonds rated BBB- fell 2.9 percent to 62.12, according to Markit Group Ltd. The ABX-HE-BBB- 07-1 index's previous low of 62.25 came on Feb. 27.

I guess some records are made to be broken.