by Anonymous on 3/25/2007 08:34:00 AM

David S. Hilzenrath reports in yesterday's Washington Post:

Freddie Mac, still fixing weaknesses that came to light in 2003, yesterday issued its first timely annual report in five years, which showed that the giant mortgage funding company lost $480 million in the fourth quarter. That compared with a profit of $684 million in the comparable period a year earlier.
. . .
"Families are finding it hard to stay in their homes as deteriorating house prices, regional job losses and increasing mortgage payments are making their homes less affordable," chairman and chief executive Richard F. Syron said in a prepared statement.

Last year, Freddie experienced a slight deterioration in the creditworthiness of loans "as more loans transitioned through delinquency to foreclosure" and as "the expected severity of losses" on individual homes increased, the company said.
. . .
Freddie reported that the delinquency rate on its single-family home mortgages -- the percentage of loans at least 90 days past-due or in foreclosure -- declined to 0.53 percent last year, from 0.69 percent the year before.

There were also less favorable developments. The company lost $126 million last year on loans it had to repurchase from other investors because they were late 120 days or more. In 2005, there were no such losses, spokesman Michael Cosgrove said.

For a company the size of Freddie Mac, $126 million is not a crippling loss. But it shows that the repurchase problem--in this case, apparently, of loans sold with recourse--is affecting everyone in the food chain. Freddie's report also may indicate that the problem for prime and near-prime will be loss severity, not loss frequency. Subprime, it seems clear, faces the same or worse severity problems, but of course at much higher frequencies.

by Anonymous on 3/24/2007 01:51:00 PM

I had meant to post something on this a while ago; it’s a March 15 press release from HUD.

Assistant Secretary for Housing - Federal Housing Commissioner Brian Montgomery today reaffirmed the need to modernize the Federal Housing Administration (FHA) and give homeowners a better alternative to exotic high-cost mortgages. . . .

The National Association of Realtors reports that last year 43 percent of first-time homebuyers purchased their homes with no downpayment. Of those who did make a downpayment, the majority put down two percent or less. Modernization legislation, which overwhelmingly passed the House last year, would replace the FHA's stringent three percent minimum cash investment requirement with a flexible plan that allows homeowners to put down almost no money down, one, two or even ten percent.

To prevent the FHA from being priced out of many housing markets, the FHA's modernization legislation would also increase loan limits. Today, few buyers of homes in California or much of the Northeast have been able to use FHA financing because FHA's loan limits aren't high enough to meet the cost of most homes in those regions. By increasing and simplifying loan limits, FHA would once again be a major player in high-cost areas.

FHA modernization legislation would also create a new, risk-based insurance premium structure that would match the premium amount with the credit profile of the borrower. It would replace the current structure, in which there is standard premium amount for all borrowers, while still protecting the soundness of its Insurance Fund.

So, we have some interesting new terms to work with:

“Flexibility”: This is a good idea because a program that “allows” no down payment can also “allow” a 10% down payment. The old program “required” a 3% down payment, and “allowed” anything larger than that. That was inflexible, you see.

“Simplicity”: This is a good idea because a “simple” definition of a moderately-priced home—and thus a maximum FHA loan—can allow FHA to be a “major player” in the game of helping house prices keep going up and up and up. The “complex” definition of a moderately-priced home, on the other hand, might allow FHA to function as a drag on runaway home price appreciation by limiting financing options and thus helping to force prices downward.

“Modernization”: This is a good idea because having a large, fairly homogeneous risk pool, with some individual variation in credit quality, that is all priced the same way for insurance purposes, only worked in the Dark Ages. The new, modern, risk-based approach is much cooler, because there is no question that we know, precisely, how to price that risk, and that whole “group insurance policy” thing is never cheaper than individually-underwritten policies.

You may add those terms to the “Ownership Society” dictionary.

by Calculated Risk on 3/23/2007 07:19:00 PM

"[T]he persistent imbalance in housing supply and demand ... is fueling intense competition and pricing pressure among homebuilders and other participants in the new home and resale markets."
Jeffrey Mezger, CEO, KB Home, March 22, 2007

The above comment raises the question: Why not adjust the price to balance supply and demand?

This diagram shows the normal Supply and Demand relationship. When supply shifts (dark blue to light blue) then the price falls from P0 to P1.

And when demand shifts, perhaps due to the changes in lending standards (from dark red to light red), the prices falls again, this time from P1 to P2.

So, with the current changes in supply and demand, we would expect falling prices, but no "imbalance in housing supply and demand".

In fact new home prices have been falling. KB Home reported their average selling price declined 5% in Q1 2007 (compared to Q1 2006). And most homebuilders have been providing incentives (upgrades, free landscaping, etc.) that can be viewed as price reductions too.

The above diagram works well for commodities, like corn, but the housing market is far more complicated. First, housing markets are local - most housing services aren't transportable - and one area of the country might have different dynamics than other areas. Second, there are reasonable substitute goods for new homes (mostly existing homes and some rentals) that compete with homebuilders for purchasers of housing services.

Note: usually existing homes compete directly with rentals. However this impacts new home sales too because of the typical chain reactions that occur in the housing market.

During periods of weakness, prices in the existing home market typically exhibit strong persistence and are sticky downward. Sellers tend to want a price close to recent sales in their neighborhood, and buyers, sensing prices are declining, will wait for even lower prices. This means real estate markets do not clear immediately, and what we usually observe is a drop in transaction volumes.

This sticky price phenomenon in the existing home market is actually good for new home sales. The homebuilders can lower their prices, and stimulate demand. This probably helped the builders in 2006. However when existing home supply reaches a certain point, prices start to fall in the existing home markets too. Also, when lenders start taking short sales, and banks are selling REOs (bank Real Estate Owned), this puts additional pressure on prices.

Click on graph for larger image.

This graph shows monthly existing home inventory since January 2004. The National Association of Realtors (NAR) noted today: "Raw inventories peaked last July at 3.86 million, and supplies topped at 7.4 months in October." However, NAR didn't note that inventories usually increase through mid-summer, and inventories will probably be well over 4 million this summer.

In fact, if inventories grow at the same percentage rate as last year, inventory levels will reach 4.8 million in August. If inventories grow by the same quantity as 2006, inventories will be over 4.6 million by August.

With tighter lending standards, demand will probably fall too. Credit Suisse recently estimated new home sales would fall by 21% in 2007. BofA estimated a decline of 15% for new home demand in 2007. We will probably see a similar decline in existing home sales.

This graph shows annual existing home sales and inventory for the last 30 years (2007 estimated). The graph shows an estimated inventory increase to 4.5 million units, and sales falling to 5.7 million units (my estimate is 5.6 to 5.8 million existing home sales in 2007).

Inventory of 4.5 million units, and sales of 5.7 million, means 9.5 months of supply this summer. For the more optimistic, use 4 million units of inventory, and sales only falling to 6 million units, giving 8 months of supply.

Usually 6 to 8 months of inventory starts causing pricing problems, and over 8 months a significant problem. With current inventory levels at 6.7 months of supply, inventories are now well into the danger zone. By mid-summer, months of supply will likely be a significant problem.

And this takes us back to the supply demand imbalance. The huge overhang of existing home supply makes the market appear to be out of balance to the new home builders.

by Calculated Risk on 3/23/2007 12:31:00 PM

From the NYTimes: The Subprime Loan Machine. This story describes the rise of automated underwriting; both the benefits and the pitfalls.

“Automated underwriting put the credit score on such a pedestal that it obscured the other important things, like is the income actually there,” said Professor Retsinas of Harvard. “Before there was A.U., down payment mattered a lot. Where we’ve crossed the line in recent years is to say, we don’t need down payment.”

This article is very good, but Tanta notes that it doesn't mention Nicolas Retsinas previously "served as Assistant Secretary for Housing-Federal Housing Commissioner at the United States Department of Housing and Urban Development, and as Director of the Office of Thrift Supervision."

The following two articles look at the impact of the housing bust on communities (hat tip: Wayne):

From the NY Times: Foreclosures Force Suburbs to Fight Blight

“It’s a tragedy and it’s just beginning,” Mayor Judith H. Rawson of Shaker Heights, a mostly affluent suburb, said of the evictions and vacancies, a problem fueled by a rapid increase in high-interest, subprime loans.

“All those shaky loans are out there, and the foreclosures are coming,” Ms. Rawson said. “Managing the damage to our communities will take years.”

From the Charlotte Observer: Failed mortgages fly under the radar

An Observer analysis of county records found 35 Mecklenburg developments of low-priced homes built in the past decade with foreclosure rates of 20 percent or higher. Dozens of residents say the concentrations have damaged their communities. Prices fell. Renters moved in. Crime sometimes rose.

by Calculated Risk on 3/23/2007 10:07:00 AM

The National Association of Realtors (NAR) reports: Existing-Home Sales Rise Again in February

Click on graph for larger image.

Total existing-home sales – including single-family, townhomes, condominiums and co-ops – rose 3.9 percent to a seasonally adjusted annual rate1 of 6.69 million units in February from a downwardly revised level of 6.44 million in January, but are 3.6 percent below the 6.94 million-unit pace in February 2006.

The above graph shows NSA monthly sales for 2005, 2006 and 2007. This shows that March is the first key month of the year.

Total housing inventory levels rose 5.9 percent at the end of February to 3.75 million existing homes available for sale, which represents a 6.7-month supply at the current sales pace compared with a 6.6-month supply in January. Raw inventories peaked last July at 3.86 million, and supplies topped at 7.4 months in October.

A few key points:

1) March is the beginning of the spring selling season.

2) Inventory is at a record levels for February (30% above Feb 2006).

3) Existing home sales are reported at the close of escrow. This means these contracts were mostly signed in December and January. So these numbers are prior to the subprime implosion of mid-February.