by Calculated Risk on 10/11/2007 03:19:00 PM

The Census Bureau reported today for August 2007:

"a goods and services deficit of $57.6 billion, $1.4 billion less than
the $59.0 billion in July"

Click on graph for larger image.

The red line is the trade deficit excluding petroleum products. (Blue is the total deficit, and black is the petroleum deficit).

Looking at the trade balance, excluding petroleum products, it appears the deficit peaked at about the same time as the housing market / mortgage equity withdrawal in the U.S. This is an interesting correlation (but not does imply causation). I had more on MEW vs. the trade deficit a few months ago.

The ex-petroleum deficit is falling fairly rapidly, almost entirely because of weak imports (export growth is still strong). But unlike the previous decline in the trade deficit (during the '01 recession), petroleum imports are still strong.

Normally oil prices would now be falling as the U.S. economy weakens - instead we are seeing margins shrinks for U.S. refiners and record high oil prices. This would seem to imply that global demand for oil is strong, while domestic consumption is weak. This evidence supports the "decoupling" argument: that the U.S. economy could slow, but economic growth in the rest of the World would stay strong (added: I'm not buying into the decoupling argument - I think it is unlikely).

As I've mentioned before, I need to spend some time looking at oil.

by Calculated Risk on 10/11/2007 11:42:00 AM

Based on sales tax revenue, it now appears that the California economy is in recession.

Click on graph for larger image.

The graph shows the September retail sales tax collections (and fiscal year through Sept) since 1998. The large decline in 2001 was related to the '01 recession, the tech bust, and 9/11.

Here are the numbers:

California Retail Sales and Use Taxes
Sept 2007: $2,038,416,000
Sept 2006: $2,201,717,000

September sales tax revenue was off 7% compared with last year.

Source: California Statement of General Fund Cash Receipts and Disbursements (hat tip John)

by Anonymous on 10/11/2007 10:18:00 AM

This is a follow up to CR's post last night on the WSJ article using HMDA data to make some observations about "subprime" loans.

Trust the Wall Street Journal to fail to understand the point of reporting regulation. They are not the only media outfit to have made a major logical error using HMDA data, but they make a nice poster child for the problem. The WSJ's basic point of departure:

The analysis of loan data by The Wall Street Journal indicates that from 2004 to 2006, when home prices peaked in many parts of the country, more than 2,500 banks, thrifts, credit unions and mortgage companies made a combined $1.5 trillion in high-interest-rate loans. Most subprime loans, which are extended to borrowers with sketchy credit or stretched finances, fall into this basket.

Of course, if you simply assume that borrowers get a high interest rate for a good reason--they are subprime credits--then the fact of "high interest rates" needs no explaining, and the fact that such loans may be concentrated in low-income or minority borrower groups can be explained as something other than discrimination (if you simply assume that low-income or minority borrowers are more likely to have subprime credit profiles than other borrowers).

I guess we're going to have to take a walk down memory lane here. There was a time --around 1975 to be precise--when Congress was a bit concerned about anecdotal evidence that banks and thrifts were engaging in "redlining," or refusal to lend money at all in certain (mostly minority or low-income) neighborhoods. (The idea is that a lender drew a red line on a map around areas in the "wrong side of town," and loans would not be made for properties in the red areas.) In a rare recognition by Congress that anecdotal evidence is unsatisfactory, the Home Mortgage Disclosure Act (HMDA) was born. Its original incarnation required lenders to report data on the geographical location (down to census tract level) of loans originated. This data could be analyzed to see if apparent redlined areas appeared.

In 1989, HMDA got an overhaul which required lenders to report on denied applications, as well as originated loans. Further, the borrower's race, sex, and income level had to be reported on all loans. This change grew out of more anecdotal evidence--some of which was being probed in courts of law--that minority and female applicants were being turned down at disproportionate rates. Congress also gave the Federal Reserve the authority to augment HMDA reporting requirements.

In 2002, the Fed used that authority to require price data on loans originated. You see, there was anecdotal evidence that some classes of borrowers were getting higher rates on loans in ways that couldn't be explained by the loan or borrower characteristics.

This whole dynamic may be hard for the WSJ and its fellows in the Big Paid Media, so let me explain this very clearly. In 1975, some folks accused lenders of redlining, which means not granting credit at all to some people. The lenders said they weren't doing that. Congress passed HMDA, and then there was actual data about geographic lending patterns to analyze instead of anecdotes. Once we got some HMDA data under our belts, the Community Reinvestment Act came into being (in 1977) precisely because it was clear that redlining had been going on. CRA in essence forces lenders to show that they are willing to make loans in neighborhoods in which they are willing to take deposits (i.e., those deposits need to be "reinvested" in the neighborhood they came from in the form of loans, not just mortgage loans, to that neighborhood. You can't extract deposits from poor people and use them exclusively to fund loans to rich people.) CRA does not mandate price levels, or even address the question of price levels.

You may be surprised to hear this, but over time accusations of discriminatory lending practices did not go away. In a number of cases, "mystery shopper" tests were performed, in which a white applicant and a black applicant each applied for credit at the same instutition with identical credentials (employment, income, credit history, loan terms), and the results showed that black applicants were more likely to be turned down. This cast some doubt on the lenders' claims that loan rates in minority neighborhoods were a function of the lower credit quality of those borrowers. That became a hypothesis in need of some testing, you see, not an accepted explanation.

So the 1989 revision to HMDA forced collection of demographic data, for the precise purpose of testing the assumption that poor and minority people are just always bad credit risks. This resulted, as you might expect, in conjunction with CRA and other fair lending laws, in much higher rates of home mortgage lending in those areas that were once redlined.

But were these poor and minority people happy, at last? Why no, they weren't. Turns out, anecdotal evidence began to emerge that while these good people were finally getting loans, they were getting them at much higher interest rates than higher-income folks and whites generally got, and that this could not be accounted for by the difference in creditworthiness of the borrowers or the quality of the collateral (the latter proxied by census tract).

So the 2002 change to HMDA, to collect data on mortgage loan pricing, was an attempt to collect empirical data on pricing patterns to test claims about what might explain higher loan pricing, not to accept them without further probing. The whole point of the HMDA dataset is to ask if wide disparities in loan pricing exist, in the same geographical area at the same time. If they do, the data can be analyzed controlling for income level, race, and sex, to see if any of those things correlate with loan pricing. If they do--and they certainly do--there is still the question of why this happens.

The lending industry will tell you without fail that this correlation exists because low-income and minority borrowers have lousy credit histories. But the HMDA data does not support (or disprove) that claim. The HMDA data shows that these borrowers get higher rates on average, but since the HMDA dataset does not include FICO or any other reliable measure of credit history, it cannot be used to conclude that these higher rates are explained by the subprime credit of the borrowers.

And you cannot use subprime mortgage lending patterns to prove or disprove this claim, either. You are trying to test whether "subprime mortgages" are being given only to truly "subprime borrowers." Your test results will look funny if you assume your conclusion.

So. There is no measure of borrower creditworthiness, specifically, in the HMDA data. The "high priced lending" data is an attempt to quantify the number of loans made at a threshold which is usually going to be unexplainable except in terms of either the risk factors of the loan or discrimination. (That is, the threshold is set to "weed out" spikes in market rates during which everybody gets high rates. If risk factors cannot explain the difference, the presumption must be discrimination).

It also uses APR, not note rate, as its measure. APR is calculated by taking into account fees and points over the stated term of the loan, and so using an APR measure lets you pick up loans that appear to have a low note rate, but that still involved unusually high charges to the borrower. APR on an ARM is calculated by assuming that the original index value is unchanged over the life of the loan, and then by using an interest rate in the APR calculation that takes into account scheduled rate increases up to the "fully indexed" value (that is, it's kind of a "blended rate" of the initial discounted rate and subsequent rates on the loan). So you can't evade high-cost loan reporting by putting people into teaser-rate ARMs, or by offsetting low note rates with outrageous fees, because the APR measure cannot be fooled like that.

The trouble, of course, is that an absolute level of APRs isn't very helpful: we all know that what counted as a "high rate" in 2003 is not the same as what counts as a high rate today, because market rates change. We also know that second liens get higher rates than first liens, and that the term of the loan affects rate. So the threshold was set based on the price of comparable-maturity Treasury securities at the approximate time the loan application was made, with a spread of 3.00% for first liens and 5.00% for second liens. If the APR on the loan exceeds these thresholds, it is reported as "high rate."

However, since the 2002 change to HMDA did not force lenders to collect other data that could account for pricing differences, such as LTV, doc type, FICO, or DTI, you have a set of pricing data but you're back to square one in terms of using it to decide whether this pricing is fair or predatory or discriminatory. (And yes, the Fed initially proposed collecting more loan level data, and yes, the industry lobbied long and hard over the "reporting burden" this would create.)

You also find that the data itself can be weirdly skewed when a lot of loans are ARMs and the yield curve is flat or inverted. Without the other data on borrower credit quality and loan terms, it's very hard to sort out the noise.

So we have data from HMDA showing that high-priced lending is not necessarily limited to low-income and minority neighborhoods. The WSJ takes this to mean that subprime lending is not necessarily limited to low-income and minority neighborhoods.

Subprime mortgages were initially aimed at lower-income consumers with spotty credit. But the data contradict the conventional wisdom that subprime borrowers are overwhelmingly low-income residents of inner cities. Although the concentration of high-rate loans is higher in poorer communities, the numbers show that high-rate lending also rose sharply in middle-class and wealthier communities.

First of all, I take major exception to the claim that "subprime mortgages were initially aimed at lower-income consumers with spotty credit." Near-prime programs like FHA were until quite recently the backbone of lending to lower-income consumers with "spotty" credit. Subprime mortgages were aimed at people with terrible credit, and if you think that problem is limited to those with low income, you'll have to explain to me how these low income folks racked up enough credit to have major problems with it in the first place. If people won't lend to you, you don't have a credit report full of late payments and charge-offs. I bring up the whole history o' HMDA to point out that the concern has always been as much about whether credit was granted at all to some folks as it has been about the terms on which that credit is granted. I will also note that FHA loans, because of HUD and Ginnie Mae rules, can rarely end up in the "high rate" category in HMDA. You can write FHA loans all day and not worry that your HMDA report will make you look like a predator. Yes, FHA loans have higher rates than conforming conventional loans, to account for their riskier nature, but they're comfortably within that "spread" used in the HMDA definitions, because they are near-prime or "spotty" credit, not terrible credit.

Further, the WSJ "contradicts" the "conventional wisdom" that subprime is mostly a matter of urban poor folk by showing that some suburban middle-and-upper income folk get high rate loans, too. However, because they accept without question that "subrime falls into the basket" of high-rate loans, they manage to assume that increasing numbers of high-rate loans to the suburban middle class means that these loans are "subprime." As CR notes, the whole phenomenon of "Alt-A" seems to have escaped them.

The possibility also seems to have escaped them that maybe subprime is, at the end of the day, just "high rate lending." If that's the only constant we can find in that category called "subprime"--if income, credit history, property location and price in that bucket is apparently rather random--then you begin to suspect that "subprime" is "loans to naive or desperate borrowers," not this ballyhooed "risk based priced" stuff of recent legend.

If you don't find that idea perfectly convincing, then you will indeed have to collect and analyze the data on LTV, FICO, doc type, etc. to establish that the category "subprime" means risk-based price, not just high-price.

The bottom line is, as CR notes, that "high-risk" lending was everywhere in the boom years. Of course there is a desire to collapse it all into the easy category of "subprime." And there has for a long time been a lot of political pressure to keep the association of "subprime" and "urban minorities" in place, because it has functioned as a good excuse for the subprime lenders (they "help" the poor and minorities, remember?). My view is that a whole lot of parties are very interested in maintaining rather than seriously analyzing a lot of faulty assumptions about risk, rates, and borrower credit characteristics. If this ain't "just a subprime problem," then an entire debt-based economy in which even the middle and upper middle class cannot afford homes given RE inflation and wage stagnation is suddenly in question. The last thing certain vested interests want to hear is that, basically, "we are all subprime now."

by Calculated Risk on 10/11/2007 09:22:00 AM

From AP: Retailers Report Slow September Sales

Lingering summer weather and an uncertain economy kept consumers out of malls and stores in September, leaving many of the nation's big retailers with disappointing sales for the month and forcing several to cut their earnings forecasts.

As the store owners reported sales figures Thursday morning, the biggest losers were apparel sellers including Limited Brands Inc. and Mothers Work Inc. Target Corp., J.C. Penney Co., Limited Brands Inc. and Nordstrom Inc. were among those lowering their earnings outlooks.

Wal-Mart Stores Inc. posted a modest sales gain that was slightly below analysts' expectations, but raised its third-quarter profit outlook because of cost-cutting.

"Sales are coming in soft, as expected," said Ken Perkins, president of RetailMetrics LLC, a research company in Swampscott, Mass. "It was a perfect storm, a combination of abnormally warm weather, high food and energy prices, a continued sluggish housing marketing and tight credit."

The sharp slowdown in September consumer spending was not a surprise.

by Calculated Risk on 10/11/2007 09:19:00 AM

From USAToday: Foreclosures drop, but they're nearly double 2006

Home foreclosure filings fell 8% in September from a 32-month peak in August, but they were still nearly double year-ago levels, real estate information company said Thursday.

A total of 223,538 foreclosure filings were reported in September, down from August's 243,947 but up from 112,210 in the same month a year ago, according to RealtyTrac of Irvine, Calif.

Despite the monthly decline, the September figure represents the second-highest total for filings in a month since the company began tracking filings two years ago.

by Calculated Risk on 10/10/2007 11:30:00 PM

TXU closed today. From Bloomberg: TXU Closes $32 Billion Sale to Group Led by KKR, TPG

TXU Corp. completed its $32 billion sale to a group led by Kohlberg Kravis Roberts & Co. and TPG Inc. in a record buyout ...

Including assumed debt, the transaction was valued at about $45 billion, the most ever in a leveraged buyout of a U.S. company.

According to TheStreet.com, the TXU Debt Sale is Set for Monday

Citi and JPMorgan are expected to sell some $5 billion of loans to help finance the private equity group's $32 billion acquisition.

It will be interesting to see how much debt is sold on Monday, and on what terms. And also how large any pier loans will be at Citi and JPMorgan.

by Calculated Risk on 10/10/2007 09:57:00 PM

From the WSJ: The United States of Subprime (hat tip jim)

... an analysis of more than 130 million home loans made over the past decade reveals that risky mortgages were made in nearly every corner of the nation, from small towns in the middle of nowhere to inner cities to affluent suburbs.

The analysis of loan data by The Wall Street Journal indicates that from 2004 to 2006, when home prices peaked in many parts of the country, more than 2,500 banks, thrifts, credit unions and mortgage companies made a combined $1.5 trillion in high-interest-rate loans.

... the data contradict the conventional wisdom that subprime borrowers are overwhelmingly low-income residents of inner cities. Although the concentration of high-rate loans is higher in poorer communities, the numbers show that high-rate lending also rose sharply in middle-class and wealthier communities.

The Journal's findings reveal that the subprime aftermath is hurting a far broader array of Americans than many realize, cutting across differences in income, race and geography. ...

The data also show that some of the worst excesses of the subprime binge continued well into 2006, suggesting that the pain could last through next year and beyond, especially if housing prices remain sluggish. Some borrowers may not run into trouble for years.

I'm a little confused by this analysis. The WSJ used the federal Home Mortgage Disclosure Act data to scan for "high interest loans". My understanding is that not all "high interest" loans are "subprime", some are Alt-A. And I'm not sure if this analysis included IO ARMs and Neg Am ARMs; two loan types frequently used by homebuyers in more affluent areas. Hopefully Tanta will help me understand.

But the analysis does make it clear that the bubble was widespread, and that the bust will also be widespread.

by Calculated Risk on 10/10/2007 04:37:00 PM

Ramsey Su reported on an auction in San Diego (see REO Auction in San Diego).

Here is a report on an auction in Virginia from the Washington Times: Foreclosed homes flood auction (hat tip X)

Auctioneer Hudson & Marshall sold nearly 240 foreclosed homes in the Washington area last weekend, making a small dent in a large backlog of homes abandoned by buyers who couldn't keep up with escalating payments.
...
Many sold for 20 percent below market value. About 75 of the properties offered at auction failed to sell.

Here are a couple of recent amateur videos on auctions:

Northern Virginia Auction

San Diego Foreclosure Sale Oct 3, 2007

And check out the Vandalized REO too. WARNING: Foul language on walls.

by Calculated Risk on 10/10/2007 02:40:00 PM

From Fortune Magazine: Trucking giant sees blue Christmas (hat tip Andrew)

Here are some excerpt from an interview with YRC Worldwide CEO Bill Zollars. (emphasis added)

Fortune: How is the holiday season shaping up?

Zollars: We've got a window now of about ten weeks or so where we should really see a big increase in shipment volumes as we get ready for Christmas. We have not seen that, and that's a concern. Last year's inventory buildup for Christmas was lower than historical standards, and the season ended up okay - not terrible. This year you have some easy comparisons, so you would expect to see more of a preholiday inventory buildup, but we have not seen that. Maybe it's coming later. Maybe it's not coming.
...
Fortune: Getting back to the economy, could things get worse before they get better?

Zollars: We have not felt the bottom yet. I'm still a bit nervous. Right now, if things continue to deteriorate, I'm worried we may head into a recession. [I feel that] there is a one-in-three chance of a recession. We are prepared for the worst and hoping for the best.

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

The comedians at the National Association of Realtors (NAR) revised down their forecast today for existing home sales in 2007 again. Their current forecast is for sales to be 5.78 million in 2007, down for 5.92 million last month.

Compare this to their original forecast from Dec '06 of 6.4 million units in 2007. (My forecast was for existing home sales to be between 5.6 and 5.8 million units).

The NAR forecast is still too high, even after eight straight months of negative revisions. Luckily for the NAR, they still have two more downward revisions to go.

From the NAR: Improvement in Mortgage Market Bodes Well for Housing in 2008

Existing-home sales are expected to total 5.78 million in 2007 and then rise to 6.12 million next year, in contrast with 6.48 million in 2006. New-home sales are forecast at 804,000 this year and 752,000 in 2008, down from 1.05 million in 2006; a recovery for new homes will be delayed until next spring.
...
Existing-home prices will probably slip 1.3 percent to a median of $219,000 in 2007 before rising 1.3 percent next year to $221,800. The median new-home price should drop 2.1 percent to $241,400 this year, and then increase 1.0 percent in 2008 to $243,900.

Very funny. Thanks for the laughs!

by Anonymous on 10/10/2007 10:00:00 AM

Of course I expect Father Market to grant absolution . . .

NEWPORT BEACH, Calif., Oct 10, 2007 /PRNewswire-FirstCall via COMTEX/ -- Downey Financial Corp. (DSL:Downey Financial Corp. announced today that it will report third quarter 2007 financial results on October 17, 2007, and, subject to finalization of results, that it expects to incur an operating loss for the quarter of approximately $23 million or $0.84 per share on a fully diluted basis. This will reduce net income for the first nine months of 2007 to approximately $52 million or $1.87 per share on a fully diluted basis.

The third quarter results are adversely affected by the continued weakening in the housing market. More specifically, the quarter will include the following pre-tax amounts:

-- An approximate $82 million provision for credit losses, which will increase the allowance for loan losses to approximately $144 million or 1.22% of loans held for investment.
-- An approximate $9 million valuation reduction to real estate held for development to reflect declines in the value of single family home lots in which the company is a joint venture partner.

Daniel D. Rosenthal, President and Chief Executive Officer, commented, "We are clearly disappointed with our third quarter results. The continued weakening and uncertainty relative to the housing market, coupled with the third-quarter disruption in the secondary mortgage markets, unfavorably impacted our borrowers and the value of their loan collateral. This has been particularly true in certain geographic areas such as the greater Sacramento and Stockton areas of Northern California and San Diego County. As a result, single family loan delinquencies, as well as losses from foreclosures, rose significantly during the third quarter and led to this quarter's large increase to the allowance for losses."

Mr. Rosenthal further stated that, "In response to recent trends and events, we have further tightened our lending guidelines, activated a loan modification group to work with borrowers on a proactive basis, and provided the necessary resources to dispose of homes acquired through foreclosure on a timely basis. Finally, despite this quarter's unfavorable results, Downey remains well positioned to continue funding quality loans because of our strong capital position and stable source of funds from our retail branch franchise."

by Anonymous on 10/10/2007 09:40:00 AM

More unattractive little snips from my unattractive spreadsheet collection (earlier posts here and here). What can I say? UberNerds don't need no steenkin' fancy formatting.

Item one gives you some sense of the size of the residential first lien securitization market since 1988.

I have been avoiding the terms "agency" and "nonagency" on this blog, but I'm breaking down and using them here. These are an established and pretty old-fashioned way of describing things inside the biz, but they are traps for the unwary. In this particular context, "agency" means Ginnie Mae (which securitizes FHA, VA, and a few other government-insured loans), Fannie Mae, and Freddie Mac, even though only Ginnie Mae is actually an agency of the government (Fannie and Freddie are GSEs, Government-Sponsored Enterprises, not actual agencies). But we used to call them all agencies, and the term survived reality by about a generation and a half, so there. "Nonagency" just means any private issuer.

The column "Issues / Originations" is simply that: one annual number divided by another annual number. That is a very, very approximate way to describe the rate of securitization of originated loans. You would get a number much closer to reality if you used quarterly numbers with a one quarter lag, but I don't have quarterly origination numbers handy. So do throw this number around with a high degree of caution.

What we learn from this spreadsheet is something like the approximate size of the segment of mortgage outstandings that have been in the news lately. The nonagency category (in these charts) includes Jumbo A, Alt-A, and Subprime, primarily first liens. (It includes some MBS that have a small percentage of second liens in them, but excludes MBS that are exclusively second liens. I complain regularly about the "lumpy" or Bridge Mix nature of recent nonagency MBS issues, and this is one reason why.) Basically, all the reporting you are seeing that is based on securitized nonagency loans is discussing around a third of securitized loans outstanding, or 19% of all loans outstanding (as of Q4 2006). Because there is so little data available on unsecuritized loans, it is extremely difficult to answer the question of the extent to which "nonagency" unsecurtized (these are mostly but not exclusively bank and thrift portfolio loans) will perform like their securitized brethren. Most of us believe that the securitized loans were written to much riskier standards than the unsecuritized loans, although as I noted yesterday in reference to the C of the C's last exasperated speech, I do believe that portfolio lending standards have loosened significantly in the last several years. You may in any case draw your own conclusions.

Item two is all the information I have on the break-out of the nonagency category. I got nuthin' on outstandings prior to 2000, but you can guess from what's here that they were rather modest in relation to total mortgage outstandings in those years.

I do not have a refi mix breakout by product for Jumbo A and Alt-A, so I didn't include it. But you can get a sense for how much of new origination is refinance (turnover in the outstandings rather than net additions to it) by comparing issues to the change in outstandings in a given year.

You can also get an idea for why people like me have been snorting derisively for years over this claim that "Alt-A" has a stellar performance history. It barely has a "history" at all. Furthermore, the definition of "Alt-A" in 1995 bears little resemblance to the definition of "Alt-A" in 2006. Remember that "Alt-A" means "alternative" to "A," and so whatever it is, its composition will change as the definition of "A" or "prime," to which it is an "alternative," changes. Back in the mid-90s, SIVA (stated income/verified asset) or--gasp!--CLTVs of 95% were the big "alternatives" and "interest only" was the sort of thing you ran into in commercial lending. Not only do you have, nowadays, IO SIVA with 100% CLTV in "A" (conforming or Jumbo), you have stuff in Alt-A that was simply unimaginable in 1995. So as "A" gets more "alty" over time, "alt" gets waaay more "alty" over time. What people are trying to get at by asking how "Alt-A" can "revert to normal" is, as far as I'm concerned, not very clear. I have no idea what other people think "normal" Alt-A is.

by Calculated Risk on 10/09/2007 10:10:00 PM

My friend Ramsey Su sent me an update tonight:

This is the 3rd San Diego REO auction of its kind in 5 months, 4th, if you count the DHI auction by the same auctioneer. Fortunately, of the 83 properties, only 7 were not previously listed in the MLS so this is an easy batch of properties to research.

I noted yesterday that unlisted REOs are one of the reasons the reported inventory level is currently too low. In this case, over 90% of the REOs were listed.

REOs are now an integral part of the real estate market. Appraisals have come down to earth and REO brokers are selling properties in record volume, though not matching the pace of acquisitions.
...
Similar to the homebuilders, as the REOs force the price down, it "impairs" the neighborhood and homeowners in default are even more likely to be foreclosed upon now.
...
"Previously Valued To"
REDC abandoned previous practice of using the last sold price as their "Previously Valued To" price. I use available tax record and recreated that value. It appears the last average list price of these properties is 81.4% of the last sold price.

Lenders are now aggressively cutting prices on REOs. The average LIST price is almost 20% off the previous selling price! Ouch. Ramsey also notes that many of these homes were previously purchased with 100% LTV, so the homeowners were substantially underwater and workouts were near impossible.

If someone is thinking the lenders are working down the REO inventory in San Diego, Ramsey Su offers the following graph:

Click on graph for larger image.

This graph shows:
NODs: Notice of Default,
NOTs: Notice of Trustee’s sale,
and
REOs: Real Estate Owned by the Lender.

After a NOD is filed, the lender must wait 3 months before filing a NOT. Then the foreclosure sale happens 3 weeks later. Ramsey has shifted the graph to account for these lags.

The graph of NODs shows where NOTs and REOs will go over the next 3 months.

Ramsey adds this comment:

719 REOs in San Diego during the last 4 weeks, comparing to just 1,239 sales reported so far by the MLS for September, are we going to see over 50% REO prevalence next quarter?

It's about to get ugly.

by Calculated Risk on 10/09/2007 09:37:00 PM

From the WSJ: Strip-Mall Vacancies Hit 7.4%

U.S. strip-mall vacancies only inched up in the third quarter, but still hit a 5½-year high ... Rentals of retail space in weak housing markets are getting hit disproportionately hard, as consumers rein in their purchases.

The retail sector has been a pillar of the commercial real-estate industry -- and the overall economy -- for the last seven years ...

The strip-mall vacancy rate rose to 7.4% in the third quarter, from 7.3% in the second quarter and 7% in the year-earlier period. Along with the first quarter of 2002, when the vacancy rate was also 7.4%, that level was the highest in 11 years, according to a survey of 76 U.S. retail markets by Reis.
...
Shopping-mall vacancies have shown no impact from the housing problems yet. Because of malls' long lease terms, economic problems typically take 18 months to 24 months to show up in vacancies and rents.

The CRE slowdown is here.

UPDATE (from an earlier post): As a reminder, in a typical business cycle, investment in non-residential structures follows investment in residential structures with a lag of about 5 quarters.

Click on graph for larger image.

This graph shows the YoY change in Residential Investment (shifted 5 quarters into the future) and investment in Non-residential Structures. In a typical cycle, non-residential investment follows residential investment, with a lag of about 5 quarters. Residential investment has fallen significantly for five straight quarters. So, if this cycle follows the typical pattern, non-residential investment will start declining later this year.

by Calculated Risk on 10/09/2007 04:07:00 PM

From San Francisco Fed President Janet L. Yellen: Recent Financial Developments and the U.S. Economic Outlook. Here are some excerpts. Housing was turning down before the credit turmoil:

... forward-looking indicators of conditions in housing markets were pointing lower even before the financial market turmoil began. Housing permits and sales were trending down. Inventories of unsold new homes remained at very high levels, and they will need to be worked off before construction can begin to rebound. Finally, most measures of house prices at the national level fell moderately. Notably, despite these declines, the ratio of house prices to rents—a kind of price-dividend ratio for housing—remains quite high by historical standards, suggesting that further price declines may be needed to bring housing markets into balance. This perspective is reinforced by futures markets for house prices, which expect further declines in a number of metropolitan areas this year. The downturn in house prices would likely be intensified by a simultaneous decline in employment, should that occur, since significant job loss would weaken demand for housing and raise foreclosures.

And on the impact of the housing bust on consumer spending:

Beyond the housing sector’s direct impact on GDP growth, a significant issue is its impact on personal consumption expenditures, which have been the main engine of growth in recent years. Indeed, data on consumption spending in the last few months have continued to show strength. The nature and extent of the linkages between housing and consumer spending, however, are a topic of debate among economists. Some believe that these linkages run mainly through total wealth, of which housing wealth is a part. Others argue that house prices affect consumer spending by changing the value of mortgage equity. Less equity, for example, reduces the quantity of funds available for credit-constrained consumers to borrow through home equity loans or to withdraw through refinancing. The key point is that, according to both theories, a drop in house prices is likely to restrain consumer spending to some extent, and this view is backed up by empirical research on the U.S. economy.

Indeed, in the new environment of higher rates and tighter terms on mortgages, we may see other negative impacts on consumer spending. The reduced availability of high loan-to-value ratio and piggyback loans may drive some would-be homeowners to pull back on consumption in order to save for a sizable down payment. In addition, credit-constrained consumers with adjustable-rate mortgages seem likely to curtail spending, as interest rates reset at higher levels and they find themselves with less disposable income.

Repricing of risk will be "contractionary":

Many of the liquidity problems afflicting banks and other financial market participants are gradually being resolved, but it’s not clear that all markets will return to “business as usual,” as defined by conditions in the first half of this year, even after that occurs. For one thing, many of the structured credit products that became so widely used may prove to be too complex to be viable going forward, and this would more or less permanently reduce the quantity of credit available to some risky borrowers. Moreover, as I mentioned, if financial intermediation that was routinely conducted via asset securitization and off-balance sheet financing vehicles ultimately migrates back onto the books of the banks, borrowing spreads and lending terms are likely to remain tighter given current limitations on bank capital and the higher costs of conducting intermediation through the banking sector. Most importantly, the recent widening of spreads appears to reflect a return to more realistic pricing of risk throughout the economy. This development may be positive for the long run, but it will be contractionary in the short run.

by Calculated Risk on 10/09/2007 01:49:00 PM

From William Poole, President, Federal Reserve Bank of St. Louis: Real Estate in the U.S. Economy. On housing (emphasis added):

"... recent events suggest that housing will remain weak for several more quarters; stabilization may not begin until well into 2008. Probably the most important statistics in this regard are the number of unsold new homes still on the market relative to their current sales rate and the recent trends in house prices. Figure 7 shows that the inventory-to-sales ratio of unsold new and existing single-family homes has risen sharply since early 2005. The current level of inventories relative to sales is about double the average levels from 1999 to 2005.

Some potential homebuyers are no doubt delaying purchase because they expect house prices to fall. As seen in Figure 8, prices have decelerated sharply nationwide. According to the price index published by the Office of Federal Housing Enterprise Oversight (OFHEO), through the second quarter of 2007 prices are still a bit above year earlier levels.(11) However, another measure of national house prices—the S&P/Case-Shiller price index (SPCSI)—actually declined 3 percent in the second quarter from a year earlier. A subset of this measure, indexes based on house prices in the 10- and 20-largest U.S. markets, suggests that prices have declined even more in the third quarter. In July 2007, the 10-city composite has declined 4.5 percent from 12 months earlier and the 20-city composite has declined about 4 percent.

A decline in home prices on a national average basis is relatively rare. In fact, using OFHEO data, there has been no such decline over four quarters since the inception of the purchases only OFHEO index in 1991 or since 1975 using OFHEO’s total index, which includes refinancings. It appears that we are in uncharted territory, and, given that fact, a forecast of house prices must be regarded as highly uncertain."

And concluding remarks:

"The financial market turmoil that began in August hit hard an already struggling housing market. Financial markets appear to be stabilizing, but they have not returned to normal and are still fragile. Most forecasters have reduced their expectations for GDP growth and believe that downside risks have risen. However, the employment report for September, the latest available at this time, does not suggest that the downside risk is occurring. As an aside, the substantial upward revisions to data released in the August report remind us that it is a mistake to place too much weight on any one report.

Although this episode of financial turmoil is still unfolding, my preliminary judgment is that there are no new lessons. Weak underwriting practices put far too many borrowers into unsuitable mortgages. As borrowers default, they suffer the consequences of foreclosure and loss of whatever equity they had in their homes. It is painful to have to move, especially under such forced circumstances. Investors are suffering heavy losses. There is no new lesson here: Sound mortgage underwriting should always be based on analysis of the borrower’s capacity to repay and not on the assumption that a bad loan can be recovered through foreclosure without loss because of rising property values.

The other aspect of the current financial turmoil that reaffirms an old lesson is that it is risky to finance long-term assets with short-term liabilities. Consider a portfolio of any sort of long-term assets or assets carrying substantial credit risk, such as securities collateralized with subprime mortgages. Financing such a portfolio with commercial paper makes the firm vulnerable to the risk that holders of the commercial paper will refuse to roll over maturing issues. Over the past few months, firms that structured their portfolios this way found themselves faced with exactly this problem. No manufacturing firm would ever finance a portfolio of fixed assets with commercial paper; once market sentiment became distrustful of subprime assets, these assets lost value and became no more marketable than investments in factory buildings.

The Federal Reserve has neither the power nor the desire to bail out bad investments. We do have the responsibility to do what we can to maintain normal financial market processes. What that means, in my view, is that we want to see restoration of active trading in assets of all sorts and in all risk classes. It is for the market to judge whether securities backed by subprime mortgages are worth 20 cents on the dollar, or 50 cents, or 100 cents. Obviously, the market will judge different subprime assets differently, based on careful analysis of the underlying mortgages. That process will take time, as it is expensive to conduct the analysis that good mortgage underwriting would have conducted in the first place. Although there is a substantial distance to go, restoration of normal spreads and trading activity appears to be under way, and we can be confident that in time the market will straighten out the problems. We do not know, however, how much time will be required for us to be able to say that the current episode is over."

by Anonymous on 10/09/2007 01:45:00 PM

Here's a classic example of why some of us are simply beyond disgusted with the mortgage industry. It comes from an American Banker (not online) article on FDIC Chairman Sheila Bair's recent proposal to a mortgage banking conference that servicers use their ability to modify loans to "freeze" endangered subprime ARMs at the start rate.

The day before the interview, Ms. Bair had done some jawboning in a speech at a New York mortgage investor conference sponsored by Clayton Holdings Inc. Her proposal is "a clear, categorical move that can be applied on a wholesale basis by servicers," she told nearly 100 professionals at the conference. "I don't think servicers have the time or the resources to go through these case by case, renegotiate, [and] restructure every single one."

Moreover, "if the industry doesn't do it themselves, either Congress is going to do it for them, or a bankruptcy judge is going to do it for them," she said, a reference to legislative proposals to allow bankruptcy courts to modify mortgages. "I'm trying to make one suggestion at least for a certain category of loans where I perceive these to be more sympathetic borrowers, and show policy makers that the industry is working to find a solution."

But questions from the audience revealed a reluctance in some corners to cut subprime homeowners much slack.

"The behavior of a subprime borrower, the reason they became subprime, is because they get themselves into [a] credit issue," one audience member told Ms. Bair. "If you, in turn, fix a liability that they have, they will max out their credit card. There will be another event that they will put themselves in trouble, in default. You're just going to postpone" the inevitable and, "in a declining housing market, just make things worse."

See, this is how it all started:

Dude with "credit issues" wanders into a branch of Subprime R Us, wanting a loan to buy a house. Loan officer looks at the fact that Dude has a history of getting into credit messes, and says, "there will just be another event you will put you in default. By buying a house and adding to your living expenses, you are just going to end up inevitably in foreclosure. Loan application denied."

Oh, it didn't happen that way? OK, so Dude got the purchase money loan. Then the credit card bills started racking up, just like the loan officer didn't predict would happen.

Dude goes back to Subprime R Us, wanting a cash-out refi to consolidate debt. Loan officer looks at the fact that Dude has a history of getting into credit messes, and says, "there will just be another event you will put you in default. By fixing a liability that you have by giving you a cash-out, I would just allow you to max out your credit card again. It would just be postponing inevitable default. Loan application denied."

Oh, it didn't happen that way? OK, so Dude got the cash-out refi. Then the combination of the expensive mortgage and the credit card bills started racking up, just like the loan officer didn't predict would happen.

Dude calls up mortgage servicer, because Subprime R Us has apparently filed for bankruptcy and does not answer phone calls. Dude asks for a workout of loan terms. Servicer says . . . sorry. We only make loans to people we know will default when home prices are rising. Now that home prices are falling, the fact that we "know" that you will just max your credit cards out later is relevant. The fact that it used to be irrelevant is immaterial.

You listen to these people and you get the impression that subprime loans are kind of like the Messiah: an immaculate conception and a virgin birth. No lender was apparently involved the first time; the borrowers just made these loans to themselves. Now that reality has intervened to show how stupid some of these lending practices are, it's time to remember that we "know" what subprime borrowers will do if you lower their monthly payments.

Yeah, sure we "know" that. That's why you find so many mortgage servicers advocating outlawing subprime mortgage lending, on the grounds that they know it never works out.

by Anonymous on 10/09/2007 11:52:00 AM

John Dugan, Mr. I Hate Stated Income and also Comptroller of our Currency, is on the warpath again:

San Diego, CA – Comptroller of the Currency John C. Dugan said today that banks need to strengthen their underwriting standards, particularly on loans sold to third party investors.

“I am here to say that bank underwriting standards for these products, in many cases, moved too far away from what they would have been if the bank had held those loans on its own books,” Mr. Dugan said in a speech to the American Bankers Association’s Annual Convention.

Mr. Dugan noted the many positive aspects of the “originate-to distribute” model, but said there can be negative effects on underwriting standards, including relaxing significantly the incentives to use caution and prudence in underwriting loans sold to third parties.

“When a bank makes a loan that it plans to hold, the fundamental standard it uses to underwrite the loan is that most basic of credit standards that I’ve already talked about: the underwriting must be strong enough to create a reasonable expectation that the loan will be repaid,” the Comptroller said. “But when a bank makes a loan that it plans to sell, then the credit evaluation shifts in an important way: the underwriting must be strong enough to create a reasonable expectation that the loan can be sold—or put another way, the bank will underwrite to whatever standard the market will bear.”

Comptroller Dugan outlined what needs to be done. “I am here to say that banks need to strengthen their underwriting standards so that they move back towards the fundamental principle of maintaining a reasonable expectation that loans will be repaid, even if the loans are to be sold to third parties – and that goes for mortgage loans, leveraged loans, or any other syndicated credit,” Mr. Dugan said.

What Dugan neglects to mention--or at least, what isn't in the reported summary of the speech--is the vicious feedback loop that goes on with this model. The problem is that for many years, banks often used a standard for determining an "investment quality loan" based on what secondary market investors--traditionally, Fannie and Freddie--would purchase. So when the GSEs and private investors relax standards for what counts as "capacity to repay," banks find themselves with a widening gulf between their own portfolio standards and "what the market will bear." This begins to suggest to portfolio managers that internal credit standards are "too tight," and so the banks don't just lower standards for loans they intend to sell, they lower standards for their own portfolio production.

(Hat tip FFDIC)

by Anonymous on 10/09/2007 10:04:00 AM

More stuff from the spreadsheet collection. This one looks at characteristics and some performance measures of securitized subprime loans from 2000-2006. Unfortunately, there is very little publically available data on unsecuritized subprime.

Comments:

1. Total MBS issued on this chart is mostly, but not exclusively, first liens. (It includes securities that have some second liens, but excludes securities that are exclusively second liens.)

2. The average loan amount is based on first liens.

3. WAC is weighted average coupon or "interest rate" in English.

4. "Reported" DTI simply means that's what was reported. While I have some doubts about the accuracy of that number when the full doc percentage is dropping, do notice that it is climbing even so. The historical maximum acceptable DTI for conforming agency-quality loans was 36%.

5. Historically, subprime was a refinance business, not a purchase money business. This chart shows that very clearly.

6. "Serious Delinquency" means 60 or more days delinquent, FC, REO, or BK. Because this is calculated on the current balance of these securities, this number will be much higher than what you see reported based on original balance. You should be aware that the remaining current balance of these older vintages is very low; the average "pool factor" or balance remaining for 2000, for instance, is around 5%, as opposed to 83% for 2006.

7. "Default" is a very specific technical measure here. A loan is reported as a default in a month when its balance is reported as zero and its last reported status was in foreclosure, REO, delinquent more than 150 days, or any other status and a loss of more than $1000 was recorded at payoff. In other words, "default" is the final disposition of a loan, and it includes things like short sales and short refis as well as foreclosures. It does not include active modifications or forbearances, since these loans still have a reported balance. It is a loss measure, and because it involves the final disposition of a loan, it is always much lower for new issues than for older issues, even if they are performing equally.

8. Cumulative loss is based on the original security balance, and is equal to default times severity.

Now, about that FICO average. On the one hand, the fact that the average FICO is rising can be filed under "I sure as hell hope so." When you look at the steadily rising risk factors of CLTV, documentation level, DTI, and so on, you would certainly expect that higher FICOs were being required as some kind of risk offset.

On the other hand, those average FICOs are getting awfully close to near-prime or even prime territory, depending on your definition (620-660 being the usual floor for prime). That means that a lot of these loans have FICOs clearly in prime range. In order to rule out the possibility of predatory steering, you have to trust that the subprime industry has been scrupulous about giving subprime loans to higher-FICO borrowers only when the other loan characteristics are clearly non-prime. This question cannot be solved by looking at averages or even really good stratifications; it takes loan-file-level reviews to really understand what's going on. As those loan-file-level reviews were, apparently, not done by aggregators and raters and investors, they are now being done by servicers and courts.

by Calculated Risk on 10/09/2007 02:08:00 AM

From the LA Times: Slipping imports reflect slowing economy

Cargo containers crammed with foreign-made goods that were supposed to set a record in August at major U.S. ports took an unexpected turn, with imports sinking 1.4% in another sign of the slowing of the economy.
...
The slump in oceangoing imports unloaded at the 10 largest U.S. container ports in August was the first drop since Global Insight began its monthly Port Tracker report in 2005. The number stunned some port watchers.

"When I first saw these numbers, I called the researchers and asked them if they had left a column out of the spreadsheet. I thought it was a typo," said Craig Shearman, vice president of the National Retail Federation, which pays Global Insight to conduct the trade research.