by Calculated Risk on 1/20/2013 05:03:00 PM

Note: Tanta wrote the following post on May 8, 2007. Ownit had filed for bankruptcy a few months earlier, Countrywide was purchased by BofA in 2008, and Bear Stearns collapsed in March 2008 - both after Tanta wrote this post.

From Doris "Tanta" Dungey, May 2007:

CR used to like to quote this one every now and again, back in the days when this blog was just a little back-water hand-wringer in a sea of housing and mortgage bulls:

"A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him."

John Maynard Keynes, "Consequences to the Banks of a Collapse in Money Values", 1931

It's amazing how ever-fresh this particular avoidance of blame is. There's the CEO of Countrywide:

"I've been doing this for 54 years," Mozilo recently said during a speech in Beverly Hills, California. For many years, he said, "standards never changed: verification of employment, verification of deposit, credit report."

But then new players came in with aggressive lending policies. Names like Ameriquest, New Century, NovaStar Financial and Ownit Mortgage Solutions set a new, lowered standard, changing the rules of the game, Mozilo said.

"Traditional lenders such as ourselves looked around and said, 'Well, maybe there's a (new) paradigm here. Maybe we've just been wrong. Maybe you can originate these loans safely without verifications, without documentation,"' Mozilo said.

There's Tom Marano of Bear Stearns:

But Tom Marano, who heads the mortgage business at Bear Stearns, disputed the contention that Wall Street pressure led to the loosening of credit standards. Investment banks, he said, do not directly make many loans.

“If enough independent companies set standards, that becomes the market,” he said. “Wall Street’s role is largely one where we assess risk, we purchase loans.”

And there is our famous Bill Dallas of Ownit Mortgage:

Bill Dallas, chief executive of Ownit, the nation's 20th-largest subprime lender in 2006, said he saw the handwriting on the wall in April 2005 after he overheard a rival account executive tell a customer how to get a better rate by committing occupancy or income fraud.

"I just went, 'We are hosed as an industry,"' Dallas said. "I told our guys, 'We're the problem."

The structure of the industry was part of the problem, he said: "Our account reps are talking to the mortgage broker, the mortgage broker is talking to the borrower, and they're teaching them all the wrong things."

Sound bankers, to a man.

by Calculated Risk on 1/20/2013 01:48:00 PM

A few thoughts on the "next recession" ... Forecasters generally have a terrible record at predicting recessions. There are many reasons for this poor performance. In 1987, economist Victor Zarnowitz wrote in "The Record and Improvability of Economic Forecasting" that there was too much reliance on trends, and he also noted that predictive failure was also due to forecasters' incentives. Zarnowitz wrote: "predicting a general downturn is always unpopular and predicting it prematurely—ahead of others—may prove quite costly to the forecaster and his customers".

Incentives motivate Wall Street economic forecasters to always be optimistic about the future (just like stock analysts). Of course, for the media and bloggers, there is an incentive to always be bearish, because bad news drives traffic (hence the prevalence of yellow journalism).

In addition to paying attention to incentives, we also have to be careful not to rely "heavily on the persistence of trends". One of the reasons I focus on residential investment (especially housing starts and new home sales) is residential investment is very cyclical and is frequently the best leading indicator for the economy. UCLA's Ed Leamer went so far as to argue that: "Housing IS the Business Cycle". Usually residential investment leads the economy both into and out of recessions. The most recent recovery was an exception, but it was fairly easy to predict a sluggish recovery without a contribution from housing.

Since I started this blog in January 2005, I've been pretty lucky on calling the business cycle.  I argued no recession in 2005 and 2006, then at the beginning of 2007 I predicted a recession would start that year (made it by one month with the Great Recession starting in December 2007).  And in 2009, I argued the economy had bottomed and we'd see sluggish growth.

Finally, over the last 18 months, a number of forecasters (mostly online) have argued a recession was imminent.  I responded that I wasn't even on "recession watch", primarily because I thought residential investment was bottoming. 

Now one of my blogging goals is to see if I can get lucky again and call the next recession correctly.  Right now I'm pretty optimistic (see: The Future's so Bright ...) and I expect a pickup in growth over the next few years (2013 will be sluggish with all the austerity).

The next recession will probably be caused by one of the following (from least likely to most likely):

3) An exogenous event such as a pandemic, significant military conflict, disruption of energy supplies for any reason, a major natural disaster (meteor strike, super volcano, etc), and a number of other low probability reasons. All of these events are possible, but they are unpredictable, and the probabilities are low that they will happen in the next few years or even decades.

2) Significant policy error. This might involve premature or too rapid fiscal or monetary tightening (like the US in 1937 or eurozone in 2012).  Two examples: not reaching a fiscal agreement and going off the "fiscal cliff" probably would have led to a recession, and Congress refusing to "pay the bills" would have been a policy error that would have taken the economy into recession.  Both are off the table now, but there remains some risk of future policy errors. 

Note: Usually the optimal path for reducing the deficit means avoiding a recession since a recession pushes up the deficit as revenues decline and automatic spending (unemployment insurance, etc) increases.  So usually one of the goals for fiscal policymakers is to avoid taking the economy into recession. Too much austerity too quickly is self defeating.

1) Most of the post-WWII recessions were caused by the Fed tightening monetary policy to slow inflation. I think this is the most likely cause of the next recession. Usually, when inflation starts to become a concern, the Fed tries to engineer a "soft landing", and frequently the result is a recession. Since inflation is not an immediate concern, the Fed will probably stay accommodative for a few more years.

So right now I expect further growth for the next few years (all the austerity in 2013 concerns me, especially over the next couple of quarters as people adjust to higher payroll taxes, but I think we will avoid contraction). I think the most likely cause of the next recession will be Fed tightening to combat inflation sometime in the future - and residential investment (housing starts, new home sales) will probably turn down well in advance of the recession. In other words, I expect the next recession to be a more normal economic downturn - and I don't expect a recession for a few years.

by Calculated Risk on 1/20/2013 09:56:00 AM

From Ezra Klein: The case for deficit optimism Here’s a secret:

For all the sound and fury, Washington’s actually making real progress on debt.

... Start the clock — and the deficit projections — on Jan. 1, 2011. Congress cut expected spending by $585 billion during the 2011 appropriations process. It cut another $860 billion as part of the resolution to the 2011 debt-ceiling standoff. And it added another $1 trillion in spending cuts as part of the sequester. Then it raised $600 billion in taxes in the fiscal cliff deal.

Together, that’s slightly more than $3 trillion in deficit reduction. ... In fact, that’s about enough to stabilize the nation’s debt-to-GDP ratio over the next decade.

... Obama said ... we have “a health-care problem,” not a spending problem. This is, in general, a fairly uncontroversial point on the right ...

Back in December 2011, I asked Rep. Paul Ryan, budget guru to the House Republicans, for his favorite chart of the year ... He sent me one from the Bipartisan Policy Center showing four lines. One, labeled “discretionary spending,” was drifting down. Another, “mandatory spending,” was also falling. A third, denoting Social Security expenses, was rising a bit, but not by enough to worry anyone. The fourth, health-care spending, was shooting skyward. “Government spending drives the debt, and the growth of government health-care programs drives the spending,” Ryan explained.

So here’s the good news: The growth of health-care costs has slowed in recent years. Big time. From 2009 to 2011, which is the most recent data available, health-care costs have grown by less than four percentage points. That’s compared to typical growth of six or seven percentage points through most of the Aughts. ... The $64,000 question — actually, it’s worth trillions of dollars more — is whether this slowdown is a recession-induced blip or the product, at least in part, of cost controls that will persist long after the economy has returned to health.  At the moment, there’s evidence to support both views. ...

... the truth is that deficit reduction is going better than you’d think from listening to the sniping in Washington.

A few key points:
1) the deficit as a percent of GDP has been declining and will probably continue to decline over the next several years even without further deficit reduction measures (see the third chart here),

2) the debt to GDP ratio will probably stabilize and may even decline over the next decade,

3) the key long term budget issue is health care costs.

by Calculated Risk on 1/19/2013 09:34:00 PM

Alan Blinder lists 10 financial commandments to remember - and starts by reminding us that "people do learn. The problem is that they forget — sometimes amazingly quickly."

The old Wall Street saying is "there is no institutional memory". Each new generation of Wall Street wizards figures out a new way to turn lead into gold, and to become wealthy while damaging the financial system.   Some of these wizards are probably perfecting their financial alchemy right now.

Maybe next time people will remember Blinder's 10 step plan, but I doubt it: Financial Collapse: A 10-Step Recovery Plan

1. Remember That People Forget
...
2. Do Not Rely on Self-Regulation
...
3. Honor Thy Shareholders
...
4. Elevate Risk Management
...
5. Use Less Leverage
...
6. Keep It Simple, Stupid
...
7. Standardize Derivatives and Trade Them on Exchanges
...
8. Keep Things on the Balance Sheet
...
9. Fix Perverse Compensation
...
10. Watch Out for Consumers

Blinder concludes:

Mark Twain is said to have quipped that while history doesn’t repeat itself, it does rhyme. There will be financial crises in the future, and the next one won’t be a carbon copy of the last. Neither, however, will it be so different that these commandments won’t apply. Financial history does rhyme, but we’re already forgetting the meter.

All of these items are important, but I think the key is to watch for excessive speculation using leverage. One thing is certain, there will be another bubble ...

Earlier:
• Schedule for Week of Jan 20th
• Summary for Week Ending Jan 18th

by Calculated Risk on 1/19/2013 05:44:00 PM

Here is the unofficial problem bank list for Jan 18, 2012.

Changes and comments from surferdude808:

With the FDIC having a closing for the second consecutive week and the OCC releasing its actions through mid-December 2012, it was a busy week for the Unofficial Problem Bank List. In all, there were 10 removals and four additions, which leave the list holding 826 institutions with assets of $308.7 billion. A year ago the list held 963 institutions with assets of $389.2 billion.

First Federal Bank Texas, Tyler, TX ($192 million Ticker: FFBT) merged on an unassisted basis and Evergreen International Bank, Long Beach, CA ($28 million) closed via a voluntary liquidation. The involuntary liquidation or FDIC closing was 1st Regents Bank, Andover, MN ($50 million).

Actions were terminated against Southwest Securities, FSB, Dallas, TX ($1.3 billion Ticker: SWS); Bank of Blue Valley, Overland Park, KS ($662 million Ticker: BVBC); Mountain West Bank, National Association, Helena, MT ($633 million Ticker: MTWF); First Federal Bank, Harrison, AR ($544 million Ticker: FFBH); Tulsa National Bank, Tulsa, OK ($165 million); and RiverWood Bank, Baxter, MN ($157 million). Also, Triumph Savings Bank, SSB, Dallas, TX ($286 million) was removed based on media report provided by a reader. However, the FDIC has not recognized the action termination by press release or in its enforcement action database.

The following four banks joined the list this week -- Citizens Financial Bank, Munster, IN ($1.1 billion Ticker: CITZ); Fieldpoint Private Bank & Trust, Greenwich, CT ($682 million); Delanco Federal Savings Bank, Delanco, NJ ($133 million); and Ben Franklin Bank of Illinois, Arlington Heights, IL ($100 million Ticker: BFFI).

Next week, we anticipate the FDIC will release its actions for December 2012.

Earlier:
• Schedule for Week of Jan 20th
• Summary for Week Ending Jan 18th