by Calculated Risk on 5/16/2005 11:04:00 PM

Speaking to the Australian Business Economists in Sydney tonight (via videoconferencing), Federal Reserve Governor Donald Kohn made several remarks concerning US interest rates:

"We have not yet finished this task," [Kohn] said.

"The federal funds rate appears still to be below the level that we would expect to be consistent with the maintenance of stable inflation and full employment over the medium run.

"And if growth is sustained and inflation remains contained, we are likely to raise rates further at a measured pace."

Further Fed changes to interest rates should induce an increase in the personal savings rate, by increasing a return to saving and dampening the upward momentum in housing prices, Dr Kohn said.

Higher rates would thereby lessen one of the significant spending imbalances in the US economy.

Dr Kohn said there were a number of spending imbalances in the US economy, but that at the most aggregated level there were a large and growing discrepancy between what the US spent and what it produced, as measured by the current account deficit.

"The growing current account deficit has been associated with a pronounced decline in the savings proclivities of the private and public sectors over the last year," he said.

"Households have saved only about one per cent of their after-tax income, and that compares to about eight per cent on average from 1950 to 2000."

Hat tip to The Housing Bubble's Ben Jones for the article.

by Calculated Risk on 5/16/2005 04:32:00 PM

Today, the Office of the Comptroller of the Currency, the FED, the FDIC and other agencies issued a new credit risk management guidance for home equity lending.

UPDATE: See MarketWatch's Rex Nutting: "Lenders warned of home equity risks"
UPDATE2: WaPo: U.S. Warns Lenders To Elevate Standards

In the late '90s, the FED was criticized for not using higher margin requirements as a tool to prick the stock market bubble. Economist Simon Kwan of the San Francisco Federal Reserve Bank argued that using margin requirements as a policy tool would not be effective, because "Investors can use financial derivatives to obtain exposure to equities without owning stocks, and they also can substitute margin credit with other types of credit."

These arguments do not apply to the housing bubble: investors cannot use derivatives to invest in homes, and rarely are other sources of credit sufficient for a home purchase. Today the various agencies have acted and tightened lending requirements, primarily to protect lending institutions, but indirectly to prick the housing bubble.

In the guidance, the agencies point to several "product, risk management, and underwriting risk factors and trends that have attracted scrutiny":

· Interest-only features that require no amortization of principal for a protracted period;

· Limited or no documentation of a borrower’s assets, employment, and income (known as "low doc" or "no doc" lending);

· Higher loan-to-value (LTV) and debt-to- income (DTI) ratios;

· Lower credit risk scores for underwriting home equity loans;

· Greater use of automated valuation models (AVMs) and other collateral evaluation tools for the development of appraisals and evaluations; and

· An increase in the number of transactions generated through a loan broker or other third party.

All of these areas of concern are addressed with tighter lending requirements in the various provisions of the new guideline. These include tighter controls to detect mortgage fraud, better controls on third party originations, more stringent appraisal guidelines and more.

Probably the two most important provisions concern HELOCs (home equity lines of credit) and HLTV (High Loan to Value) loans. With the HLTV loans, the agencies remarked that "in recent examinations, supervisory staff has noted several instances of noncompliance with the supervisory loan-to-value limits ..." In addition to more controls to address this noncompliance, they added a new requirement:

"Loans in excess of the supervisory LTV limits should be identified in the institution's records. The aggregate of high LTV one- to four-family residential loans should not exceed 100 percent of the institution's total capital. Within that limit, high LTV loans for properties other than one- to four-family residential properties should not exceed 30 percent of capital."

Lending institutions that are over or close to the limit of allowable HLTV loans must stop making these types of loans.

For HELOCs, lenders are now advised to consider the borrowers ability to pay over the life of the loan. This is a key difference in lending standards; previously lenders only considers the current interest rate and the borrower's income. Here is the key passage:

"... underwriting standards for interest-only and variable rate HELOCs should include an assessment of the borrower's ability to amortize the fully drawn line over the loan term and to absorb potential increases in interest rates."

The agencies must be very concerned when they caution lending institutions as follows:

"... prudently underwritten home equity loans should include an evaluation of a borrower's capacity to adequately service the debt."

Altogether, this is a clear warning shot across the bow of the housing bubble.

by Calculated Risk on 5/16/2005 03:52:00 PM

From the Federal Reserve today:

Agencies Issue Credit Risk Management Guidance for Home Equity Lending

PDF File: CREDIT RISK MANAGEMENT GUIDANCE FOR HOME EQUITY LENDING

Press Release:

The federal bank, thrift, and credit union regulatory agencies today issued guidance that promotes sound risk management practices for home equity lines of credit and loans. The agencies have found that in some cases credit risk management practices for home equity lending have not kept pace with the product's rapid growth and eased underwriting standards.

The rise in home values, coupled with low interest rates and favorable tax treatment, have made home equity lines of credit and loans attractive to consumers. To date, delinquency and loss rates for home equity portfolios have been low, due at least in part to the modest repayment requirements and relaxed structures of this lending. However, the agencies have identified risk factors that, along with vulnerability to interest rate increases, have attracted scrutiny, including:

Interest-only features that require no amortization of principal for a protracted period;

Limited or no documentation of a borrower's assets, employment and income;
Higher loan-to-value (LTV) and debt-to-income ratios;

Lower credit risk scores for underwriting home equity loans;

Greater use of automated valuation models and other collateral evaluation tools for the development of appraisals and evaluations; and

An increased number of transactions generated through a loan broker or other third party.

The agencies note that active portfolio management is especially important for financial institutions that project or have already experienced significant growth or concentrations in higher risk products, such as high LTV, limited documentation and no documentation interest-only, and third-party generated loans.

Like most other lending activity, home equity lending can be conducted in a safe and sound manner with appropriate risk management systems. This guidance outlines the agencies' expectations for sound underwriting standards and effective credit risk management practices for a financial institution's home equity lending activity.

by Calculated Risk on 5/16/2005 12:19:00 AM

My most recent post is up on Angry Bear: "1,346 Days".

I ask a simple question:

It took 1,346 days to win WWII. 1,346 days after 9/11, what have we accomplished?

In addition to the ongoing human tragedy, I am concerned about the economic impact of the poorly defined "war on terror".

Also, I just read Paul Krugman's NYTimes piece "Staying What Course?". It is excellent.

Best Regards to all.

by Calculated Risk on 5/13/2005 01:51:00 PM

As a follow up to my earlier posts this week on the UK housing market (here on Angry Bear and here), the Bank of America has issued a report warning of potentially serious consequences from the housing bust in Britain. I've argued that Britian might be a little ahead of America in this cycle, and that America might see similar problems in the near future.

A few excerpts from the Telegraph article:

"Bank of America warned yesterday that Britain could face a "nightmare scenario" as collapsing house prices combined with the pain of tighter fiscal policy."

"...the debt financed spending spree of consumers is petering out while the almost unprecedented surge in government spending looks increasingly unsustainable"

"Skyrocketing house prices" had enabled consumers to draw down "staggering" levels of mortgage equity for spending. But the "multiplying" effect of the boom was running out under the delayed impact of earlier rate rises.

"We cannot rule out a nightmare scenario in which a decline in consumption caused by a sudden correction in house prices would lead to an explosive rise in the fiscal deficit that would have to be addressed by a tighter fiscal policy,"

Stephen Robinett once wrote: "Speculative bubbles go on longer and end quicker than most people expect." When the bubble ends, it will probably happen very quickly. Most likely prices will first stablize and then deflate slowly, but transaction volumes will drop precipitously.

by Calculated Risk on 5/13/2005 02:43:00 AM

Former Treasury Secretary Robert Rubin writes in the NYTimes about the fiscal challenges facing America:

"Most pressing is the 10-year federal deficit, which most independent analysts project at $4.5 trillion to $5 trillion ... "

The General Fund deficit is clearly the largest and most immediate fiscal problem facing America. Any good business manager or political leader would insist that the most pressing problem be fixed first. Rubin proposes:

"...if the tax cuts for those earning above $200,000 were repealed and the inheritance tax as reformed were continued rather than eliminated, the 10-year projected deficit would be reduced by roughly $1.1 trillion, or almost 25 percent, and the 75-year fiscal reduction would be roughly $3.9 trillion, or approximately equal to the Social Security shortfall. This course of action would be similar to the income tax increases that were combined with spending cuts in the 1993 deficit reduction program, which some predicted would lead to recession but which, instead, was followed by the longest economic expansion in our nation's history."

Unfortunately tax increases appear ideologically unacceptable to this administration. Instead they are relying on what Warren Buffett refers to as "wishful thinking and its usual companion, thumb sucking". Rubin concludes:

Of course, we can continue to close our eyes and hope for the best. There's no way to predict whether that will work for another few months or for many more years. But the odds are extremely low that our fiscal imbalances will solve themselves, and we place ourselves at great peril by not facing these realities. Conversely, if we do address these challenges, then with our flexible labor and capital markets, and our historic embrace of change and willingness to take risks, our prospects over time should be very favorable.

I agree with Rubin. I believe if we acknowledge our problems and address them in a rational manner, we can fix them. But all I see from the Bush Administration is denial and wishful thinking. With the Bush Administration's course of non-action, it is difficult to remain optimistic.

by Calculated Risk on 5/13/2005 12:57:00 AM

Dr. Mark Thoma has convinced his colleague, Dr. Tim Duy to write a regular piece on the Fed at Economist's View. Before going to the University of Oregon, Tim was an International Economist at Treasury and a Fed Watcher for The G7 Group, a private consulting firm.

Dr. Duy's first piece is up "The Art and Practice of Fed Watching" and offers some great advice, like:

The secret to remember is that Fed Watching is not about your interpretation of the economy or what you would do if you were a Board member. That approach will lead you down a bad road. The secret is to interpret the data as the Fed sees it, and remain agnostic about whether the policy is wrong or right.

And about the housing bubble:

... there may in an asset bubble in the housing market, but don’t expect the Fed to react to that, at least not before it bursts.

A very valuable addition to the econ blogosphere.

by Calculated Risk on 5/12/2005 12:43:00 PM

From CNN, the National Association of Realtors reports:

U.S. residential real estate markets lost no steam in the first quarter of 2005, according to statistics released Thursday by the National Association of Realtors.

The NAR's quarterly report covers 136 metro areas. A record 66 of these have experienced double-digit jumps in home prices over the past year.

The previous record was 62 in the last quarter of 2004. Only six areas showed a fall in prices and those declines were fairly modest.

In a separate news release, NAR report that "First Quarter State Existing-Home Sales in Record Territory".

Total existing-home sales, which include single-family and condos, were at the third-highest pace on record in the first quarter. In addition, 44 states and the District of Columbia showed higher sales in comparison with a year earlier, according to the National Association of Realtors.

NAR’s latest report on total existing-home sales shows that nationwide the seasonally adjusted annual rate was 6.84 million units in the first quarter, up 8.3 percent from a 6.32 million-unit level in the first quarter of 2004. The record was a pace of 6.90 million units in the second quarter of 2004, followed by 6.88 million in the fourth quarter of last year.

CNN also provides a list of the price changes by metro area. The usual suspects are at the top of the list (mostly Florida), but many surprising cities reported double digit price gains:

Charleston WV	13.0%	$112,500
Champaign/Urbana/Rantoul IL	12.9%	$120,700
Biloxi/Gulfport MS	12.8%	$121,100
Wichita KS	11.7%	$105,100
Portland ME	11.5%	$243,100
Nashville TN	11.3%	$152,100
Albuquerque NM	11.1%	$149,700
Aurora/Elgin IL	11.0%	$229,300
New Orleans LA	10.9%	$141,200
Birmingham AL	10.9%	$152,100
South Bend/Mishawaka IN	10.7%	$91,100
Amarillo TX	10.7%	$102,600
Springfield IL	10.4%	$92,700
Green Bay WI	10.3%	$152,800

The boom is close to Nationwide.

by Calculated Risk on 5/12/2005 09:51:00 AM

The Census Bureaus released the retail sales report for April.

The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for April, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $344.9 billion, an increase of 1.4 percent (±0.7%) from the previous month and up 8.6 percent (±0.8%) from April 2004. Total sales for the February through April 2005 period were up 7.5 percent (±0.5%) from the same period a year ago. The February to March 2005 percent change was revised from +0.3 percent (±0.7%)* to +0.4 percent (±0.3%).

Retail trade sales were up 1.4 percent (±0.7%) from March and were 8.7 percent (±1.0%) above last year. Gasoline station sales were up 19.8 percent (±3.1%) from April 2004 and sales of nonstore retailers were up 12.4 percent (±3.5%) from last year.

Meanwhile, WalMart warned:

Wal-Mart Stores Inc. reported a 14 percent increase in first-quarter earnings Thursday, but the results missed Wall Street estimates. The world's largest retailer also warned that second-quarter results would likely be lower than expected as unseasonably cool weather and higher gasoline prices continue to hurt business.

What is wrong with this picture?

by Calculated Risk on 5/12/2005 02:24:00 AM

The Financial Times is reporting that "France's manufacturing industry may be in recession after unexpectedly weak industrial production figures on Wednesday"

Manufacturing output tumbled by 0.3 per cent in the first three months of 2005, and by 0.9 per cent in March compared with February, according to Insee, the French statistics office. France has been one of the eurozone's best performing economies but the latest data point to a marked deterioration.

Confidence indicators suggest French manufacturing has also remained weak in the current quarter. A second successive quarterly fall would mark a technical recession in manufacturing although the strength of the rest of the economy means France is still some way from overall recession.

Meanwhile, the International Herald Tribune is reporting "Japan's index of leading economic indicators was below 50 percent in March for a second month, suggesting that the country's economic growth may stall, the Cabinet Office said Wednesday."

"The slump of the Japanese economy will continue, though the risk that it will fall back into recession is fading," said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management in Tokyo. "We can't expect corporate profits to expand this year as they did last year."

Industrial production fell 0.3 percent in March from February, the government said on April 28. Spending by households headed by a salaried worker slid 1.1 percent in the same month, the second month of decline, the government said on the same day.

The Japanese economy probably expanded at an annual 2.5 percent pace in the first quarter, according to a Bloomberg News survey.

The global imbalance story continues ...