by Calculated Risk on 8/19/2008 04:09:00 PM

Click on graph for larger image in new window.

The CMBX is a CMBS (Commercial Mortgage-Backed Securities) credit default index just like the ABX - except up is down for the CMBX indices. The CMBX is quoted as spreads, whereas ABX is quoted as bond prices. When the spreads increase - chart going up - the bond prices are going down.

Most of the CMBX indices are setting new record lows again.

This graph is the CMBX-NA-BB-4 close today.

by Calculated Risk on 8/19/2008 01:29:00 PM

It is difficult to compare monthly housing starts directly to sales. The monthly housing starts report from the Census Bureau includes apartments, owner built units and condos that are not included in the New Home sales report. However, every quarter, the Census Bureau releases Starts by Intent, and it is possible to compare "Single Family Starts, Built for Sale" to New Home sales.

Click on graph for larger image in new window.

This graph compares quarterly starts of single family homes built for sale (and completions of single family homes built for sale in red) with New Home sales.

This data is not seasonally adjusted for any series. There are clear seasonal patterns for all series, and completions lag starts by about 6 months.

The period of significant overbuilding in recent years is highlighted. It now appears that starts and completions are running below sales. Note that most new home sales occur before a housing unit is started, so completions lag sales.

The second graph shows the quarterly starts by intent at an annual rate through Q2 2008. This shows 1) Single Family starts built for sale, 2) Owner built units, 3) Units built for rent, and 4) Condos built for sale.

As of Q2, Single Family starts built for sale, had rebounded slightly to 512 thousand on a non seasonally adjusted annual rate. As noted above, this level of starts is below the current level of New Home sales.

Note the minor seasonal rebound for Single family starts built for sale. There was no Spring for housing in 2008.

Also, starts for condos has fallen significantly - just slightly above the average level of the '90s.

Rental units are the lone bright spot (other than minor seasonal upswings), and it was rental units that accounted for the increase in overall starts for June (somewhat because of the changes in the NY construction code). With the rental vacancy rate at 10.0%, the rental construction will probably decline in Q3.

There is still a huge overhang of existing home inventory for sale (especially distressed inventory including short sales and REOs), and until that inventory declines significantly, starts and housing prices will remain under pressure. However this report does provide some evidence that the home builders are starting fewer homes than they are selling.

by Anonymous on 8/19/2008 09:02:00 AM

Here we have a detailed two-parter (part one and part two) on a sorry case of mortgage fraud from the OC Register. Dogged local cop pursues small-balance fraud case, nails crook, unveils huge regulatory failure. But . . .

*********

I have to confess to being as fascinated by the victims in this case as by the perp. Before everybody starts in on me about "blaming the victim," let me point out that yes, fraud is fraud, even when the victim is so lacking in common sense and elementary skepticism as to pass into Darwin Award territory. I do not excuse anyone who preys on the vulnerable, the foolish, or the ignorant.

Nonetheless, it's hard to prevent certain kinds of fraud against homeowners if you do not deal with the extent to which they "work" only because the victim colludes with them, up to and beyond the point where they become so outlandish as to defy belief. The case before us seems to me less a case of "mortgage fraud" than a classic confidence scam that simply takes as its incidental starting point a dubious mortgage offer. In other words, it's like a Nigerian scam email. From part one:

Nobody believed in Osborn more than Steve Ryancarz.

Ryancarz, 62, an Ohio businessman, wanted to refinance his 5,000-square-foot luxury house on a 5-acre lot to get some cash out for his refrigeration company. A major customer had gone belly up, owing Ryancarz's firm $1.2 million, he said.

Ryancarz wasn't just trying to get a loan for himself. He also was trying to do a favor for a friend, Kim Koslovic.

Ryancarz was engaged to Koslovic's mother. Koslovic, 38, and her husband had filed for Chapter 13 bankruptcy protection while he was unable to work because of an injury. In order to keep her modest, $107,000 house, she needed to refinance, but she couldn't find a lender in Ohio who would take a chance on her.

Ryancarz said he found Osborn online in 2003 through HomeLoanAdvisors.com. Ryancarz, who had good credit, figured that by bundling a loan for himself with one for Koslovic, Osborn might find a lender willing to take both.

"No matter how much money I had, I always help people out," Ryancarz said. "That's just how I am. Everybody needs a break. What I could do to help them – could help them get to a point where they turn their lives around, it's worth it."

There were warning signs, even early on. The first loan Osborn delivered for Ryancarz was bungled, resulting in much higher payments than Ryancarz had expected. Osborn blamed the problem on his boss.

Ryancarz said he called Osborn's boss, but the man wouldn't speak to him, so Ryancarz believed Osborn.

"It just snowballed after that," Ryancarz said.

Osborn said he would help Ryancarz sue the first lender, but he wanted money up front to pay for the lawsuit. Ryancarz sent thousands in fees.

Here's how much sway Osborn was able to exert over his victim: Ryancarz sent Osborn money to bail him out of jail when he was arrested for driving without a license. He also sent Osborn money to pay off a purported fine from the Department of Real Estate, according to records Ryancarz provided.

Ryancarz even sent $5,000 to pay for Osborn, his girlfriend and their children to take mini-vacations at the Loews Coronado Bay Resort.

"He said, 'I've done all this work for you. You owe me a favor. How about putting us up for the weekend?'" Ryancarz recalled.

Ryancarz said he believed that Osborn was working very hard trying to get loans for him and Koslovic, and if these loans didn't come through, well, that was understandable.

"I just thought they were axing the loans because of Kim's credit," he said.

Ryancarz never met Osborn in person. Over the phone, he sometimes heard Osborn use abusive language to office assistants, calling them nasty names if they made a mistake or didn't have the right paperwork.

"He was smooth to the clients, but as far as the people that done his work for him, he wasn't too kind," Ryancarz said.

To dispel any doubts about Osborn, Ryancarz would call the lenders that Osborn said he was working with.

Each time, Ryancarz said, he got confirmation.

"You gotta figure he's gotta be on the up and up. He's not going to be jeopardizing his reputation talking to these people or lying to you and saying he did," Ryancarz said. "You fall back on the sense of well, he's doing his job, it's just a little tougher than you thought it would be and blah blah blah."

Or, as Koslovic put it, "It's easy to push time away with the excuse of paperwork and glitches and technicalities, with all those words that everyone uses."

Ultimately, Ryancarz and Koslovic lost their houses.

It turned out that Ryancarz could have done a much better deed for Koslovic if he'd simply paid off her mortgage rather than trying to get her a new loan through Osborn.

Her house was worth $107,000. Ryancarz paid Osborn more than $370,000, court records show.

"I almost done it and I decided, no, that's not getting them where they want to be," Ryancarz said. "So I didn't do that. Hindsight indicates I should have."

My sense is that there will always be someone--a customer of his business who is allowed to rack up a $1.2MM receivable, a mortgage broker, somebody else--able and willing to part Mr. Ryancarz from his money. I am all in favor of prosecuting fraud and tightening up mortgage broker regulations, but I suspect we're kidding ourselves if we think there is any kind of workable law or regulation that will assure that the Ryancarzes of the world are protected from scammers.

I argued last year in this post, Unwinding the Fraud for Bubbles, that it was getting a bit difficult during the boom to tell the difference between the victimizers and the victims in a lot of cases. Now that we're deep into the horrors of the unwind, it is becoming increasingly fashionable in a lot of quarters to accept at face value many people's claims to have been nothing but innocent victims of the mortgage industry, and certainly with poster children like this Osborn character, the mortgage industry doesn't have much of a case for the defense. But some frauds just won't work without the greed, irresponsibility, or outright collusion of the mark. And not all of these cases are as blatantly clear as the Osborn-Ryancarz debacle. Reader Gary sent me this one, from Crain's New York Business:

Noel, a 28-year-old math teacher from Harlem who asked that his last name not be used, always thought it would be smart to invest in real estate. So when his cousin introduced him to a mortgage broker who promised he wouldn't have to put a penny down on a $1 million piece of property in New Rochelle, he jumped at the chance. Then, the same broker told him about a home in Yonkers. Again, he didn't have to put any money down.

Before he realized what he was getting into, Noel says, he was scammed into signing two mortgages totaling more than $1.5 million. The mortgage broker even provided a lawyer for the closing.

"I make $50,000 as a schoolteacher," he says. "There's no way I should have been approved for loans that big."

Hemmed in by monthly payments totaling more than $10,000 and bills for maintaining a third property on Long Island, Noel had no choice but to file for bankruptcy, he says. He filed without the help of a lawyer—he couldn't afford one—and he plans to walk away from the three homes and get a fresh start, this time without dreams of making it big.

"I thought real estate was a good business," he says. "But I guess it's not for me. I'm not buying property again—ever again."

I agree that Noel should never have been approved for the loan. I am perfectly willing to believe that the broker misrepresented Noel's income without his knowledge. But I am not quite willing to believe that Noel did not realize that mortgage loans have to be paid back. How did he think he was going to make payments on $1.5MM in loans out of a $50,000 salary? I mean, the lender probably didn't know what Noel's actual income was, but surely Noel did. Noel is a math teacher.

Noel could be scammed because Noel bought into the idea that real estate investing is a magical kind of business unlike any other kind of business in which you can put nothing down and make no loan payments and strike it rich. This does not excuse Noel's mortgage broker. It explains Noel's mortgage broker.

But what, Tanta?

by Calculated Risk on 8/19/2008 08:30:00 AM

First, the headline number was distorted by a change in the construction code in New York City that was effective July 1, 2008. Many builders filed for permits prior to this deadline, especially for multifamily construction. This boosted both permits and starts in June, and this distortion has been partially unwound in the July numbers.

So the key is to focus on single family starts.

Single-family starts were at 641 thousand in July; the lowest level since January 1991. Single-family permits were at 584 thousand in July, suggesting starts will fall even further next month.

Also employment in residential construction tends to follow completions. Completions will follow starts lower over the next few months. Single-family completions are still at 791 thousand - well above the level of single-family starts.

Click on graph for larger image in new window.

The graph shows total housing starts vs. single family housing starts.

Note that the current recession on the graph is not official.

Here is the Census Bureau reports on housing Permits, Starts and Completions.

Building permits decreased:

Privately-owned housing units authorized by building permits in July were at a seasonally adjusted annual rate of 937,000.
This is 17.7 percent (±1.3%) below the revised June rate of 1,138,000 and is 32.4 percent (±1.5%) below the revised July 2007 estimate of 1,386,000.

Single-family authorizations in July were at a rate of 584,000; this is 5.2 percent (±1.4%) below the June figure of 616,000. Authorizations of units in buildings with five units or more were at a rate of 318,000 in July.

The declines in single family permits suggest further declines in starts next month.

On housing starts:

Privately-owned housing starts in July were at a seasonally adjusted annual rate of 965,000. This is 11.0 percent (±9.0%) below the
revised June estimate of 1,084,000 and is 29.6 percent (±5.1%) below the revised July 2007 rate of 1,371,000.

Single-family housing starts in July were at a rate of 641,000; this is 2.9 percent (±10.9%)* below the June figure of 660,000. The July rate for units in buildings with five units or more was 309,000.

And on completions:

Privately-owned housing completions in July were at a seasonally adjusted annual rate of 1,035,000. This is 8.7 percent (±10.0%)*
below the revised June estimate of 1,134,000 and is 31.7 percent (±6.6%) below the revised July 2007 rate of 1,515,000.

Single-family housing completions in July were at a rate of 791,000; this is 7.2 percent (±9.3%)* below the June figure of 852,000. The July rate for units in buildings with five units or more was 229,000..

Notice that single-family completions are still significantly higher than single-family starts.

by Calculated Risk on 8/19/2008 08:18:00 AM

From Home Depot: The Home Depot Announces Second Quarter Results

Sales for the second quarter totaled $21.0 billion, a 5.4 percent decrease from the second quarter of fiscal 2007, reflecting negative comparable store sales of 7.9 percent, offset in part by sales from new stores.
...
"We continue to see pressure on our market and the consumer, generally," said Frank Blake, chairman & CEO. ...

Given the continued softness in the housing and home improvement markets as well as the commitment to invest in its key retail priorities, the Company believes fiscal 2008 sales will decline by approximately five percent ... This is consistent with its previous guidance.

And the beat goes on ...

by Calculated Risk on 8/18/2008 09:45:00 PM

Click on graph for larger image in new window.

The Shanghai SSE composite index is now below 2320, the lowest since the amazing run up started in 2006. The index is off over 60% from the peak.

This is a stunning stock market crash. Usually a stock market crash leads to less business investment, and an economic slowdown.

The second graph compares the NASDAQ (as a percent from the peak) to changes in business investment in structures and software and equipment.

This shows that business investment in both categories went negative about 3 quarters after the stock market peaked. Of course there are major differences between the U.S. and China, but I'd expect business investment to slow in China.

by Calculated Risk on 8/18/2008 06:23:00 PM

Abstract from Professor Leamer: What's a Recession, Anyway?

Monthly US data on payroll employment, civilian employment, industrial production and the unemployment rate are used to define a recession-dating algorithm that nearly perfectly reproduces the NBER official peak and trough dates. The only substantial point of disagreement is with respect to the NBER November 1973 peak. The algorithm prefers September 1974. In addition, this algorithm indicates that the data through June 2008 do not yet exceed the recession threshold, and will do so only if things get much worse.

Real Time Economics blog at the WSJ has more: UCLA Professor Says U.S. Is Still Far From Recession

Leamer is a very good forecaster, and his presentation at the Jackson Hole Symposium last year is an excellent read on how housing impacts the economy: Housing is the Business Cycle. Here is an excerpt:

The temporal ordering of the spending weakness is: residential investment, consumer durables, consumer nondurables and consumer services before the recession, and then, once the recession officially commences, business spending on the short-lived assets, equipment and software, and, last, business spending on the long-lived assets, offices and factories. The ordering in the recovery is exactly the same.

If we look at Professor Leamer's temporal road map for a recession, we are starting to see weakness in equipment and software investment (off 3.4% in the Q2 advance GDP report), and we can be very confident that investment in offices and other commercial real estate will decline in the 2nd half of 2008 and into 2009. This would argue that we are already in a recession.

Also, Leamer is correct that housing usually leads the economy both into and out of a recession. Housing busts usually look like a "V" with a sharp decline, and a sharp recovery. This time housing will probably look like an "L" shape with little recovery for some time (until the huge overhang of inventory is reduced). We are already seeing this in the NAHB confidence report released today. And we will probably see the same pattern for single family housing starts and new home sales. No quick recovery.

So once again I disagree with Dr. Leamer: I think the economy is already in a recession (not severe), however we agree that the period of economic weakness will probably linger.

by Calculated Risk on 8/18/2008 03:16:00 PM

From DataQuick: Southland home sales post annual gain -- prices drop again

The number of Southern California homes sold last month edged up to its highest level in more than a year as bargain hunters swept up foreclosure properties in affordable neighborhoods, a real estate information service reported.

A total of 20,329 new and resale houses and condos sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties last month. That was up 16.7 percent from 17,424 the previous month and up 13.8 percent from 17,867 for July a year ago, according to San Diego-based MDA DataQuick.

Last month's sales count was the highest since 21,856 homes were sold in March 2007, though it still fell 23 percent short of the average July sales total since 1988, when MDA DataQuick's statistics begin. From last September through June, sales for each month were at an all-time low for that particular calendar month, with the exception of April which was the next lowest. Last month's sales total was the first since September 2005 to rise above the year-ago level.

"What we're looking at is a fire sale of properties in newer affordable neighborhoods that were bought or refinanced near the price peak with lousy mortgages. What we're still not seeing is this level of distress spreading to more expensive or established neighborhoods," said John Walsh, MDA DataQuick president.
...
Foreclosure resales continue to be a dominant factor in today's Southern California market, accounting for 43.6 percent of all resales. That was up from a revised 41.8 percent in June, and up from 7.9 percent in July 2007. Foreclosure resales -- where a foreclosure had occurred at some point in the prior 12 months -- ranged from 22.2 percent of all resales in Orange County last month to 64.4 percent in Riverside County.
...
Foreclosure activity is at record levels ...
emphasis added

by Calculated Risk on 8/18/2008 01:20:00 PM

The NAHB reports that builder confidence was at 16 in August, unchanged from July. Usually housing bottoms look like a "V"; this one will probably look more like an "L". (this refers to activity like starts and sales, but will probably also be apparent in the confidence survey).

Click on graph for larger image in new window.

Current sales activity is near a record low of 16. Traffic of Prospective Buyers
is at a record low of 12.

NAHB Press Release: Builder Confidence Holds Steady In August

Anticipating positive impacts of newly enacted housing stimulus legislation, single-family home builders registered some improvement in their outlook for home sales in the next six months, according to the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) for August, released today. The overall confidence measure held even this month at 16, while the component gauging sales expectations rose two points to 25.
...
“While our overall measure of builder confidence remains at a record low at this time, it is a good sign that two out of three of the HMI’s component indexes rose in August, and this may be an indication that we are nearing the bottom of the long downswing in new-home sales,” said NAHB Chief Economist David Seiders. “Our current forecast shows stabilization of sales during the second half of this year, followed by solid recovery in 2009 and beyond.”

by Calculated Risk on 8/18/2008 09:44:00 AM

From the Financial Times: US banks scramble to refinance maturing debt (hat tip AT)

Battered US financial groups will have to refinance billions of dollars in maturing debt over the coming months, a move likely to push banks’ funding costs higher ...

Mohamed El-Erian, co-chief executive of Pimco, the asset management group, said: “If banks keep borrowing at these levels, you will get a repricing of credit for the whole economy.”
...
Adding together 10 of the biggest bank borrowers, Dealogic said that maturing bonds total $27bn in August, $52bn in September, $23bn in October, $20bn in November and $86bn in December. The extent of the scramble for funds became clear last week when banks tapped central lending facilities ... US commercial banks borrowed a record daily average of $17.7bn from the Fed last week.

Higher borrowing costs for banks probably means higher lending costs for customers, negatively impacting the economy.

by Calculated Risk on 8/18/2008 09:16:00 AM

From MarketWatch: Housing malaise eats into Lowe's net

Lowe's said while big-ticket item purchases continued to be hurt by the housing downturn, it saw relative strength in seasonal sales as homeowners restored lawns and outdoor landscaping after last year's drought in much of the country. The company said it also benefited from the stimulus checks from the U.S. government.
...
Sales rose 2.4% to $14.5 billion as the company opened in more locations. Same-store sales, or sales at stores open at least a year, dropped 5.3%.

Last quarter, Lowe's same store sales declined 8.4%. The stimulus checks probably helped some this quarter, but I expect the 2nd half of '08 will be difficult for home improvement retailers. Home Depot reports tomorrow.

by Calculated Risk on 8/17/2008 10:51:00 PM

A couple of articles on Lehman ...

From the WSJ: Lehman Faces Another Loss, Adding Salt To Its Wounds

With the end of the New York company's fiscal third quarter less than two weeks away, some analysts are girding for a loss of $1.8 billion or more ... [with] widely anticipated write-downs in a portfolio saddled with more than $50 billion in risky real-estate and mortgage assets ...

And on some of those real estate assets, from the Financial Times: Lehman faces fight to shed real estate assets

Lehman's near-term fate depends in large part on whether it can attract buyers for the assets and securities in its commercial real estate portfolio, valued at $40bn at the end of May.
...
Lehman's portfolio is very diverse. It consists of so-called whole loans, commercial mortgage-backed securities, risky financings such as equity bridges and individual projects.

In the Archstone deal, mentioned in the article, Lehman was in the riskiest position and it's very likely that their investment is now worthless.

For those interested in more details of the Archstone deal, from the NY Times (Oct 6, 2007): Deal Is Complete to Take Archstone REIT Private

And from the WSJ: Lehman's Property Bets Are Coming Back to Bite.

by Calculated Risk on 8/17/2008 08:42:00 PM

From the Sunday NY Times magazine: Dr. Doom (a profile of Professor Nouriel Roubini) (hat tip Peter Viles, L.A. Land)

Roubini, a respected but formerly obscure academic, has become a major figure in the public debate about the economy: the seer who saw it coming.

Professor Roubini may have been "obscure" to the general public, but he was very well known and respected in his field for some time.

The ’90s were an eventful time for an international economist like Roubini. Throughout the decade, one emerging economy after another was beset by crisis, beginning with Mexico’s in 1994. ... Roubini began studying these countries and soon identified what he saw as their common weaknesses. On the eve of the crises that befell them, he noticed, most had huge current-account deficits ... and they typically financed these deficits by borrowing from abroad in ways that exposed them to the national equivalent of bank runs.
...
After analyzing the markets that collapsed in the ’90s, Roubini set out to determine which country’s economy would be the next to succumb to the same pressures. His surprising answer: the United States’.

So far Professor Roubini has been pretty accurate and his blog is always a great read!

by Anonymous on 8/17/2008 08:00:00 AM

The moral of this story is, make sure to keep the interval between your banking crises short enough so that your experienced soldiers from the last one are still alive and hardy enough to travel when the next crisis starts.

by Anonymous on 8/17/2008 07:15:00 AM

I have had occasion before now to compliment Michelle Singletary's personal finance column, The Color of Money, in the Washington Post. I don't read a lot of "personal finance" stuff because, frankly, most of it is drivel. But even in a better field of competition, I think Singletary's work would stand out as a combination of no-nonsense advice and original reporting.

Today she takes on the subject of the new $7,500 tax credit for first-time homebuyers. What started out as an attempt to explain the tax credit to potential homebuyers ends up being an interesting report on the extent to which the IRS has no particular plan at this point for managing this thing.

Since this is a loan from the IRS, will the IRS be sending an annual loan statement to taxpayers?

The details of how the IRS will collect this money or inform people have not been worked out. Smith said a line would probably be added to the standard 1040 tax form to indicate that the credit should be paid as part of your tax liability.

Can I pay off the loan early?

The IRS hasn't yet come up with a system to accommodate an early payoff. . . .

Will this be a debt that has to be settled at closing if you sell the house?

This debt isn't tied to your home but rather to you as a taxpayer. The outstanding loan will probably not be required to be paid at the closing table, Smith said. . . .

If there is not a lien on the property, how will a settlement company know the debt is due when a homeowner sells?

It probably will be up to the homeowners to inform the IRS that a sale has occurred and that they need to pay off the loan balance, Smith said.

It's this last answer that I see as an oversight nightmare for the IRS.

Let's say a homeowner sells and realizes a $7,000 profit. However, he or she still has $6,000 left on the first-time home buyer loan. This means the homeowner will have to set aside the bulk of that gain -- $6,000 -- from the sale to satisfy the tax debt, which would be due in the tax year of the sale.

If the person isn't financially disciplined and spends the money, he or she could end up with a hefty tax liability.

"We have to look at all the issues involved with this credit and figure out the best controls," Smith said.

No kidding.

I don't exactly expect any elaborate bureaucracy like the IRS to have all its operational and procedural ducks in a row within a couple of days of the passage of this kind of "stimulus" legislation, which by definition can't exactly wait for all the details to be ironed out before passage (or it is too late to "stimulate" the market). On the other hand, the work eventually has to get done, unless the IRS is willing to promise to not penalize people who don't handle this correctly. You can't exactly make it difficult for people to know when and how much to pay you and then turn around and slap them with penalties and fines if they don't follow the rules. The IRS can tell itself it's got years to figure this out, since the first installments won't be due until the 2010 tax year for people buying this year. But that inability to handle prepayments on sale of the property is going to mess that plan up.

If we had a dime, of course, for every story we've read lately that tells us that your average first-time homebuyer either doesn't read mortgage documents or manages to understand approximately every tenth word of them, including "the" and "and," we would be rich enough to fund a study comparing the relative comprehension on the part of the public of mortgage documents versus the tax code. If we had another dime for every story we've read about mortgage servicers making it difficult for people to prepay loans, refusing to provide clear payoff statements, fouling up servicing transfers and proofs of claim and generally making it an insurmountable challenge for people to know what they actually owe and where to send the damned payment, we would also be rich enough to buy the IRS a loan servicing platform it could manage not to use correctly, just like everyone else.

But no one is handing out dimes, so we will just have to send the IRS a cheap homemade housewarming present: a little note welcoming it to the neighborhood, Love, The Mortgage Industry.

by Anonymous on 8/16/2008 09:15:00 AM

I am very pleased to offer you this post, which is actually a "Guest Nerd" offering by our regular commenter and expert mort_fin, who works on undisclosed mortgage matters in an undisclosed location and often straightens us out in the comment threads when the conversation gets to technical matters of statistical analysis of mortgages. I helped a little bit with this post (any errors in the tables are mine), but the bulk of this is mort_fin's.

Some important context for the genesis of this: it came about after dear mort_fin, and a number of our other regulars, spent most of a frustrating Saturday afternoon arguing with another commenter about this post on the FHA "DAP" program (the infamous seller-money-laundered-downpayment-assistance-program). We basically came to the conclusion that a lot of people who defend the DAPs are not arguing in good faith about the performance of these loans--they pick out statistics they don't ever define clearly and wield them in misleading ways.

Because things like the FHA DAP are such important public policy questions, it seemed to mort_fin that there was much to be gained by helping non-specialists get a better grip on the various default statistics that are available and what they do (and do not) actually tell you. This is UberNerditude at its finest, and I thank mort_fin for taking the time and effort to help us move the intellectual ball a few yards in the never-ending battle with the DAP shills.

*************

Mort_fin says:

A recent flap in the comments surrounding default rates in FHA, especially with respect to down payment assistance programs, showed how easy it is to misunderstand and abuse mortgage default rates. So I thought I’d take a shot at writing The Fairly Intelligent Person’s Guide to Default Statistics.

The first issue to note is just the words. Default, as Tanta has noted in a previous excellent UberNerd, has a fairly precise legal definition, and a fairly vague usage in the popular and financial press. To a lawyer, if you move and rent out your abode you are probably in default, even if you keep making your mortgage payment every month, since you have violated the clause in the note that says you will occupy the premises. When reading the trade press, delinquency usually means not paying the mortgage, and default might mean that foreclosure proceedings have started, have finished, are being negotiated, etc. You can’t understand the analysis if you don’t read the fine print in the definitions. I’m going to stick with default meaning “foreclosure has happened” for the following examples.

To keep everything clear, and countable on fingers without resorting to toes, let’s say 10 people all get mortgages in a year (a group all getting mortgages at the same time is a “vintage” or a “cohort”). All the initial examples will relate to these 10 people. They are color coded based on their mortgage status. The first thing to notice is that life is complicated, and there are a lot of possible outcomes. Some loans end in foreclosure (default), some are refinanced into another mortgage (which can then end in a variety of ways), some people sell the house and pay off the mortgage, and some people just sit there paying the monthly nut for 10 years or more. And you don’t follow people forever—who knows what happened to any of these folks after 10 years?


In our sample pool of ten loans, each originated in 2000, we have the following outcomes:

• Fred: Purchase mortgage for 1 year, 1 year foreclosure process, foreclosed, becomes renter
• Matilda: Purchase mortgage for 1 year, refinanced mortgage for 2 years, 1 year foreclosure process, foreclosed, becomes renter
• Jose: Purchase mortgage for 3 years, refinanced mortgage for 5 years, sells home, becomes renter
• Rashid: Purchase mortgage for 4 years, foreclosure for 1 year, foreclosed, becomes renter
• Seamus: Purchase mortgage for 4 years, foreclosure process for 2 years (stayed because of a bankruptcy filing), foreclosed, becomes renter
• LuAnne: Purchase mortgage for 4 years, refinanced mortgage for 1 year, refinanced mortgage again for 1 year, foreclosure process for 1 year, foreclosed, becomes renter
• Saty: Purchase mortgage for 2 years, purchases new home
• Mitko: Purchase mortgage for 5 years, refinanced mortgage for 5 years
• Bob: Purchase mortgage for 10 years

This may or may not be a “typical” set of outcomes for any given pool of ten mortgages. But these are all very possible outcomes, and the point of this little exercise is to see clearly just how these possible outcomes are—or are not—reflected in the default statistics we have come to rely on for measuring mortgage performance.

A vintage of loans something like this would get sliced and diced in various ways by analysts. You might see a “lifetime projected default rate” or a “cumulative to date default rate” or a “conditional default rate” or a “foreclosure initiated rate" (also sometimes call the “foreclosure inventory”). None of them is right or wrong, but any of them can be misunderstood or abused.

Start with the “cumulative to date default rate.” (Remember that this counts foreclosures completed, not started.) If these are loans originated in December of 2000, you might ask in 2000 or 2001 “what percent have gone bad?” and the answer would be zero. For most borrowers, it is rare to miss payments in the first year (the fact that it wasn't rare starting about 2 years ago should have been an enormous alarm bell for people), and it takes very roughly a year between the time people stop missing payments and the time they finish foreclosure (timeline varies widely by state). But at the end of the 2002, you have one default, Fred, for a cumulative to date default rate of 10% (1 in 10). At the end of 2003 it’s still 10%, but by the end of 2004 it’s risen to 20% because Matilda has also gone bad. But, wait a minute, Matilda refinanced in 2001, so she never defaulted on a 2000 originated mortgage. I guess it stays at 10%. The “to date” cumulative rate eventually rises to 30% as first Rashid, and then Seamus, go to default.

At the end of 2009 the “to date” is 30%, and assuming that these are 30 year mortgages, we still do not know the “lifetime projected default rate” since Bob is still out there with an active loan. You know that the lifetime cumulative rate will be at least 30% since it can’t go down (well, actually in states with rights of redemption, it theoretically could go down, but those are pretty rare events) and it can’t be more than 40%. If Bob stays good it’s 30% and if he goes bad it’s 40%. Since few people go bad after 10 good years you would probably project a 30% lifetime cumulative default rate for these loans. Matilda and LuAnne don’t count, since they refinanced and are a “success” as far as the original lender is concerned (although they might be failures from the perspective of a policy to promote homeownership). And if you’ve taken comfort in the fact that the “to date” cumulative default rate is zero at the end of 2002 you’re in for an uncomfortable surprise next year.

Note that if you want to assess what these things will cost you from a credit cost perspective, the relevant figure is lifetime cumulative defaults. When you originate the loans (which is the date that matters, since you can’t retroactively up the interest rate or the insurance premium, the horse is out of the barn at that point) all you have are projections. You don’t know what anyone has done, since they just started. After 5 or 6 years you can make a pretty good projection, but it’s far too late at that point. In this business you have two and only two options: highly uncertain knowledge when it’s useful, or very precise knowledge long after it’s useful. That’s why this business is so much fun. And the projections are sensitive not only to the quality of the underwriting (how did Fred manage to get a loan in the first place???) but also to future house prices and unemployment rates, and refinancing opportunities (a rolling loan gathers no loss).

But cumulative defaults aren’t the only, or even the most commonly presented, statistics. The commenter in the aforementioned Haloscan thread was led astray by the Foreclosures Initiated (or Foreclosure Inventory) statistic. This counts how many foreclosures are “in process.” Foreclosure is a process, not an event. The details vary by state, but a common method of judicial foreclosure is the filing of a “notice of default” in which the servicer tells the seriously delinquent borrowers that they are headed to court. This may start the foreclosure clock. Motions and countermotions are filed, court dates are scheduled and postponed, and a date for the sale of the property is set. This is the process that can take, in very rough terms, a year to play out.

In 2001 the foreclosure initiation rate in our example pool would be zero, but in 2002 it would be 11%. Why 11% you ask? Well, one loan (Fred) is in process, and there are 9 loans still active (Matilda refinanced, remember). So 1 out of 9 is 11% (with a little rounding). In 2005 the foreclosure initiation rate is 40%. Only 5 loans are still active, and two of them are in the process of being foreclosed upon.

Note that the foreclosure initiation rate tells you very little about how much of an insurance premium you needed to charge to cover the credit risk, or even whether you had a bunch of good loans or bad loans. This rate depends on the denominator as well as the numerator, and the denominator can change for all sorts of reasons, like borrowers moving and borrowers refinancing, that don’t have any direct bearing on whether these were good loans or bad loans. The inventory rate has its uses, but summarizing credit quality or expected costs isn’t one of them. It is a pretty sensitive number for summarizing current conditions – it tends to rise rapidly when things get bad, and fall back to earth when things get good.

The other commonly cited statistic is the CDR, the Conditional Default Rate. It is “conditional” because it is “conditioned by survival.” The denominator consists of all the loans that have survived until today, neither prepaying in the past nor defaulting in the past. Again, for the first two years, the CDR is zero. In 2002 it is 13% since 8 loans are still alive, and 1 is defaulting. In 2003 and 2004 it is back to zero, and then in 2005 it skyrockets up to 33%, as only 3 loans still survive, and one of them has gone bad. The CDR is useful as an input to complicated cash flow models, but by itself it doesn’t tell you much about credit quality, since, again, it depends on the denominator as much as it does on the numerator, and for older pools of loans the denominator can be pretty small.

Returning to our little pool of ten loans, these are the values we get for these three measures over ten years. (Click on the table to enlarge.) You can see how confused a conversation at any given point in time would be that tossed these numbers around without context:


The big analytical mistake you do not want to make here, of course, is the one Tanta likes to complain about in the work of various apologists for high-risk lending: assuming that if 30% of the loans in a given vintage fail, then 70% of the borrowers were “successful.” Here’s another way of looking at our example pool that contrasts the results of a standard vintage analysis (what happened to the loans that were originated in 2000?) with an actual borrower analysis (what was the mortgage performance of these ten borrowers over ten years?). You get very different numbers:


Now try a more complicated graphic, which looks a lot more like an active portfolio of loans than a static vintage. Imagine that 10 people a year are flowing into your sights as an analyst, and the world looks boringly the same from year to year—each new vintage performs just like the previous one.


Here's the tabular result:


In the first year, foreclosures (cumulative to date, inventory, and CDR) are all zero again. In year 2 the foreclosure rate, cumulative and CDR, are still zero, but the inventory is now 1/19. There are 9 loans still active from the first cohort, and 10 new loans have come into the picture. Of course, new loans are almost never in foreclosure, so letting new loans flow into the picture lowers the foreclosure inventory rate substantially. It is still the case that 30% of loans in each vintage and 50% of borrowers will ultimately go bad, but now the foreclosure inventory is a little over 5%, and the cumulative default rate and CDR are still zero. Go out one more year, and 10 new loans have flowed into the picture. 30 loans have come in, 3 have left via prepayment, and 1 of the remaining 27 is a foreclosure that has happened in that year. So the CDR is now a little under 4% (1 out of 28), and the cumulative claim rate is a little over 3% (1 out of 30). Interpreting the numbers from a dynamic pool of mortgages (loans constantly flowing into the system) is harder than interpreting a static pool (always looking at the same set of loans).

A great real-life example of cumulative (to-date and projected) default rates and CDRs can be found in FHA’s Actuarial studies. Go down to Appendix, and click on Econometric Results in Excel. There are tabs for All_Orig_CumC (All Originations Cumulative Claims – to FHA, a foreclosure is a claim, since they are an insurer, not a mortgage investor) and tabs for All_Orig_ConC for the Conditional Claim Rates. In the cumulative tab, note that FHA projects 15.89% of 2007 originations will ultimately go bad, and this is entirely a projection. For 2000, they project 7.61% will go bad – as these loans are now 7 years old, this is based on actuals of 6.73% having gone bad, and a projection that there will only be a few more foreclosures left to go. On the Conditional Claims rate tab, note that the expectation over the next year is that 0.5% out to 3% of loans are expected to go bad in the next year, depending on how old the loans are (which cohort they are in). It is these annual rates, properly accumulative (you have to adjust the figures so your denominator is always originated loans, not surviving loans), that get you anywhere from 6% to 22% lifetime foreclosure rates, for the good years vs. the bad years. You may want to revisit the HUD site next year to see how projections get revised. These are based on an August 2007 house price forecast. I suspect that has now been rendered inoperative.

The lesson to learn here is to ask questions. 1) What are the definitions in use? 2) Are you looking at a static or a dynamic population? 3) What are you trying to measure? 4) What is happening to the denominator in your ratio?

If you’re trying to ascertain credit costs, failures to date or failures over the past year won’t get you where you want to go. And if you’re trying to ascertain homeownership success, mortgage failures alone won’t give you an answer. Matilda and LuAnne “succeeded” on their first mortgages, but still had a sheriff evict them eventually. Jose and Tania didn’t get foreclosed—the statistics would simply count them as a “voluntary prepayment”—but it’s hard to say that homeownership was a success for them since they ultimately found the cost of owning impossible to maintain and were simply “lucky” enough to sell before they were foreclosed. And even if you’re trying to do an apples to apples comparison—like “Did the CDR for this pool exceed the CDR for that pool?”—it’s important to keep in mind that numerators and denominators can shift because of prepayments, not just defaults. We really don’t know what was motivating the refinances in our pool—lowering interest rates? Taking cash out? We don’t really know whether the refinances improved or worsened the borrower’s actual financial position, but we do know that higher or lower prepayments in a pool can certainly make statistics like CDR “look” more or less frightening.

The unfortunate truth is that mortgage analysts simply do not in any normal circumstances have access to a dataset like the one we have made up for this post. Whether you are looking at a static pool with a single vintage or a dynamic portfolio with multiple vintages, you are tracking loans, not borrowers or properties, and you are tracking “prepayments” of those loans. You simply do not know whether that prepayment was a refinance or a sale of the home; you don’t know what that borrower did after the prepayment. This information simply isn’t in the standard databases. The bottom line about making claims regarding borrower “success” by reference to mortgage default statistics is “you can’t necessarily get there from here.”

Click here for Guest Nerd Special!

by PJ on 8/16/2008 07:45:00 AM

Via the Wall Street Journal, we learn this morning that the FBI is looking into sellers' use of incentives to prop up home prices during the early days of the RE crash. The idea here is that giving away a boat if a buyer spends half a million on a $400K house sort of puts the lender at a severe disadavantage, esp. if that sort of incentive wasn't disclosed ....

The FBI ... confirmed that it is looking at cases where the disclosures of incentives "haven't made it all the way to the ultimate lender," says William Stern, financial crimes supervisor for the FBI in Palm Beach County, Fla., and the bureau's former national mortgage-fraud coordinator.

Interviews with real-estate agents, home buyers and former employees at home builders describe an industry where competitive pressures fueled unusually creative giveaways in a last-ditch attempt to prevent price cuts....

"You weren't buying a house. You were buying a package," says Dana Ellis, who worked as an escrow manager for Centex from 2004 to 2006. To qualify, Centex required the buyer to use the company's in-house mortgage unit to originate the loan, and the loan application included an incentive "addendum" that listed the incentives but wasn't always sent to the lender. "They weren't disclosing any of this. That was on separate paper that was pulled," she says.

Centex says that the program was confined to about 50 sales and was shut down in June 2006, about six months after it began. Centex averaged 63 home sales a month for the year beginning April 2006. "These incentives did not reflect standard corporate practice and, once discovered, the practice was immediately halted," Centex spokesman David Webster says. Centex says only one of the loans was government-backed, through the Veterans Administration home-loan program, and the builder has promised to stand behind all of those loans.

Elsewhere, developers offered "sweat equity," or payments for buyers to receive home improvements such as landscaping. "You're basically getting banks to give you a cash advance," says Chip Hickman, the general manager of Easy Street Realty in Las Vegas. He said such programs weren't heavily advertised and were offered by many area builders, although he declined to name them. "It was more sales agents in the model home saying, 'Look, tell me what you need and I got a lot of money to play with.' "

There aren't any strict limits on incentives, but they could run afoul of federal regulations if they cause the mortgage to increase by more than the cost of the incentive. "It's a phantom incentive to mask it in an excessive loan," says Brian Sullivan, a Department of Housing and Urban Development spokesman.

Of course, banks could and should have caught much of this sort of deception. What about the appraisal, you ask? Let's muddy the waters a little bit here:

Stronger due diligence by banks might have caught some of these problems. Banks, however, say they relied on professional appraisal companies to insure property pricing. Mortgage-fraud experts say appraisers sometimes cooperated with builders because it was the only way to get business. Appraisers say that determining the value of new homes is more difficult because comparable sales figures are provided by builders...

Some builders continue to make generous offers. Wagner Homes Inc., a local home builder, advertises in big capital letters at the top of a flyer "$130,000 commission any way you like it!" for homes in developments like "Dawn Day Fusion," a northwest Las Vegas subdivision that offers homes with Asian-inspired architectural flourishes. New homes listed there in mid-July for $530,000 even though similar model homes in that development sold for $400,000 two years ago.

And so we pull the thread a little further on fraud. Cue The Sweater Song (for any Weezer fans out there).

by PJ on 8/15/2008 07:00:00 PM

As opposed to death by. Bad joke, I know. But Friday marked the latest in a growing list of retail casualties, and one I relied on for my chocolate fix at the mall, too:

Cookie retailer Mrs. Fields Famous Brands LLC said on Friday it plans to file for Chapter 11 bankruptcy protection to help restructure its business, according to a U.S. Securities and Exchange Commission filing.

The company, which licenses and franchises about 1,200 Mrs. Fields Cookies and TCBY frozen yogurt locations worldwide, has begun soliciting votes from creditors for a "prepackaged" bankruptcy reorganization plan.

Under a prepackaged plan, creditors vote on certain aspects of the plan prior to the bankruptcy filing in court.

More than two-thirds of its bondholders have agreed to vote in favor of the prepackaged plan, though their support is contingent upon the company submitting its bankruptcy filing to the court by August 25, according to the regulatory filing.

It's Friday, and the FDIC is quiet .... (and hat tip for the story to just about everyone in the comments!)

by PJ on 8/15/2008 03:28:00 PM

While we're talking about high profile foreclosures, via the LA Times, Ed McMahon's ship has arrived:

... Donald Trump has agreed to buy Ed McMahon's Beverly Hills house for an undisclosed amount and allow McMahon to continue living in it.

"I don't know the man, but I grew up watching him on TV," Trump said in an exclusive interview with The Times....

Trump said he stepped in because helping McMahon "would be an honor." His plan is to buy the home from the lender and lease it back to McMahon.

"When I was at the Wharton School of Business," Trump said, "I'd watch him every night. How could this happen?"

Same way it happens to many other, less famous borrowers, I'd guess.

by Anonymous on 8/15/2008 01:15:00 PM

I guess it's just Freaky Friday on the real estate front.

Y'all remember Rep. Laura Richardson (D-Deadbeat)? How those meanies at WaMu foreclosed on her poor innocent self, and how she threw her weight around and got the foreclosure rescinded and a loan modification done?

So far this noble effort to prevent foreclosure and keep the dream of ownership alive is workin' out great. From the LA Times:

This week, in the latest chapter in the housing saga, the Code Enforcement Department in Sacramento declared her home a "public nuisance."

The city has threatened to fine her as much as $5,000 a month if she doesn't fix it up.

Neighbors in the upper-middle-class neighborhood complain that the sprinklers are never turned on and the grass and plants are dead or dying. The gate is broken, and windows are covered with brown paper.

"I would call it an eyesore," said Peter Thomsen, a retired bank executive who lives nearby.

Thanks, Brian!