by Calculated Risk on 2/02/2006 03:06:00 PM

The New Economist reviews the HSBC report: A Froth-Finding Mission: detecting US housing bubbles

The report itself concludes that the "glass is half froth":

We suggest that about half of the US housing market is frothy and that this ‘bubble zone’ may be overvalued by as much as 35-40%, after taking into account low interest rates and tax advantages. Current valuations imply a large permanent reduction in the risk premium and/or a sizable step up in future capital gains, not all of which, we think, is justified. ... Therefore, when these housing bubbles begin to deflate, it is likely to have substantial macroeconomic consequences.

The New Economist is not overly concerned:

I do not consider this to be the greatest threat facing the US or global economy. As I have argued before, the experience of both the Reserve Bank of Australian and Bank of England is that housing bubbles can successfully be deflated over a 2-3 year period by steady rate hikes and clear, consistent messages to investors. If the Federal Reserve is able to follow their example - and there's no obvious reason why they can't - that would detract around 1.0 to 1.5 percentage points a year from GDP growth. Enough to drag annual US growth below trend, but nowhere near recession territory.

I'm not quite as sanguine.

by Calculated Risk on 2/02/2006 12:58:00 PM

Here are FED Governor Susan Schmidt Bies' comments on nontraditional mortgage products, from her speech today at the Financial Services Institute:

The U.S. banking agencies have also issued draft guidance on certain mortgage products. Over the past few years, the agencies have observed an increase in the volume of originations for residential mortgage loans that allow borrowers to defer repayment of principal and, sometimes, interest. These mortgage loans, often referred to as “nontraditional mortgage loans,” include “interest-only” (IO) mortgage loans, in which a borrower pays no loan principal for the first few years of the loan, and “payment-option” adjustable-rate mortgages (option ARMs), in which a borrower has flexible payment options--and which also could result in negative amortization.

In 2005, option ARMs and IOs were an estimated one-third of total U.S. mortgage originations. By contrast, in 2003, these products were estimated to represent less than 10 percent of total originations. Despite the recent publicity, however, it is estimated that these mortgages still account for less than 20 percent of aggregate domestic mortgage outstandings of $8 trillion. While the credit quality of residential mortgages generally remains strong, the Federal Reserve and other banking supervisors are concerned that current risk-management techniques may not fully address the level of risk in nontraditional mortgages, a risk that would be heightened by a downturn in the housing market.

Nontraditional mortgage products have been available for many years; however, these types of mortgages were historically offered to higher-income borrowers only. More recently, these products have been offered to a wider spectrum of consumers, including subprime borrowers who may be less suited for these types of mortgages and may not fully recognize their embedded risks. These borrowers are more likely to experience an unmanageable payment shock at some point during the life of the loan, which means they may be more likely to default on the loan. Further, nontraditional mortgage loans are becoming more prevalent in the subprime market at the same time that risk tolerances in the capital markets have increased. When risk spreads return to more “normal” levels, banks need to be prepared for the resulting impact on liquidity and pricing. Supervisors have also observed that lenders are increasingly combining nontraditional mortgage loans with weaker mitigating controls on credit exposures, such as allowing reduced documentation in evaluating the applicant’s creditworthiness and making simultaneous second-lien mortgages as competition in the mortgage banking industry intensifies. These “risk layering” practices have become more and more prevalent in mortgage originations. Thus, while elements of the product structure may have been used successfully by some banks in the past, the absence of traditional underwriting controls may have unforeseen effects on losses realized in these products.

In view of these industry trends, the Federal Reserve and the other banking agencies decided to issue the draft guidance on nontraditional mortgage products. The proposed guidance emphasizes that an institution’s risk-management processes should allow it to adequately identify, measure, monitor, and control the risk associated with these products. The guidance reminds lenders of the importance of assessing a borrower’s ability to repay a loan, including monthly payments when amortization begins and interest rates rise. Lenders should recognize that certain nontraditional mortgage loans are untested in a stressed environment; for instance, nontraditional mortgage loans to investors that rely on collateral values could be particularly affected by a housing price decline. Bankers should ensure that borrowers have sufficient information so that they clearly understand, before choosing a product or payment option, the terms and associated risks of these loans, particularly how far monthly payments can rise and that negative amortization can increase the amount owed on the property above what was originally borrowed. These products warrant strong risk-management standards as well as appropriate capital and loan-loss reserves.

Recently mortgage lenders have asked for an extension of the comment period to respond to the new guidance. I haven't seen if this extension has been granted.

by Calculated Risk on 2/01/2006 03:02:00 PM

"By passing these reforms, we will save the American taxpayer another $14 billion next year, and stay on track to cut the deficit in half by 2009." George W. Bush, SOTU Address, Jan 31, 2006

After four months, Fiscal 2006 continues to set new records for the YTD increase in National Debt. For the first four months of fiscal year 2006, the National Debt increased $263.4 Billion to $8.196 Trillion as of Jan 31, 2006.


Click on graph for larger image.

The previous record for the first four months was in fiscal 2005 with an increase in the National Debt of $248.7 Billion.

Each month I will plot the YTD increase in the National Debt and compare it to the proceeding years. I expect fiscal 2006 to set a new record for the annual increase in the National Debt.

NOTE: I quoted the SOTU address last night for two reasons: first, $14 Billion is an inconsequental amount compared to the US budget, and second, there is no way the US will "cut the deficit in half" by 2009. George W. Bush has no credibility on the budget:

"... our budget will run a deficit that will be small and short-term" George W. Bush, SOTU Address, Jan 29, 2002

by Calculated Risk on 2/01/2006 11:01:00 AM

The Mortgage Bankers Association (MBA) reports: Mortgage Application Volume Declines In Latest Survey

Click on graph for larger image.

The Market Composite Index — a measure of mortgage loan application volume was 626.8 – a decrease of 5.1 percent on a seasonally adjusted basis from 660.5 one week earlier. On an unadjusted basis, the Index increased 9.1 percent compared with the previous week but was down 12.1 percent compared with the same week one year earlier.

The seasonally-adjusted Purchase Index decreased by 8.0 percent to 435.7 from 473.7 the previous week whereas the Refinance Index decreased by 1.5 percent to 1747.2 from 1773.9 one week earlier.

Rates on mortgages increased:

The average contract interest rate for 30-year fixed-rate mortgages increased to 6.20 percent from 6.04 percent one week earlier ...

The average contract interest rate for one-year ARMs increased to 5.48 percent from 5.44 percent one week earlier ...

Activity is still high, but falling again as mortgage rates are once again rising.

by Calculated Risk on 1/31/2006 05:37:00 PM

The AP is reporting:

President Bush ... [will say] Tuesday that "America is addicted to oil" and must break its dependence on foreign suppliers in unstable parts of the world.

The problem is not the source of the oil, but that America is addicted to oil in general. Oil is a global market, and to break the addiction the US needs to reduce consumption, not drill for more domestic oil. Unfortunately Bush's energy policies have been focused primarily on oil, even promoting the consumption of more oil with tax breaks for small businesses that buy large SUVs. From 2003:

This year, the perks of buying a large SUV — if you're a small business owner — got even bigger.

Congress recently passed a tax bill, as proposed in President Bush's economic stimulus plan, that offers a $100,000 tax credit for business owners who purchase any vehicle weighing 6,000 pounds or more when fully loaded.

There are several benefits of moving away from oil; economic, geopolitical and environmental. Hopefully, Bush will not call for more domestic drilling (a huge mistake), but instead call for new innovation and more conservation.