by Calculated Risk on 2/25/2007 11:30:00 PM

With the recent subprime mortgage news and the somewhat disappointing economic numbers, I've been looking to see if economists would start revising their forecasts for 2007.

Sure enough, the National Association for Business Economics (NABE) released their quarterly survey of 47 economists, from AP:

... forecasters now believe housing construction will plunge by 14.9 percent this year. That would be nearly three times bigger than the 5.5 percent fall in residential construction they had projected [for 2007] in the [November survey].

So once again these economists are "surprised" by housing.

And the impact on GDP?

The panel predicted that the overall economy will grow by 2.7 percent this year. ... NABE's November forecast put GDP growth this year at 2.5 percent.

So, three months later, these economists revised their forecasts down significantly for the housing market, and their GDP growth forecast up slightly. Uh, OK.

by Calculated Risk on 2/25/2007 12:46:00 PM

From U.S. News & World Report on Denver: A House Unsold, the Dream Dims

The ... result is ... [a] vicious cycle of "for sale" signs, foreclosures, then more "for sale" signs that is all but devastating Montbello. Bank-owned properties now represent more than 80 percent of all homes on the market there, putting even seemingly stable homeowners like Garcia up against a financial wall.

"I just can't take it anymore," he says of his street's overgrown yards, abandoned houses, and declining property values. "I put so much into this house and this community, but I don't have no equity."

With more than 2,500 square feet, new kitchen cabinets, tile, and a recently finished basement apartment, Garcia's house two years ago "would have gone for $210,000, maybe more," says David Cabrera, the real-estate agent whom Garcia hired last fall to sell the home, now priced at $195,500. "But nobody's buying now with all the foreclosures."

Garcia orginally paid $207,000 for this house four and a half years ago.

by Calculated Risk on 2/24/2007 01:02:00 AM

From CR: Every time Tanta posts on this blog, I receive a number of emails asking: Who is Tanta? Unfortunately her real identity is a state secret, but hopefully it is sufficient to say that Tanta is an experienced mortgage banker, and also an excellent and entertaining writer.

Holden Lewis recently mentioned Tanta at Bankrate.com:

Tanta ... has vast knowledge of the mortgage biz ... and is an excellent writer. ... if you're a mortgage loan officer or broker, o[r] if you're merely a homeowner who wants to understand the mortgage-servicing business, you must read Tanta's latest post, "Mortgage Servicing for Ubernerds."

Mr. Lewis also suggested that "a lot of this will be over your head", but I think you'll find that Tanta makes the inner workings of the mortgage business both interesting and understandable. So if you are interested in the mortgage business - and who isn't right now? - here are a few of Tanta's recent posts:

Tanta 2/20/2007: Mortgage Servicing for UberNerds

Tanta 1/31/2007 on "Scratch and Dent" Loans

Tanta 1/15/2007: Information is Power, Which is Why You Don’t Get Any

Tanta 12/21/2006: On Hybrids, Teasers, and Other Mortgage Guidance Problems

Tanta 12/15/2006: Let Slip the Dogs of Hell

Read, learn, and you'll probably laugh some too! All my best to Tanta.

by Calculated Risk on 2/23/2007 03:27:00 PM

From the San Diego Union: Lenders told foreclosure picture grim

Mortgage professionals who are struggling with a national spike in residential foreclosure rates were warned yesterday to expect more of the same in 2007.

Unemployment, mortgage fraud and speculative buying are among the factors behind the recent surge in filings, experts said at a conference of the Mortgage Bankers Association.

And this year $1 trillion in adjustable-rate mortgages are due to reset before Dec. 31.

“This is really a wild card,” said Rick Sharga of the Irvine firm RealtyTrac. “We don't have a precedent.”

Record inventories (see previous post) and rising foreclosures in 2007 is two of the keys to my 2007 housing predictions.

Mortgage attorney Daniel D. Phelan echoed Sharga's concerns.

“I personally think we are at the beginning of this cycle,” he said. “It is going to get worse before it gets better.”

The following graph shows Notices of Default (NOD) by year in California since 1992.

Click on graph for larger image.

Home mortgage loans in California went into default last quarter at the highest rate in more than eight years, according to the DataQuick Information Systems research firm. Lenders sent notices of default, the first step in the foreclosure process, to 37,273 California homeowners during the fourth quarter.

by Calculated Risk on 2/23/2007 12:28:00 PM

From the Chicago Tribune: Canceled contracts masked glut of homes, economist says

Housing analyst David Seiders told Chicago-area builders Thursday that the federal estimate of 3.5 million homes for sale at the end of 2006 is "grossly understated."

"There is a big inventory overhang out there, and it's bigger than anybody understands," he said.

In an annual forecast on the local industry in Addison, Seiders, chief economist of the National Association of Home Builders, cited the high level of sales contract cancellations in 2006. It created a snag in the recordkeeping, so many homes marked as sales in government data ended up back on the market too late to be counted as inventory, he said.

"Cancellation rates more than doubled between the end of 2005 and the end of 2006, meaning that net sales for the year nationally may be down 65 percent."

Caroline Baum reported on this issue last September: Think Housing's Stabilized? See Cancellations

Of course Seiders thinks the bottom is near:

But Seiders was not all gloom, saying the market is probably at the year's low spot right now. He expects slight improvement at midyear.

by Calculated Risk on 2/23/2007 12:20:00 AM

"We're a little more disappointed than two weeks ago. For President's Day weekend we had good sales, but we didn't have anywhere near the bump up that we normally see. That's disappointing."
Robert Toll, Chief Executive, Toll Brothers

From AP: Toll Brothers 1Q Profit Falls 67 Percent

Alex Barron, an analyst with JMP Securities in San Francisco, said he wasn't surprised that Toll's comments have taken a more sober tone.

"Now, he's sounding a bit more concerned and depressed," he said. "You can't have five years of a good time and fix everything in a few quarters."

by Calculated Risk on 2/22/2007 08:42:00 PM

From Bloomberg: Subprime Mortgage Derivatives Extend Drop on Moody's Reviews

The perceived risk of owning low- rated subprime mortgage bonds rose to a record for a fifth day after Moody's Investors Service said it may cut the loan servicing ratings of five lenders.

An index of credit-default swaps linked to 20 securities rated BBB-, the lowest investment grade, and sold in the second half of 2006 today fell 5.6 percent to 74.2, according to Markit Group Ltd. It's down 24 percent since being introduced Jan. 18, meaning an investor would pay more than $1.12 million a year to protect $10 million of bonds against default, up from $389,000.

Graph from Markit:

The BBB- rated portions of ABX contracts are ``going to zero,'' said Peter Schiff, president of Euro Pacific Capital, a securities brokerage in Darien, Connecticut. ``It's a self- perpetuating spiral, where as subprime companies tighten lending standards they create even more defaults'' by removing demand from the housing market and hurting home prices, he said.

by Calculated Risk on 2/22/2007 10:43:00 AM

From the Department of Labor:

In the week ending Feb. 17, the advance figure for seasonally adjusted initial claims was 332,000, a decrease of 27,000 from the previous week's revised figure of 359,000. The 4-week moving average was 328,000, an increase of 1,250 from the previous week's revised average of 326,750.

Click on graph for larger image.

This graph shows the four moving average weekly unemployment claims since 1968. Although the four week moving average has recently been trending upwards, the level is still fairly low and not a concern.

Also, from the Conference Board today: Help-Wanted Advertising Index Dips Two Points

The Conference Board Help-Wanted Advertising Index — a key measure of job offerings in major newspapers across America — declined two points in January. The Index now stands at 32. It was 38 one year ago.

Although both claims and the help-wanted index were slightly weaker than expected, there is nothing indicating a significant slowing of the labor market.

by Calculated Risk on 2/21/2007 08:25:00 PM

"If there is one development to worry about the potential of recession it will be housing."
San Francisco Fed President Janet Yellen, 2/21/2007

San Francisco Fed President Janet Yellen spoke today in California: The U.S. Economy in 2007. Here are some excerpts on housing:

[T]he housing sector has been at the leading edge of the overall economic slowdown, and I’d like to turn my attention to that important sector now.
...
Despite the continued weakness in housing construction, which ... enters directly into the calculation of real GDP, there are some signs of stabilization in other aspects of housing markets, suggesting that construction activity may level out before too long. For example, home sales have steadied somewhat after falling sharply for a year or so. Considering this in combination with the continued drop in housing starts that I mentioned earlier, it is not surprising to find that inventories of unsold homes have begun to shrink. This development suggests that the process of resolving the imbalances between demand and supply in the housing market may be underway, and, as a result, we could very well see the drag on real GDP from housing construction wane later this year.

It's probably important to understand how "housing construction enters directly into the calculation of real GDP". Every month, the Census Bureau calculates construction spending, value put in place. The BEA uses this number to calculate Residential Investment (RI). This is essentially the amount of money homebuilders spend on construction each month. It doesn't matter if the home is sold, what matters for GDP is that a home is being built.

Since housing completions are still near record levels (even though starts have fallen off a cliff), construction spending hasn't fallen very much yet. And because starts have fallen significantly, we know that the RI component of GDP will continue to decline over the next few quarters. The question is if there will be another downturn in housing or, as Dr. Yellen suggests, the drag from housing will "wane".

However, since home completions are still near record levels, there has been very little impact yet on jobs and consumer spending - at least so far. Those impacts are in the future.

Of course, such a turn of events is by no means a given, because the improvements we’ve seen may just be temporary. ...

In addition to concerns about weakness in housing construction, there has been worry that difficulties related to housing markets could spread to consumer spending more generally. Since consumption expenditures represent two-thirds of real GDP, even a relatively modest impact from housing markets on this big sector could put a noticeable dent in overall economic activity.

Up to this point, we haven’t seen signs of such spillovers. Consumption spending has been well maintained, showing a robust growth rate for all of 2006. However, going forward, there are at least a couple of ways that spillovers from weakness in housing could depress consumer spending, and these channels bear watching. First, housing makes up a significant fraction of many people’s wealth, so a significant change in house values can affect consumer wealth and therefore consumer spending. As you know, there have been fears about plummeting house prices. But so far, at least, house prices at the national level either have continued to appreciate, though at a much more moderate rate, or have fallen moderately, depending on the price index you look at. Looking ahead, futures markets are expecting small declines in a number of metropolitan areas this year. While these modest movements are undoubtedly imparting less impetus to consumer spending now than during the years of rapid run-ups, their effects are not likely to be dramatic.

... housing market developments also could spread to consumer spending if enough homeowners experienced financial distress. For example, rising variable mortgage rates could strain some consumers’ cash flow. What we find, however, is that, because of the rapid appreciation of home prices in prior years, most homeowners are sitting on a substantial amount of equity, a financial resource that they can fall back on. In particular, adjustable-rate borrowers with equity can avoid a rate reset by refinancing. Moreover, only a small fraction of outstanding variable rate mortgages are scheduled to be reset in each of the next few years.

Although Dr. Yellen mentions the housing wealth effect, I'm surprised she doesn't mention the possible impact of less Mortgage Equity Withdrawal (MEW). The wealth effect and MEW are related, but MEW probably shows up more directly in consumer spending. The wealth effect just means someone feels wealthier and therefore they are a little more willing to spend. However MEW is actual money burning a hole in the consumer's pocket.

Of course, financial distress could be a bigger problem for some borrowers who used so-called exotic financing—like interest-only loans, piggy-back loans, and loans with the possibility of negative amortization. These instruments are often designed to allow subprime borrowers into the market. In fact, there are signs of trouble for some households. Delinquencies on variable-rate mortgages to subprime borrowers have risen sharply since the middle of last year and now exceed 10 percent. But fortunately, delinquency rates for other types of mortgages—including all prime borrowers and even subprime borrowers with fixed-rate loans—have edged up only very modestly. I know that it’s common to see newspaper stories about homeowners who have run into trouble, and those situations are, indeed, regrettable. From a national perspective, however, the group with rising delinquencies still represents only a small fraction of the total market, with little impact on the behavior of overall consumption.

A forward-looking view of the credit risks associated with subprime mortgages can be obtained from a new financial instrument related to these mortgages. These instruments suggest a big increase in the risk associated with loans made to the lowest-rated borrowers, but little change in risk for other higher-rated borrowers. Based on these results, it appears that investors in these instruments expect the losses to be fairly well contained. Of course, a shift in market sentiment about the risk of some of these securities is always possible. Such a shift would have ramifications for mortgage financing and housing, likely through tighter credit standards and higher mortgage rates for certain borrowers. In fact, we already have seen some tightening among commercial banks in recent months.

The bottom line for housing is that the concerns we used to hear about the possibility of a devastating collapse—one that might be big enough to cause a recession in the U.S. economy—while not fully allayed have diminished. Moreover, while the future for housing activity remains uncertain, I think there is a reasonable chance that housing is in the process of stabilizing, which would mean that it would put a considerably smaller drag on the economy going forward.

I've never felt housing would experience (edit) "plummeting prices" or a "devastating collapse" (note: ac points out that Yellen defines a devastating collapse as one that takes the economy into recession, so I agree that is possible), and I think that is a bit of a strawman from Dr. Yellen. But what happens when credit standards are tightened as Yellen suggests is happening? Some potential buyers are removed from the market, and demand decreases. So we currently have record levels of supply and we will probably see less demand. Does that sounds like a market that is coming into balance?

I discussed the possible impact of tighter credit standards on the 2007 housing market before: Subprime: The impact on Existing Home Sales in 2007 Needless to say, I'm not as sanguine as Dr. Yellen.

by Calculated Risk on 2/21/2007 12:11:00 PM

Click on graph for larger image.

This graph shows the MBA Purchase Index since the inception of the index in 1990.

At the end of 2006 there appeared to be a surge in purchase applications. This might have been due to increased activity, or possibly favorable weather.

Another possibility is that because many smaller lenders have closed shop, more potential buyers are applying for loans from the lenders covered by the MBA survey. From the MBA:

The survey covers approximately 50 percent of all U.S. retail residential mortgage originations, and has been conducted weekly since 1990. Respondents include mortgage bankers, commercial banks and thrifts. Base period and value for all indexes is March 16, 1990=100

As an example, suppose 1000 people applied for loans in a given week from 10 lenders.

Lender 1: 250
Lender 2: 150
Lender 3: 100
Lender 4-10: remaining 500 applications.

The MBA survey covers "approximately 50 percent of all U.S. retail residential mortgage originations", so in this example the MBA would only need to survey the top 3 lenders. Now if lender 10 closed shop (with 50 applicants), and the applicants all applied in equal proportions to the other lenders, the MBA index would increase 5% without any increase in overall activity.

My suspicion is this is what happened in late 2006, especially since the increased activity didn't show up in New or Existing home sales.