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Tuesday, May 27, 2008

The Bagholder Battles: Investors vs. Banks

by Calculated Risk on 5/27/2008 08:25:00 PM

From Ruth Simon at the WSJ: Investors Press Lenders on Bad Loans

Unhappy buyers of subprime mortgages, home-equity loans and other real-estate loans are trying to force banks and mortgage companies to repurchase a growing pile of troubled loans. The pressure is the result of provisions in many loan sales that require lenders to take back loans that default unusually fast or contained mistakes or fraud.
...
The potential liability from the growing number of disputed loans could reach billions of dollars ...
Tanta and I were discussing who the eventual bagholders would be way back in 2005 - while the bubble was still inflating - and although the picture is much clearer today, some bagholders still don't want to be, uh, bagholders! And who could blame them?

NPR on Mortgage Quality Control

by Tanta on 5/27/2008 04:49:00 PM

This is a sobering, if rather overstated, segment on mortgage loan sale due diligence and the pressures to accept even the most dubious of loans.

Tracy Warren is not surprised by the foreclosure crisis. She saw the roots of it firsthand every day. She worked for a quality control contractor that reviewed subprime loans for investment banks before they were sold off on Wall Street. . . .

Warren thinks her supervisors didn't want her to do her job. She says that when she would reject, or kick out, a loan, they usually would overrule her and approve it.

"The QC reviewer who reviewed our kicks would say, 'Well, I thought it had merit.' And it was like 'What?' Their credit score was below 580. And if it was an income verification, a lot of times they weren't making the income. And it was like, 'What kind of merit could you have determined?' And they were like, 'Oh, it's fine. Don't worry about it.' "

After a while, Warren says, her supervisors stopped telling her when she had been overruled.
I have no particular reason to question Ms. Warren's abilities or her take on the situation; I have no doubt that for any number of reasons marginal loans were pushed back into pools over the objections of perfectly competent auditors. I have also had experience with staff whose supervisors stopped telling them when they had been overruled, because . . . life is too short. I suspect I am not the only one who has had this experience. Whatever the merits of this story may be, this I think is an overstatement:
"This is a smoking gun," says Christopher Peterson, a law professor at the University of Utah who has been studying the subprime mess and meeting with regulators. "It suggests that auditors working for Wall Street investment bankers knew how preposterous these loans were, and that could mean Wall Street liability for aiding and abetting fraud."
Forgive me for being a shill for Wall Street, but this strikes me as silly. The investment banks, including Bear Stearns, published loan underwriting guidelines detailing what they would accept in mortgage pools, and everybody in the industry had a copy at the time. The things came right out and said that things like stated income for a wage earner were acceptable. Was Mr. Peterson calling that "preposterous" at the time? I was. And I never had to look at a single loan file.

What I suspect Ms. Warren is overlooking is, precisely, that the due diligence on those Bear Stearns pools--like every other pool for every other investor--was based on evaluating the individual loans' compliance with the specific guidelines agreed to for the pool. If the guidelines allowed utter stupidity, it isn't likely that the project supervisors would kick out a loan for displaying that particular kind of stupid. If there's something preposterous here, it was in plain sight in the prospectuses to every one of these loan deals. I am having a hard time with the idea that "the smoking gun" didn't show up until this week.

And then there is this part, which has made it all over the web today:
A bankruptcy examiner in the case of the collapsed subprime lender New Century recently released a 500-page report, and buried inside it is a pretty interesting detail. According to the report, some investment banks agreed to reject only 2.5 percent of the loans that New Century sent them to package up and sell to investors.

If that's true, it would be like saying no matter how many bad apples are in the barrel, only a tiny fraction of them will be rejected.

"It's amazing if any investment bank agreed to a maximum number of loans they would kick back for defects. That means that they were willing to accept junk. There's no other way to put it," says Kurt Eggert, a law professor at Chapman University.
Now, I actually plowed my way through that New Century report, and I have to say that there's a reason this claim was, um, "buried" therein. From page 135 of the report (Warning! Big Honkin' pdf that will take forever to download!):
[K]ickout data may not be a true indication of loan quality trends because New Century was able, particularly when the subprime market was strong and housing prices were rising, to negotiate understandings with certain loan purchasers to limit kickouts to a maximum rate, such as 2.5%. Flanagan [NEW's former head of loan sales] was explicit in stating to the Examiner that such understandings were reached. The Examiner was unable to establish corroboration for this statement. Nevertheless, such understandings may have limited kickouts, masking loan quality problems that existed but were not reported.
The report goes on to document that NEW's typical kickout rate was north of 5.00% and in many months much higher than that; except in securitization (not whole loan) deals where NEW retained residual credit risk, the kickout rate of 2.5% was, to quote the report, "probably more aspirational than real." The fact that no one could produce a contract or set of deal stips or e-mail or sticky note "corroborating" this claim suggests to me that it may have existed only in Mr. Flanagan's mind.

There are, of course, situations in the whole loan sale world in which people have perfectly respectable reasons to agree to limit "kickouts" up front. Occasionally pools are offered for bid with the stipulation of no kickouts: these are "as is" pools and it is expected that the price offered will reflect that. I have myself both offered and bid on no-exclusion loan pools. This is mostly an issue in the "scratch and dent" loan market, where one might have a mixed pool of pretty good and pretty botched up loans to sell. Allowing a buyer to "cherry pick" the deal just leaves you with all the botched up loans to sell separately, which is never anyone's preferred approach. Of course any buyer of loans can decline to bid on a no- or limited-kickout basis. Those who do bid on these deals tend to lower the bid price accordingly. The NEW report also documents the steady deterioration in NEW's profit margin on its whole-loan sales, and trying to get investors to take packages of loans with limited or no kickouts might explain some of that. My guess, from reading the report, is that while NEW might have thought it wanted a 2.5% kickout rate, it ended up accepting a much higher one because the price discount was more than it could face.

I am not trying to suggest that anyone is particularly innocent here. This all just has a sort of Captain Renault quality to it: we are shocked, shocked! that gambling went on in these casinos. The published underwriting guidelines that were available to everyone involved made explicit what was going on with these loans, and those guidelines were published with the deal prospectuses. Now we have a bunch of investors--including institutional ones with absolutely no excuse--wanting to grab hold of stories like Ms. Warren's about cruddy individual loans, as if the pool guidelines weren't themselves a big flaming hint that the loans were absurd.

New Home Sales: No Spring in 2008

by Calculated Risk on 5/27/2008 03:59:00 PM

There was no spring this year.

New Home Sales NSA No Spring Click on graph for larger image.

This graph shows the Not Seasonally Adjusted (NSA) new home sales for the last 45 years.

Usually sales increase in the spring - but not this year. The pervious worst spring on record was 1982 - in the midst of a severe recession, with 30 year fixed mortgage rates at 17%, and close to double digit unemployment.

In 1982, sales picked up late in the year as interest rates declined sharply (30 year fixed rates fell from 17% to about 13% at the end of the year).

New Home Sales Monthly Not Seasonally AdjustedThe second graph shows monthly new home sales NSA for the last few years (repeated from this morning).

The Red columns are for 2008. This is the lowest sales for April since the recession of '91.

Once again, the 2008 spring selling season has never really started.

Case-Shiller: Real Prices off 21% from Peak

by Calculated Risk on 5/27/2008 12:34:00 PM

Here are three key graphs ...

The first graph compares real and nominal Case-Shiller Home Prices (real is current index adjusted using CPI less Shelter).

Real and Nominal Case-Shiller National Home Price Indices Click on graph for larger image.

In real terms, the Case-Shiller National Home price index is off 21% from the peak. Real prices are now back to the Q3 2003 level (nominal prices are back to Q3 2004).

With existing home inventory at record levels, prices will probably continue to decline over the next few years - perhaps another 20% in real terms on a national basis.

Here is an update to the scatter graph comparing existing homes Months of Supply and the quarterly change in the Case-Shiller National index (hat tip Langley Financial Planning blog for the idea):

Note: this graphs uses data since Q1 1994. In prior periods, Months of Supply appeared to be higher with less negative impact on prices, see 2nd graph of Existing Homes: Months of Supply vs. Real Prices

Months of Supply vs. Nominal Case-Shiller Prices This graph compares the Months of Supply and the quarterly change in the nominal Case-Shiller National Home Price index. The best linear fit has been added to the graph (plus the formula with an R2 of 0.665).

This is a limited amount of data (since Q1 1994), but this does suggest a relationship between price changes and Months of Supply (something we would normally expect). This suggests when there are more than 7 months of supply, nominal prices will decline (with some variability).

In April, the existing homes Months of Supply hit 11.2 months, and will probably be over 12 months this summer. This suggests nominal price declines of around 5% in Q2.

Case-Shiller Selected Cities The third graph shows the price changes for several selected cities. Prices are falling faster in the 'bubble' cities, like San Diego, Miami, and Las Vegas.

Year over year prices are also falling in areas that saw less price appreciation, like Denver and Cleveland. It's important to note that different areas - even different parts of the same city - are seeing different price changes. See: House Price Mosaic for some analysis.

Eighteen of the twenty cities in the Case-Shiller composite saw declining prices in February (prices in Dallas were up 1% and Charlotte prices were flat), led by a 4.5% one month decline in Miami, 4.4% in Las Vegas, and over 3% in Los Angeles, San Francisco, Phoenix and Tampa.

Military Foreclosures

by Tanta on 5/27/2008 11:09:00 AM

Bloomberg reports:

Foreclosure filings in 10 towns and cities within 10 miles of military facilities, including Norfolk, Virginia, home of the Navy's largest base, rose by an average 217 percent from January through April from a year earlier. Nationally, the rate was 59 percent in the same period, according to RealtyTrac, which tallies bank seizures, auctions and default notices.

The biggest surge was in Columbia, South Carolina, home to Fort Jackson, where the Army trains recruits for combat in Afghanistan and Iraq. Properties in some stage of foreclosure rose 492 percent from a year earlier, RealtyTrac said. The second-biggest increase was 414 percent in Woodbridge, Virginia, next to the Marine Corps Base Quantico.

Foreclosure filings tripled in the cities surrounding Norfolk Naval Base and the Camp Pendleton Marine Corps Base near Oceanside, California, RealtyTrac said. Havelock, North Carolina, site of Marine Corps Air Station Cherry Point, saw foreclosures more than double.
Military families were of course favored targets of the subprime industry.

April New Home Sales

by Calculated Risk on 5/27/2008 10:00:00 AM

According to the Census Bureau report, New Home Sales in April were at a seasonally adjusted annual rate of 526 thousand. Sales for March were revised down to 509 thousand.

New Home Sales and Recessions Click on graph for larger image.

Sales of new one-family houses in April 2008 were at a seasonally adjusted annual rate of 526,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 3.3 percent above the revised March rate of 509,000, but is 42.0 percent below the April 2007 estimate of 907,000.
This graph shows New Home Sales vs. recessions for the last 45 years. New Home sales were falling prior to every recession, with the exception of the business investment led recession of 2001.

New home sales in April were the lowest April since 1991. This is what we call Cliff Diving!

New Home Sales Monthly Not Seasonally AdjustedThe second graph shows monthly new home sales (NSA - Not Seasonally Adjusted).

Notice the Red columns for 2008. This is the lowest sales for April since the recession of '91.

As the graph indicates, the spring selling season has never really started.

And one more long term graph - this one for New Home Months of Supply.

New Home Months of Supply and Recessions "Months of supply" is at 10.6 months; the highest level since 1981. Note that this doesn't include cancellations, but that was true for the earlier periods too.

The all time high for Months of Supply was 11.6 months in April 1980.

Once again, the current recession is "probable" and hasn't been declared by NBER.

And on inventory:

New Home Sales Inventory
The seasonally adjusted estimate of new houses for sale at the end of April was 456,000. This represents a supply of 10.6 months at the current sales rate.
Inventory numbers from the Census Bureau do not include cancellations - and cancellations are near record levels. Actual New Home inventories are probably much higher than reported - my estimate is just under 100K higher.

Still, the 456,000 units of inventory is below the levels of the last year, and it appears that even including cancellations, inventory is now falling.

This is another very weak report for New Home sales.

S&P Case-Shiller National Index off 6.7% in Q1

by Calculated Risk on 5/27/2008 09:05:00 AM

S&P Case-Shiller reported that house prices fell sharply in Q1 2008.

Case Shiller House Price Index Click on graph for larger image.

The first graph shows the Case-Shiller index since 1987. The index fell to 159.18 in Q1 2008, from 170.62 in Q4. A decline of 6.7%, or almost 30% at an annual rate.

This is the lowest level for the index since Q3 2004.

Case Shiller House Price Index YoY Change The second graph shows the year-over-year change in the Case-Shiller index.

Prices fell 14.1% over the last four quarters according to Case-Shiller.

The index is off 16.2% from the peak.

Monday, May 26, 2008

HELOCs and Auto Sales

by Calculated Risk on 5/26/2008 09:57:00 PM

From Eric Dash at the NY Times: As Credit Tightens, the Auto Industry Feels the Pain

Home equity loans, which had been used in at least one of every nine deals, when lenders were more generous, are no longer a source of easy money for many prospective buyers.
...
As home values have declined, millions of consumers have maxed out on home equity debt. In hot markets like California, nearly 30 percent of all consumers tapped into the value of their homes to help finance their new cars, according to CNW Marketing Research. In Florida, about 20 percent used home equity loans. New car sales in both states are down about 7 percent.
According to the NY Times graphic "Mortgaging the House to Buy a Car" (see article), about 1.9 million new cars were purchased using HELOCs in 2007, or 11.8% of the 16.2 million total new cars sold in 2007.

Although HELOCs were used for a variety of household expenditures, probably the two most common uses were for new cars and home improvements. It's not surprising that these two areas are being severely impacted as lenders sharply restrict HELOC borrowing.

Scatter Graphs: Months of Supply vs. House Prices

by Calculated Risk on 5/26/2008 05:12:00 PM

The following two scatter plots compare existing home Months of Supply vs. the quarterly change (both nominal and real) in the Case-Shiller National Home Price index. (hat tip Langley Financial Planning blog for the idea)

Note: these graphs use data since Q1 1994. In prior periods, Months of Supply appeared to be higher with less negative impact on prices, see 2nd graph of Existing Homes: Months of Supply vs. Real Prices

Months of Supply vs. Nominal Case-Shiller Prices Click on graph for larger image.

The first graph compares the Months of Supply and the quarterly change in the nominal Case-Shiller National Home Price index. The best linear fit has been added to the graph (plus the formula with an R2 of 0.6).

This is a limited amount of data (since Q1 1994), but this does suggest a relationship between price changes and Months of Supply (something we would normally expect). This suggests when there are more than 7 months of supply, nominal prices will decline (with some variability).

The average Months of Supply in Q1 2008 was just over 9.9 months, suggesting a nominal price decline of about 3.1% for Q1 (+/-2% or so). The Case-Shiller price index will be released on Tuesday.

Months of Supply vs. Real Case-Shiller Prices The second graph compares the Months of Supply and the quarterly change in the real (adjusted for inflation using CPI less shelter) Case-Shiller National Home Price index. The linear best fit is also added, and R2 is 0.54.

In real terms, prices start to decline when Months of Supply are greater than 6.3 months. This suggests the Case-Shiller index will decline about 3.4% in real terms in Q1 2008.

In April, the existing homes Months of Supply hit 11.2 months, and will probably be over 12 months this summer. This suggests nominal price declines of over 5% in Q2.

UBS: More Mortgage Losses Possible

by Calculated Risk on 5/26/2008 03:24:00 PM

From Bloomberg: UBS Falls After Saying More Mortgage Losses Possible

UBS, in the prospectus for its 16 billion-franc rights offer, said the bank's losses on non-U.S. residential and commercial real-estate securities ``could increase in the future.''
...
``UBS will have to fight against negative news flow for at least several more quarters,'' said Rolf Biland, who helps manage about $3.1 billion, including UBS shares, as chief investment officer at VZ Vermoegenszentrum in Zurich. ``The U.K. housing market is almost as overheated as in the U.S., and could lead to losses for banks.''

U.K. home values fell for an eighth month in May ...
The confessional is still open.