by Calculated Risk on 8/31/2007 06:23:00 PM

From the WSJ: U.S. Auto Market Shows Signs Of Softening, Honda Official Says (hat tip jg)

The U.S. auto market is showing signs of softening ...

"The initial dealer pulse from across the industry is that mix is a little bit soft," said John Mendel, executive vice president auto operations for Honda motor Co.'s U.S. sales arm.

Mr. Mendel ... said Honda expects U.S. sales for 2007 will range between 15.9 million to 16.3 million light vehicles.

A Reuters article puts the Honda estimate at 16 million.

Auto makers sold 16.56 million vehicles in 2006.

Asha Bangalore at Northern Trust suggests (hat tip Steve):

The “timeliest indicators” we think are weekly initial jobless claims, August nonfarm payrolls, August retail sales, the August ISM manufacturing survey, and August industrial production. Each of these reports will be published prior to the September 18 FOMC meeting.

Click on graph for larger image.

Graph from Northern Trust. Note: Scale doesn't start at zero to change monthly changes.

And Bangalore on auto sales (due Tuesday):

The CEO of AutoNation has indicated that his company’s sales have been suffering. Auto sales have dropped during each of the seven months of the year. The sales tally for August will be published on September 4.

by Calculated Risk on 8/31/2007 03:40:00 PM

The BEA released the Personal Income and Outlays report for July this morning. At MarketWatch, Rex Nutting has an overview of the data: Inflation remains moderate in July. It is important to remember this is pre-turmoil data.

I want to focus on how the monthly data contributes to the quarterly BEA report.

You can use the monthly series to exactly calculate the quarterly change in PCE. The quarterly change is not calculated as the change from the last month of one quarter to the last month of the next (this is a common misunderstanding). Instead, you have to average real PCE for all three months of a quarter, and then take the change from the average of the data for the three months of the preceding quarter.

So, for Q3, you would average real PCE for July, August and September, then divide by the average real PCE for April, May and June. Of course you need to annualize this rate (take it to the fourth power).

Once we have two months worth of data (after August is released) we can estimate the PCE contribution to the GDP report using the Two Month Method, see Estimating PCE Growth for Q2. The Two Month method is very accurate, and the correlation to the actual quarterly data is high (0.92).

With the release of the July report, we now have the first data point for Q3. To estimate the contribution to the quarterly growth in real PCE, we should look at the growth in real PCE from April to July, not June to July (as is common).

From April to July, the increase in real PCE spending was 1.6% annualized. Still sluggish, but not recessionary. Perhaps real consumer spending will pick up in August and September.

by Tanta on 8/31/2007 01:14:00 PM

Color me underwhelmed.

According to the Wall Street Journal, the key components of the plan are:

Among the moves will be an administrative change to allow the Federal Housing Administration, which insures mortgages for low- and middle-income borrowers, to guarantee loans for delinquent borrowers. The change is intended to help borrowers who are at least 90 days behind in payments but still living in their homes avoid foreclosure; the guarantees help homeowners by allowing them to refinance at more favorable rates.

Mr. Bush also will ask Congress to suspend, for a limited period, an Internal Revenue Service provision that penalizes borrowers who refinance the terms of their mortgage to reduce the size of the loan or who lose their homes to foreclosure. And he will announce an initiative, to be led jointly by the Treasury and Housing and Urban Development departments, to identify people who are in danger of defaulting over the next two years and work with lenders, insurers and others to develop more favorable loan products for those borrowers.

What this looks like to me:

1. Immediate FHA assistance for people who are already 90 days down. Does this mean "up to 90 days down," "at least 90 days down," or what? Waiting to offer refi assistance until borrowers are in the foreclosure process isn't likely to make them want to go find the friendly neighborhood loan officer to do an FHA refinance. And by then, they've got a big chunk of past-due payments (not to mention possibly a prepayment penalty) to roll into the new loan. However,

2. We can't offer more proactive assistance to those who look like they're ready to default but haven't gotten there yet, because apparently after all this time we still need some more task forces. I'm guessing that we're still working on how the "more favorable rates" become available when the FHA insurance premium has to be raised and investors aren't exactly crushing each other in the rush to buy these loans.

3. But if you've already lost your home to foreclosure or short sale, you might get a tax break. This will "keep people in their homes" by making it less expensive for them to give up their homes. Or something.

My view? FHA will be an important part of the process of trying to save as many subprime borrowers who want to keep their homes as we can save. Surprise. FHA is the traditional home of "disaster relief." But this is a bigger disaster than FHA can absorb.

The rest of Bush's plan seems to involve arm-twisting with lenders and Fannie Mae and Freddie Mac. That's already going on all over the place as we write here, and has been for some time. But our fearless leader has used the Friday before a long holiday weekend to make a big "market moving" announcement about it. There's news for you.

by Calculated Risk on 8/31/2007 10:00:00 AM

From Fed Chairman Ben Bernanke at Jackson Hole: Housing, Housing Finance, and Monetary Policy.

"It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.

The incoming data indicate that the economy continued to expand at a moderate pace into the summer, despite the sharp correction in the housing sector. However, in light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation. Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country. Inevitably, the uncertainty surrounding the outlook will be greater than normal, presenting a challenge to policymakers to manage the risks to their growth and price stability objectives. The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets."
emphasis added

Excerpt on mortgage equity withdrawal and consumption:

"... housing may have indirect effects on economic activity, most notably by influencing consumer spending. With regard to household consumption, perhaps the most significant effect of recent developments in mortgage finance is that home equity, which was once a highly illiquid asset, has become instead quite liquid, the result of the development of home equity lines of credit and the relatively low cost of cash-out refinancing. Economic theory suggests that the greater liquidity of home equity should allow households to better smooth consumption over time. This smoothing in turn should reduce the dependence of their spending on current income, which, by limiting the power of conventional multiplier effects, should tend to increase macroeconomic stability and reduce the effects of a given change in the short-term interest rate. These inferences are supported by some empirical evidence.

On the other hand, the increased liquidity of home equity may lead consumer spending to respond more than in past years to changes in the values of their homes; some evidence does suggest that the correlation of consumption and house prices is higher in countries, like the United States, that have more sophisticated mortgage markets (Calza, Monacelli, and Stracca, 2007). Whether the development of home equity loans and easier mortgage refinancing has increased the magnitude of the real estate wealth effect--and if so, by how much--is a much-debated question that I will leave to another occasion."

by Tanta on 8/31/2007 08:26:00 AM

This issue of the GSE portfolio caps has been tossed around a lot lately. In the spirit of improving the quality of the discussions, I offer a simple version of what the deal is here. If you're new to UberNerdity, a primer on GSE MBS is here.

The GSEs can "provide liquidity" to the secondary mortgage market in two ways: they can buy loans outright for their own investment portfolios, which means they keep those loans, funded with their own money (raised through debt issues, generally), and earn the interest income from them, taking the credit risk as any investor does. Or, they can buy loans to pool for MBS issues. When they do that, outside investors buy the MBS, fund the loans, and earn the interest income. Because the GSEs guarantee their securities, they charge a guarantee fee to the lenders who sell them the loans, and they have the guarantee obligation left on their books while the MBS is outstanding. Occasionally, the loans that end up in the portfolio are the ones the GSEs bought out of those MBS pools in honor of their guarantee obligation.

Also, the GSEs buy two general types of loans: what we might call "inventory" and "flow." You will usually see the inventory stuff described as "bulk" purchases. That means the GSEs are buying loans, usually in a big chunk (a "bulk" deal), that the lenders already originated, using some guidelines that may not be exactly the same as what the GSEs require in their standard MBS programs. So these deals involve negotiation of pricing. But since the loans have already been originated, you negotiate over the exact pile of loans you have, not over some guidelines that might generate some unknown pile of loans in the future.

The flow business is the forward business. This is a matter of the GSEs publishing guidelines and putting out prices that allow lenders to originate new loans into a forward commitment. Clearly, for the GSEs and the lenders, this stuff is harder to price. You might see reference to "TBA" deals. That means the actual composition of a pool of loans is "to be announced." This is true "rep and warranty" business: the price is established based on the representation that the pool of loans that we end up with will follow all the published guidelines. (The "warranty" means you pay back some or all of that price if your representations were not true.)

As a general rule, the GSEs buy bulk for their portfolios and flow for their MBS programs. There isn't really a law about this, it's just the way they do business most efficiently. If you want to think about it in terms of their "liquidity" functions, they use their portfolios to liquify lender inventory, and their MBS business to liquify lender current production. Small banks and most non-bank mortgage companies don't have the capital to build up "inventory," so all of their business is flow. It's usually the big banks who accumulate "inventory," and either sell it in bulk to the GSEs or securitize it privately or sell it to some insurance company or hold it in their own portfolio, as the market and the bank's investment needs may warrant. Of course, for years now those "inventory" trades generally didn't go to the GSEs, they went into this private security market. A great deal of that ended badly.

It does not have to be that way, and in fact we saw Freddie announcing a few weeks ago that they were shifting some portfolio dollars from bulk to forward on Alt-A purchases. They were more concerned about the liquidity crunch at the level of current production than at the level of inventory. This required them to limit the forward Alt-A purchases to only those lenders from whom they have purchased bulk Alt-A deals in the past, because that offers some kind of reference for a forward commitment. It was a matter of saying, if you originate stuff that is sufficiently like the stuff you have sold us in the past, we will buy it on a forward basis at a predetermined price level. Without some kind of reference point like that, you've got a pig in a poke, and nobody rational can price such a thing in advance.

The portfolio caps for the GSEs are in place in an attempt to control their risk-taking by limiting the dollar amount of loans they can own outright. The caps do not limit what they can buy for their MBS programs: they can buy as much of that as they can 1) find investors for and 2) afford to guarantee.

The assumption has been, in many quarters, that if the GSEs are to provide substantial liquidity to the subprime or near-prime (say, refis of subprime loans that don't quite meet standard guidelines, often because the LTV is so high) markets, they would do so by portfolio purchases. These loans are not uniform and prime-quality like the usual stuff in the MBS program.

And, after all, the problem appears to be a lack of investor appetite for the stuff. If the GSEs bought it for their MBS programs, they would be able to sell the resulting securities only because they were offering that guarantee on those MBS that you don't get in the private issue market. At some level this means the GSEs would have to "price" the risk on loans that the private market has essentially said it cannot or will not price. Most of us are assuming that the GSEs would have to put a pretty steep G-fee on this stuff in order to pull that off. That, in turn, increases the interest rate on the loan, and you do get into that problem of how the new loan can be more affordable to the borrower than the old loan was at a certain point.

The options for the GSEs, then, are to buy for portfolio or buy for MBS. In terms of portfolio purchases, they have some room left to increase holdings up to their caps (they are both under their caps right now), but that's not, most people think, enough in dollar terms to really make headway with the liquidity problem. So one solution is to raise the caps so they can buy more. Another is for them to sell off some of what they have in portfolio to "make room" for these subprime or near-prime purchases.

We just looked yesterday at Freddie's Q02 report, which showed that its portfolio holdings are about 80% prime MBS and 20% "other" (subprime, Alt-A, and other higher-risk loans). As the idea is not to add more subprime or Alt-A paper to the market, you couldn't have them sell off the hinky stuff, so you'd be asking them to sell off some of the 80%.

I'm not sure I follow the logic, necessarily, of leaving the portfolio caps in place to control risk, and then forcing the agencies to rebalance these portfolios so that a higher percentage of their holdings is in the highest-risk classes. Personally, I think the only way this makes much sense is to limit such purchases to that "bulk" or "inventory" part of the business, precisely because it can be more accurately priced. And, of course, because that means originators can share some of the pain here: by "more accurately priced" I mean the GSEs can insist on a reasonable discount. They can free up dollars on lender balance sheets by taking the loans, but they don't have to do so at a profit to the lenders. We're talking liquidity injections here, not transferring bad pricing decisions from private lenders to the GSEs. You will, however, note that this means targeting the big banks and mortgage companies for "relief," not the little community banks and credit unions and so on who don't do bulk deals.

That leaves the flow or current production problem to be solved by the MBS programs, not the portfolios. This is what the GSEs mean when they talk about putting together new mortgage products for these distressed refis, for instance. These new products put a set of standard guidelines or underwriting practices on the table that lenders can originate to in current production. The struggle for everyone will be to put a price on it that makes investors, the GSEs, the lenders, and the borrowers come out ahead.

I will suggest that anyone who thinks the GSEs can do this for free is deluded. In order to fix the mess we're in, someone is going to be subsidizing something somewhere. That does not necessarily mean a direct taxpayer cash subsidy, at least not in immediate terms. But it may mean forcing the GSEs to underprice their risk, and if they do too much of that, the taxpayers will own the problem.

I don't have an answer for that, but I do suggest that those who are really freaked out over the raising of the portfolio cap issue think it through: that isn't necessarily worse than "rebalancing" the portfolios or having the GSEs issue securities at "below market" G-fees. Remember that "rebalancing" the portfolios would require the GSEs to sell off their good stuff into a market that isn't offering top dollar for anything, good, bad, or indifferent.