by Calculated Risk on 11/28/2007 09:24:00 AM

From Fed Vice Chairman Donald L. Kohn: Financial Markets and Central Banking

... uncertainties about the economic outlook are unusually high right now. In my view, these uncertainties require flexible and pragmatic policymaking--nimble is the adjective I used a few weeks ago.

That sounds like Kohn supports a rate cut in December.

by Calculated Risk on 11/27/2007 06:54:00 PM

From Reuters: Freddie Mac cuts dividend, slates $6 billion preferreds

Freddie Mac ... said it halved its quarterly dividend and will sell $6 billion in preferred stock to bolster capital in anticipation of mortgage-related losses.

No surprise.

by Calculated Risk on 11/27/2007 06:50:00 PM

From MarketWatch: Wells sets aside $1.4 bln to cover home loan losses (hat tip crispy&cole)

Wells Fargo & Co., the second-largest U.S. mortgage lender, said late Tuesday that it will set aside $1.4 billion during the fourth quarter to cover higher losses on home-equity loans caused by deterioration in the real estate market.
...
The special reserve covers an $11.9 billion portfolio of loans that the bank originated or acquired through indirect sources such as mortgage brokers, Wells explained. That portfolio will be sold off under the guidance of a dedicated management team, the bank added.

by Calculated Risk on 11/27/2007 05:34:00 PM

Goldman Sachs Chief Economist Jan Hatzius released a new report on housing today: Housing (Still) Holds the Key to Fed Policy

There is no link available.

Note: The following excerpts are used with permission.

In this new report, Goldman revised down their housing outlook significantly (here is their August forecast). Goldman now sees housing starts falling to 750K (their earlier forecast was for starts to fall to 1.1 million units).

On housing prices:

Home prices are also likely to decline substantially. If the economy narrowly escapes a full-blown recession—as we continue to expect in our baseline forecast—a peak-to-trough decline of 15% in house prices is the most likely outcome. This would imply price declines in states such as Florida of up to 30%. If the economy does enter a recession, prices could decline as much as 30% nationwide.

On the impact of less Mortgage Equity Withdrawal (MEW) on consumer spending:

Consumer spending growth has remained stable over the last 1-2 years as rising equity prices and sturdy income growth have offset the drag from falling mortgage equity withdrawal (MEW) and slowing home prices. Nevertheless, consumption has underperformed income growth, as predicted by our MEW-augmented consumption model. Going forward, our model points to a more substantial drag of housing on real consumer spending growth, with a slowdown from the recent 3% pace to a 1% annualized rate in early 2008.

Click on graph for larger image.

On negative equity:

The basic problem is that house price declines create large amounts of negative equity. Homeowners with negative equity lose their ability to respond to adverse financial events such as job loss or mortgage reset by refinancing or selling their home, and they therefore become much more likely to default. The importance of this problem is illustrated in Exhibit 16, which shows the distribution of home equity among US mortgage holders at the end of 2006 according to an analysis by First American CoreLogic, Inc. About 7% of US mortgage holders had negative equity at that point, and another 14% had equity of less than 15%. Thus, 21% of all mortgage holders—holding about $3 trillion in aggregate mortgage debt given the average mortgage debt held by the vulnerable borrowers—would be put into a negative-equity position if home prices fell by 15%.

There is much more in the report. Goldman now puts the odds of a recession in 2008 at around 40%, and they see the unemployment rate rising to 5.5% by the end of 2008.

In the past, such a rise in the unemployment rate has invariably come in the context of an overall recession ... The risk that it would do so again is high ... however, our analysis does not imply a recession when taken at face value. Instead, it points to a long period of below-trend growth.

I'll post more on the details of their analysis - and offer my view - later this week. Goldman has definitely turned significantly more bearish on housing and the economy.

by Calculated Risk on 11/27/2007 02:59:00 PM

The S&P Case-Shiller National home price index was released this morning. (See note at bottom).

The reported Case-Shiller numbers are nominal; not adjusted for inflation. Most people think in nominal terms, but it's also important to look at real house prices.

Click on graph for larger image. The first graph shows the nominal Case-Shiller index. The index peaked in Q2 2006, and nominal prices have declined about 5% from the peak.

The second graphs shows real prices according to the Case-Shiller index (adjusted using CPI less Shelter). Real Prices peaked in Q1 2006, and are off about 8% from the peak.

The second graph probably provides a better first estimate of how far prices still need to fall (for the Case-Shiller universe). If prices fall to 120 (in real terms) that is about another 25% from the current level.

This could happen with falling nominal prices, or from several years of inflation, or a combination of both. Say nominal prices fall 15% over the next three years, with a 2% per year inflation rate, then real prices would fall to about 130 on the Case-Shiller index.

This suggests to me that price declines have just started, and that the process will last several years. It's important to remember that different areas will see different percentage price declines - the bubble areas will see the largest declines - and the time frames for each location will be different.

NOTE: There are significant differences between the OFHEO HPI and the Case-Shiller National index. This is an excellent summary by OFHEO economist Andrew Leventis: A Note on the Differences between the OFHEO and S&P/Case-Shiller House Price Indexes. The OFHEO note suggests that the primary reason for the difference between Case-Shiller and OFHEO price indices is geographical coverage (not the loan limitations for OFHEO).