by Anonymous on 11/10/2007 02:11:00 PM

My recent posts on WaMu’s Very Bad No Good Rotten Day involving inflated appraisals have drawn a lot of questions. One question I keep getting is a variant of “What’s so wrong with the alleged conduct anyway? Why is it such a big deal for WaMu to insist on a list of approved appraisers? Isn’t that just good risk management on WaMu’s part?”

Possibly it is just good risk management on WaMu’s part: an indictment is, after all, an allegation of misconduct, not a verdict. However, what WaMu is alleged to have done is itself the kind of conduct that is an automatic “red flag” for anyone who knows anything about how the appraisal management business works. Since most of you are fortunate enough to be entirely innocent of that, I thought I’d go through some issues here.

First off, I’m talking about how the business works, not about how the principles of appraiser independence are derived by the Appraisal Foundation or why they matter so much. I’m taking as a given that we accept the axiom that when an appraiser’s compensation is based on his or her willingness to come up with the answer an interested party wants, instead of the answer he or she thinks the facts of the subject property, the transaction requested, and the local real estate market warrant, an appraisal is nothing more than a ratification of the loan amount someone has already decided on, and that “someone” isn’t the ultimate bagholder. The real bagholder wants to know whether it is lending too much or risking owning an unsalable piece of REO. That an individual loan officer or broker just wants to know how high we can make the loan amount—and thus a commission—is an artifact of a business structure in which a lender’s own employees or agents are not aligned with its own corporate best interests. At some level the appraisal problem will never get solved until the compensation of loan processing employees and intermediaries gets solved, but that’s not today’s argument.

In the olden days of local lenders, you had either staff appraisers or “fee appraisers.” You could actually have appraisers on your payroll because you lent in a defined local area: you didn’t have to worry about needing an appraisal for a property six states away that your staff appraisers couldn’t get to, even if they were licensed in that state. If you relied on fee appraisers, possibly because it was too expensive to keep appraisers on the payroll during down-cycles in RE, you still worked in a local market, you got to know all of them, and you could order appraisals from people whose work was familiar. If you were smart, you worked with the best appraisers there were. If you were stupid, you channeled business to your golf buddies. A number of S&Ls did the latter, and they did not live happily ever after. We have this thing called FIRREA, which brought into being USPAP, in large part because of that second option.

Once local lenders became regional lenders and then national lenders, the distance between corporate headquarters, the Appraisal Department, and the actual properties and markets grew to the point that having staff appraisers was impractical and hiring fee appraisers was a crap-shoot. You can pick up the Yellow Pages to find an appraiser in a market you just entered, but this means you will learn by doing in terms of quality. That goes double if you entered this market via wholesale lending: you now have a broker you don’t know much about hiring an appraiser you don’t know anything about in an RE market you’ve never done business in before.

The early years of national wholesale lending supplied lots of excitement, as Podunk National Bank changed its name to Ubiquitous, Inc. and charged into market areas about which it knew nothing, on the assumption that, say, Miami is just like Podunk except the loan amounts are bigger. Sometimes this was actually retail lending: Ubiquitous, Inc. started buying up branches in all these new and exciting markets, with the plan of managing them long-distance from corporate headquarters. Often those branches (complete with their employees) could be acquired for amazingly cheap sums of money. The Lender Formerly Known As Podunk often didn’t ask itself why the current owner of that branch wanted out so badly, but that’s hardly a problem unique to mortgage lending or banking.

Eventually, everyone had to deal with the hard knocks. You might be able to justify taking risks on the unknown when you move into a new market, but you still have to do something about the problems that crop up. Everyone got at least some really bad appraisals from the Yellow Pages approach, and had to start making some lists. I really think that a major problem lurking in the industry happened right here, when wholesalers and correspondent lenders made a decision about what kind of list to make. Do you make an “Approved Appraiser” list of the ones you haven’t had problems with, or do you make an “Excluded Appraiser” list of the ones you have had problems with?

There is no question that logically, the most efficient thing to do is make the exclusion list. Even if you believe that there are more than just a few bad apples, you don’t get into the national mortgage lending business if you believe that bad appraisers outnumber good appraisers by a wide margin. Exclusionary lists are just shorter and easier to administrate.

If you’re still a retail lender (just a long-distance one), you can keep the shorter exclusionary list internal to your own organization. The major disadvantage of exclusionary lists developed for the wholesale and correspondent lenders, and for any lender in the “originate and sell” rather than “originate and hold” business. If you are contracting with brokers, correspondent lenders, third-party investors and servicers and other folks who need to conduct due diligence on your loans, you end up having to make your list available to all those parties. It becomes nearly impossible to keep it confidential.

And that started the defamation fear. Too many lenders faced real or imagined threats of lawsuits from appraisers who did not want their names appearing on what had basically become a public hall of shame list. (I hasten to add that these things were not “public” to you, the consumer. They were an open secret to everyone in the business except the consumer.) So even though an approved appraiser list was a much more expensive, time-consuming, cumbersome way to get there, more and more big operations started keeping one. (Why not go to the regulators and beg for a "safe harbor" against defamation liability for exclusion lists? Because lenders are almost never long-sighted enough to ask for regulation that benefits them. They're too afraid that it always comes with the wrong strings attached. Then after the criminal probes and class actions and general shirt-losing, we look back wistfully on those strings we were so afraid of, wondering why we didn't snap that deal right up.)

The alternative to exclusionary lists opened up the problem of what it means to be “approved.” The handy thing about the exclusionary list was that its criteria were easier to understand: anyone on that list gave me at least one bogus appraisal, or a series of very weak appraisals, or did some other bad thing like turning in all assignments late and never answering the phone. The lender would have documentation of this, since that’s where the exclusionary lists came from: a review of the lender’s internal notes and logs and quality control reports and so on. The approved appraiser list, however, didn’t just include appraisers whose work you really liked; it included appraisers whom you hadn’t yet caught red-handed, at least in theory. Many people became a bit queasy about the potential liability of appearing to put the Good Housekeeping Seal of Approval on a bunch of appraisers when the actual purpose of the list was just to indicate ones that could still be hired by the branches or brokers because we don’t know any reason why not yet.

Furthermore, these lists were (and are) huge work projects. It’s not just that a national lender has thousands and thousands of appraisers to deal with. It’s that if you’re any kind of conscientious about risks, you don’t limit your internal appraiser management functions to sitting around waiting for your QC department to find an obviously bogus one. You get a giant database going of all your appraisals, including the appraiser’s name and license number and a bunch of other facts, and you manipulate that information looking for patterns. A lot of lenders actually started stratifying the approved appraiser list: there was the A-team, whose appraisals got normal review, and the B-team, whose work could be ordered by a branch, but which had to undergo an extra layer of review or an AVM backup or something. The results of that had to be fed back into the model to see if anybody qualified for upgrade or downgrade. Plus you had to have a “probationary” list or some way of dealing with a new appraiser you’d never done business with before. Plus somebody had to monitor state licensing boards and other sources to pick up on appraisers with invalid or expired licenses or insufficient certification to handle large jumbo loans and so on.

Even worse, every big national lender was doing the same tedious expensive administrative work independently. This is why companies like eAppraiseIT exist. It didn’t take all that long for the lenders to figure out that this work could be outsourced, and for some enterprising party to offer to do it. Besides offloading the liability onto the vendor, the big lenders offloaded a whole bunch of those back-office corporate mouths to feed in the appraisal analysis department.

So fast forward to the specific allegations about WaMu and eAppraiseIT. It is utterly normal in the current environment for a big national wholesaler/correspondent buyer like WaMu to outsource appraisal administration. It is not usual for a lender to pay a vendor to make up a list of approved appraisers, and then for that company to continue to make its own list, and to demand that the vendor use the lender’s list. The whole idea is getting out from under having to make and maintain these lists, not to pay someone to do something and then incur all the expenses of doing it yourself at the same time. This would be a bug, not a feature.

I am theorizing that this is one reason why what WaMu wanted struck at least one manager at eAppraiseIT as out of line. It doesn’t have to involve any evidence anywhere that any individual appraisal is bad: you have to wonder what’s in it for WaMu to do business this way. From the facts alleged in the indictment, it sounds like eAppraiseIT asked why this was happening, and WaMu admitted that it was happening because WaMu wanted to make sure that one criterion for the “real” approved appraiser list was “the ones who hit the numbers we like,” not the ones eAppraiseIT’s database shows are not subject to documented lender or licensing board complaints.

You have to be aware that eAppraiseIT and its competitors do not base their management of individual appraisers on just one lender’s experience: that’s the beauty of the service they offer. To an individual lender, the sales pitch is something like this: why should you make the same mistakes Ubiquitous, Inc. has already made? With a third-party vendor, you get the benefit of the collective experience of every client. No appraisal management vendor expects a client to pipe up and say we want an “approved panel” that includes appraisers we know will wag their tails, roll over, and show us their bellies when one of our loan officers or correspondents or brokers asks for a certain value. Or if they do, they expect some circumspection about it. I don’t know if WaMu’s request was unusual because of its nature or because of its brazenness, but it seems to have struck someone at eAppraiseIT as a downright regulatory violation. Given the amount of interpretation and so on of a lot of regulations, many practices can be considered kinda squirrelly but allowable. It’s not that common for an outfit like eAppraiseIT to baldly assert that what’s going on is a clear violation of FIRREA.

That’s actually why I find those emails quoted in the indictment to be so explosive. I have spent a lot of years learning to decipher coded language about regulatory-not-exactly-improprieties-but-perhaps-areas-of-concern and other corporate-speak ways of putting it that I’m utterly blown away by the unvarnished language being used here. You just don’t accuse a major account like WaMu of out-and-out violation of safety and soundness regulation unless the conduct is egregious in the extreme, or you think it is clear that you are being lined up for bagholder duty, or both. It sure sounds to me like WaMu wanted to tell eAppraiseIT what to do, while having eAppraiseIT do the scut work plus the small matter of making all the relevant warranties in the utterly certain event it backfired. Mortgage market participants can be so amazingly short-sighted sometimes it’s hard to believe, but somebody at eAppraiseIT seems to have figured out who the sucker at the table was. No doubt they wouldn’t be on the receiving end of a civil suit from Mr. Cuomo if someone higher-up had listened to whatever internal employee called bull on this one.

Why didn’t they listen? Why doesn’t any corporation ever listen? Because the WaMu account is huge, and nobody wants to stop a gravy train. The indictment also includes snippets of emails suggesting that WaMu dangled other business relationships outside the appraisal management function in front of First American if it rolled over. Which is more or less exactly what lenders to do appraisers all the time: offer repeat business if they play ball, or being kicked off the team if they don’t.

I don’t want to sound too terribly nostalgic for the old days. Was it impossible to manipulate a staff appraiser? Of course not. They worked for you. You could saunter down the hall to their cubicles and make their lives a living hell in a very direct and personal way. As long as you didn’t think of yourself as the bagholder. And staff appraisers would roll over because you do that for the party paying your health insurance premiums. Especially when you believe that if it blows up, your employer, not you personally, is going to be liable.

These days appraisers have the same pressures to play ball and absolutely none of the protections of being employees. I wonder if we haven’t gotten to that point where someone with nothing left to lose has nothing left to lose. The lenders are asking appraisers to take personal liability for inflated appraisals, while offering them no salary (protection from falling volume cycles), no benefits, no institutional legal or compliance support. Even the per-deal fee we pay has become typically paid only out of closing proceeds. (We used to pay for the appraisals up front out of an application fee, so the appraiser got paid even if the loan didn’t close. These days the appraiser often never gets paid if the loan doesn’t close because the broker has nothing to pay it with.) And guess who is the target of the Cuomo indictment? Not the lender doing the bullying. At some point these appraisers have to realize that they don’t lose much by going state’s evidence and providing the other half of those email chains. And that would mean a Very Bad No Good Rotten Day for everybody.

by Calculated Risk on 11/10/2007 12:39:00 AM

Dow Is Down

Hat tip to lumpeninvestor who noted that this song was recorded in 2000, but the lyrics seem to fit today.

Enjoy!

by Calculated Risk on 11/09/2007 11:50:00 PM

From the Charlotte Observer: Beazer to delay paying subcontractors (hat tip idoc)

Beazer Homes USA is delaying payments to subcontractors in Nashville ...

The Observer obtained a letter dated Nov. 5 and signed by Beazer's Nashville division President David Hughes, who said, "It is unfortunate, but we cannot continue the prompt payments you have received in past years."

Not BK, but this doesn't sound good. Beazer is the 7th largest home builder in the U.S. according to BuilderOnline.

by Calculated Risk on 11/09/2007 09:04:00 PM

From Reuters: Levitt & Sons files for bankruptcy protection

Levitt Corp home-building unit Levitt & Sons said on Friday that it had filed for bankruptcy protection ..
...
Levitt & Sons is ranked as the 50th-largest U.S. home builder by trade publication BuilderOnline.

Here are the BuilderOnline top 100.

by Calculated Risk on 11/09/2007 06:29:00 PM

From AP: S&P Lowers Credit Outlook on Three Banks (hat tip 4wards, dotcommunist)

S&P downgraded its outlook for Washington Mutual Inc. and IndyMac Bancorp Inc. to "Negative" from "Stable," and for Capital One Financial Corp. to "Stable" from "Positive.

It must be Friday!

by Calculated Risk on 11/09/2007 05:54:00 PM

From MarketWatch: E-Trade backs off earnings forecast

E-Trade said the fair value of its $3 billion asset-backed securities portfolio has continued to decline since the end of the third quarter. ...

The drop in value will result in further write-downs in the fourth quarter ... Those extra write-downs weren't expected when E-Trade updated its 2007 earnings outlook on Oct. 17.

"Investors should no longer expect these earnings levels to be achieved," the broker said in a statement.

The beat goes on ...

by Calculated Risk on 11/09/2007 05:42:00 PM

From the Sacramento Bee: Dunmore Homes files for bankruptcy protection (hat tip JR)

Seeking protection from creditors, Granite Bay home builder Dunmore Homes filed for bankruptcy late Thursday as it tries to restructure its tangled finances.
...
The company, which claims to have built 22,000 homes since 1953 in California and Nevada, listed assets and liabilities of more than $100 million. It claimed between 5,000 and 10,000 creditors.

The largest is JPMorgan Chase Bank, which is owed $20 million, according to the filing. Many of the largest creditors are local construction firms.

This is just the beginning. As noted earlier, Neumann Homes filed for bankruptcy two weeks ago. Is there a home builder Implode-a-meter?

by Calculated Risk on 11/09/2007 03:17:00 PM

From MarketWatch: Bank of America: CDO dislocations may knock Q4 results

Bank of America Corp. said .. that dislocations in the market for ... (CDOs) will knock the bank's fourth-quarter results.

Here is the SEC 10-Q filing.

We expect these significant dislocations in the CDO market to continue, and it is unclear what impacts these dislocations will have on other markets in which we operate or maintain positions. ... We anticipate that these developments will adversely impact our results during the fourth quarter.

by Calculated Risk on 11/09/2007 02:45:00 PM

Here is the list of Alt-A residential mortgage-backed securities (RMBS) and U.S. net interest margin securities (NIMS) affected by the S&P negative CreditWatch actions today:

U.S. Alt-A RMBS And Related NIMS Classes Affected By Nov. 9, 2007, CreditWatch Actions (hat tip bacon dreamz)

by Calculated Risk on 11/09/2007 12:51:00 PM

The Census Bureau reported today for September 2007:

"a goods and services deficit of $56.5 billion, compared
with $56.8 billion in August"

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).

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.

UPDATE: Petroleum imports are strong in dollar terms, but they appear to be declining in BBLs, see exhibit 17. Imports are noisy month to month, but BBLs imported has declined year over year for the last several months. Also note the price per barrel. This will increase sharply over the next few months (but not to the spot level). Hat tip dryfly.

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 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. I'm not convinced by the decoupling argument, and my view is that there is simply a lag between a slowing U.S. economy and a slowdown for the rest of the world.

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).

"Interestingly, the change in U.S. home mortgage debt over the past half-century correlates significantly with our current account deficit. To be sure, correlation is not causation, and there have been many influences on both mortgage debt and the current account."
Alan Greenspan, Feb, 2005

The second graph shows the trade deficit and mortgage equity withdrawal as a percent of GDP.

Declining MEW is one of the reasons I forecast the trade deficit to decline in '07. And a declining trade deficit also has possible implications for U.S. interest rates; as the trade deficit declines, rates may rise in the U.S. because foreign CBs will have less to invest in the U.S..

Note also that import prices are surging. From Greg Ip at the WSJ:

Import prices jumped 1.8% in October from September and are up 9.6% from the previous year. To be sure, most of that was due to rising oil and natural-gas prices. But even excluding fuels, prices were 0.3% higher from September and up 2.4% from a year earlier.

The import prices problem will only get worse in October and November with surging oil prices and the falling dollar.

by Anonymous on 11/09/2007 11:55:00 AM

Thanks to bacon dreamz.

Remember that, as CR says, Up is Down.

by Calculated Risk on 11/09/2007 10:16:00 AM

From Reuters: S&P says State St-managed CDO liquidating assets (hat tips nemo idoc)

The trustee of a $1.5 billion collateralised debt obligation (CDO) managed by State Street Global Advisors has started selling assets, apparently starting a process of liquidation, Standard & Poor's said late on Thursday.
...
The trustee of the Carina CDO has started selling the asset-backed securities -- residential-mortgage backed securities and CDOs -- making up the CDO at the direction of the structure's noteholders, S&P said.

"We believe the liquidation process has begun," S&P said in its statement.

It looks like a busy news day!

by Calculated Risk on 11/09/2007 10:06:00 AM

From MarketWatch: Wachovia sees higher loan losses

Bank says CDO portfolio lost more than $1 bln during October

Due to the October market deterioration, its asset-backed collateralized debt obligations, or CDOs, experienced further declines in value in the month of October 2007 by an amount it currently estimates to be approximately $1.1 billion pre-tax.

In the third quarter, market disruption-related losses totaling $1.3 billion pre-tax included $347 million of subprime-related valuation losses, net of hedges, on CDOs.

by Anonymous on 11/09/2007 09:01:00 AM

See end of post for update.

The plot thickens on the WaMu/eAppraiseIT front. Yves at naked capitalism runs it down: James Lockhart, head of OFHEO, fires off irritated letter to Cuomo about the latter's public involvement of Fannie and Freddie in the mess without conferring first with OFHEO. The money quote (for which I have not seen anyone include the full context in the letter, alas): Lockhart says Cuomo "may not fully understand the difference between mortgages issued by government sponsored enterprises (GSEs) and those issued by other entities."

Yves runs down a preliminary list of what this might be about. I tend to assume that Lockhart is annoyed mightily because the way in which this was handled by Cuomo did, in fact, lead many people to think that Fannie and Freddie were targets of a criminal probe. That didn't help GSE share prices and it won't help calm the troubled bongwater of the credit markets. I also think it's plausible that Lockhart is responding to Cuomo's at least rhetorical linkage of the GSEs and the investment banks, and by extention prime conforming mortgage paper and subprime goofballery.

But I also suspect that Lockhart knows perfectly well that having a large seller/servicer go up in flames isn't any kind of good news for Fannie and Freddie, whether they're "innocent" or not. Seller/servicer concentration is a huge problem for the GSEs, in my view. One result of "800 pound gorilla" industry consolidations is that you have a handful of large operations not only servicing the majority of Fannie and Freddie's loans, you have that same handful making all those repurchase warranties that limit the GSEs' risk of covering guarantees on fraudulent stuff.

So it's one thing for a state AG to kick around somebody like American Home, whose agency servicing book is fairly small (and can be transferred, at least theoretically, to one of the gorillas if it fails). Kicking around a gorilla could put the GSEs in the position of feeling the effects of the concentration risk they have willingly allowed to build up over the years.

And, as I indicated yesterday, I do think part of what's being dragged out into the light of day is not just inflated appraisals but the whole "post purchase due diligence" model that the GSEs depend on (and that they "risk manage" by, exactly, doing a lot of business with big fat depositories who are, presumably, good for those warranties in the way some relatively small-change REIT isn't). Given this structural way of doing the business, there's nowhere an investigation of appraisal risk-offloading (as opposed to mere individual appraisal fraud) can go except to the parties who write the industry-standard rules on appraisal practices and whose upfront due diligence, or back-end due diligence, is or is not structured in a way that can catch bad appraisals before they, and other loose lending practices, wreak havoc in the housing and credit markets.

So I'm not sure what would be "worse" for the GSEs: that Cuomo does not understand how they operate, or that he does. Yesterday we were meditating on the problems created by relying on shallow-pocket counterparties to cover your liability. Today we are meditating on the risks of relying on deep-pocket counterparties to cover your liability. The latter is the classic "moral hazard" problem and it's worth asking whether Fannie and Freddie aren't hip-deep into it.

UPDATE:

Thanks to bacon dreamz, I have the link to Lockhart's letter to Cuomo (see post below [ed note: it's "above" for those of you who aren't standing on your heads]), which was hiding in plain sight on the internet (um, it's early . . .)

I have always had a lot of respect for Lockhart. This paragraph is making me stare in wonder at my monitor. Is it possible for anyone to be that naive about the mortgage business and still be alive? Here's the whole paragraph in question:

After reviewing these materials, I feel that you and your staff may not fully understand the differences between the mortgage-backed securities (MBS) issued by the GSEs and those issued by other entities. In particular, unlike the issuers of private label MBS, when Fannie Mae or Freddie Mac issues an MBS, they retain the credit risk on the underlying mortgages by guaranteeing repayment to MBS holders. Consequently, they have no economic incentive to knowingly purchase or guarantee mortgages with inflated appraisals. The two firms already have programs in place to prevent this and other types of mortgage fraud as well as contract terms to put back mortgages in such situations to the primary lender. For the past several years, OFHEO has been working with the two firms as they have continued to improve these anti-fraud programs.

Well, yes. Nobody has any incentive to knowingly purchase or guarantee fraudulent mortgages. If you know about it, you are party to it, and that put-back thing doesn't work. Does Lockhart seriously wish us to believe that there are no economic incentives for anybody to work extremely hard on not knowing what is going on, while still allowing it to go on because there's money in them transactions?

You do not have to accuse the GSEs of collusion in appraisal fraud to recognize that they have an economic incentive to allow a big counterparty like WaMu to push the envelope on appraisals, and they have a economic incentive to avoid having to "mark" the LTVs of their current outstanding MBS and retained portfolios to a new market (less the "fraud adjustments" on these bad appraisals).

In Lockhart's logic no one would ever have an economic incentive to request inflated appraisals, because no one is ultimately safe from having to cover the loss. Even nickel and dime mortgage brokers face disgorging loan premia that can bankrupt them, not to mention doing some time in the county jail, which is not "economic" for a small self-employed business person.

I argued a while back that the real problem with stated income lending--which the GSEs are implicated in as well as those private issuers Lockhart doesn't want the GSEs to be lumped in with--is that it allows lenders to make very high-risk loans without having to admit they're doing it, and it sets up a bagholder: the borrower who lied. To the accusation that lenders obviously allowed themselves to be lied to, the retort is that "we have no economic incentive" to be lied to. Sure you do.

Low processing costs. Inexpensive due diligence practices. Lower reserves based on "stated" DTIs and LTVs. Ability to compete with other lenders by offering "faster approval" (no hang-ups over the appraisal!) or lower closing costs (no expensive charge for an experienced independent appraiser when you get some appraisal-mill product for cheap). And on and on. How are these not "economic incentives" for the whole industry to know what is going on while not "knowing" what is going on? It's like no one ever heard of the concept of plausible deniability.

I am not suggesting that the GSEs intentionally colluded with anyone to produce bad appraisals. I actually do think they try harder than most other parties to weed that stuff out, precisely because they are motivated to limit their credit losses. But Lockhart himself names the major mechanism in play: put backs. That means that the GSEs manage their risks to the extent that their counterparties will agree to take the risks instead. And that means that if and when a counterparty gets in trouble over the risks it's taking, the GSEs have to put back nuclear waste at the exact time that doing so could conceivably ruin the counterparty, whose warranties on the other eleventy-jillion loans that don't have bad appraisals are now worthless.

Of course Fannie and Freddie don't want to participate in what could potentially be the ruin of WaMu or any other of their major counterparties. I have to think that Cuomo knows that and intentionally created this situation where they now cannot not participate in the investigation. If so, that's because he recognizes an "economic incentive" that Lockhart apparently wants to not know about.

by Calculated Risk on 11/08/2007 11:52:00 PM

From the NY Times: Stores See Shoppers in Retreat

Consumers have rendered a verdict on the coming holiday season: grim.

From discounters like Wal-Mart to luxury emporiums like Nordstrom, the nation’s biggest chains reported the weakest October in 12 years yesterday.
...
Sales at stores open at least a year, a crucial yardstick in retailing, rose just 1.6 percent last month, the slowest growth since October 1995, according to the International Council of Shopping Centers. The poor results — on the heels of a dismal September — have made this one of the worst fall shopping seasons in decades.

From the WSJ: 'Affordable Luxury' Stores Feel Economy's Pinch

Yesterday Nordstrom Inc. reported a rare 2.4% drop in October same-store sales, steeper than the 1% decline many analysts had expected. Morgan Stanley analyst Michelle Clark this week downgraded Nordstrom's shares to "underweight," the equivalent of a sell rating, citing weaker spending by the affluent middle class, rising credit-card delinquencies and the luxury retailer's exposure to risky housing markets in California and elsewhere.

How long will the slowdown last? From the NY Times article:

“We expect the challenging retail environment to continue for the foreseeable future,” [Myron E. Ullman III, chief executive of J. C. Penney] said.

The housing slump is definitely hurting consumer spending in Florida, Nevada, Arizona, and California - all states that are in or near recession - and probably impacting spending in many other places too.

We need to keep watching Mortgage Equity Withdrawal (MEW). MEW is probably declining sharply in Q4 with tighter lending standards and falling house prices, and that will likely directly impact consumer spending. In simpler terms, the Home ATM is running out of cash.

note: the advance MEW estimate suggests that MEW was still been pretty strong in Q3.

by Calculated Risk on 11/08/2007 05:59:00 PM

Tanta wrote another incredible and timely post this morning: WaMu and The Rep War

IMO Tanta's posts on the mortgage industry are the most informative anywhere, and I suggest checking them out at Tanta's The Compleat UberNerd (a directory of her posts). These posts cover Mortgage Servicing, Private Mortgage Insurance, Reverse Mortgages, Mortgage Backed Securities (MBS) and much more.

You can also click on the The Compleat UberNerd in the menu at the top of the blog to access this directory.

Felix Salmon, at Market Movers on Portfolio.com had this to say yesterday about Tanta:

"Tanta is one of the best financial writers in the world, and explains complex ideas with wit and great clarity."

I couldn't agree more. Enjoy her posts!

by Calculated Risk on 11/08/2007 03:43:00 PM

Here are some headlines (hat tip Brian) from the Toll Brothers Conference call:

Click on photo for larger image.

The audio of the conference call should be available here soon.

I miss Ivy Zelman and her KoolAid comments! Note: Ms. Zelman (while at Credit Suisse) confronted Toll Brothers CEO Bob Toll during an analyst conference call in 2006 by asking: "Which Kool-aid are you drinking?"

by Calculated Risk on 11/08/2007 02:04:00 PM

The Census Bureau, during periods of rising cancellation rates, overstates New Home sales and understates the increase in inventory. Conversely, during periods of declining cancellation rates, the Census Bureau understates sales. Here is discussion from the the Census Bureau on cancellations. Note: this shouldn't be confused with revisions that are unrelated to cancellations.

Using cancellation rates from several of the publicly traded home builders, we can estimate the actual new home inventory (as opposed to the inventory reported by the Census Bureau). Note: The Census Bureau breaks down the inventory as Completed, Under Construction, and Not Started. The following chart show the reported and cancellation adjusted inventory levels for the hard inventory (excluding the "Not Started" category).

Click on graph for larger image.

At the end of Q3, this analysis shows the Census Bureau is currently understating the hard inventory of new home sales by about 100,000 units. Even though the Census Bureau data indicated a slight decline in new home inventory in the third quarter, the adjusted inventory increased because of rising cancellation rates.


The second graph shows the reported Months of Supply for new homes, and the adjusted Months of Supply based on homebuilder cancellations. At the end of Q3, the Census Bureau reported the seasonally adjusted Months of Supply for new homes was 8.3 months. Adjusting for cancellations, the actual months of supply was 11.0 months!

However, it isn't just the inventory of new homes for sale that will impact the homebuilders. Existing homes are a competing product for new homes, and the record inventory of existing homes for sale will also pressure home-building activity. Also, it's not just the level of inventory that matters, but also the level of distressed inventory. We are already seeing record levels of foreclosures in some states, and IMO it is about to get much worse. I'll have more on total and distressed inventory soon.

by Calculated Risk on 11/08/2007 11:22:00 AM

From MarketWatch: Toll's home orders drained by cancellations

Toll Brothers ... said Thursday its net orders for new homes in the latest quarter fell 35% from a year earlier as cancellations increased, pointing to further losses in the residential housing market.

"We continue to believe that excess supply created by cancellations, speculative buyers, and overly ambitious builders; customer concerns about selling their existing homes; and a general lack of confidence are the primary impediments to our market's recovery," said Chief Executive Robert Toll in a statement.

He said tighter lending standards and inability to obtain mortgages as a result of the subprime mess do not appear to be a "major factor" affecting its mostly affluent buyers. However, he said a tougher mortgage market may make it more difficult for buyers to sell their existing houses and move into a Toll house.
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The builder had 417 cancellations during the quarter, while net contracts totaled 656 homes. Toll said the cancellations were heavily concentrated in high-priced markets and product lines.

"Unfortunately, the pace of customer cancellations increased in this fourth quarter," Rassman said. "We, and other reporting builders, have observed that October's activity appeared weaker than September's. These trends suggest that we still have challenging times ahead, which we believe are reflected in our estimates for fourth quarter impairments."

First, these higher cancellations mean the New Home inventory numbers from the Census Bureau will be too low. See this discussion on how the Census Bureau handles cancellations. Note: Toll is one of the companies I use to calculate the adjusted New Home inventory. I should have an update for Q3 soon.

Second, Toll is probably correct about the minimal direct impact of tighter lending standards on high end homes. However, as Toll noted, if the high end buyers can't sell their homes, they can't buy Toll's homes.

by Calculated Risk on 11/08/2007 10:59:00 AM

From MarketWatch: U.S. faces risks of downturn, inflation: Bernanke

The U.S. economy not only faces the risk of a sharp slowdown from the housing market's contraction but also of an inflationary surge from sharply higher crude-oil prices and the weaker dollar, Federal Reserve Chairman Ben Bernanke said Thursday.
...
Bernanke said that he and his colleagues on the policy-setting Federal Open Market Committee expect the economy to slow "noticeably" from the third-quarter growth rate and remain sluggish in the first half of 2008. But Bernanke also suggested that the hawkish members of the Fed might have a point about inflation.

There were downside risks to the subdued growth forecast, and upside risks to the benign inflation outlook, Bernanke said.
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He noted that prices for crude oil and other commodities have risen sharply in recent weeks and that the dollar has weakened in foreign-exchange markets.

"These factors were likely to increase overall inflation in the short run and, should inflation expectations become unmoored, had the potential to boost inflation in the longer run as well," Bernanke said.
...
Bernanke bluntly said that headline inflation is going to rise in the short term.

Here is Bernanke's Speech: The economic outlook