by Calculated Risk on 12/03/2007 10:48:00 AM

Remarks by Secretary Paulson on Actions Taken and Actions Needed in U.S. Mortgage Markets at the Office of Thrift Supervision National Housing Forum

As we are all aware, the housing and mortgage markets are working through a period of turmoil, as are other credit markets, as risk is being reassessed and re-priced. We expect that this turbulence will take some time to work through, and we expect some penalty on our short-term economic growth. ...

And as I have said before, the housing market downturn is the biggest challenge to our economy. When home foreclosures spike, the damage is not limited only to those who lose their homes. Homes in foreclosure can pose costs for whole neighborhoods, as crime goes up and property values decline.

... foreclosure is expensive for all participants - lenders and investors – and this expense is an incentive to avoid foreclosure when a homeowner has the financial wherewithal to own a home. ...

And so, Treasury is aggressively pursuing a comprehensive plan to help as many able homeowners as possible keep their homes.

And on the modification plan:

... our plan involves a pragmatic response to the reality that the number of homeowners struggling with their resetting subprime mortgage will increase throughout 2008. As volume increases, we will need an aggressive, systematic approach to fast-track able borrowers into a refinance or mortgage modification. This third element does not, and will not, include spending taxpayer money on funding or subsidies for industry participants or homeowners.

While the reality is a bit more complex, in the interest of simplicity, there are four categories of subprime borrowers. There are those who can afford their adjusted interest rate; these homeowners need no assistance. There are also a substantial number of homeowners who haven't been making payments at the starter rate on their subprime loan and may not have the financial wherewithal to sustain home ownership; some of these homeowners will become renters again. A third category of homeowners might choose to refinance their mortgage - putting them in a sustainable mortgage while keeping investors whole. This is the first, best option. Servicers should move quickly to assist those who can refinance.

And the fourth category is those with steady incomes and relatively clean payment histories who could afford the lower introductory mortgage rate but cannot afford the higher adjusted rate. We are focusing on this group, determining who they are and what steps may appropriately assist them.
...
We are determined to ... develop a set of standards that will be implemented across the industry, from the largest mortgage servicers to the smaller specialty servicers. An industry-wide approach is critical to the effectiveness of this effort.

To speed up the modification process, Treasury is working through the HOPE NOW alliance with the American Securitization Forum to convene servicers and investors so they can develop categories of borrowers eligible for appropriate modifications and refinancings, and an industry-wide solution. This work takes time, as all parties seek to define categories of borrowers for streamlined refinance and modification where that is in the best interest of both the borrower and the mortgage investor. I am confident they will finalize these standards soon. And I expect all servicers will implement them quickly, and create benchmarks to measure their progress along the way. As a result, what was a fragmented, cumbersome process can be a coordinated effort which more quickly helps able homeowners.

Paulson clearly defined the group of borrowers that are being targeted for modifications: Homeowners with "steady incomes and relatively clean payment histories who could afford the lower introductory mortgage rate but cannot afford the higher adjusted rate".

Whenever the freeze ends, most of the homeowners in the defined group will still face foreclosure. So the purpose of this plan is clear - since the industry lacks the infrastructure to handle the work load, this guideline helps decide which loans to foreclose on now, and which loans to foreclose on later.

by Anonymous on 12/03/2007 09:19:00 AM

From the San Diego Union-Tribune, a fabulous distillation of bubble-think in the story of Michael and Suzanne, who got Countrywide to modify their ARM.

Details: In around mid-September 2004, Michael and Suzanne borrowed $437,750 to buy a $440,000 condo. The $352,000 first mortgage was an interest-only 3/27 ARM with a start rate of 4.97%, a 3.00% first adjustment cap and 2.00% annual (1.00% every six months) periodic cap after that, with a maximum lifetime rate of 11.97%. It is presumably indexed to the 6-month LIBOR. The $85,750 second mortgage was a fixed rate (of unspecified term) at 8.00%.

The first scheduled adjustment on the first mortgage would have taken the monthly interest payment up by $880. Michael and Suzanne cannot, apparently, afford another $880. Nor is sale or refi a great option, since the value of the condo is apparently now $400,000. Michael and Suzanne did not have $40,000 for a down payment in 2004 and they still don't have $40,000 for a down payment.

They feel a touch let down by the world:

“We understood the situation with loan adjustments to be that after our first three years, our low rate would increase to the rate that everyone else is buying at right now,” said Suzanne, 38. “We didn't realize that we would see an increase of our monthly mortgage payments by several hundred dollars or that we'd now be facing this uphill interest rate climb that we're not going to be able to afford.”

That's an interesting way of thinking of an ARM: it won't hurt you because the rate will only go up to the rate buyers will buy at. This will make that rate adjustment affordable to you because nobody will ever buy in the future at a rate you cannot afford, even though your plan is that everyone will buy in the future at a higher price than you did.

A note to Countrywide: You get the borrowers you deserve in this business.

by Calculated Risk on 12/03/2007 12:47:00 AM

In Paul Krugman's dismissal of Ben Stein's NY Times piece, Krugman writes:

For what it’s worth, Goldman’s forecast of a 15 percent decline in home prices seems implausible to me, too — but on the low side. A 15 percent decline would bring prices back to their level in early 2005 — when the bubble was already well inflated. If prices fall back to their level in early 2003, that’s a 30 percent decline.

Click on graph for larger image.

This graph shows 15% and 30% nominal price declines for the S&P/Case-Shiller U.S. National Home Price Index and the OFHEO, Purchase Only, SA index.

A 15% nominal price decline would take prices back to late 2004 for both indices. A 30% price decline for Case-Shiller would take prices back to mid-2003; 30% for OFHEO would take prices back to late 2002.

If we look at price declines in real terms (inflation adjusted), and assume the price declines will occur over several years, a 15% price decline is almost guaranteed. The Case-Shiller index is already off 8% in real terms from the peak.

BTW, in a debate between Jan Hatzius and Ben Stein, the smart money will be on Hatzius. That said, here are Ben Stein's housing predictions from 2006 (along with a couple of guys that be would perfect for the Southwest "Want to get away?" ad campaign):

This show aired at the end of 2006. Note that LongIslandBubble.com overlaid the graphics and text on the video.

by Calculated Risk on 12/02/2007 07:06:00 PM

From the Financial Times: US property risks

Banks have significantly tightened their lending standards this year, and commercial real estate has felt the effects ... Commercial mortgage-backed security issues, which finance about half of deals and were a key driver of the recent market boom, dropped 84 per cent in October from a record high of $38.5bn in March. At one point, some loans actually exceeded property values. Now, typical loan-to-value ratios have retreated to about 70 per cent – when deals are completed at all.

... US banks could see $11bn to $78bn of commercial real estate losses if the lending crisis spreads, according to Goldman Sachs. ...

The commercial property sector is not likely to suffer the huge falls experienced by the worst-hit residential markets ... Supply is near its tightest point in decades.

That CRE investment would slow - and prices decline - was pretty obvious, but I'm not sure how severe the downturn will be. In the '01 recession, CRE investment was hit pretty hard (unlike residential investment), so there probably isn't the significant excess supply that exists for residential real estate.

Still, there were plenty of silly loans made in the CRE market. And there is a large amount of supply in the pipeline (to be completed in the next year). With the economy slowing, demand for office and commercial space will probably slow (or even decline). It appears the CRE slowdown is here, but how bad it will get is uncertain (more research required!).

by Calculated Risk on 12/01/2007 11:23:00 PM

Update: here is an article from Aftenposten in Norway (sent to me two weeks ago, hat tip Impy): Townships caught up in international credit crisis

Officials in four northern Norwegian townships (Narvik, Rana, Hemnes and Hattfjelldal) went along with an alleged recommendation by Terra Securities to invest a total of NOK 451 million in what they're now calling "high-risk structured products" offered by Citibank and sold for Citibank by Terra.

The American commercial paper was also tied to bonds issued by local governments in the US, and Norwegian Broadcasting (NRK) reported that hedge funds were involved. To boost returns, the Norwegian townships also borrowed NOK 3.5 billion to invest in Citibank's products, which later lost as much as 50 percent of their value because of the US credit crunch.

News started leaking out about the troubled investments when the townships were ordered to pay in millions more, to satisfy guarantee requirements. Mayor Asgeir Almås in Hattfjelldal feels cheated.

From the NY Times: U.S. Credit Crisis Adds to Gloom in Arctic Norway

What is keeping [Karen Margrethe Kuvaas] awake are the far-reaching ripple effects of the troubled housing market in sunny Florida, California and other parts of the United States.

Ms. Kuvaas is the mayor of Narvik, a remote seaport where the season’s perpetual gloom deepened even further in recent days after news that the town — along with three other Norwegian municipalities — had lost about $64 million, and potentially much more, in complex securities investments that went sour.

Tanta and I (and many others) have been wondering for a couple of years who the bagholders would be. Add Narvik, Norway to the list.