by Calculated Risk on 3/05/2007 02:18:00 PM

Governor Kevin M. Warsh spoke in Washington, D.C. today: Market Liquidity: Definitions and Implications. Excerpts:

Consider liquidity, then, in terms of investor confidence. Liquidity exists when investors are confident in their ability to transact and where risks are quantifiable. Moreover, liquidity exists when investors are creditworthy. When considered in terms of confidence, liquidity conditions can be assessed through the risk premiums on financial assets and the magnitude of capital flows. In general, high liquidity is generally accompanied by low risk premiums. Investors’ confidence in risk measures is greater when the perceived quantity and variance of risks are low.

This view highlights both the risks and rewards of liquidity. The benefits of greater liquidity are substantial, through higher asset prices and more efficient transfer of funds from savers to borrowers. Historical episodes indicate, however, that markets can become far less liquid due to increases in investor risk aversion and uncertainty. ...

Therefore, I wish to advance a simple proposition: Liquidity is confidence.
...
Let me discuss sources of liquidity of the U.S. financial markets. By my proposed definition, we must ask what forces have increased liquidity (read: confidence) in the United States over the course of the last couple of decades. I will turn, first, to two key drivers of liquidity: rapid financial innovation and strong economic performance. A third important source of liquidity--resulting from the excess savings of emerging-market economies and those with large commodity reserves--has also found its way to the United States in pursuit of high risk-adjusted returns. We must judge the extent to which each of these three liquidity drivers are structural or cyclical, more persistent or more temporary. Understanding the sources of liquidity--and the causes thereof--should help inform judgments about the level and direction of market liquidity. In so doing, we may better understand its implications for the economy and policymakers alike.

First, liquidity is significantly higher than it would otherwise be due to the proliferation of financial products and innovation by financial providers. This extraordinary growth itself is made possible by remarkable improvements in risk-management techniques.
...
The second factor, perhaps equally persistent, supporting strong investor confidence in U.S. markets has been our economy’s strong macroeconomic performance. Researchers have documented the so-called “Great Moderation” in which the U.S. economy has achieved a marked reduction in the volatility of both real gross domestic product (GDP) and core inflation over the past twenty years or so. In theory, reduced volatility, if perceived to be persistent, can support higher asset valuations--and lower risk premiums--as investors require less compensation for risks about expected growth and inflation. In this manner, confidence appears to beget confidence, with recent history giving some measure of plausibility to the notion that very bad macroeconomic outcomes can be avoided. The Great Moderation, however, is neither a law of physics nor a guarantee of future outcomes. It is only a description--an ex post explanation of a period of relative prosperity. If policymakers and market participants presume it to be an entitlement, it will almost surely lose favor.

Warsh suggests "Liquidity exists when investors are confident in their ability to transact and where risks are quantifiable". And although Warsh does not mention the mortgage market, subprime or otherwise, by his definition liquidity is drying up in the subprime mortgage sector.

by Calculated Risk on 3/05/2007 10:56:00 AM

The following is a Tantamentary (by Tanta) on a New York Times column (pay, excerpted to put Tanta's comments into context).

NY Times columnist Gretchen Morgenson writes: Mortgages May Be Messier Than You Think

WHAT investors don’t know about why the home mortgage securities market is in distress could fill volumes. ... only after fiery markets burn out do we see the risks that buyers ignore and sellers play down.

... Unlike recent corporate disasters that have occurred at hyperspeed ... the mortgage securities boom seems to be unwinding in slow motion.

Tanta: Explain that to FMT and NEW. It looks like the tempo is picking up.

...by the end of last week, many there were celebrating the fact that the indexes on mortgage securities ... had stabilized. Big brokerage firms have also tried to persuade investors that mortgage woes would be limited to subprime loans — those given to people with weak credit histories.

But last Thursday, the annual report from Countrywide Financial, a major lender, told a different story. While it confirmed fears about subprime loans — 19 percent of those in its portfolio were more than 30 days delinquent at the end of last year, up from 15 percent in 2005 — Countrywide also indicated that the percentage of prime borrowers encountering difficulties is rising. Delinquencies in the company’s prime home equity loan portfolio totaled 2.93 percent, almost double last year’s 1.57 percent.

Tanta: You had to have believed in the 1.57 as a reasonable number to be really shocked by this. No, I’m not in that crowd who thinks CFC has been lying in the reports. I’m in that crowd who has believed for years that the DLQ numbers were “masked” by easy lending conditions and a hot RE market, not by loss-mit games. This does beg for the “spread to prime” meme to be placed into some context, namely, that during the boom prime even performed better than prime. As it were.

And consider the disclosure last Thursday of American Home Mortgage Investment, a home mortgage originator and investor that specializes in loans to those with middle-tier, not weak, credit histories. As of year-end, the company said, 8.13 percent of its loans held for sale (not investment) were non-accruing. During the same period in 2005, that figure was just 0.43 percent.

Tanta: Having non-accrual loans in the held-for-sale pipeline is like having delinquent loans in the warehouse. They aren’t supposed to be there long enough for that to happen. What is getting me at this point is not, actually, AHM’s nonaccrual rate (although 8.13% is some major ick). It’s that anyone is allowed to continue to call them “held for sale.” Think of it like a grocery store. If you have bananas that are starting to turn black, do you leave them out in the produce section and pretend that someone might buy them, or do you trot them out to the dumpster and take a charge-off? You can ask someone like me all day long how one handles nonaccrual loans in the sale pipeline. And I’ll tell you all day long that I have no idea, because it’s never happened to me before. If I ever had loans that were starting to look that bad in the sale pipeline, I either sold them immediately to a scratch & dent dealer or, more likely, put them in the portfolio and took the write-down, hoping to cure them, season them, and then unload them later at a better price, while following the rules about where they go on the books while I am taking this risk. I never let anything get old enough to go nonaccrual in the HFS. The HFS is funded by the warehouse (a literal borrowed warehouse or an internal corporate warehouse, the latter being the way a bank that funds its own loans does it. In either case, it’s “temporary financing.”) The end of the story is that we’re in some brave new world of accounting, as far as I can tell, not just some brave new world of loan failures.

“The problems are far broader than subprime,” said Josh Rosner, a managing director at Graham-Fisher ... Mr. Rosner says he believes that ... investors will soon recognize that credit quality problems have also begun to seep into “the upper tranches” of the loan market.

Credit risk ... shows up over months and years, while market risk plays out in seconds and minutes. ... it is easy for some to say that a big decline in the mortgage securities index is an overreaction.

Perhaps it is. But the fact that loan losses have not yet shown up in mortgage holdings should calm no one. The way Wall Street packages home loans and sells them to investors adds to their complexity and makes them far tougher to value than other securities.

Tanta: True. The way Wall Street does this is pretty hard to figure. But to what extent is the Street playing in the prime mortgage loan market? I begin to sense, once again, that tranche/pool problem in play here. I mean, a Freddie Gold 30-year MBS is AAA. Some senior tranche of some whacko Alt-A or subprime security is AAA. These are both “prime” ratings of the security or small slice thereof. They don’t have the same loans backing them. This confusion is going to get worse before it gets better, I fear.

Moreover, a lag in reported defaults is almost certainly attributable to the increasingly aggressive practice of loss mitigation among lenders, in which they try to keep stretched borrowers from defaulting. But investors get little to no information about how lenders work with troubled borrowers and whether those efforts actually cure the problem — or simply postpone the inevitable. As a result, investors do not know whether the default figures they are seeing reflect reality.

Tanta: Translation: “I have no actual information about what the lenders are doing. Therefore, I am “almost certain” that they are doing the wrong thing. Of course, would I pick up the phone and call one or two mortgage servicers to get a comment on record? Nah! It’s much more fun to speculate and call it certainty.”

In 2002, the Office of Inspector General in the Department of Housing and Urban Development reviewed the department’s loss-mitigation program and found some disturbing practices. Financial institutions that were surveyed from May 1999 to April 2001 in many cases chose to delay foreclosures even when it was obvious that loan workouts would probably not succeed ...

Mortgage servicers “are approving borrowers for loss mitigation when, based on the servicers’ expertise and past experience with delinquent borrowers, the workout is unlikely to succeed,” the report said. “These actions are delaying the foreclosure process, increasing the cost of foreclosure, and subsidizing borrowers who do not pay their mortgage for extended periods of time.”
...
Loss-mitigation practices grew out of the significant losses incurred by big lenders in the real estate collapse of the late 1980s. Because lenders were experiencing losses of 30 percent to 60 percent of the outstanding home loans in foreclosures, they started identifying ways to keep borrowers in their homes.
...

Tanta: Nice selective paraphrasing from that IG report. How about the full context?

“In our opinion, servicers should be allowed to determine whether the borrower had a hardship when exercising good business judgment. Otherwise the Department is only encouraging irresponsible behavior. For example, we reviewed a case where the borrower’s hardship letter explained that their increase in expenses was due to gambling losses. Since the borrower had an increase in expenses, the servicer felt obligated to approve a partial claim. The borrower subsequently filed for bankruptcy protection. In another case, a servicer granted loss mitigation to a borrower who was current on their Mercedes payments but was not making payments on the less expensive home mortgage.

A first vice president of another servicer told us that HUD criticized it for not doing enough for borrowers whose expenses increased and income decreased. The HUD National Servicing Center told the servicer to make it work. HUD instructed the servicer that if a borrower meets all of the guidelines for a specific loss mitigation tool, the servicer could not deny the loss mitigation action, even though past experience shows that a borrower under the same circumstances will default again, resulting in foreclosure. The first vice president said that the servicer has to do what HUD says, because the servicer has not been given any authority or charter to make decisions. The serivcer would like to see the initiation of more discretion by HUD to the loan servicer on whether a borrower should be given additional chances to correct their delinquency. If the loss mitigation tool or tools do not work based on circumstances, then the servicer should end the process.

Finally, a senior vice president of a third large servicer said there are borrowers who learn the system and take advantage of it, as well as borrowers who do not want to deal with the fact that they are defaulting on their mortgage and may lose their home. The servicer believes they should be able to look at the behavior patterns of the borrower and decide on no more workouts when the behavior indicates that the borrower is going to default again. The servicer believes, in these instances, that providing the loss mitigation tool is just delaying the inevitable.

These servicers stated to us that they interpreted instructions from the National Servicing Center that any borrower who has had either an increase in expenses or decrease in income must be approved regardless of the borrower’s hardship or circumstances. Such action only delays the foreclosure process.

Using this criterion, virtually every interested delinquent borrower qualifies for loss mitigation. The servicers are reluctant to use good business judgment because HUD may require them to indemnify the loan if loss mitigation is denied. Consequently, servicers are delaying the foreclosure process, which increases the cost of foreclosure, and subsidizes borrowers who do not pay their mortgage for extended periods of time.

A HUD official with the National Servicing Center told us that trainers tell servicers that they must consider all borrowers for loss mitigation but are to use their best judgment when determining whether a loss mitigation tool is beneficial and warranted. If HUD expects the program to succeed, HUD needs to clarify instructions to servicers to eliminate the misunderstanding or perception that is preventing servicers from using good business judgment when working with delinquent borrowers.

A HUD official advised us that one of the biggest problems with the assignment program, which the loss mitigation program replaced, was the different ways the field offices applied it. For example, some field offices were very diligent in permitting borrowers into the program while other offices had very liberal policies and let almost anyone participate. Indications are that differing interpretations of HUD requirements by servicers, as previously discussed, may be creating a similar problem with the loss mitigation program.

We also reviewed 105 cases where the borrower continued to miss mortgage payments after receiving home retention loss mitigation assistance for the first time. The cases were reviewed to determine whether servicers are performing due diligence when approving borrowers for loss mitigation and are taking appropriate actions to apply disposition options or initiate foreclosure when it is clear that the borrower does not have the ability to repay their mortgage. We found that servicers were performing due diligence when approving the borrowers for loss mitigation. The servicers based their decisions on the information provided by the borrower. If the borrower does not have a history of problems, the servicers are inclined to take the borrower’s assertions at face value.

HUD commissioned a study by Abt Associates on the loss mitigation program. The Abt Associates report, issued in November 2000, stated that in order to evaluate program effectiveness, it is important to have information on current borrower circumstances, including their credit score, income, and expenses, as well as the property’s condition and the current estimated loan-to-value ratio. However, we found during our review that the biggest factor in determining whether loss mitigation will be effective relates to social conditions, such as desire to maintain the home, family problems, drug or alcohol abuse, and gambling.

Several servicers have done extensive analysis of their data to identify statistical factors that may dictate whether a workout will be successful. One servicer told us that they found no correlations in its statistical information to identify workouts that may or may not succeed. Another servicer had some similar results. For example, the servicer did not identify any significant trends when analyzing success rates by the credit quality, age of the loan, loan-to-value ratio, interest rates, or surplus/deficit amounts. Although, the servicer found that when borrowers surplus cash was higher than $1,000 the success rate started to drop. From this unusual trend, the servicer learned that they were not getting an accurate picture of the borrower’s actual expenses and instituted procedures to improve the gathering of expense related information.”

Long quote there, but I’m fascinated by the way an Inspector General report that found perverse incentives by well-meant HUD regulations and field office interpretations thereof is now being used to “prove” that servicers do not exercise good business judgment, or that servicers use loss-mit to “hide” delinquencies. There was, of course, never any time at which HUD did not consider these loans as under-performing. Furthermore, one could use this IG report as a useful way to consider the wisdom of stated income/stated asset/no doc loans rather than an argument against loss mit. But that would interfere with today’s story line.

While it is a splendid idea to do whatever is necessary to try to cure a sick borrower, it is worth remembering that the rollover of nonperforming loans was central to what made the savings and loan mess of the early 1990s so disastrous. And it is well worth asking: are loss-mitigation practices predatory since they give lenders an opportunity to squeeze the last ounce of blood out of a terminally ill patient?

Tanta: It might be worth talking to the 99% of students of the S&L crisis who thought that there were a whole lot of other candidates for the “central” problem. Holy Selective Memory, Batman. (Hint: can you spell “commercial loans”?) And it is well worth asking: are NYT business columnists so bird-witted that they really think that tossing people out onto the street in a foreclosure could not, on the “ounce of blood” theory, be considered just as predatory? Can anyone imagine the next story in the NYT, showing the heart-breaking pictures of the laid-off uninsured family with a sick breadwinner standing on the curb in the snow while the sheriff evicts them from the foreclosed property? What, we’re now making financial services policy based on who can print the saddest story, the pro-loss-mit or the pro-FC crowd? We just looked at an IG report that indicates that the big problem was servicers doing loss mit for borrowers WHO ASKED FOR IT, but should probably not have been given it. Um, Gretchen, borrowers who scam the HUD system by getting forbearance while driving a Mercedes are probably not the terminally ill prey of the servicers. Just sayin’. Let’s face the real issue: why were these people put in these loans in the first place by lenders? What were their financial incentives for doing so? Who provided those financial incentives? Can you spell “investors”?

Aggressive approaches to loss mitigation, Mr. Rosner said, mean that less than half of mortgages that in prior years would have been foreclosed no longer are. Unfortunately, how many of these workouts actually succeed is a question for which investors and even regulators have no answer.

Tanta: So since we have no answer, let’s assume that it’s a bad thing. Absence of evidence means never having to say you’re full of shit.

Academic studies suggest that within the first two years of a workout, re-defaults can approach 25 percent. But there are no publicly available data to analyze the success rates of loss mitigation. And this is something investors sorely need.

Tanta: Betcha there’s some privately-available data. How about placing a call to, oh, TIAA, and asking if someone there is responsible for analyzing the performance metrics of the mortgage-backed securities and/or whole loans they’re buying? Did you do that, and find that TIAA doesn’t have any information on its own investments? Can you quote them on that? Or do you mean that you and I don’t know what TIAA knows? I’m getting confused about whom I’m supposed to be disgusted with here. I mean, I’d absolutely love to see publically-available data on the performance of these mortgages. I wonder why it is that publically-traded companies and rating agencies and outfits like Loan Performance don’t give it away to us. Sheesh—and people think I’m some kind of socialist.

“There is nothing particularly wrong with loss mitigation,” Mr. Rosner said. “What is wrong is a lack of transparency in whether it is effective or predatory. How can we be surprised when volatility rises? The buyer is recognizing that he does not have appropriate information.”

... But experienced investors know that a reliance on fantasy will only prolong the pain that is racking the huge and important mortgage market.”

Tanta: “Experienced investors,” ahem, are presumably those who read the prospectus and the servicing agreement. They might even read the delinquency reports. They might even be investing in REMICs where loss mit options are extremely limited by REMIC law. They might even be buying No Doc subprime high-LTV loans, which are, ahem, pretty much guaranteed to generate excessive numbers of losers. But is that a fantasy? Nooooo. The “fantasy” is, apparently, that some servicers are probably trying to make loss-mit lemonade instead of flooding the market with REO. I’ll agree that that’s probably, in some of these cases, just prolonging the pain. But this business of crying for those innocent investors is getting on every nerve I have left. Next thing you know, someone is going to tell me that shareholders in pets.com weren’t told that it didn’t have a business plan, and I’m going to be so shocked I’ll fall off my Aeron chair.

by Calculated Risk on 3/05/2007 10:36:00 AM

Bloomberg reports: U.S. ISM Services Index Falls More Than Forecast

Service industries in the U.S. expanded at the slowest pace almost four years last month, suggesting the housing slump may be filtering through to other parts of the economy.
...
``The downtrend in home prices threatens consumer borrowing and consumer spending as a whole,'' Avery Shenfeld, a senior economist at CIBC World Markets Inc. in Toronto, said before the report. ``People recognize now that housing is not yet stabilizing.''

Service industries are still expanding, but the pace has slowed. And yes, Wall Street housing forecasts are "no longer operative"!

by Calculated Risk on 3/04/2007 06:07:00 PM

As an excuse for more discussion in the comments, here are the areas I suggested watching at the beginning of the year:

1) A credit crunch based on bad loans in the RE sector leading to another down turn in the housing market (and possibly in CRE and C&D too, later in the year),

2) the loss of several hundred thousand residential construction jobs,

3) less consumer spending based on falling MEW.

Here is my estimate of the impact of the subprime implosion on existing home sales.

After the first two months of 2007, most Wall Street housing forecasts are already - in the words of Nixon press secretary Ron Zeigler - "No longer operative."

by Calculated Risk on 3/03/2007 06:33:00 PM

Looking forward to the employment report next Friday, I'm expecting to see a significant decline in residential construction employment.

Click on graph for larger image.

This graph shows starts, completions and residential construction employment. (starts are shifted 6 months into the future). Completions and residential construction employment are highly correlated, and Completions lag Starts by about 6 months.

Based on historical correlations, it is reasonable to expect Completions and residential construction employment to follow Starts "off the cliff". This would indicate the loss of 400K to 600K residential construction employment jobs by this Summer.

Dr. Asha Bangalore suggests we also look at the YoY change in nonfarm employment.

The YoY change in employment has already started to decline, and will probably decline more during the coming months. This could be a mid-cycle slowdown, as happened in the mid-'80s and mid-'90s, or it could be the prelude to a recession. Employment is generally considered a coincident indicator for the economy, so for now the focus will be on residential construction and retail employment.

The housing bust started in San Diego before most other markets. So it is interesting to see what is happening to the job market in San Diego (hat tip: Mozo Maz) from the San Diego Union: County unemployment hits a six-month high

... significant were the cuts in the real estate industry, continuing a five-month decline. January's job cutbacks included 2,500 construction workers, 700 real estate workers and 1,100 workers at furniture and home-improvement stores.

“The housing sector is really starting to have an impact on our overall year-to-year job numbers,” said Alan Gin, economist at the University of San Diego.

Gin worried that the real estate downturn is affecting the retail market. From January 2005 to January 2006, 2,500 retail workers lost their jobs, mostly in department stores.

“When you've got fewer people working in construction and fewer people buying homes, you've got fewer people shopping in the community, and that can translate to fewer retail jobs,” Gin said.
...
Howard Roth, chief economist for the California Department of Finance, ... said the slowdown is having an impact on the state's income tax revenue.

In January, the state took in about $8 billion in income taxes – $1 billion less than previously forecast. Roth said that part of the drop was due to declines in the money earned by real estate brokers and professionals in related industries.

The report next Friday should be interesting.

by Calculated Risk on 3/03/2007 04:50:00 PM

"We're all going to be struggling, struggling more than we are today. We're headed halfway down the mountain, and we've got a ways to go."
Robert A. Camerota, Sr., GMAC Mortgage Group senior vice president, March 3, 2007

From North County Times: Prominent mortgage exec sees further dip in market

by Calculated Risk on 3/03/2007 01:18:00 PM

Floyd Norris writes in the NY Times: When It Comes to House Prices, the Bloom Is Off the Cactus

The [Standard & Poor’s/Case-Shiller home price] indexes, which now cover 20 regions, ... [record] all sales in an area, and then [compare] the price with the price that house fetched the last time it changed hands. They include only single-family homes, not condominiums or cooperative apartments, which can distort the picture in areas where such apartments form a major part of the housing market.

Click on graph for 12 areas.

The graphic shows the performance of the indexes, year over year, for 12 areas. They illustrate the wide regional variances, showing that Phoenix was not the only part of the desert that boomed. Las Vegas, with a 53 percent year-over-year rise in the fall of 2004, set the mark for best annual performance. In 2006, prices there rose just 0.9 percent.

Big coastal markets also did very well, although not to that extreme, and are now coming down. Prices in the New York region slipped just a bit in 2006, although that figure is distorted because it ignores Manhattan apartment prices, which have been strong. Larger declines were recorded in Boston, Washington, San Francisco and San Diego, but Los Angeles eked out a 2 percent rise for the year.

by Calculated Risk on 3/02/2007 09:11:00 PM

New Century Financial filed their "Notification of Late Filing" today with the SEC. A few excerpts:

To date, six of the Company’s 11 financing arrangements whose agreements contain this rolling two-quarter net income covenant have executed waivers. Certain of these waivers will become effective when the Company receives similar waivers from each of the other lenders having the rolling two-quarter net income covenant.
...
In the event the Company is unable to obtain satisfactory amendments to and/or waivers of the covenants in its financing arrangements from a sufficient number of its lenders, or obtain alternative funding sources, KPMG has informed the Audit Committee that its report on the Company’s financial statements will include an explanatory paragraph indicating that substantial doubt exists as to the Company’s ability to continue as a going concern.

And on the criminal probe:

On February 28, 2007, the Company received a letter from the United States Attorney’s Office for the Central District of California (the “U.S Attorney’s Office”) indicating that it was conducting a criminal inquiry under the federal securities laws in connection with trading in the Company’s securities, as well as accounting errors regarding the Company’s allowance for repurchase losses. The U.S. Attorney’s Office is requesting voluntary assistance by the Company, which the Company has agreed to provide.

by Calculated Risk on 3/02/2007 05:34:00 PM

From the Fremont SEC filing:

Fremont General Corporation (the "Company") could not file its Annual Report on Form 10-K for the fiscal year ended December 31, 2006 by March 1, 2007 without unreasonable effort or expense for the reasons set forth below.

In light of the current operating environment for subprime mortgage lenders and recent legislative and regulatory events, Fremont Investment & Loan, the Company's wholly owned industrial bank subsidiary ("FIL"), intends to exit its subprime residential real estate lending business. Management and the board of directors are engaged in discussions with various parties regarding the sale of the business.

Additionally, the Company expects that it, FIL and the Company's wholly owned subsidiary, Fremont General Credit Corporation ("FGCC"), will enter into a voluntary formal agreement, to be designated as a cease and desist order (the "Order"), with the Federal Deposit Insurance Corporation (the "FDIC"). Among other things, the Order will require FIL to cease and desist from the following:

o Operating with management whose policies and practices are detrimental to FIL;

o Operating FIL without effective risk management policies and procedures in place in relation to FIL's brokered subprime mortgage lending and commercial real estate construction lending businesses;

o Operating with inadequate underwriting criteria and excessive risk in relation to the kind and quality of assets held by FIL;

o Operating without an accurate, rigorous and properly documented methodology concerning its allowance for loan and lease losses;

o Operating with a large volume of poor quality loans;

o Engaging in unsatisfactory lending practices;

o Operating without an adequate strategic plan in relation to the volatility of FIL's business lines and the kind and quality of assets held by FIL;

o Operating with inadequate capital in relation to the kind and quality of assets held by FIL;

o Operating in such a manner as to produce low and unsustainable earnings;

o Operating with inadequate provisions for liquidity in relation to the volatility of FIL's business lines and the kind and quality of assets held by FIL;

o Marketing and extending adjustable-rate mortgage ("ARM") products to subprime borrowers in an unsafe and unsound manner that greatly increases the risk that borrowers will default on the loans or otherwise cause losses to FIL, including (1) ARM products that qualify borrowers for loans with low initial payments based on an introductory rate that will expire after an initial period, without adequate analysis of the borrower's ability to repay at the fully indexed rate, (2) ARM products containing features likely to require frequent refinancing to maintain affordable monthly payment or to avoid foreclosure, and (3) loans or loan arrangements with loan-to-value ratios approaching or exceeding 100 percent of the value of the collateral;

o Making mortgage loans without adequately considering the borrower's ability to repay the mortgage according to its terms;

o Operating in violation of Section 23B of the Federal Reserve Act, in that FIL engaged in transactions with its affiliates on terms and under circumstances that in good faith would not be offered to, or would not apply to, nonaffiliated companies; and

o Operating inconsistently with the FDIC's Interagency Advisory on Mortgage Banking and Interagency Expanded Guidance for Subprime Lending Programs.

The Order will also require FIL to take a number of steps, including (1) having and retaining qualified management; (2) limiting the Company's and FGCC's representation on FIL's board of directors and requiring that independent directors comprise a majority of FIL's board of directors; (3) revising and implementing written lending policies to provide effective guidance and control over FIL's residential lending function; (4) revising and implementing policies governing communications with consumers to ensure that borrowers are provided with sufficient information; (5) implementing control systems to monitor whether FIL's actual practices are consistent with its policies and procedures; (6) implementing a third-party mortgage broker monitoring program and plan; (7) developing a five-year strategic plan, including policies and procedures for diversifying FIL's loan portfolio; (8) implementing a policy covering FIL's capital analysis on subprime residential loans; (9) performing quarterly valuations and cash flow analyses on FIL's residual interests and mortgage servicing rights from its residential lending operation, and obtaining annual independent valuations of such interests and rights; (10) limiting extensions of credit to certain commercial real estate borrowers; (11) implementing a written lending and collection policy to provide effective guidance and control over FIL's commercial real estate lending function, including a planned material reduction in the volume of funded and unfunded nonrecourse lending and loans for condominium conversion and construction as a percentage of Tier I capital; (12) submitting a capital plan that will include a Tier I capital ratio of not less than 14% of FIL's total assets; (13) implementing a written profit plan; (14) limiting the payment of cash dividends by FIL without the prior written consent of the FDIC and the Commissioner of the California Department of Financial Institutions; (15) implementing a written liquidity and funds management policy to provide effective guidance and control over FIL's liquidity position and needs; (16) prohibiting the receipt, renewal or rollover of brokered deposit accounts without obtaining a Brokered Deposit Waiver approved by the FDIC; (17) reducing adversely classified assets; and (18) implementing a comprehensive plan for the methodology for determining the adequacy of the allowance for loan and lease losses.

In addition, the Company is analyzing, in connection with the preparation of the Company's consolidated financial statements as of and for the period ended December 31, 2006, the FDIC's criticism with respect to the Company's methodology for determining the carrying value of the Company's residential real estate loans held for sale.
...
In addition, the Company is analyzing, in connection with the preparation of the Company's consolidated financial statements as of and for the period ended December 31, 2006, the FDIC's criticism with respect to the Company's methodology for determining the carrying value of the Company's residential real estate loans held for sale.

The Company will report a net loss from continuing operations for the fourth quarter of 2006 as compared to net income of $54.5 million for the fourth quarter of 2005. The net loss to be reported for the fourth quarter of 2006 will be due in part to increased provisions for loan repurchase and repricing, valuation and premium recapture reserves. In light of the Company's reported operating results for the nine months ended September 30, 2006, and the fact that the Company will report a net loss for the fourth quarter of 2006, the Company's operating results for the fiscal year ended December 31, 2006 will represent a significant change from the Company's operating results for the fiscal year ended December 31, 2005.

The Company is unable to estimate its results of operations for the fourth quarter of 2006 and full-year 2006 until it completes its review of its methodology for determining the carrying value of its held-for-sale residential real estate loan portfolio, as discussed above.

by Calculated Risk on 3/02/2007 02:06:00 PM

From MarketWatch: Bond default protection shoots up for banks

The cost of insurance against a default by top investment banks Goldman Sachs Group Inc., Merrill Lynch & Co Inc, Lehman Brothers Holdings Inc and Morgan Stanley ballooned this week, amid increased nervousness about their exposure to the shaky subprime lending market.

The trend toward more expensive credit-default swap protection for these four banks began last week and accelerated this week, said Michael Fuhrman, an institutional equities salesman for GFI, an inter-dealer broker for credit derivatives.
...
On Friday credit default swaps for Goldman Sachs, the world's biggest securities firm, grew to $33,000 per $10 million in credit protection instruments, up from $26,000 per $10 million on Monday, according to GFI data.

Merrill Lynch CDS cost $25,000 per $10 million in instruments on Monday and grew to $33,000 per $10 million at the end of the week; Lehman CDS protection rose from $28,000 per $10 million in instruments to $35,000 per $10 million and Morgan Stanley CDS protection rose from $27,000 per $10 million to $33,000 per $10 million in the last five days, GFI said.

And from Bloomberg (hat tip: Brian): Goldman, Merrill Almost `Junk,' Their Own Traders Say

Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.

Prices for credit-default swaps linked to the bonds of the New York investment banks this week traded at levels that equate to debt ratings of Baa2, according to Moody's Investors Service. For Goldman, Morgan Stanley and Merrill that's five levels below the actual Aa3 rating on their senior unsecured notes and two steps above non-investment grade, or junk.