by Calculated Risk on 11/29/2007 11:45:00 AM

First, three key points to consider on housing.

Note: For more graphs, please see my earlier post: October New Home Sales

Let's start with revisions. In August, I wrote:

The new homes sales number today [August] will probably be revised down too. Applying the median cumulative revision (4.8%) during this downtrend suggests a final revised Seasonally Adjusted Annual Rate (SAAR) sales number of 757 thousand for August (was reported as 795 thousand SAAR by the Census Bureau). Just something to remember when looking at the data.

Sure enough, sales for August have been revised down to 717 thousand! The same is true for September (initially reported at 770 thousand, now revised down to 716 thousand).

The same will probably be true for the just reported October sales number of 728 thousand. It is likely the final number will be below 700K.

I believe the Census Bureau is doing a good job, but the users of the data need to understand what is happening (during down trends, the Census Bureau initially overestimates sales).

For an analysis on Census Bureau revisions, see the bottom of this post.

Next up, inventory. The Census Bureau reported that inventory was 516 thousand units. But this excludes the impact of cancellations. Currently the inventory of new homes is understated by about 100K (See this post for an analysis of the impact of cancellations on inventory).

This also means that the months of supply is understated. The Census Bureau reported the months of supply as 8.5 months. Assuming a typical downward revision, and adjusting for the impact of cancellations, the actual months of supply is probably closer to 10.5 months.

The impact of OFHEO reported falling prices on household assets. Also this morning, OFHEO reported that house prices fell in Q3. This will impact the Fed's calculation of household real estate assets. I expect household real estate assets to decline around $60 Billion in Q3. (0.3% price decline times $21 Trillion in assets).

Since Mortgage Equity Withdrawal appears to have still been strong in Q3, the percent equity will decline sharply! I believe this will start to impact the ability of homeowners to use the Home ATM in the near future.

Click on graph for larger image.

This graph shows New Home Sales vs. Recession for the last 35 years. New Home sales were falling prior to every recession, with the exception of the business investment led recession of 2001.

This is what we call Cliff Diving!

And this shows why so many economists are concerned about a possible consumer led recession - possibly starting right now!

The second graph compares annual New Home Sales vs. Not Seasonally Adjusted (NSA) New Home Sales through October.


Typically, for an average year, about 86% of all new home sales happen before the end of October. Therefore the scale on the right is set to 86% of the left scale.

It now looks like New Home sales will be around 800 thousand - the lowest level since 1996 (758K in '96). My forecast was for 830 to 850 thousand units in 2007 and that now appears a little too high.

by Calculated Risk on 11/29/2007 10:38:00 AM

From OFHEO: House Prices Weaken Further in Most Recent Quarter

For the first time in nearly thirteen years, U.S. home prices experienced a quarterly decline. The OFHEO House Price Index (HPI), which is based on data from sales and refinance transactions, was 0.4 percent lower in the third quarter than in the second quarter of 2007. This is similar to the quarterly decline of 0.3 percent (seasonally-adjusted) shown in the purchase-only index. The annual price change, comparing the third quarter of 2007 to the same period last year showed an increase of 1.8 percent , the lowest four-quarter increase since 1995. OFHEO’s purchase-only index, which is based solely on purchase price data, indicates the same rate of appreciation over the last year.

Finally OFHEO shows prices falling.

by Calculated Risk on 11/29/2007 10:10:00 AM

According to the Census Bureau report, New Home Sales in October were at a seasonally adjusted annual rate of 728 thousand. Sales for September were revised down substantially to 716 thousand, from 770 thousand. Numbers for July and August were also revised down.

	Click on Graph for larger image. Sales of new one-family houses in October 2007 were at a seasonally adjusted annual rate of 728,000 ... This is 1.7 percent above the revised September rate of 716,000 and is 23.5 percent below the October 2006 estimate of 952,000.
	The Not Seasonally Adjusted monthly rate was 57,000 New Homes sold. There were 74,000 New Homes sold in October 2006. October '07 sales were the lowest October since 1996 (56,000).
	The median and average sales prices are generally declining. Caution should be used when analyzing monthly price changes since prices are heavily revised and do not include builder incentives. The median sales price of new houses sold in October 2007 was $217,800; the average sales price was $305,800.
	The seasonally adjusted estimate of new houses for sale at the end of October was 516,000. The 516,000 units of inventory is slightly below the levels of the last year. Inventory numbers from the Census Bureau do not include cancellations - and cancellations are once again at record levels. Actual New Home inventories are probably much higher than reported - my estimate is about 100K higher.
	This represents a supply of 8.5 months at the current sales rate.

This is another VERY weak report for New Home sales. The stunning - but not surprising - downward revision to the August and September sales numbers was extremely ugly. This is the third report after the start of the credit turmoil, and, as expected, the sales numbers are very poor.

I expect these numbers to be revised down too - perhaps below 700K. More later today on New Home Sales.

by Anonymous on 11/29/2007 09:53:00 AM

Regular readers of this site will remember more or less constant outbursts of complaining about the lack of full-file due diligence in the securitization process. People look at data tapes and write contract warranties; people don't actually open up loan files and assess the accuracy of those data tapes, let alone go beyond the tape elements (quantifiable information like LTV and DTI and FICO) to qualitative aspects and conformity with "soft guidelines" (the rules of processing or evaluating documents or information that generates the quantities).

Well, glory be. Some analysts at Fitch rolled up their sleeves and sat down with a pile of loan files (45 of them, to be precise). What they discovered are the parameters of the the most innovative product the industry has ever offered, the NUNA (No Underwriting, No Accountability).

While we realize this was a very limited sample, Fitch believes that the findings are indicative of the types and magnitude of issues, such as poor underwriting and fraud, which are prevalent in the high delinquencies of recent subprime vintages. In addition, although the sample was adversely selected based on payment patterns and high risk factors, the files indicated that fraud was not only present, but, in most cases, could have been identified with adequate underwriting, quality control and fraud prevention tools prior to the loan funding.

I suggest reading the whole thing, if you've got a few minutes to blow on mortgage credit risk assessment arcana. What is happening here, although Fitch doesn't state it in these terms, is that someone went through a pile of loan files that were originally processed and underwritten in the "innovative" (cheap) way, and subjected them to processing and underwriting in the traditional (less cheap) way. As far as I can tell, the results here did not come from "extraordinary" levels of investigation or even much in the way of hindsight data (that is, by working back from events that took place after the loan was closed).

What this little exercise of Fitch's shows is that doing things like working through a credit report, looking carefully at the ownership of accounts (sole, joint, authorized user) and the relationship of tradelines to the information listed on the application (matching mortgage tradelines to real estate owned and matching general debt usage and spending patterns to income claimed) provides you with vital information that leads you to reject a mere FICO score as either a sole determinant of credit quality or as a "magic offset" that can let you ignore other weaknesses in the deal. No, really. All that is what we used to do before we started relying on FICOs and AUS.

But don't think this is just an anti-technology rant: 22% of the files Fitch looked at had a "HAWK Alert" right there on the original credit report, visible to anyone who reads English. What's that? It's a warning message that the credit repositories print on a report when some combination of facts or transactions trigger one of its potential fraud algorithms. It does not prove fraud, but it is designed to make your average human underwriter sit up straight and start poring over documents at a much greater level of detail and skepticism than might be usual.

Computers are great for this kind of thing: they help you put your work into "buckets" right off the bat. Any loan with a HAWK Alert should be immediately routed out of the "automation" pipeline and onto the desk of a senior underwriter. The technology helps you direct your human expertise where it really pays off.

Yeah, right, except that as Fitch notes, there is no indication in any of these files that anyone even noticed the HAWK Alert. And the problems that caused that Alert were, apparently, quite visible in the original file documents, if you looked past the FICO score to the details of the tradelines or the relationship of the tradelines to the loan application. (Loan app says borrower is a first-time homebuyer, credit report says there are existing mortgage tradelines. Duh.)

And of course the ridiculousness of the whole stated income thing is here on display, but Fitch never quite gets to asking the question raised by it all: if stated income is such high risk that you need to develop all sorts of processes and practices for testing it, contextualizing it, and subjecting the rest of the file to a fine-toothed review to compensate for it, what, exactly, is the benefit, in cost and speed, of doing it in the first place? At some level Fitch's analysis reads like a medical school textbook on using expensive fifth-generation antibiotics to treat staph infections caused by failure of doctors and nurses to wash their hands between patients. It's nice to know that can be treated, but it would be even nicer--not to mention cheaper--if hand-washing became more popular in the first place.

The fact is that many mortgage shops did, actually, put all kinds of practices and processes and "risk management control points" in place over the last several years to compensate for the risk created by their reliance on AUS, stated income, FICO scores, AVMs, and so on. For a lot of these shops, all that compensating was at least as expensive as just doing it the old way from the beginning. Certainly it remains to be demonstrated what kind of originator the files Fitch found came from: newbies who never learned the old ways and hence never saw the risk? Thinly-capitalized budget operations who just couldn't afford to produce anything except NUNA loans? Cynical players who knew the stuff was junk but who also knew that neither the security issuers nor the rating agencies would notice, and who also knew that the game of representations and warranties, properly played, would insulate them from having to take it back?

The whole thing really begins to take on an amazing Rube Goldberg quality once you refuse to accept the beginning premise--that these "innovative" ways of underwriting loans are a given, it's the compensation mechanisms that are the question. You do not have to believe that traditional human underwriting is perfect to wonder whether the cure is worse than the disease when it comes to compensating for automation.

(Hat tip to some awesomely cool dood)

by Calculated Risk on 11/28/2007 10:19:00 PM

From Bloomberg: Wall Street Failed in CDO `Lottery,' SEC's Sirri Says

Securities firms and banks sold ``too many lottery tickets'' tied to U.S. mortgages and failed to look closely enough at their growing risks, the head of the Securities and Exchange Commission's market regulation division said today.

Financial companies had ``a significant risk management failure'' on so-called super senior classes of collateralized debt obligations made up of asset-backed bonds, Erik R. Sirri said at a conference in New York ...

``There is a spectrum of lottery tickets that can be written,'' offering little upside for the seller and potentially large, sudden losses in a worst-case scenario, Sirri said.

Here is Sirri's speech:

If a firm were to have a concentrated position in a risk that suddenly became illiquid, that would clearly be bad. However, much worse would be a concentrated position with negative convexity that suddenly became illiquid. That trifecta is a risk manager's nightmare, as there is little to do once the markets start moving adversely and liquidity goes away, other than to hope. And as one head trader wisely said recently, "Hope is a crappy hedge." Combine this unhappy situation with risk that has begun to morph into less obvious forms and one starts to understand what occurred with super senior ABS CDO over the past nine months.