by Anonymous on 6/28/2007 10:17:00 AM

Naked Capitalism has another great post up on the Sturm und Drang in the CDO market. It doesn't exactly answer the question that has been nagging at me, namely, to what extent this "CDO valuation" crisis is truly a "direct" consequence of subprime mortgage-backed securities melting down, or whether the latter is just one of a cluster of debt-binge problems that is being amplified by Wall Street's crazy leverage schemes, one that is "easy" for the mainstream press to see and politically palatable for everyone to "blame." Save for the potentially compensatory stories of predatory lending and steering of prime or near-prime borrowers to subprime, which erupt from time to time but never become the main story, the narratives in play today are that subprime borrowers are fraudsters and deadbeats, as are subprime lenders, and this makes the two fine candidates for scapegoating.

What makes me think there might be some scapegoating going on? I'm not claiming that there are no troubles in Subprime City, of course. I am simply having a hard time reconciling the claim that there is a simple and uncomplicated relationship between these hedge funds' CDO asset valuation meltdowns, on the one hand, and deterioration in subprime mortgage performance on the other, when at the very same time this claim is made, we are informed that CDO portfolios are opaque, no one knows what's in them, and what we do know suggests that subprime ABS tranches cannot possibly be the largest share of their holdings:

And there are a few other barriers: you can't get the deal documents. No kidding. The Fed can't even get them because it isn't a "qualified investor." (Should the Fed start a hedge fund so it can study this problem?). From "Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions," by Joshua Rosner and Joseph Mason (pages 83-4):

At present, even financial regulators are hampered by the opacity of over-the-counter CDO and MBS markets, where only “qualified investors” may peruse the deal documents and performance reports. Currently none of the bank regulatory agencies (OCC, Federal Reserve, or FDIC) are deemed “qualified investors.” Even after that designation, however, those regulators must receive permission from each issuer to view their deal performance data and prospectus in order to monitor the sector.

So if regulators can't get the description of the securities, market participants certainly won't. So what good is a price if you aren't really certain what is being traded?

In addition, the discussion in the FT article presupposes the CDOs are passive CDOs, meaning the assets are assembled and the CDO is structured before it is sold to investors. Yet many CDOs are "active" or "managed" CDOs, meaning blind pools. Blind pools that are tranched, often with leverage and often buying other CDOs or "CDO squared" (CDOs of CDOs). That means the investors pony up money before the fund (it is like a convoluted mutual fund) is formed, and the managed gets to trade it over its three to five year life. No CDO manager is going to disclose his holdings (it would put him at a competitive disadvantage) but how can you value it otherwise?

So how do we know these things are chock-full-o'-subprime paper? Well, Yves gives us this, from the Financial Times:

What makes the CDO sector unusual is that it has exploded at such a breakneck pace with bankers packaging bonds, loans and other debts into ever more complex structures. Last year alone, about $1,000bn (£500bn, €745bn) in cash and derivatives CDOs was issued in Europe and the US, according to data from the Bank for International Settlements. More than one-third was composed of asset-backed securities, often including low-grade mortgages.

Let us first note that the term "asset-backed security" or ABS denotes a quite diverse set of instruments; "ABS" is not a synonym for "MBS." ABS issues can be and are backed by commercial loans, student loans, credit cards, auto loans, insurance premiums, aircraft leases, and probably a few dozen other asset types. When an ABS is backed by mortgages, it can, in fact, be backed by "high-grade" mortgages. (Remember the tranche versus pool problem: you can have a low-rated security tranche that is backed by a pool of very high-rated mortgages; the rating on the tranche is due to its subordination in payment priority within the security, not the quality of the collateral, since it's backed by the same collateral as the high-rated tranches.) So BIS tells us that "often" there are low-grade mortgage securities in the one-third of CDO collateral that is ABS. If you wish to claim without reservation that subprime mortgages are driving this dog cart, you're braver than I am. We just got told that not even the regulators get to see the prospectuses.

Of course the fearless reporters of the New York Times and its friends are getting on- or off-the record quotes from industry insiders claiming or implying that the CDOs and hedge funds under pressure right now are the ones heavily invested in subprime. I am only observing that not every industry quote-bot knows what it is talking about and it is quite possible that some participants have an interest in exaggerating the "subprime" part.

The curious part of it all, for me, is this question of "liquidity." Or, more properly, "illiquidity":

As this explosion has occurred, some corners of this universe have already become relatively widely traded and transparent. Every day in the London and New York markets, for example, billions of dollars worth of deals are struck involving indices of derivatives on well-known corporate bonds – making it easy to obtain prices.

However, many other such products are created by bankers directly with their clients and then simply left to sit on the books of an investor. Since such instruments typically last three to five years – and the CDO boom is so recent – many have not come to the end of their life. Nor have they been traded. Christopher Whalen of Institutional Risk Analytics, a consultancy, says: “The lack of a publicly quoted market for CDOs and like assets is exacerbating the liquidity problems for these assets beyond the underlying economics, for example, in subprime real estate.”

As Yves notes, it sounds as if Mr. Whalen is suggesting that the illiquidity of CDOs is exacerbating the illiquidity of CDOs (maybe that's the "squared" part?). But you can see why some mere mortgage punk like me gets puzzled here: was there any asset created in the last five years or so that was more liquid than mortgages? Anyone remember that part about how the investment community was beating our doors down and in fact buying up us mortgage originators as a package in unquenchable thirst for product? How liquid can you get? It wasn't quite as bad as the day-trading thing--you probably didn't get subprime whole loan bid color from cab drivers--but I'm having a hard time remembering the secretive part of the whole thing.

I can't be the only one who suspects that "illiquidity" is in some quarters the new term for "I don't like the bid." Remember all the uproar in March and April about the deterioriation of the whole-loan market for Alt-A and subprime? I can say from personal experience that nobody likes being offered par when your profitability requires you to get bids of 102.50, but that doesn't make the market "illiquid." It does suggest to me that someone has some explaining to do, not about subprime mortgages, but about these CDOs. How did we get "illiquid" securities backed by "liquid" assets? That's some impressive financial magic.

Ponder this, as well:

Some bankers and policymakers argue that this is simply a teething problem that will fade as structured finance becomes more mature. History suggests that most opaque, illiquid markets eventually become more transparent when they grow large enough – and behind the scenes, the Bear Stearns hedge fund problems are prompting bankers and investment managers to re-examine their valuation techniques. . . .

I am not a historian of financial markets, so perhaps it is true that the Whigs always win in this regard. But I would be inclined to think that perhaps it is true that in some cases "opaque, illiquid markets" become large enough to implode spectacularly before they ever get around to becoming "transparent." In fact, I wonder if in certain cases "opacity" is a feature, not a bug.

I do know enough of the history of the mortgage market to be willing to claim that it was, once upon a time, an opaque and illiquid market that did indeed become both very large and highly transparent for quite a while there. You can get an amazing amount of information about one of those nice low-yield boring vanilla GSE MBS, you know, not to mention a price right off the old Bloomberg terminal. Now, you might want to say that in the last few years somehow that famous liquidity and transparency of the residential mortgage market has largely evaporated on us, right at the time that tons of unregulated private money started pouring into it and yields of 12-18% became just not good enough. You might observe that right about the time, historically speaking, when we'd managed to accumulate giant performance databases about mortgage loans, we started offering "low doc, no doc and snow doc" deals with drive-by "appraisals" and automated underwriting and tiny due diligence sampling and every other mechanism we could think of to assure that there was, in fact, no data to be "transparent" about.

So now that we've "innovated" our way into a situation in which nobody has the first bloody idea what's going on with a huge portion of recently-originated mortgage loans, we've noticed that we've innovated our way into a situation in which nobody has the first bloody idea what's going on with the securities they're in or the CDOs that buy the tranches of the securities or the hedge funds that buy the tranches of the CDOs of the securities of the mortgages that were written on a hope and a prayer and a FICO. And this is a "teething" problem? Holy Mastication, Batman, you think this thing will improve if it grows some fangs?

Perhaps certain market participants need to be reminded why we call some of this stuff "nuclear waste." Generating a jillion-gigawatts of power is always a blast. Figuring out what to do with all the leftover plutonium-239 is a drag. How that only just got to be a problem of an "immature market" is beyond me.

And while we're on the subject of revisionist history, note this little gem courtesy of naked capitalism:

See that little footnote? Alt-A is "slightly less risky than subprime"?

Except for Calculated Risk and a few other cantankerous contrarian cranks, do you remember anyone in the last five years describing Alt-A as "slightly less risky than subprime"? My, my. How the worm turns.

by Calculated Risk on 6/28/2007 09:16:00 AM

"Our second quarter results reflect the current oversupply of new and resale housing inventory, a difficult situation compounded by aggressive competition and continued weak demand. Housing affordability challenges and tighter credit conditions in the subprime and near-prime mortgage market have also exacerbated current market dynamics, keeping prospective buyers out of the market, slowing the absorption of excess supply and further delaying a housing market recovery. Pricing pressure intensified in many of our markets during the second quarter, compressing margins and requiring inventory impairment charges in certain of our communities."
Jeffrey Mezger, president and CEO, KB Home, June 28, 2007 emphasis added.

And for the quarter:

Housing revenues of $1.30 billion were down 41% from the prior year's second quarter, the result of a 36% year-over-year decline in unit deliveries to 4,776 and an 8% year-over-year decrease in the average selling price to $271,600....

The Company reported a loss from continuing operations of $174.2 million or $2.26 per diluted share in the second quarter of 2007 ...

by Calculated Risk on 6/27/2007 07:53:00 PM

Tomorrow the "final" GDP report will be released for Q1. Of course the Bureau of Economic Analysis (BEA) keeps on revising the estimate for some time, so "final" is just a name for the report.

In the near future, I'd expect the BEA to look into the suggestion by Business Week that offshoring has led to an overstatement of GDP in recent years. Most analysts think that Business Week is correct, but the overstatement is probably less than 0.2% per year.

Click on graph for larger image.

The BEA releases three GDP reports per quarter: Advance, Preliminary and Final. This chart shows the release numbers for each release, and also the current estimate for each quarter for the last few years.

Although it seems that the estimates change substantially, they are actually pretty similar from a macro perspective.

For tomorrow, I've seen estimates for the "final" Q1 report ranging from 0.4% to 1.5%. The consensus is 0.8%, mostly because of changes to net imports.

by Calculated Risk on 6/27/2007 04:41:00 PM

From the Financial Times: Debt deals pulled as banks feel subprime chill

Companies are pulling financing deals across the globe, in one of the clearest signs yet that investors’ worries about rising interest rates and US subprime mortgages could be infecting other areas of the credit world and driving up the cost of corporate borrowing.
...
MISC, the world’s biggest owner of liquefied gas tankers on Wednesday shelved its $750m bond offering. The move came a day after US Foodservice, the American division of Ahold, the Dutch supermarket group postponed its $650m bond offering and Arcelor Finance put plans for its euro-denominated benchmark bond issue on hold, citing turbulent market conditions.

The bonds and loan deals were pulled after investors refused to buy them under the proposed terms, demanding higher premiums and more protection.

Stephen Green, chairman of HSBC, on Wednesday fuelled investor concern when he forecast that some large corporate deal was going to “end in tears” because of over-leverage. He warned the losses could be high because the parcelling out of risk to some many parties would make it more difficult to organise a financial reconstruction.

In an interview with the Financial Times, Mr Green admitted that he was “worried by the degree of leverage in some big ticket transactions nowadays” and felt that “something is going to end in tears”.

UPDATE: Another interesting quote from MarketWatch: Hedge fund CEO: 'day of reckoning to come' in credit market

Eric Mindich, the chief executive of Eton Park Capital Management ... said the "day of reckoning" may be here, in reference to recent problems in the securitized debt markets. "There's dry timber out there," Mindich said at the Wall Street Journal Deals and Deal Makers Conference on Wednesday. "There are people's lives that are going to be changed by what happens."

by Calculated Risk on 6/27/2007 12:28:00 PM

Blackstone is now trading below the IPO price of $31.00 per share (last quote was $29.99).

When a deal is sold, the underwriters (the lead underwriters for Blackstone were Morgan Stanley and Citigroup) actually sell more shares than the amount raised by the company. Blackstone sold 133.3 million shares raising $4.13 Billion, and for this deal, the overallotment was 20 million shares, meaning the underwriters raised an additional $620 million - and they put the money in what is called the "Green Shoe".

For most IPOs, the underwriter exercises the overallotment option after some waiting period, and the entire amount in the Green Shoe goes to the company. But if the stock falls below the initial price, the underwriters start buying back stock using the cash in the Green Shoe. This usually sets a floor for the price of the stock, at around the IPO price - just for the overallotment period.

Since the current stock price is below the IPO price, the Green Shoe is probably being spent right now to support the stock price. We will know how much was spent in a couple of months when (if) the overallotment option is exercised.

IMO, the Blackstone IPO probably marks the peak of the PE LBO wave. And if the stock price stays below the IPO price, the company will jokingly be called Blackpebble (or something far worse).

by Calculated Risk on 6/27/2007 11:22:00 AM

Following the postponement of the U.S. Foodservice debt offering, the WSJ put together a table titled: Ten Horses of the Buyout Apocalypse?

The course of the great leveraged-buyout and corporate-acquisition boom of the early 21st century will be determined in large part by 10 companies. ... The companies have agreed to be bought and will soon be asking credit investors to finance the deals. It’s part of a $200-billion plus tidal wave of financing needs that will crash ashore in the next six months.

The ten companies listed are:
TXU $25.9 Billion
First Data $24B
Alltel $23.2B
Clear Channel $22.1B
Chrylser $20B
Sallie Mae $16.5B
Cablevision $9.2B
Harrah’s Entertainment $9B
Biomet $7B
Alliance Data $6.6B

A nice list of deals to watch.

by Anonymous on 6/27/2007 09:00:00 AM

Yeah, another mortgage post.

Via the intrepid Housingdoom.com, we see that the forthright, reputable, upstanding and not funny firm eAppraiseIT, LLC is suing a website, mortgagefraudwatchlist.org.

Mortgagefraudblog.com posts a copy of the complaint:

Defendant's false and malicious statements, when considered alone and without innuendo, have (a) negatively impacted Plaintiff's trustworthiness and character, (b) caused Plaintiff to be subjected to distrust, ridicule, contempt and disgrace, and (c) injured Plaintiff's reputation and goodwill in the appraisal management industry.

Of course, it should be noted that Calculated Risk is drawing your attention to this story, alone and without innuendo, merely for the purpose of informing the investment community, which has big boatloads of money at stake in mortgage and housing-related investments, and which often relies on muck-raking blogs for crucial information ignored or garbled by the mainstream media and paid-for analysts, which information has saved them a lot of money over the last few years, that the possibility exists that bloggers may have to form legal defense funds if certain complaints which have nothing to do with the complaint referenced above are filed and are not dismissed on the grounds of distrust, ridicule, contempt and disgrace.

I'm willing to bet that there's not a lot of deep pockets to be picked in blogland. Most blogs are volunteer efforts and the legal costs of nuisance suits would shut them down, pronto. If the eAppraiseIT suit has merit--if the statements made about eAppraiseIT were truly false and defamatory, and I wouldn't know that--then by all means it should proceed, and the blogger in question should make it right. If, on the other hand, those parties who have enabled a disastrous frenzy of fraud and misrepresentation in the mortgage and housing market over the last few years are going to respond to their deserved ridicule with legal harassment, I for one am going to call on the moneyed bagholder community to step up to the plate behind the shoestring blogs. You know who you are and why you read us and what you have to lose.

by Calculated Risk on 6/26/2007 11:50:00 PM

From the WSJ: Bonds Becoming a Tougher Sale

Investors issued a resounding 'No' to a leveraged-buyout debt offering yesterday, leaving banks holding the bag for more than $3 billion and raising concerns about the changing economics of the takeover boom.
...
Underwriters pulled a $1.55 billion bond offering by U.S. Foodservice, the nation's second-largest food distributor. The company also postponed plans to sell $2 billion in loans to fund the deal, according to people familiar with the matter. For now, the banks involved in underwriting the deal will have to lend the $3.6 billion directly to U.S. Foodservice, which is being bought from Royal Ahold NV of the Netherlands.
...
The pushback comes at a challenging moment. Investors are looking ahead at $250 billion of new debt coming to market in the coming months. Just this week, Chrysler Group, which is being sold by DaimlerChrysler AG, began marketing a debt fund raising that will total more than $60 billion.

From the NY Times: Delay in Buyout Bond Sale

This week, two other buyouts, the $4.7 billion deal for ServiceMaster and the $6.9 billion sale of Dollar General, are expected to price their bonds.

It will be interesting to see what happens to these other bond sales. The WSJ noted that ServiceMaster reduced it's "payment in kind" feature, so maybe that sale will be OK.

by Calculated Risk on 6/26/2007 06:52:00 PM

From Bloomberg: Alt A Loans `Disconcerting,' Jumbos Weaker, S&P Says (hat tip risk capital)

U.S. homeowners with good credit are increasingly falling behind on mortgage payments, a sign lenders have been offering ``higher risk'' loans outside the so-called subprime market, Standard & Poor's Corp. said today.

Rising late payments and defaults on so-called Alt A mortgages made last year are ``disconcerting'' and delinquent borrowers appear to be ``finding it increasingly difficult to refinance'' or catch up on their payments, S&P analysts said today in a statement. ``Serious'' delinquencies, foreclosures and seized property among ``prime jumbo'' mortgages in bonds from 2006 reached the highest among loans of less than 13 months since at least before 2000, S&P said in a separate report.
...
S&P, one of the two largest ratings firms, is now ``examining how the risk profile clearly increased'' in the Alt A market, it said in a statement sent by e-mail today. ``We will communicate our findings to the market,'' S&P said, in language it typically uses ahead of adjusting its rating methodology.

Is this the end of the word "contained"?

by Calculated Risk on 6/26/2007 05:00:00 PM

From Bloomberg: Planned CDO Sales Dry Up Amid Bailout, JPMorgan Says (hat tip Brian)

Planned sales of collateralized debt obligations backed mainly by subprime mortgages are drying up and may shut down amid concerns about the integrity of the market following the near collapse of hedge funds run by Bear Stearns Cos., JPMorgan Chase & Co. said.

The amount of U.S. high-grade, structured finance CDOs that are being offered to investors has plunged to $3 billion, from $20 billion a month ago ...

"We expect events surrounding warehousing liquidations last week to further slow, if not halt entirely, the new issue market," JPMorgan analysts led by Chris Flanagan in New York said in the report.
...
The damage to the $1 trillion CDO market could freeze what has been a large source of liquidity for the credit markets, Tim Backshall, chief strategist at Credit Derivatives Research LLC, said yesterday.

No wonder Dr. Altig asks: What's That Unpleasant Sound?

According to Lombard Street Research, it's a credit crunch. From the U.K. Telegraph:

The United States faces a severe credit crunch as mounting losses on risky forms of debt catch up with the banks and force them to curb lending and call in existing loans, according to a report by Lombard Street Research.

Altig is rightly skeptical of the report, but I do think the sector specific credit crunch is definitely getting more severe, and might expand to other sectors (like M&A loans and CRE investments).

by Calculated Risk on 6/26/2007 03:32:00 PM

For more graphs, please see my earlier post: May New Home Sales

Click on graph for larger image.

The first graph shows New Home Sales vs. Recession for the last 35 years. New Home sales were falling prior to every recession, with the exception of the business investment led recession of 2001. This should raise concerns about a possible consumer led recession in the months ahead.


For Fun: Here is the same graph after the December 2006 sales were reported just a few months ago. The housing bust was "over". Not! The bounce back was revised away.

Once again, this reminds us to take the "just reported" data with a grain of salt. As reported this morning, much of the surprise "bounce back" in April has already been revised away.


The third graph compares annual New Home Sales vs. Not Seasonally Adjusted (NSA) New Home Sales through April.

Typically, for an average year, about 44% of all new home sales happen before the end of May. At the current pace, new home sales for 2007 will probably be under 900 thousand - about the same level as the late '90s. This is significantly below the forecasts of even many bearish forecasters.

As a final note, this puts total reported inventory at a record 4.967 million units (4.431 existing homes and 0.536 new homes).

by Anonymous on 6/26/2007 02:08:00 PM

Instead of writing intellectually-serious posts that provide cogent analyses of financial and economic issues of profound import, I've been playing on the internet. And I found this, the Internet Anagram Server.

So I had to test it by typing in "Bear Stearns."

Bareness Rat. Bean Arrests. Barren Asset. Banes Raters. Absent Rears. Barest Snare. Bases Errant. Barn Teasers. Bars Nearest. Stabs Earner. Baa Nests Err. Bare Ass Rent. Betas An Errs. (I left out all the ones with "breast" and "bra" because this is a family blog.)

Enjoy yourself, from Data Click Rules (a/k/a A Crack Duellist).

by Anonymous on 6/26/2007 12:00:00 PM

I want some of of what the man is smoking:

Well prudence and rating agency standards change with the times, I suppose. What was chaste and AAA years ago may no longer be the case today. Our prim remembrance of Gidget going to Hawaii and hanging out with the beach boys seems to have been replaced in this case with an image of Heidi Fleiss setting up a floating brothel in Beverly Hills. AAA? You were wooed Mr. Moody’s and Mr. Poor’s by the makeup, those six-inch hooker heels, and a “tramp stamp.” Many of these good looking girls are not high-class assets worth 100 cents on the dollar. And sorry Ben, but derivatives are a two-edged sword. Yes, they diversify risk and direct it away from the banking system into the eventual hands of unknown buyers, but they multiply leverage like the Andromeda strain. When interest rates go up, the Petri dish turns from a benign experiment in financial engineering to a destructive virus because the cost of that leverage ultimately reduces the price of assets. Houses anyone?

If I followed all that, somebody just got called a ho.

But look at it this way: using the current default rate of 7% (3-4% total losses), the holders of some BBB investment grade subprime-based CDOs will lose all of their moolah because of the significant leverage. No need to worry about fictitious 100 cents on the dollar marks here. One hundred percent of nothing equals nothing. If subprime total losses hit 10% then even some single-A tranches face the grim reaper. AAA’s? Folks the point is that there are hundreds of billions of dollars of this toxic waste and whether or not they’re in CDOs or Bear Stearns hedge funds matters only to the extent of the timing of the unwind. To death and taxes you can add this to your list of inevitabilities: the subprime crisis is not an isolated event and it won’t be contained by a few days of headlines in The New York Times.

Wow. Maybe Mr. Gross should take a yoga class. He sounds a little stressed out.

by Calculated Risk on 6/26/2007 10:10:00 AM

According to the Census Bureau report, New Home Sales in May were at a seasonally adjusted annual rate of 915 thousand. Sales for April were revised down significantly to 930 thousand, from 981 thousand. Numbers for February and March were also revised down.


Click on Graph for larger image.
Sales of new one-family houses in May 2007 were at a seasonally adjusted annual rate of 915,000 ... This is 1.6 percent below the revised April rate of 930,000 and is 15.8 percent below the May 2006 estimate of 1,087,000.


The Not Seasonally Adjusted monthly rate was 85,000 New Homes sold. There were 102,000 New Homes sold in May 2006.

May '07 sales were the lowest May since 2001 (80,000).


The median and average sales prices were up. Caution should be used when analyzing monthly price changes since prices are heavily revised.

The median sales price of new houses sold in May 2007 was $236,100; the average sales price was $313,000.


The seasonally adjusted estimate of new houses for sale at the end of May was 536,000.

The 536,000 units of inventory is slightly below the levels of the last year. Inventory for the previous months were revised up slightly. For April, the inventory was initially reported at 532,000 (so May would show an increase), but was revised up to 542,000 (so May shows a slight decrease).

Inventory numbers from the Census Bureau do not include cancellations - and cancellations are at record levels. Actual New Home inventories are much higher - some estimate about 20% higher.


This represents a supply of 7.1 months at the current sales rate.

The large downward revision for April removed some of the strength from April's report. It appears we are back to were sales are being revised down every month - probably indicating another downturn in the market - and I expect the trend to continue. More later today on New Home Sales.

by Anonymous on 6/26/2007 07:55:00 AM

Gretchen Morgenson on the Everquest IPO. Being the vicious nasty blogger with no redeeming social qualities that I am, I must take the opportunity to point out that I have no idea how accurate this reporting on the Everquest deal is, but sentences like this do not raise my confidence level:

The funds that sold the securities to Everquest invested in big pools of loans backed by home mortgages, known as collateralized debt obligations.

"Pools of loans backed by home mortgages"? I'm drinking some good coffee this morning--for which I have our generous tippers to thank--but I don't think there's enough coffee in the continental U.S. to make that sentence mean anything. I believe the linguists call it "word salad."

That doesn't mean that the rest of the reporting is equally confused, of course, but then again it makes me tread cautiously. UberNerds 4 Warned.

*Dear Chief Justice Roberts: the title of this post is not an "incitement to imminent lawless action." It is a "joke." And you people can't throw my sorry little butt out of high school because I've already got my diploma and I don't need you anymore.

by Calculated Risk on 6/25/2007 07:46:00 PM

From the WSJ: Existing Home Sales, Prices Decline

"If builders can be disciplined and cut back on production, then overall inventory would begin to diminish,"
Lawrence Yun, senior economist for the Realtors association.

New home inventory is actually a small portion of the overall inventory. See this post from Saturday: Housing: Total Inventory

Click on graph for larger image.

This graph shows the year end inventory levels, since 1982, for new and existing homes. (2007 numbers are for April, I'll update when the New Home numbers are released tomorrow).

Yes, the builders need to cut back on production, but even if the builders stopped building, it would take some time to work through the significant excess supply currently on the housing market.

Alternatively a significant price decline might spur demand; I wonder why the NAR economist doesn't suggest that solution?

by Calculated Risk on 6/25/2007 04:53:00 PM

From BusinessWeek: Bear's Big Loss Arouses SEC Interest

Bear Stearns (BSC) may have a lot of explaining to do about a big restatement of losses at one of its troubled hedge funds—and not just to its investors. BusinessWeek has learned that the Securities & Exchange Commission recently opened a preliminary inquiry into the near-collapse of Bear Stearns' High-Grade Structured Credit Strategies Enhanced Leveraged Fund. People familiar with the inquiry say regulators are interested in learning how the Wall Street investment firm came to dramatically restate the April losses for the 10-month-old fund ...
...
Privately, Bear Stearns is spreading the word that the April restatement was prompted by actions by some of their lender banks. People familiar with the matter say the Wall Street firm claims the banks began demanding that the hedge fund put up more collateral for the loans it had taken.

The banks, on their own accord, began marking down the value of the subprime bonds that the hedge fund had invested in, which had the effect of precipitating the current crisis, according to the people familiar with Bear Stearns' account of the events.

Your daily dose of BS. (uh, Bear Stearns).

UPDATE: BofA Analyst on impact on housing of Bear Stearns Hedge Fund debacle, via Mathew Padilla: Will Bear Stearns' woes lead to higher mortgage rates, lower home prices?

• While these discrepancies may not be revealed in the short term, we believe the object lesson in liquidity would at the very least give CDO investors a reason to require better yields and more likely would result in more restrictive margining requirements by those firms accepting CDOs as collateral. A cascading deleveraging from CDO^2s through CDOs to the non-investment grade tranches of private label securitizations would ultimately produce higher rates to new mortgage borrowers.

• Short-term, private label securitizers (of subprime and Alt-A) should experience weaker gain on sale margins and/or reduced securitization leverage (increased non-investment grade retention). Longer term, it should result in higher coupon rates, reducing mortgage borrowing demand, which the disproportionate impact on subprime and Alt-A would further pressure housing prices by taking out of the market the marginal buyers. Weaker house prices and higher rates would not only increase the pace of foreclosures but more importantly increase loss severities on the foreclosures. The higher losses would in turn create more pressure for higher rates (relative to reference rates) potentially triggering another round of tightening. ...

by Calculated Risk on 6/25/2007 12:43:00 PM

For more existing home sales graphs, please see the previous post: May Existing Home Sales

NAR reported that existing home inventories are at record levels today. To put these numbers into perspective, here are the year-end inventory and months of supply numbers, since 1982 (Note: The only data I have is year-end starting in 1982).

Click on graph for larger image.

The current inventory of 4.431 million units is an all time record. 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.

The "months of supply" is calculated by dividing the total inventory by the seasonally adjusted annual rate (SAAR) of sales, and multiplying by 12. Currently inventory is 4.431 million, SAAR sales are 5.99 million giving 8.9 months of supply.

Both the numerator and the denominator are moving in the wrong direction. Not only is inventory at record levels, but sales - though falling - are still significantly above the normal range as a percent of owner occupied units (a measure of turnover). See the second graph.

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 May sales rate and inventory are used. For owner occupied units, Q1 2007 data from the Census Bureau housing survey was used for May 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 5.9%! Imagine if sales fell back to the median level for the last 35 years; the months of supply would be ONE YEAR.

And writing about sales, the followings shows the actual cumulative existing home sales (through May) vs. three annual forecasts for 2007 (NAR's Lereah, Fannie Mae's Berson, and me).

My forecast was for sales to be between 5.6 and 5.8 million units (shown as 5.7 million).

NSA sales are 91% of 2006 at this point. If sales maintain that percent of 2006, then total sales will be 5.94 million - about at Fannie Mae's forecast.

To reach the NAR forecast (revised downward on April 11 to 6.34 million units), sales will have to be above 2006 levels for the remainder of the year. Given tighter lending standards, we can probably already say the recent NAR forecast is "no longer operative"!

UPDATE: We do requests (occasionally) at CR. The following graph was requested by BrooklynInDaHouse.

This graph shows the ACTUAL annual sales, year end inventory and months of supply, since 1982 (sales since 1969). For 2007, the May inventory and Seasonally Adjusted Annual Rate (SAAR) for sales were used.

Unfortunately I don't have inventory data prior to 1982. Note that in graph 2 above, sales and inventory are normalized by the number of Owner Occupied Units.

by Calculated Risk on 6/25/2007 10:12:00 AM

The National Association of Realtors (NAR) reports Home Sales Show Market is Under Performing

Total existing-home sales – including single-family, townhomes, condominiums and co-ops – eased by 0.3 percent to a seasonally adjusted annual rate1 of 5.99 million units in May from an upwardly revised pace of 6.01 million in April, and are 10.3 percent below the 6.68 million-unit level in May 2006.
...
The national median existing-home price2 for all housing types was $223,700 in May, which is 2.1 percent below May 2006 when the median was $228,500.

Click on graph for larger image.

The first graph shows the NSA sales per month for the last 3 years.

The pattern of YoY declines in sales is continuing. For New home sales, March is usually the strongest sales month of the year. For existing homes, the Summer months are more critical.


The second graph shows the months of supply. With the months of supply now over 8 months, we should expect falling prices nationwide. The NAR reports that YoY prices fell again in May.





The third graph shows nationwide inventory for existing homes. According to NAR, inventory increased to a record 4.431 million units in May.

Total housing inventory rose 5.0 percent at the end of May to 4.43 million existing homes available for sale, which represents an 8.9-month supply at the current sales pace, up from an 8.4-month supply in April.

For some reason the NAR forgot to mention this is the all time record for inventory (not months of supply though). More on existing home sales later today.

by Calculated Risk on 6/24/2007 12:23:00 PM

To celebrate Tanta's six month anniversary as my co-blogger, from now through next Saturday (June 30th), instead of splitting the tips, all the tips will go to Tanta.

This is your chance to tip Tanta without the greedy CR taking half!

I'm sure everyone appreciates that Tanta is an incredible writer with extensive knowledge of the mortgage industry. She is a former bank officer and mortgage lending specialist, on extended medical leave while undergoing treatment for cancer.

Let me be clear: This isn't a cry for sympathy. This isn't charity. And Tanta isn't destitute. Only tip her if you appreciate her work.

These are tips for her virtuoso writing performances - think of it like tipping Billy Joel at the piano - except Tanta is smarter and better looking.

Just tap the Tip Jar on the right, and it will take you to a PayPal payment screen.

I'm doing this without her knowledge or permission.

P.S. A warm thank you to the many generous readers for your previous tips.